Credit Agricole haunted by rating agency appeasement

Fri Jan 17, 2014 10:48am EST

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By Aimee Donnellan and Helene Durand

LONDON, Jan 17 (IFR) - There is no question that Credit Agricole's inaugural Additional Tier 1 issue priced this week was a roaring success, yet it was also another example of how an issuer can face unintended consequences from pandering to rating agency whims.

In an upset to the traditional bank capital structure hierarchy, holders of the bank's new USD1.75bn dual trigger Additional Tier 1 find themselves potentially above creditors who bought a USD1bn Tier 2 high-trigger CoCo back in September - sold explicitly to get equity credit with S&P and protect Credit Agricole's single A rating.

"The Tier 2 was a mistake because they did it for rating purposes and issuers shouldn't look at doing deals just for the rating agencies," said one bank capital expert.

"The RAC [risk-adjusted capital] ratio is an illusion, the rating agencies have proved it: they can change their mind and move the goal posts."

Credit Agricole was careful to align the triggers on the two transactions at 7% of Common Equity Tier 1 at the group level, but investors in the two deals potentially face a different fate.

In the case of the Tier 2, holders get wiped out permanently if Credit Agricole breaches the 7% trigger - one of the conditions set by S&P to give RAC ratio benefit. Holders of the Additional Tier 1, however, only see a temporary write-down.

This is not the first example. In the past few months, both Danske Bank and Societe Generale bought back expensive Tier 2 notes that had lost almost all of their equity content following an unexpected rating methodology U-turn.

In the case of Credit Agricole, the discussion might be purely academic. The bank has stated that it intends to operate with high capital buffers, which ensure it will never near the 7% trigger.

The performance of the deals indicates that investors don't seem worried about a disastrous outcome, and the Tier 2 is still trading well above par.

Yet, they should really be asking themselves if they want to hold an instrument that could be wiped out when the bank is still very much a going concern while AT1 lives on.

"There has yet to be a realisation by the market that Tier 2 could provide a buffer for the AT1," said a banker.

CAPITAL PLANNING PITFALLS

Capital planning in recent years has been harder than ever. Regulators moving the goal posts at a whim have been a particular bug bear. But there is more certainty now and banks need to have a clear view on the path ahead to avoid messing up their capital hierarchy further down the line.

"I think issuers should stick to one structure for each instrument; there is no value in having 10 different structures that could behave in different ways in times of crisis," another capital solutions specialist said.

"It's clear that France has not asked its banks to go above and beyond what's in the CRR if you look at what Societe Generale has done," said one of the structuring specialist.

Societe Generale's two Additional Tier 1 issues only had a 5.125% trigger, in keeping with the Capital Requirement Regulation, showing that, unlike the UK regulator for example, France is not gold plating capital requirements for its banks.

A number of bankers agree that Credit Agricole did not need to include the higher 7% trigger in the Additional Tier 1.

But sources close to Credit Agricole say the issuer may have had other reasons for including it.

As the EBA prepares to begin stress testing European banks, the feeling is that under the adverse scenario, only high trigger instruments will be eligible as capital, potentially helping banks avoid a capital raise. In that case, Credit Agricole would have the upper hand, while bondholders have everything to lose. (Reporting by Aimee Donnellan and Helene Durand, editing by Julian Baker, Alex Chambers)

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