Bank CoCo Coupon Payments Made Safer Under ECB Capital Rules

  • New capital ‘guidance’ makes payout restrictions less likely
  • Stress test won’t limit banks’ ability to distribute profits

Investors in European banks’ riskiest bonds have less reason to worry about skipped coupon payments next year thanks to a change in the way the European Central Bank sets capital requirements.

The ECB’s oversight arm is easing banks’ capital burden by replacing a portion of binding requirements with non-binding guidance, the Frankfurt-based central bank said on its website. This change makes it less likely that banks will face restrictions on dividends, bonuses and additional Tier 1 coupon payments.

Under European Union rules, once a bank’s losses pierce the capital level comprising statutory and lender-specific requirements and its combined buffers, it must prevent money from leaving the business: the distribution of profits is capped by the so-called maximum distributable amount. The ECB has increased the distance to this trigger because capital guidance isn’t relevant for imposing the payment restriction.

The new ECB policy “means the MDA triggers could fall quite substantially, from being equivalent to the SREP ratio to a lower ratio,” said Simon Adamson, an analyst at CreditSights Inc. in London, referring to the supervisory review and evaluation process. “All things being equal, that should be positive for the AT1 market.”

Capital Demand

The introduction of guidance means “the capital requirements of a bank in terms of Pillar 1 plus Pillar 2,” or statutory minimum and bank-specific, “requirements will be reduced -- all things being equal,” the ECB said. “As a result, the trigger for the maximum distributable amount will go down –- also all things being equal. At the same time, the overall capital demand, including Pillar 2 guidance, will remain about the same.”

For a QuickTake explainer on the debate around Coco bonds, click here

The ECB’s change in policy caps moves over the past year as EU policy makers gradually gave in to a lobbying effort by banks against the distribution restrictions. Last September, nine of the euro area’s largest lenders privately appealed to the ECB for a loosening of the constraints to shield investors in contingent convertible bonds.

The lobbying paid off this year when the European Commission, the EU’s executive arm, proposed splitting supervisory capital demands into requirements and guidance. Daniele Nouy, head of the ECB’s supervisory arm, welcomed the clarification, and laid out the new policy last month.

Stress Test

The ECB has now made clear that guidance won’t come on top of existing requirements, but will be part of the total capital demand. 

This distinction wasn’t set out in the commission’s guidance on the issue. The Brussels-based commission explained that supervisors can issue guidance when it “suspects that an institution may not be able to meet its capital requirements at all times.”

What’s still unclear as of now is how big a portion of the bank-specific requirement will be turned into guidance. The European Banking Authority’s stress tests, whose results are expected this Friday, will be one of the key inputs into that number.

Adamson said that while it’s not yet clear what the proportions will be for requirements and guidance in Pillar 2, investors will probably find out.

“I think we’ll know what the split is, as banks will presumably have to disclose both the SREP ratio and the MDA trigger,” he said.

Nouy said this month that the fact that the guidance isn’t immediately binding doesn’t mean banks could take it lightly. “Guidance is something very serious,” she told reporters July 13. “I don’t expect banks to breach the guidance or to go below the guidance.”

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