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Hybrids: European supply outlook hinges on M&A

Only strong M&A-related capital-raising will allow hybrid debt volumes to remain firm in 2007.

It seems that strong M&A-related financing is needed if hybrid volumes are to breach the €74 billion sold during 2006. A key reason is that bank capital issuance from Europe, the mainstay of the international hybrid market, is unlikely to grow substantially this year. There are a number of reasons why hybrid bank capital supply could dip this year. One is that, in the absence of M&A, banks are under less impetus to raise external capital because their internal generation of capital is supporting asset growth.

“Go back a few years and we had a very obvious scenario of risk-weighted assets growing faster than profits, which required significant capital-raising. But now we are in more of an equilibrium, which means increasingly banks have sufficient retained earnings to support asset growth,” says Alan Patterson, European head of the financials institutions group at Citigroup.

Hybrid capital is a cost-effective way for banks to leverage their balance sheets because of tax deductibility. Furthermore, such capital does not dilute shareholders’ equity. But when the Basle Committee on Banking Supervision first approved hybrid capital in 1988 it limited the amount of innovative (hybrid) capital that a bank could have as part of its tier 1 capital structure to 15%.

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