Tuesday, April 17, 2012

BarCap: investor confidence requires UK banks need to raise 25 billion euros in additional capital

According to a BarCap analysis of credit default swap spreads, UK banks need to raise 25 billion euros of additional capital to restore investor confidence and improve access to the bond market.

Of course, this raises two interesting questions:  why are the spreads on UK bank CDS trading at such a wide spread and why would anyone invest in the banks given the issues that are causing the wide spreads in the first place.

Analysts said banks across Europe may have to boost their capital by up to €120bn in order to bring credit default swap (CDS) spreads down to "acceptable levels" and spark activity in the debt markets. 
CDS are a form of insurance on bonds that help offset the risk that a borrower will default on payments to an investor....

The default insurance costs for part-nationalised lenders such as Royal Bank of Scotland and Lloyds Banking Group have spiked to all-time highs in recent months as fears about the health of the sector continue to grow.
According BarCap, RBS's CDS currently trade at about 316 basis points. In order to bring this down to an "acceptable" 150 points, the bank would need to raise €11.08bn in capital, about a third of its current market value. 
Similarly, Lloyds's CDS currently trade at 319 basis points, and BarCap reckons it would need to raise €8.1bn - again about a third of its market capitalisation.... 
Analysts said market conditions would affect how the institutions raised this capital. 
"It's tempting to assume that the funding problems for European banks are cyclical, and that resolving the European sovereign debt crisis is all that is needed to ease banks' access to the bond market. But what if the Spanish and Italian sovereigns neither default nor look particularly safe in the next few years? 
"While the greatest pressure for additional capital is for banks in the periphery, even core banks may need to offer bond holders greater protection from default."
According to the analysis, banks in the core need to raise approximately one third of their current market value in new capital to provide bond holders with enough protection to reduce CDS spreads to 'acceptable levels'.
With market conditions not conducive to banks executing rights issues at the moment BarCap reckons we could see greater issues of CoCoS - a form of debt that converts into equity at times of stress - by core UK banks.
Without ultra transparency and disclosure of each bank's current asset, liability and off-balance sheet exposure details, why would any investor buy a CoCo security in the absence of the ability to independently assess the risk of each bank? 

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