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* 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 thedevelopment of CoCos, this time with Tier 1 convertible hybrids,could be its toughest challenge yet as the bank faces pushbackfrom both equity and bond investors.
Bond investors claim the instruments do not fit fixed-incomemandates due to their perpetual tenors and deferrable coupons,while equity investors are worried about the possible dilutionimpact and erosion of pre-emption rights.
The latter's fears are likely to be easier to soothe thanthose of bondholders, judging by the rhetoric from both camps.
"I have not seen a structure yet that is viable forbondholders. The EBA guidelines state the instruments must beperpetual with discretionary coupons, but that creates aninstrument 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 nationalchampion - that has pioneered the growth of the contingentcapital product with more aggressive structures, and has beenkeen to prove real-money demand exists for the instruments.
Its first deal, a USD3bn 10-year bullet instrument sold lastNovember stood out because of its high trigger, total lossfeatures, while its second, a USD1bn 10NC5 high-trigger dealthis month, was a new structure for the target US audience.
Having sold USD4bn of the instrument, Barclays is now tippedto be one of the first to sell high-trigger Additional Tier 1(AT1) perpetual bonds that convert into equity, rather thanbeing 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 the0.5% goal from Tier 2 hosts, its priority is now on the 1.5% AT1target.
"It's certainly going to be an interesting development.Barclays could potentially be the first issuer to have Tier 1convertibles and Tier 2 write-down structures, so how investorscompare these instruments will be key to how the marketdevelops," 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 AT1instruments in CRD IV.
CHARM OFFENSIVE
In theory, bankers say, convertible instruments should beeasier for bond investors to get comfortable with, because theyare at least left with shares that have the potential to rise ifa 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; butthese are perpetuals. They are not bonds, and we would not buythem," 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 themarket."
Banks initially therefore may have to settle for provenstrong demand for CoCos from Asian investors, as well as hedgefunds and equity income funds who are chasing yield.
The downside to that is the potential higher volatility thiscan lead to in secondary markets. That was certainly the casefor the first Barclays CoCo, and something that issuers wouldtherefore rather avoid.
Bankers still insist that there is a place for theinstruments and predict the AT1 market to grow to EUR150bn asissuers race to improve capital buffers.
Their confidence is based on the premise that thealternative - raising equity - is just too expensive. As aresult, comments from the Association of British Insurers thisweek urging investors to think twice before backing the bank'sCoCo plans have largely been shrugged off.
"Equity investors are better off voting for an instrumentthat is unlikely ever to convert than a rights issue that wouldimmediately dilute them," said Simon McGeary, head of the newproducts group at Citigroup.
MORE BANG FOR YOUR BUCK
Getting equity investors onboard is still vital, andBarclays cannot afford be too complacent. Withoutshareholder-backing at a crucial vote on April 25, Barclay's AT1plans will be hamstrung.
The bank is seeking to win shareholders over by giving themthe chance to buy the instruments if they do convert to equity.
Assuming that is successful, once CRD IV hits the statutebook in April and the technical standards from the EuropeanBanking Authority are finalised, it should give bankers the allclear. The only hurdle then is uncertainty over the taxtreatment 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 thatapplies to every institution. However, we expect it will beefficient for all institutions to supplement equity capital withboth Additional Tier 1 and Tier 2 capital, provided theinstruments can be raised at reasonable costs," said anothercapital solutions banker.
Additional Tier 1 instruments would provide the broadestrange 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 tocount towards the leverage ratio - benefits which Tier 2instruments would not provide.
"Taking that into account, AT1 issuance is a logical step toconsider," the banker said.
