Market eyes RBS's costly capital pile

By Aimee Donnellan

LONDON, Sept 15 (IFR) - Royal Bank of Scotland (LSE: RBS.L - news) could be gearing up to launch a bumper exchange of Tier 1 bonds in the coming year in a bid to reduce its overall capital charges, according to analysts at Morgan Stanley (Xetra: 885836 - news) .

RBS, 81%-owned by the UK government, has £9.4bn of non-core Tier 1 capital representing 2.4% of risk weighted assets - well above the 1.5% regulatory minimum.

"This excess capital is of little use unless it'll fill a GLAC bucket," said Morgan Stanley analysts.

GLAC, Gone-Concern Loss Absorbing Capacity, is a buffer which Tier 1 bonds can fill, although Tier 2 and senior unsecured debt is far cheaper, and should count as GLAC.

Therefore RBS's excess of costly capital could prompt the bailed out lender to exchange up to £6bn of Tier 1 for £2bn worth of AT1 bonds that the bank plans to issue next year.

"Just like Lloyds used its expensive ECNs to generate compliant AT1, RBS could use its expensive legacy T1s," Morgan Stanley analysts said.

Back in March, Lloyds Banking Group targeted 33 series of euro, sterling, and US dollar Enhanced Capital Notes with £8.4bn-equivalent outstanding for exchange. As a result of the offer, the borrower printed £5.4bn-equivalent of new, higher risk, AT1 bonds.

Unlike Lloyds, however, RBS does not have the regulatory par call to wield over investors, indicating the terms of the exchange are likely to be very attractive to investors.

Barclays (LSE: BARC.L - news) is the other UK bank to have used the liability management route back in June to transition its old capital instruments into the new world of hybrids. It offered to exchange some £3.7bn-equivalent of hybrid Tier 1 debt into new AT1 issues.

The Morgan Stanley analysts are expecting a minimum three-point premium on the target bonds.

Some of RBS's subordinated debt has been under pressure over the past week, hit by the uncertainty surrounding the Scottish election. The 5.5% Tier 1 for example dropped around 4 points last Monday, but has recovered since and is now about 2.5 points off the June highs. All the other bonds are quoted above par, according to Tradeweb.

"Given the high 'excess' in Tier 1s, the generally high cost of their coupons, the fact that £5.5bn of them are trading below par and £2bn of them have first call dates only in late 2017 or after, we think RBS is likely to announce a redemption through a LME for many of them in the coming year," said the Morgan Stanley analysts. (Reporting by Aimee Donnellan; Editing by Helene Durand and Julian Baker)