Barclays CoCos at risk from PRA Pillar 2 change

Thu Sep 5, 2013 5:17am EDT

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LONDON, Sept 5 (IFR) - Barclays could lose the regulatory benefit from its contingent capital notes if the PRA takes a more a stringent line on Pillar 2 capital, which could lead to the notes being called early or being the subject of a liability management exercise, according to research from BNP Paribas.

The Prudential Regulatory Authority is proposing that firms should meet Pillar 2A capital requirements (for risks not captured or not fully captured under the CRR) with at least 56% Common Equity Tier 1 from January 2015. It is consulting on whether to increase this to 100% by January 2016.

Right now, any bank capital can be used to meet these needs, but Common Equity Tier 1 (CET1) is the tightest definition of bank capital and excludes all hybrids in debt hosts.

The PRA acknowledges that "this change may increase the cost of capital for some firms to the extent that existing, voluntary capital buffers are not of sufficient quality to support Pillar 2A".

If these rules are put in place and the Barclays notes are not grandfathered, then "they no longer qualify for Pillar 2 and become just relatively expensive Tier 2 for Pillar 1 for which loss absorption in the T&Cs is not required", according to the BNP Paribas analysts.

HSBC's EUR1.5bn Tier 2, for example, was priced at mid-swpas plus 195bp on Tuesday (3.375% coupon, 99.878 reoffer price), while Barclays paid 7.75% for its USD1bn T2 Coco in April.

The Barclays notes have a regulatory call event in place, allowing redemption at par if they fully lose Tier 2 status (subject to prior regulatory approval). However, losing Pillar 2 status would not trigger this event.

"If [the bonds no longer qualify], we would imagine that Barclays would likely want to do a liability management on these instruments, potentially as an exchange into AT1s, but not necessarily," said the analysts.

Barclays declined to comment.

The report from BNPP also considers the impact on Lloyds' ECNs in the same scenario. These bonds are Lower Tier 2, but in contrast to the Barclays notes, have a call at par for loss of Pillar 2 status "if ECNs lose either Tier 2 status under Pillar 1 or CT1 status under Pillar 2".

The BNP Paribas analysts say that they do not expect a call at par, since the ECNs are trading over par (the most liquid notes at 103.40, some in 105-107 area), and Lloyds would want to preserve its reputation in the market.

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