CoCos seen as acquired taste as Barclays opens door
LONDON (Reuters) - After several false starts, Barclays (BARC.L) is optimistic it can sell a debt instrument that bolsters capital at times of trouble and could clear a path for European rivals to follow.
That, at least, is the hope.
Several banks have signaled plans to sell debt that converts into equity when a bank's capital runs low, but both regulators and investors have appeared cool, causing uncertainty about how they would be structured and generating only a handful of issues.
Contingent convertible bond instruments, dubbed "CoCos", have failed to take off in the way many predicted two years ago, when they were lauded as a potential $1 trillion asset class that would recapitalize the industry.
Global regulators said CoCos would not count as core capital and failed to lay out clear standards for them, leaving it up to national regulators to determine how far banks could use them.
But Barclays Finance Director Chris Lucas this week said his bank had made progress with regulators and would be speaking to investors "in the next few weeks" with a view to an issue.
"I have no doubt that Barclays can get one away - because there are lots of sovereign wealth funds and hedge funds who will love this. It is just more a question of how this evolves over time, and whether more people get involved," said Edward Farley, senior portfolio manager at Pramerica.
Hedge funds and sovereign investors could be joined by private banking clients, but insurers, pension funds and other traditional debt buyers may shy away from the higher risk, higher return product.
UK regulators have warmed to them in the last couple of months, as they encourage banks to build more capital.
"There's a clear message from the regulators wanting the UK banks to continue building their absolute levels of capital, and a willingness to allow CoCos as one way to achieve that," said Simon McGeary, head of new products at Citi in London.
"A number of other international regulators have also previously supported the idea but wanted to see markets emerge. If you start to see issuance out of the UK it could lead to more people looking to follow," he said.
Deals up to now have been sporadic, led by Switzerland's Credit Suisse (CSGN.VX) and UBS (UBSN.VX) and topped up by isolated issues by Lloyds (LLOY.L) and Rabobank.
Key issues that surround any CoCo issues are at what point it converts into equity, the interest the bank pays and the position of CoCos in the capital structure.
In the current low interest rate environment, higher yields could attract some types of buyers but not from the traditional fixed income investment community, experts argue.
"From a traditional bond fund perspective, that kind of structure just doesn't fit in, irrespective of the yield. It's like saying, yields have fallen in credit markets, aren't you interested in buying high dividend stocks?" Ben Bennett, credit strategist at Legal & General Investment Management said.
Strong banks could pay annual interest of 6-8 percent on bonds, whereas second-tier operators may have to pay around 10 percent, but it will depend on where the debt gets converted into shares, bankers said.
Antony Vallee, senior portfolio manager at JPMorgan Asset Management, said he was dubious CoCos will become a new asset class due to concerns about liquidity and the uncertain regulatory environment.
"The upside to me looks fairly limited and the downside looks quite unlimited," Vallee said.
Bankers are optimistic the structure will evolve to meet a need in specific markets, even if it struggles to become mainstream.
James Mitchell, portfolio manager at Russell Investments, said some investors were slowly becoming more open to the merits of subordinated debt investment given that senior debt is no longer the haven it once was.
Swiss banks have led as their regulator has told them to hold core equity of at least 10 percent, and an extra 9 percent cushion that can include contingent capital.
UK banks have been told a 10 percent minimum capital level needs an extra 7 percent cushion. If banks have to make much of their debt able to absorb losses to meet that need, it could increase the attraction of CoCos.
That could see Barclays followed by HSBC (HSBA.L) or Royal Bank of Scotland (RBS.L). Swedish or other Nordic banks will also be watching closely to see if the market picks up, bankers said.
Credit Suisse launched the purest CoCo to date in February 2011, paying a coupon of around 9 percent for bonds that convert into shares if its core Tier 1 ratio falls below 7 percent. (Editing by David Cowell)
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