Friday, November 16, 2012

Who was dumb enough to buy Barclays' contingent capital? Asian retail investors

In an earlier post, your humble blogger asked who would be dumb enough to blindly bet and buy Barclays' contingent capital notes.  The answer was Asian retail investors.

I observed
Barclays is proposing a security that is written down if the bank incurs losses that cause its Tier I capital to fall below 7%. 
So now Barclays is looking for investors who are willing to have their investment wiped-out if Barclays' experiences greater than a 2% decline in its Tier I capital. 
Before any investor should be willing to take on this risk, they should independently assess the risk of Barclays.  Unfortunately, because Barclays disclosure leaves it resembling a 'black box', assessing its risk is impossible to do.   
This leaves the pool of potential buyers greatly diminished. In fact, the pool consists solely of hedge funds and other investors who are comfortable blindly betting. 
To make contingent capital securities attractive to investors like pension funds and insurance companies requires the banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details. 
With this information, market participants can independently assess the risk of a bank like Barclays and its contingent convertible securities. With this risk assessment, investors can then make an investment decision as to how much exposure they would like.
According to a Bloomberg article, my analysis was correct.

  • Investors like pension funds and insurance companies stayed away.

  • The buyer of this debt was in fact an investor group that is comfortable blindly betting:  Asian retail investors.
Based on the analysts' comments it appears that investors in these bonds are not properly compensated for the "out of the money put" that they are writing.

Barclays Plc (BARC)’s $3 billion of new contingent capital notes .... will be written down to zero if the U.K.’s second-largest lender has losses that reduce its core Tier 1 equity ratio to 7 percent or lower. 
The securities were marketed globally and attracted orders of more than $17 billion, with most coming from Asia, Mark Harmer, the head of developed markets credit research at ING Groep NV in Amsterdam, said in a client note. 
Its size and relatively high price leaves it vulnerable to short sellers, according to Paul Smillie, a Singapore-based bank credit analyst for Threadneedle Asset Management. 
“Barclays is a monster of a deal so it’s going to be the most liquid thing out there for some time, and it’s easy to short,” Smillie said. “When Asia closed the Asian retail bid disappeared and U.S. fast money used it as a simple short.”...
The 7 percent trigger for a complete write-off, rather than conversion to equity, makes Barclays’s bonds more vulnerable to loss than previous issues of contingent capital instruments. 
“The bond was priced and structured with an eye to the Asian retail market,” said Harmer at ING. “That’s left little room for maneuver now that U.S. and European institutions appear to be setting the pace.”...
Robert Smalley, a strategist at UBS Securities LLC in StamfordConnecticut, in a note to clients. “The differential between the trigger and stated capital levels should have led to a higher coupon.”
Barclays would have to lose about 10.25 billion pounds ($16.3 billion) to trigger the writedown, according to Simon Adamson, an analyst at independent debt research firm CreditSights Inc. in London.

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