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| Barclays | |
| Size | $3 billion of 10-year contingent capital notes |
| Date | November 2012 |
| Global coordinating bookrunner and structuring adviser | Barclays |
| Bookrunners | Citi, Credit Suisse, Deutsche Bank and Morgan Stanley |
| return to the Global Deals of the Year index | |
Science fiction has no place in the real world of bank capital, but when one bank goes boldly beyond where any other bank has gone before with a CoCo under CRD IV, there is perhaps something of a whiff of the future about it.
For Barclays, the bank that boldly broke new ground for the banking sector, the remarkable success of its $3 billion contingent capital notes (CoCo) sale in November last year was very real indeed.
At a stroke, the UK bank met its December 2013 primary loss-absorbing capital target – as is required under the Capital Requirements Directive IV (CRD IV) which transposes Basle III into EU law – in an instrument that has all the loss absorbency of equity while still counting as debt for investor purposes.
Although other banks have issued CoCos before, Barclays’s $3 billion of tier 2 10-year CoCos broke new ground on a number of levels. By far the most audacious, though, was the fact that it was the first permanent write-down, so-called high-trigger CoCo.
In essence, this means that the value of Barclays’ CoCo will be automatically written down to zero should the bank’s common tier 1 equity ratio ever drop below 7%, requiring bond investors to take a bath before equity holders.
UBS certainly helped pave the way for Barclays in August last year when it sold the first yankee permanent write-down tier 2 CoCo, but its trigger level was low by comparison at 5%.
That Barclays opted for a far higher 7% trigger certainly took the market by surprise. However, there was method in the bank’s apparent madness.
The bank presented this transaction, during a roadshow to over 250 potential investors in 10 cities across seven countries, as a natural evolution of its capital plans, and one that solved a fiendishly complex problem.
At the end of last year, Barclays had about £42 billion ($66.7 billion) of core tier 1 equity, giving it a core tier 1 ratio of just below 8% on a full Basle III basis. It plans to reach a 9.5% ratio under Basle III by the end of 2013, requiring £6 billion of equity. Ultimately, the bank believes it will need to raise this ratio to 10.5%.
On top of that, the bank also believes it will need alternative tier 1 capital covering 1.5% of risk-weighted assets, which could be equity or CoCos, plus a 5.5% buffer of tier 2 capital.
However, Barclays was under pressure to get its core tier 1 ratio to around 10% much sooner than would be possible were the bank to rely solely on retained earnings. The CoCo, therefore, achieved that.
Stephen Penketh, managing director, Barclays Treasury, says: “A necessary part of the transaction’s success was articulating the importance of the contingent capital within the parameters of CRD IV. After all, CRD IV requires 1.5% of risk-weighted assets to be in contingent capital form [the Additional Tier 1 requirement].”
He adds: “With CRD IV around the corner it has become essential for the European banking sector to help build this [contingent capital] market if capital is going to be managed with maximum efficiency. Investors have got to get comfortable with the relevant trigger levels and a bank’s ability to build and sustain appropriate buffers to the trigger event.”
Given the $17 billion order book the Barclays CoCo attracted, and the bumper order books of similarly structured – permanent write-down, high-trigger – tier 2 CoCos from Bank of Ireland and Belgium’s KBC in January, investors appear to be getting comfortable, undoubtedly helped by the high yield these securities offer.
Barclays CoCos, for example, were priced to yield 7.625% – far tighter than the formal guidance pitched in the 7.75% area – by Barclays, and joint bookrunners Citi, Credit Suisse, Deutsche Bank and Morgan Stanley.
This bodes well for growth in the asset class.
“While a high trigger, permanent write-down security will obviously be the harder deal to sell, it does appear to be gaining acceptance in the market generally”, says Penketh. “Given the scale required of the contingent capital market for the European banking sector as a whole and the differing appetites among investors, I am sure that the equity conversion contingent capital market will continue to develop over the coming years and have not given up hope that workable solutions could ultimately be found for temporary write-down contingent capital securities too.”
