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Oct. 1 (Bloomberg) -- Banks issued a record amount of their riskiest bonds in Europe last month as their efforts to bolster capital were aided by Mario Draghi’s attempts to revive the region’s economy by showering it with cheap cash.

HSBC Holdings Plc, Europe’s biggest lender, led sales of about $12 billion of additional Tier 1 notes which have no set maturity and give borrowers the option of missing an interest payment in times of trouble. Issuance of the contingent capital bonds, known as CoCos, totals $51 billion this year, according to data compiled by Bloomberg.

While policy makers vowed not to bail out the financial system again after the credit crisis, the flood of easy money from the European Central Bank is ensuring banks face few difficulties repairing their balance sheets. Demand for CoCos, which lenders need to issue to meet new capital regulations, has surged as record-low benchmark interest rates push investors into riskier assets.

“The ECB had the option of helping the economy back to life and therefore helping the banks, or of letting it go completely,” said Caspar van Grafhorst, a credit analyst based in The Hague at ING Investment Management, which oversees the equivalent of about $406 billion including CoCos. “Investors have been looking to get the best yields possible from the huge amount of liquidity the ECB has made available.”

Targeted Refinancings

ECB President Draghi is offering low-cost, long-term money in a series of targeted refinancings that started last month, as about 1 trillion euros lent to banks at the height of the sovereign debt crisis approach due dates.

The policy has helped lenders achieve an average Tier 1 capital ratio of 12.2 percent. The gauge of their ability to absorb losses was at 8 percent at the end of 2007, data compiled by Bloomberg show.

“The fundamentals of the banks are better now than they were,” said Francois Lavier, a Paris-based money manager at Lazard Freres Gestion SAS, which manages about $19 billion. “Banks have more capital and their ability to support losses is greater now than it was.”

Reassured by the capital banks have raised, investors’ new- found readiness to buy securities that can incur losses even before equity suffers has helped boost the CoCo market to about $62 billion within 18 months of the first notes being sold.

September Losses

Losses of 2.9 percent in September, the biggest monthly decline since the inception of a benchmark gauge in January, reduced returns on Tier 1 notes to 4.96 percent this year, according to Bank of America’s contingent capital index. Average yields on the securities rose to 6.83 percent last month from a low of 5.80 percent in June, the index shows.

That compares with the record low 1.14 percent that investors demand to hold senior bank bonds, according to Bank of America Merrill Lynch’s Euro Banking index, down from a peak of 7.86 percent in March 2009.

Regulators created additional Tier 1 bonds to transfer the risk of bank failures to investors from taxpayers. Analysts such as Simon Adamson at CreditSights Inc. in London estimate the bonds cost issuers about half as much as equity.

Asset Reviews

September’s issuance moves the market closer to the about $80 billion total issuance forecasted for year-end by Barry Donlon, UBS AG’s head of capital solutions for Europe, Middle East and Africa. The estimate is based on the needs of Europe’s biggest banks using current regulatory criteria, he said.

Banks are meeting with supervisors to learn how their institutions performed in the asset reviews and stress tests before the ECB takes over supervision in November. The publication of test results on Oct. 24, coupled with the approach of interim results, will probably halt issuance in October before leading to a rush after that, Donlon said.

As regulators phase in new rules governing banks by 2019, Tier 1 capital will consist of common equity and additional securities that have equity-like characteristics that allow regulators to stem cash outflows in a crisis. These features include having no fixed maturity, optional interest payments and being subordinate to most other claims, as well as a trigger whereby capital ratios declining to a preset level cause a writedown or conversion to equity.

“These bonds are something new, different, born out of regulatory design and desire,” said Filippo Alloatti, who helps oversee about $41 billion as an analyst at Hermes Fund Managers Ltd. in London. “The market has to be seen in the context of the grab for yield and very low interest rates. There’s definitely a link, an indirect link, with ECB policy.”

--With assistance from Jennifer Joan Lee in London.

To contact the reporter on this story: John Glover in London at johnglover@bloomberg.net To contact the editors responsible for this story: Shelley Smith at ssmith118@bloomberg.net Michael Shanahan

Bloomberg