In step with Basel III
Latin America’s banks are already miles ahead on the road to Basel III compliancy, but some banks face regulatory roadblocks that threaten to hinder their ability to issue Basel III-compliant securities.
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Latin America’s key financial centres are keeping up to speed with Basel III regulatory requirements on bank capital and liquidity, which were drafted by the Bank for International Settlements’ Basel Committee, which drafted the requirements. The regulations are designed to boost bank capital requirements by increasing liquidity and decreasing leverage.
Domestic capital regulations in Brazil, LatAm’s largest economy, were recently found to be compliant with the minimum Basel III standards, according to the BIS’ Regulatory Consistency Assessment Programme published in December. Brazil issued a new set of capital regulations in October to strengthen existing regulation, and these recent amendments found favour with the global banking regulator.
Many LatAm banks, such as Mexican bank Banorte and Brazilian bank Banco do Brasil are already well capitalised, due to strict domestic regulation. Banks must have a total minimum capital requirement of 8% under Basel III, but Brazilian regulation requires banks have an 11% total minimum capital requirement.
Debt bankers are quick to point out that many LatAm countries have tackled their own set of financial dilemmas long before the most recent global financial crisis, with the LatAm debt crisis of the 1980s and the Mexico tequila crisis of 1994 prompting regulators in the region to toughen banking laws.
“Throughout LatAm, most of the banks are well capitalised,” said Katia Bouazza, co-head of global capital markets for the Americas at HSBC. “Even though some of the countries are not necessarily signing up to Basel III, a lot of institutions in the region already have high standards that comply with or exceed Basel III.”
Many banks in the region can meet the new requirements using retained profits instead of having to raise new capital, but those that wish to grow at an ambitious rate will need to issue capital securities. Santander Brasil is notably going down the capital securities route – it is set to pay its shareholders a R$6bn (US$2.56bn) dividend and, at the same time, offer them the same amount in newly issued Basel III-compliant hybrid capital and subordinated debt.
Meanwhile, there is not a single bank in Mexico that cannot meet Basel III requirements by using retained earnings, according to Franklin Santarelli, managing director of LatAm financial institutions at Fitch.
FIG bankers predict a trickle of debt issuance as institutions begin to replace their existing securities with new, Basel III-compliant securities. Indeed, Banco do Brasil issued two perpetual bonds in 2012 that raised US$1.75bn worth of Tier 1 capital, and set a key benchmark for Brazilian and LatAm banks. Santander Mexico raised the bar in December with US$1.3bn worth of Basel III-compliant Tier 2 subordinated capital notes, which it announced on December 18.
“It makes logical sense for banks to replace expensive equity with a Tier 2 capital instrument,” said Michael Schoen, head of debt capital markets origination for LatAm at Scotiabank. “A number of Peruvian banks are already looking at incremental financing.”
Financial institutions are now considering issuing Basel III-compliant subordinated hybrid debt, according to Alexei Remizov, head of Brazil at HSBC. However, it has been a slow start to the year for debt overall – LatAm financial institutions have issued just US$1.8bn worth of bonds for the year up to February 27, a 72% year-on-year decline, according to data provider Dealogic.
“The implementation of Basel III will be gradual; instruments that are not compliant will be subject to capital qualification reduction over time so compliance won’t be abrupt,” said Remizov.
There is no urgency at all for LatAm’s overcapitalised banks to tap the debt market in the first half of 2014, said Santarelli.
“Most countries in LatAm have strong balance sheets and can cope. What remains is a matter of price; banks will be selective to gauge whether they really want to go there and pay a high price, or if they can wait. Banks are not in urgent need. They are just waiting [on the Santander Brasil hybrid bond issue] to see what the pricing is on that, and how that pricing can be used for them. They need to make a decision, but I don’t see an extreme urgency for the first half of the year.”
“The best banks will try to anticipate when is best to issue; [but] they don’t want to be the last banks and find that investors have reached [their investment] limits and have to pay a high price,” he said.
