Barclays Said to Favor CoCos Over Shares to Meet Rules

Barclays Plc, Britain’s second-largest bank by assets, is considering plans to bolster capital by selling contingent convertible bonds, according to two people with knowledge of the talks.

The lender, under pressure by the the country’s Prudential Regulation Authority, favors issuing CoCos instead of new stock, said the people, who asked not to be identified because the bank is still in talks and no decision has been reached. London-based Barclays received shareholder approval at its annual meeting on April 25 to sell CoCos, which become shares if its core Tier 1 equity ratio drops below a set level.

Barclays, which holds the least capital as a proportion of its assets of Britain’s four biggest banks, must either raise 7 billion pounds ($11 billion) in equity or cut 240 billion pounds of assets to meet a 3 percent leverage ratio set by the Bank of England’s PRA if it’s forced to comply this year, analysts estimate. The lender, which is eliminating 3,700 jobs to cut costs, will report second-quarter results on July 30.

“CoCos would be attractive to Barclays as they’re cheaper than raising equity,” said Gary Greenwood, an analyst at Shore Capital in Liverpool, England, who recommends buying the stock. Still, that could mean “there’d be little future motivation for equity holders to put money into a struggling bank, waiting instead for CoCos to trigger.”

‘Quite Happy’

Barclays is the second-best performer of Britain’s five largest banks after Lloyds Banking Group Plc, having gained 22 percent this year. The shares closed at 320.15 pence yesterday, down 0.7 percent, leaving them little changed in the week.

The bank has held talks with investment banks in recent weeks about a potential stock offering, according to the Wall Street Journal. Officials at Barclays declined to comment.

Barclays is seeking to persuade regulators that contingent capital would be sufficient to make it safer, said one of the people. Chief Executive Officer Antony Jenkins told investors in February the bonds would be part of the capital plan.

“Equity holders are now quite happy for banks to be well-capitalized and safer,” said Cormac Leech, a London-based analyst at Liberum Capital Ltd. with a hold rating on the stock.

Basel Guidelines

The bank may opt for additional Tier 1 bonds, which are likely to be priced more expensively than CoCos and convert to shareholder funds to absorb losses rather than shares, said Christopher Wheeler, an analyst at Mediobanca SpA in London, with an outperform rating. They could count as core Tier 1 capital in a similar way shares do under Basel rules, he said.

The Basel committee published a draft leverage ratio in 2010 as part of a general overhaul of its capital standards. The group is working on the details of the measure, which is scheduled to become binding from 2018. It would require banks to hold Tier 1 capital equivalent to 3 percent of their assets, with no scope for these assets to be risk weighted.

Paul Tucker and Andrew Bailey, deputy governors of the Bank of England, have said that the leverage ratio should be imposed immediately, bringing Basel guidelines forward.

Jenkins, 52, said last month the Barclays can meet the requirement quicker than planned “with minor income effects.” The CEO announced in February that the bank will trim 1.7 billion pounds in annual expenses by 2015 and cut costs to about 55 percent of income from 71 percent in the first quarter.

Leverage Ratio

The bank could reduce the size of its 177 billion-pound repo-financing business, where securities such as Treasuries and mortgage bonds are sold with an agreement by the borrower to buy them back later, Morgan Stanley analyst Huw van Steenis wrote in a note to clients. Barclays may also cut loans to other banks or reduce its liquid asset buffer, he said.

The 3 percent leverage ratio, which aims to limit the risks to the taxpayer in a repeat of the financial crisis, would force banks to hold 3 pounds of equity for every 100 pounds of assets. Both Barclays and Nationwide Building Society, the U.K.’s largest customer-owned lender, fell short of the goal at 2.5 percent and 2 percent respectively.

The PRA gave Nationwide until 2015 to comply, allowing the mutual to avoid issuing capital that could have forced its member-owners to cede control. Jenkins suggested last month that bringing forward the leverage ratio may choke off lending.

‘Pessimistic Scenario’

Even if given until the end of 2014, Barclays may still need to sell as much as 6 billion pounds of stock because the bank, which acquired the North American business of Lehman Brothers Holdings Inc. in 2008, may be required to hold more capital by U.S. regulators, said Mike Trippitt, a London-based analyst at Numis Securities Ltd. with a sell rating on Barclays.

“Recent history suggests that the pessimistic scenario may well become the realistic scenario,” wrote Trippitt, adding that Barclays may be reticent about raising equity as the stock is trading at a discount relative to its book value.

The lender trades at 0.79 times its book value, according to data compiled by Bloomberg. Out of Britain’s five biggest banks, Edinburgh-based Royal Bank of Scotland Group Plc is the only other lender to trade below its net asset value.

With RBS trading below the government’s 407-pence break-even price, Chancellor of the Exchequer George Osborne may struggle to meet his 2010 election pledge to offer the shares to voters. The bank, which is 81 percent owned by the government, closed at 328 pence in London yesterday.

By contrast, Lloyds has increased 43 percent this year, trading above the 61-pence break-even price the government has set to start reducing its 39 percent stake in the lender. While the preference is to wait until September or October, the process could start after the lender reports first-half results on Aug. 1, according to a person familiar with the talks.

Officials at Lloyds and U.K. Financial Investments Ltd., which oversees the government stake, declined to comment.

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