* Tier 1 convertibles seen as a tough sell
* Bond investors balk at perpetual features, income risk
* Equity investor concerns shrugged off
By Natalie Harrison
LONDON, April 19 (IFR) - Barclays' ambition to spearhead the development of CoCos, this time with Tier 1 convertible hybrids, could be its toughest challenge yet as the bank faces pushback from both equity and bond investors.
Bond investors claim the instruments do not fit fixed-income mandates due to their perpetual tenors and deferrable coupons, while equity investors are worried about the possible dilution impact and erosion of pre-emption rights.
The latter's fears are likely to be easier to soothe than those of bondholders, judging by the rhetoric from both camps.
"I have not seen a structure yet that is viable for bondholders. The EBA guidelines state the instruments must be perpetual with discretionary coupons, but that creates an instrument that is by definition not a bond," said Roger Doig, fixed-income analyst at Schroders.
That is a blow for an issuer like Barclays - a UK national champion - that has pioneered the growth of the contingent capital product with more aggressive structures, and has been keen to prove real-money demand exists for the instruments.
Its first deal, a USD3bn 10-year bullet instrument sold last November stood out because of its high trigger, total loss features, while its second, a USD1bn 10NC5 high-trigger deal this month, was a new structure for the target US audience.
Having sold USD4bn of the instrument, Barclays is now tipped to be one of the first to sell high-trigger Additional Tier 1 (AT1) perpetual bonds that convert into equity, rather than being completely written off, if the bank's Common Equity Tier 1 (CET1) falls below a specified level.
Barclays' target is to sell 2% of its risk-weighted assets (RWA) in loss-absorption securities. Having more or less met the 0.5% goal from Tier 2 hosts, its priority is now on the 1.5% AT1 target.
"It's certainly going to be an interesting development. Barclays could potentially be the first issuer to have Tier 1 convertibles and Tier 2 write-down structures, so how investors compare these instruments will be key to how the market develops," said one capital solutions banker.
If structured in the same way as the bank's previous CoCos, the trigger will be 7% - higher than the 5.125% set for all AT1 instruments in CRD IV.
In theory, bankers say, convertible instruments should be easier for bond investors to get comfortable with, because they are at least left with shares that have the potential to rise if a bank's capital position improves.
That is not the picture that is coming across however.
"Yes, it's better to get something rather than nothing; but these are perpetuals. They are not bonds, and we would not buy them," said another investor.
"There are also only a handful of banks that could do them. Tier 2 and Tier 3 issuers would find it very hard to access the market."
Banks initially therefore may have to settle for proven strong demand for CoCos from Asian investors, as well as hedge funds and equity income funds who are chasing yield.
The downside to that is the potential higher volatility this can lead to in secondary markets. That was certainly the case for the first Barclays CoCo, and something that issuers would therefore rather avoid.
Bankers still insist that there is a place for the instruments and predict the AT1 market to grow to EUR150bn as issuers race to improve capital buffers.
Their confidence is based on the premise that the alternative - raising equity - is just too expensive. As a result, comments from the Association of British Insurers this week urging investors to think twice before backing the bank's CoCo plans have largely been shrugged off.
"Equity investors are better off voting for an instrument that is unlikely ever to convert than a rights issue that would immediately dilute them," said Simon McGeary, head of the new products group at Citigroup.
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Getting equity investors onboard is still vital, and Barclays cannot afford be too complacent. Without shareholder-backing at a crucial vote on April 25, Barclay's AT1 plans will be hamstrung.
The bank is seeking to win shareholders over by giving them the chance to buy the instruments if they do convert to equity.
Assuming that is successful, once CRD IV hits the statute book in April and the technical standards from the European Banking Authority are finalised, it should give bankers the all clear. The only hurdle then is uncertainty over the tax treatment of the instruments in individual countries. France, Italy, Spain and the UK are more advanced in the latter area.
"There is no one-size-fits-all capital structure that applies to every institution. However, we expect it will be efficient for all institutions to supplement equity capital with both Additional Tier 1 and Tier 2 capital, provided the instruments can be raised at reasonable costs," said another capital solutions banker.
Additional Tier 1 instruments would provide the broadest range of benefits, said the banker.
That includes Pillar 1 recognition as Tier 1 capital, recognition as capital for S&P's RAC model, and eligibility to count towards the leverage ratio - benefits which Tier 2 instruments would not provide.
"Taking that into account, AT1 issuance is a logical step to consider," the banker said.