Recent Basel III-compliant issues from Santander Mexico and Brasil could serve as a price template for future capital securities from banks in those countries, according to Santarelli. This is despite the fact that neither were strongly market-driven – Santander Mexico’s parent, Santander Spain, agreed to buy 75% of its US$1.3bn subordinated capital notes while Santander Brasil’s only offered its R$6bn hybrid and subordinated debt issue to existing shareholders.
Looming regulatory roadblocks
Despite the anticipation of capital raisings this year, debt bankers and lawyers have raised concerns about existing local regulations in both Brazil and Mexico, which they believe are hindering issuance.
Jose Luiz Homem de Mello, partner at Brazilian law firm Pinheiro Neto Advogados, said that Brazil’s central bank amended its capital regulations in October 2013 under Resolution 4278 to reinforce the concept of “no modification of remuneration”.
This means that once the coupon on subordinated debt has been established, it can never be changed, said de Mello. Ordinarily, long-term or perpetual bonds include a reset clause whereby the coupon can be adjusted at a set future date, to move it in line with the market.
“This is a risk for investors that does not make sense; they are stuck with the percentage established in the beginning,” said de Mello. “This is indeed a hurdle that is affecting the market; I think it is holding the banks back. [Some] banks are talking with the central bank to convince them this has to be changed; others are waiting for a resolution of this matter.”
Brazil’s central bank’s press office said in an e-mailed statement the text does not contain any specific provision prohibiting Basel III-compliant securities of having reset clauses, but that all instruments to be included in regulatory capital must be previously authorised by the central bank. During this process, the “central bank analyses the main clauses of the contracts and will judge, under the concrete situation, if eventual reset clauses are in line with the Brazilian requirements”.
Capital markets bankers are flummoxed by this definition, and remain in doubt as to what will be considered acceptable regulatory capital by the central bank and how best to market debt instruments to investors.
“Capital securities pay a higher yield than regular senior debt, yet it acts and behaves like debt for all practical purposes. You see a much broader demand and bid for paper”
Meanwhile, banks in Mexico face a rather different problem. Those that do not have a local listing are limited in the amount of subordinated debt they can issue. The authorities introduced this rule to encourage banks to list in Mexico, but it is having unintended consequences for banks that need to issue significant amounts of Basel III-compliant subordinated debt. Mexico’s central bank did not respond to requests for comment.
Investor appetite comes at a price
Debt bankers insist that investor appetite for capital securities remains strong, despite the aforementioned problems and an ongoing sell-off in emerging markets, initially triggered by the US Federal Reserve’s announcement to withdraw stimulus measures.
“In terms of overall appetite, it remains quite healthy for LatAm despite some of what we hear in negative headline news on emerging markets,” said HSBC’s Bouazza.
Steve Aloupis, managing director and regional head of capital markets for the Americas at Standard Chartered, said if a LatAm bank were to come to market today, it would be met with strong investor demand from as far afield as Asia.
“Capital securities pay a higher yield than regular senior debt, yet it acts and behaves like debt for all practical purposes. You see a much broader demand and bid for paper,” he said.
But investors are still seeking clarity as to when the Basel III regime will be fully implemented in certain countries and how old Basel II instruments will be treated, said Polina Kurdyavko, partner and senior portfolio manager at BlueBay Asset Management.
Furthermore, the key for debt investors will be to assess whether trigger points in LatAm capital securities will be set low enough for banks to be quickly written off as a “gone concern” if the bank fails. Bondholders are in a better position from a creditor perspective if the bank is classified as a “gone concern” but if the trigger point is high, it can stutter along as a “going concern”.
There is even a remote risk that if economic growth were to unexpectedly slow down in the region, investors would shun buying bank debt altogether, making it hard for banks to issue capital securities, said Ismail Erturk, senior lecturer in banking at the University of Manchester.
A significant slowdown in Chinese growth would impact on Latin America, as China is Brazil’s largest trading partner. Prolonged economic slowdown, coupled with ongoing currency depreciation in the region, would “make it difficult [for banks] to raise capital”, said Erturk.