European "haircuts" and how to recapitalise a continent's banks

“the prospect of sovereign debt restructurings – and therefore losses for holders of that debt – are mounting steadily.”

“So far, most banks have factored in only one hit – a 21 per cent haircut on the bulk of their Greek sovereign holdings, sitting in portfolios of assets designed to be held to maturity, whose value is not normally marked down in line with market values.”

What type of capital will be raised?  “This is the area of greatest uncertainty. Under examination, according to people briefed on the talks in Brussels, are instruments that could avoid governments taking straight shareholdings in banks.

“Discussions include a [preference share issue] which has some convertibility features,” Morgan Stanley wrote in a note to clients. Under that model, banks might have a fixed period, say three years, during which to plug the capital deficit with equity under its own steam, either from new or existing investors or through retained profits; otherwise the preferences would convert to equity”. 

Please click here to view a copy of the report published in the Financial Times on 5 October 2011.