Colombia‘s Ministry of Finance earlier this week released a framework for new bank capital securities that will open the door for local banks to issue new loss absorbing securities, according to Fitch Ratings. The Colombian Financial Superintendence still needs to issue the regulations for implementation and would need to review any new issue request to determine the classification of such securities as regulatory capital. In general, Fitch believes the new rules could lead to stronger capitalization levels among Colombian banks that choose to replace their Tier II subordinated debt, which is being phased out of Basel capital rules.
Until now, plain vanilla subordinated debt, such as the securities issued both locally and abroad by Bancolombia, Banco de Bogota, Banco Davivienda and Banco GNB Sudameris, among others, has been a standard form of noncommon equity issuance among Colombia’s banks. Such securities have lower marginal capacity to provide cushion above the point of nonviability, which explains why Fitch ascribes no equity credit to such securities. Any higher loss absorbing capacity from newer securities, (such as noncumulative preferred issued in other regions) would benefit the overall capital structure of Colombian banks.
Fitch believes further strengthening of Colombian banks‘ capital base is warranted given future growth expectations and the risk of internal capital generation falling short of adequately supporting such growth. Recognizing capitalization concerns, the Colombian regulator has already approved changes that drive regulatory capital measures nearer to international standards. Such changes have included the exclusion of goodwill (generated since August 2012) from regulatory capital calculations and clearer guidelines on regulatory capital minimums for common equity, Tier I capital and additional Tier I capital. The decree issued by the finance ministry on Sept. 2 now provides guidelines on higher loss-absorbing capital securities.
As of June 2014, about 20% of total regulatory capital (USD5 billion) included legacy, plain vanilla subordinated debt, which in Fitch’s view are considered ‘gone concern’ securities and are not included as capital per the agency’s criteria. Fitch expects those securities to be phased out over the medium term.
As is the case in other regions, Fitch will review the final conditions of each future issuance to assess the equity credit of each security, which will range from 100% (the most equity like securities) to 0%, depending on the terms of each security and the capacity to provide going concern loss absorption. In Fitch’s view, the fulfillment of the conditions presented in this framework may not be enough to achieve 100% equity credit for any given security. The use of additional buffers (higher triggers) and/or the ability of the banks to voluntarily defer coupons to preserve their capital are conditions that would enhance the equity credit of those securities.
Fitch will provide more information on the potential equity credit of the prospective securities and the possible rating of those securities based on our global criteria when the final regulations are in place. Basel III-compliant securities are typically “notched” down by two to five notches from an anchor rating, usually an issuer’s Viability Rating, because Fitch believes in most cases sovereign support cannot be relied upon to extend to a bank’s junior debt.
Any new breed of securities would require the current investor base, which holds legacy subordinated debt to enhance their investment policies and analysis tools for investing in riskier securities. This may result in a mix of domestic and international issuances to obtain a broader international investor base. Currently within Latin America, only Mexican and Brazilian banks operate under a regulatory framework that allows the issuance of new Basel III-compliant securities. As of today, virtually all of these issuances have been sold to foreign investors. It is yet to be determined if local investors will follow.
This article was first published on Funds Society.