LONDON, Nov 30 (IFR) - UK banks' Additional Tier 1 bonds
would be fair game and converted into equity if they hit severe
problems, the Bank of England's most stringent stress tests yet
showed on Wednesday.
This year's test was the third annual healthcheck by the
Bank of England's Prudential Regulation Authority (PRA) and was
more severe than in 2014 and 2015. It was the first based on the
central bank's new approach to stress testing, which includes
potential misconduct costs.
It is the first test in which the UK regulator theoretically
converted the instruments as a way of getting banks back to a
stronger footing, a clear reminder for investors of the
potential losses posed by holding this type of debt.
New regulation following the last financial crisis has
forced lenders across Europe to beef up their stock of loss
absorbing capital in recent years.
By end-2015, the seven participating banks had issued a
combined £23bn of AT1, which in the case of UK lenders converts
into equity if a bank's Common Equity Tier 1 (CET1) ratio drops
The CET1 ratios of RBS, Barclays and Standard Chartered all
slipped below 7% in the stress scenario, forcing the
hypothetical conversion of their AT1 bonds.
In the case of the latter two, that helped pushed their CET1
ratios back over the hurdle rate, to 8.3% and 7.2% respectively.
RBS fared worse. Its CET1 ratio only clawed back to 6.7%
even after its AT1 was converted, but the bank has already
submitted an updated capital plan to the PRA.
"The conversion of AT1 was a positive development insofar as
it reflected increased amounts of such loss-absorbing capacity
on some banks' balance sheets," the Bank of England said.
"Banks for which AT1 converted in the stress were more
resilient, all else equal, than if they had not issued AT1
The focus on AT1's ability to absorb losses serves as a
timely reminder of the risks posed by the asset class, which
suffered a violent sell-off earlier this year simply on fears of
"To me it's pretty clear that as an AT1 holder, the BoE will
nail you," said one investor. "Some people don't always think
that way. It's interesting because if you think about it, RBS
hasn't really been that volatile."
All three banks have already taken further action over 2016,
not taken into account by the tests, which reduces the
probability of breaching the trigger. RBS has issued a further
£2bn of AT1 since December 2015, for example.
AT1 bonds were narrowly trading up by late morning,
reflecting that progress.
A Barclays US$1.5bn 7.875% callable in March 2022 rallied
from 97.75 to 98.2, while an RBS US$2.65bn 8.625% callable in
August 2021 initially dropped half a point to 97.3 before
climbing to 98.2, for example.
The fact that its capital plan has already been approved by
the PRA, coupled with already depressed valuations across RBS'
capital structure, means the impact on credit spreads is likely
to be very limited, BNP Paribas analysts wrote in a note.
But people "definitely forget" that the debt can be written
down, said Filippo Alloatti, a senior credit analyst at Hermes
"It carries some weight if you see that in an official
document, within an exercise by the Bank of England. 7%, to some
extent, is far away, but it's still pretty high."
UK AT1 bonds are more punishing for investors than the
majority of European jurisdictions where bonds are structured
with a 5.125% trigger, reducing the chance of conversion.
"I think it underlines the value of having high trigger AT1
instruments," said Roberto Henriques, European credit analyst at
JP Morgan. "I think that this might end up with the sector
moving to high trigger AT1 structures."
(Reporting by Alice Gledhill, editing by Helene Durand, Sudip