Market eyes Barclays CoCo for clues on price, regulation

Tue Nov 6, 2012 12:43pm EST

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* Barclays tests investors with 7% trigger

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By Helene Durand and Aimee Donnellan

LONDON, Nov 6 (IFR) - The planned Barclays contingent capital (CoCo) bond is getting wide attention in the market, which is waiting to see not only how much the capital will cost but also how this latest experiment in improving bank balance sheets will be treated by regulators.

The bank is poised to file with the SEC on Tuesday in what will be the first true test for CoCos out of the UK, amid an uncertain regulatory environment for the still-developing product.

"This will be an interesting trade," said a hybrid capital banker.

"There has been a lot of debate around contingent capital. And while it wasn't endorsed by global regulators as an asset-class under Pillar 1, the fact that the UK regulator is endorsing it under Pillar 2 means that other regulators might take a second look, and we do see a real market spring up."

In recent months, the Bank of England's Financial Policy Committee and the UK Financial Services Authority have both come out in favour of contingent capital.

In minutes published in July, the FPC said that "banks might issue equity or contingent capital instruments on terms approved by the FSA, incorporating high triggers for conversion."

The Barclays CoCo features a full write-down rather than a conversion into equity that some regulators consider to be potentially destabilising for a bank.

The instrument will trigger if the bank's Common Equity Tier 1 (post CRD IV) ratio falls below 7%. If the bank hits that trigger, then the instrument would be completely written-off, thus creating instant capital for the bank.

The 7% trigger is well below the SIFI (systemically important financial institution) buffer, which requires banks that are considered too big to fail to carry 9% common equity capital and below which Barclays will be required to restrict discretionary payments such as dividends and discretionary compensation. It is therefore expected that the 7% trigger would be shielded by at least a 2% capital layer.

The FSA has been actively involved in the development of the CoCo product in the UK, and approves of the 7% trigger, which it considers to be adequately protected by the additional layer of capital.

TIER 2 HOST

The Barclays deal is expected to be treated as Tier 2 capital under Pillar 1, the minimum capital requirements set by global and European regulators.

But market participants expect it will also meet the Pillar 2 additional capital requirments on banks that are set by local regulators.

So far, only Swiss banks have been required to issue contingent capital, under the so-called Swiss finish, while other regulators have been wary of endorsing these instruments.

Barclays will begin a two-week global roadshow Tuesday for the new CoCo via its in-house investment bank, Citi, Credit Suisse, Deutsche Bank and Morgan Stanley, in what is only the second-ever CoCo issue in the UK.

Because the first, from Lloyds in 2009, was part of that bank's distressed recapitalisation, the Barclays issue will be the first true measure of how investors respond to the product.

In particular, the deal will test how far investors are prepared to go in search of yield, especially as it has a high trigger - the UBS issue has a 5% trigger, for example - and carries a severe potential loss.

Credit Suisse's CoCo had a "high-trigger" of 7%, but was convertible into equity, thereby giving converted bondholders a stake in the bank should it recover.

Rabobank also sold a Senior Contingent Note issue with a relatively high trigger of around 7%, but investors get 25% of par upon the conversion trigger being hit.

For Barclays, the instrument is thought to be cheaper than issuing equity as it is expected to be tax-deductible. And unlike a CoCo deal convertible into equity, there is no dilution threat for shareholders.

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