Barclays writes new chapter in CoCo history

Fri Nov 16, 2012 10:24am EST

* High-trigger CoCo to remain the preserve of top banks

* Bondholder opinions split on structure

* Poor aftermarket performance blamed on weaker backdrop

By Helene Durand and Danielle Robinson

LONDON, Nov 16 (IFR) - A USD3bn high-trigger total loss bond priced by Barclays Bank this week will set the market up for other issuers from the UK and elsewhere in Europe, the bank argues, although others still question who will emulate the trade without formal global regulatory endorsement.

The UK bank is paying only a 7.625% coupon for the BBB- rated Tier 2 10-year bullet that attracted USD17bn of demand despite the structure being the most aggressive of its kind yet.

Under the terms of the deal, which was led by Barclays, Citigroup, Credit Suisse, Deutsche Bank and Morgan Stanley, the notes will be automatically written down to zero if the bank's Common Equity Tier 1 ratio falls below 7% (post CRD4).

"CRD4 requires banks to hold 1.5% of your RWAs in contingent capital and we need to start to build interest in this market. This transaction and the investor support it received will be relevant for other institutions in Europe," said Steven Penketh, managing director, Barclays Treasury.

Global regulators have not explicitly endorsed contingent capital but have asked that all bank capital instruments be able to absorb losses at the point of non-viability or before any taxpayer money is injected into a bank.

The CRD4 draft requires that banks can either writedown or convert into equity Additional Tier 1 instruments at a minimum pre-set trigger of 5.125%, while there is no hard-wired trigger for Tier 2 instruments. The Barclays issue goes above and beyond that requirement.

"This deal expands the envelope and it clearly got a very strong response from the market. But I think this will be something that only top tier banks will use," said Simon McGeary, head of the new products group at Citigroup.

"There are some investors who still have reservations about the structure and the high-trigger but got comfortable because of the credit and how far the bank will operate from that trigger."

Under the CRD4 transitional rules, Barclays' Common Equity Tier 1 ratio is expected to be at 12.1% by the end of next year, giving a 510bp buffer above the trigger level. Furthermore, as a systematically important financial institution, Barclays will have to operate at least 2% above the 7% Common Equity Tier 1 ratio set by Basel.

McGeary added that having a major jurisdiction, a big issuer and an important regulator endorse the instrument may mean that others revisit their thinking around the product.

"It's worth pointing out that the UK has a long history of exercising real discretion under Pillar 2 and that level of discretion has not been there in the same way in other jurisdictions," he said.

Depending on the size of Barclays' balance sheet going forward, the bank could sell as much as GBP8bn of this type of debt over the next six-years.

Another hybrid banker said that what was applicable to Barclays and the UK might not apply to others, and that it was not quite the time to go CoCo nuts yet. "Other will continue to look at adhering to the global minimum capital requirements through raising Tier 2 and Additional Tier 1 under Pillar 1," he said.

SWEEPING UP THE GLOBE

Barclays carried out a global charm offensive for over a week and began marketing the deal in the US on Tuesday at mid to high 7%.

As demand grew, with USD10bn coming from Asia, Barclays had to strike the right balance between size and pricing. The issuer opted for size and priced the trade with a 7.625% coupon, which equated to 603.7bp over Treasuries and was some 300bp back from Barclay's existing Lower Tier 2 debt, the wider end of the premium market participants thought it would have to offer.

Unlike recent bank capital issues in Reg S format (which mainly sold into private bank networks), the Barclays trade had to cater for institutional investors, making it difficult to price through initial price guidance.

Final allocations saw fund managers take 42.5%, private banks 27.5%, insurance companies 10.7%, hedge funds 10.5%, banks 6.2% and others 2.6%. US investors were allocated the lion's share of the bonds at 51.9%, followed by Europe at 27.7%, Asia at 16.1% and others at 4.3%.

The strong US take-up was helped by the strong performance of UBS' low-trigger contingent capital issuer launched this summer.

"The UBS deal traded better than anyone thought it would," said one banker. "It has gone up to 110 which has prompted the market to take a good hard look at the product."

STILL AN ACQUIRED TASTE

Some institutional investors, in particular in Europe, still find CoCos are an acquired taste, arguing that their success is proof of a raging bull market.

"Hopefully other issuers won't use this particular CoCo structure as a precedent," said Satish Pulle, a portfolio manager at ECM, echoing the view of many.

"From an equity investor perspective, I can see why they would do it: it allows them to get all the upside in the good times and protect their downside in the bad times," he added.

He complains that this security is junior to equity, and weakens shareholders' incentive to prevent excessive risk-taking by management.

However, Andrew Fraser, a FIG analyst at Standard Life Investments said that investors would have to get used to loss-absorbing features, whether they like or not.

The bond's poor aftermarket performance, where it dropped by as much as two points, was a setback, and fuelled speculation that investors who had put in heavily inflated orders ended up with more bonds than they bargained for.

However, bankers close to the deal said the whole financial sector had performed poorly overnight on the back of negative headlines, with sub issues from the likes of Citigroup and Prudential trading down by more than a point.

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