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Contingent capital is not a panacea, says Standard & Poor’s

Contingent capital securities are not a panacea for banks because they are not being designed to address the need to repair existing weak balance sheets, according to Standard & Poor’s.

In a report, published today, the rating agency says contingent capital securities are one potential answer to the capital management question but many banks will still need to address their capital positions through traditional forms of equity.

Credit analyst Michelle Brennan says: “We expect that there will be investor interest in contingent capital securities but we do not yet know whether they will remain a niche product or become a more mainstream part of the bank capital funding market.

“This will affect the capacity of the banking sector to rely on these instruments.”

Standard & Poor’s says contingent capital adds a different strand to bank capital management strategy and the situations in which contingent capital securities convert into equity would be transparent for investors.

But the firm has raised questions about whether contingent capital securities will convert into capital early enough to help the bank.

For contingent capital securities to prove effective as a buffer for senior bondholders, the conversion triggers need to be set at appropriate levels. But this is difficult to determine before a crisis hits.

Standard & Poor’s adds that contingent capital securities may not be sufficiently attractive to investors at a price that is also attractive to the issuing banks.

It says the level of investor demand is unclear given the difficulty that investors may face in pricing the potential conversion risks therefore it is too early to gauge how the market will develop.

Brennan says: “While we expect to see material interest in and debate around this concept, we note that contingent capital securities are not designed to repair current weak capital positions and are not meant to act as a main plank of capital strategy.

“The ongoing debate about banks’ capital positions will need to cover other topics as contingent capital is not and is not designed to be the whole answer.”

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