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Hybrid capital: Possible new blow to bank capital investors

UK legislation has created coupon deferability on LT2 within the context of a winding-down situation.

In a sector already battered by the decision of Deutsche Bank and Banco Sabadell to not call hybrid securities, news that the UK government has introduced legislation that give it the option to stop Bradford & Bingley lower tier 2 bondholders receiving coupon payments has met an expected 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 significantly negative.

“There wasn’t much flow on the news, mostly a remarking of prices. The B&B lower tier 2s are trading down around seven points to 2-7 in price terms,” says a credit trading head.

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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