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Early redemptions unlikely after Dutch CoCo bond tax move, analysts say


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Early redemptions unlikely after Dutch CoCo bond tax move, analysts say

The Netherlands' decision to remove tax deductibility for coupons on contingent convertible bonds will make them more expensive for issuing banks, but will probably not push them to redeem existing CoCos early, according to Rabobank analysts.

CoCos, otherwise known as Additional Tier 1, or AT1, bonds, can serve as a loss-absorbing instrument in times of trouble, converting into equity if a bank's capital drops below a certain level.

The Dutch government said June 29 that, from the beginning of 2019, CoCo coupons will not be tax deductible. This "tax event" will allow banks to use an early call option for the instruments, Rabobank Research credit analysts wrote in a July 3 note.

But most Dutch banks will probably not use this option to redeem outstanding CoCos ahead of their first call date — partly because they would need to replace the AT1s with costlier equity financing, and partly because doing so might rattle the market. Early redemption could upset AT1 investors, which does not bode well for the banks' long-term issuance plans, the analysts said.

ABN AMRO Group NV, the third-largest bank by assets in the Netherlands, said it has no plans to exercise the tax call on its existing AT1 bonds, and that it "continues to value the role of AT1 in its capital structure." The group has two €1 billion AT1 bonds with coupons of 5.75% and 4.75%, respectively. Yield on the 5.75% perpetual AT1 bond increased to 3.43% on July 3, from 3.05% on June 29, according to data from S&P Global Market Intelligence.

Other countries have made similar noises to the Netherlands. In late 2016, Sweden proposed legislation that was even more far-reaching than the Dutch action and extended to coupons on all types of subordinated debt.

The Dutch government said its decision was designed to strengthen the domestic financial sector and placate EU authorities that had raised state aid concerns. The Netherlands expects about €150 million in additional tax revenues as a result of the decision, to be included in its tax plan for 2019. The cabinet will vote on the allocation of the additional revenues in August.

The European Commission had opposed the preferential tax treatment of CoCos on the grounds of state aid concerns and the measure is in line with the Commission's thinking, the government said.

The Dutch statement also said the Commission "intends to address concerns in all European member states with comparable specific measures."

"[W]e are in touch with several member states on the issue and have invited member states to take appropriate action where required," European Commission spokesman Ricardo Cardoso told S&P Global Market Intelligence in an email. The spokesman declined to name the member states the Commission has contacted.

Until similar changes are made across jurisdictions, Dutch banks will be at a disadvantage compared to EU peers, at least in the short term, according to the Rabobank analysts.

Insurers may also be affected by the government decision as their restricted Tier 1, or RT1, bonds play a similar role in the building up of their Solvency II regulatory capital buffers. The government statement included a reference to the insurance industry which "could raise questions on how insurers will adjust their funding/capital plans going forward," the analysts wrote.