Barclays Capital’s September deal marks the first placing of the innovative Tier One Notes (Tons) structure in the US market. The AA rated perpetual yankee issue with a 30-year call option had a 6.86% coupon and was priced at 215 basis points over 30-year US treasuries. If the deal is not called after 30 years its coupon will be transformed into floating-rate Libor plus 1.73%. Any coupon repayment after the call date will have to be made via the Alternative Coupon Settlement Mechanism (ACSM). The ACSM is a method of funding coupon payments through share issuance. The trustee sells shares and distributes the cash proceeds to the securities holders. The ACSM is used to ensure that investors will be guaranteed the full amount due in perpetuity.
The unusual Tons structure used in the deal is a development of Barclays Capital’s popular Reserve Capital Instrument (RCI) product that was first launched by Barclays Capital in June 2002. It is pioneering because it gives banks a more cost effective way of raising core tier-one capital. The deal achieved a 15bp premium over what could have been achieved with the RCI structure.
Tons are a breakthrough because they are a new class of non-equity securities that qualify as core tier-one capital, are directly issued, are tax deductible, and are not considered to be hybrid. Tons are also a cheaper method of raising core tier one capital than either equity or preference shares. Furthermore, because they are not considered to be hybrid, they are also not subject to the 15% limit on hybrid tier-one capital that applies to other structures. Barclays Capital estimates that issuing tier-one capital with Tons costs about half the 10% of equities issuance. Also because Tons are a debt structure, their issuance does not result in any earnings per share dilution.
All other non-equity tier-one structures, with the exception of Merrill Lynch’s virtually identical Tier One Non-Innovative Securities (Tonics), are either not considered as core tier-one capital or are considered as hybrid. Many of these structures also have to be issued indirectly through SPVs or offshore in order to be tax deductible while preference shares, which are core tier one, are not tax deductible.
Although regulators including the UK’s Financial Services Authority have yet to finalize their tier-one capital guidelines, the Tons structure has received confirmation that it will qualify as core tier-one capital. The key requirements for non-equity core tier-one securities are likely to be that they are deeply subordinated to the level of preference shares, that they have no defined maturity, and that they must be directly issued.
The deal attracted substantial demand and was doubled in size from the originally planned $500 million on the back of approximately $2 billion in orders. The issue was widely distributed to 65 predominantly US accounts. The investor mix was institutional and retail, with insurers showing a particular interest. Insurers were attracted to the long call option of the deal, a relative rarity in the US market.
Many investors who were seeing the structure for the first time cited the probability of the call option being exercised as the most important consideration they faced. “The bookrunners marketed the deal as a 30-year transaction that was only perpetual in name so that it could count as core tier one,” said one investor. According to one financial institutions group analyst investors will trade the deal as a 30-year issue on the expectation that it will be called. “Investors can expect the issue to be called at the 30-year date because the hassle and expense of issuing equity to fund the coupons payments is a disincentive and there is a real risk to the issuer’s reputation if it does not call,” says the analyst.
Since the debut of the Tons structure in June with the £400 million ($600 million) Barclays Bank deal, there have been three others including this one. In July Merrill Lynch did a £160 million Tonics deal for Anglo Irish, and in August Barclays Capital led a £200 million transaction for UK bank Northern Rock. The future for further use of the Tons structure is promising but still somewhat clouded by its lack of universal acceptance amongst regulators in the US and other major European and Asian jurisdictions.
“We expect to see more issuance of this kind in other countries,” says David Lyon, head of financial institutions (debt capital markets) at Barclays Capital. “We have received great interest from a wide range of banks in mainland Europe and are currently in discussion with a number of regulators.”
While some speculate that part of the reason Barclays Bank has been issuing such large amounts of these notes is to promote the structure developed by its investment bank, the FSA is said to have issued a highly favourable consultation paper to banks about its use.
