Germany’s Commerzbank has this year embarked on a sizeable liability management exercise. In the first transaction, the bank tackled the lower part of its capital structure, effectively swapping out most of its Basel II-compliant hybrids into core Tier 1, helping to create €900m of core capital for the bank.
In part two of the exercise, concluded in March, Commerz focused on its Tier 2 capital, converting some of its outstanding non-Basel III-compliant stock into €1.25bn of Tier 2 capital that will count towards Basel’s grandfathering bucket.
These are bold moves by Commerzbank. For one thing, banks are still waiting for clarity on what the minimum capital requirements will be as each country implements Basel III. For another, the bank had to pay a whopping 250bp premium to its senior paper on its Tier 2 transaction.
Some believe Commerzbank has moved too early and has paid the price for it. But the high cost is unavoidable: this is what investors will demand for Tier 2 bank debt in the world of bank resolution regimes and tough capital rules. Equally, by being an early mover, Commerz will avoid issuing into the crowded market that will surely emerge the minute regulatory clarity is given.
Setting a blueprint
Just as importantly, Commerz serves as a possible blueprint for other German banks – many of whose capital structures are stuffed with large amounts of hybrid capital. As a proportion of Tier 1, hybrid represents about 30% at Deutsche Bank, 33% at LBBW, 34% at BayernLB, 72% at Commerzbank, and more than 77% at WestLB.
One-quarter to one-third of German banks’ capital reserves are in the hybrid form of ‘silent participation’, a German construction of non-voting capital that does not absorb losses as long as a bank is still in business. The Basel Committee has granted German banks an extended transition period to replace their silent participation in exchange for keeping Basel III on track.
Many have criticised the Basel Committee – and, more broadly, the European Commission – for being soft on German banks, giving them more leeway than they afford to banks in other countries. Commerzbank’s move shows that there is another way.
