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Hybrid capital: UK knocks lower tier 2 with B&B threat

Legislation to stop coupon payments could have wide consequences.

In a sector already battered by the decision of Deutsche Bank and Banco Sabadell not to call hybrid securities, news that the UK government has introduced legislation that gives it the option to stop Bradford & Bingley lower tier 2 bondholders receiving coupon payments met with a predictable response. The bonds were instantly marked several points lower and the rest of the UK market widened in sympathy, although that has reversed slightly.

Lower tier 2 capital ranks lower than senior debt in the capital structure when a bank is wound up. Unlike tier 1 and upper tier 2 debt, it does not have loss-absorbency language and the sudden inclusion of such features – even on a nationalized bank – is negative.

"There wasn’t much flow on the news, mostly a re-marking of prices. The B&B lower tier 2s are trading down around seven points to 2-7 in price terms," says Henrik Raber, head of European investment-grade credit trading at UBS.

The government said that B&B cannot pay coupons on its LT2 unless it has "satisfied in full its liability to the FSCS". Despite making this law change, the Financial Services Compensation Scheme continues to allow coupon payments on B&B LT2 in the short term but in today’s jittery market conditions the longer-term implications were viewed negatively.

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