Coventry puts new spin on Additional Tier 1

By Helene Durand

LONDON, June 20 (IFR) - Coventry Building Society this week successfully raised Additional Tier 1 debt that converts into something that does not yet exist, but the nature of the credit could make it hard for other issuers to replicate the structure.

The UK lender priced a £400m perpetual non-call 5.5-year issue that converts into Core Capital Deferred Shares (CCDS) if its Common Equity Tier 1 ratio falls below 7%. However, unlike Nationwide Building Society, which issued CCDS before going to the AT1 market, Coventry skipped that stage.

"It was very helpful for Coventry that Nationwide (LSE: CCDS.L - news) had issued CCDS before and there was quite a lot of familiarity from the investor base around the concept," said Daniel Fairclough, FIG DCM (KSE: 024090.KS - news) at Barclays (LSE: BARC.L - news) . "The deal might have been a lot harder to pull off had it not been for investors' awareness of the product and previous investor work undertaken by the issuer."

While Coventry's CCDS are purely conceptual at this stage, the issuer has passed rule changes through its AGM providing the flexibility to issue CCDS, either on conversion of the AT1 or as standalone issuance.

"We didn't have a requirement for core equity, given that our Common Equity Tier 1 ratio stands at 22.7%," said Lorne Williams, treasurer at Coventry Building Society. "We did this deal because we wanted to raise additional capital and cover our regulatory needs going forward."

This high level of capitalisation was key to the success of the trade, according to bankers on the deal. Coventry would have to burn through £600m of capital before hitting the trigger, which is 100 times the levels of impairments it has seen during the crisis.

"Investors were genuinely impressed with Coventry's capital strength and their profitability during the crisis," said Fairclough. "This is also likely to be a one-off opportunity to buy AT1 from the issuer in the medium term."

The deal attracted more than £3.25bn of demand from 230 investors and printed at 6.375%, tighter than initial price thoughts of 6.5% area.

Final pricing offered a small pick-up over Nationwide's £1bn perpetual non-call five-year AT1 which was quoted in the low 6s. That priced with a 6.875% coupon back in March.

"It is a good price and reflects our credit and the stability of our business model," said Williams.

LEVERAGE BOOST

The transaction goes a long way towards addressing Coventry's leverage ratio, which was the main rationale for the deal, according to Coventry's treasurer.

"Additional Tier 1 is a more efficient and cost-effective way of tackling the leverage ratio," he said.

Investors welcomed Coventry's move and proactive approach to capital management.

"They could quite easily just let their leverage ratio improve organically through retained earnings but they, like us, think that the 3% minimum is not the ultimate goal of the PRA," John Magrath, partner and head of distribution at TwentyFour Asset Management wrote in a note.

"By issuing £400mm of AT1, they can boost this measure of their balance sheet by 140bp to 4.4%, taking them into the very comfortable end of the leverage spectrum, but importantly placing them nicely ahead of the 4% hurdle, which is where they feel the regulator may be going - in the US the big banks now have 5% as their hurdle."

MOVING TARGET

While the distance to the conversion trigger is large, there is more uncertainty around the cushion investors have before Coventry potentially has to defer coupon payments.

"Right now, we don't know what the countercyclical buffer is going to be and whether we will be deemed as a systemic institution," said Williams. "There is so much uncertainty around what the combined buffer requirements will be, but with a capital ratio as high as we have, we think we are a long way away from that."

Simon Adamson from CreditSights warned in a note on Friday that investors were not being compensated for the risk they were taking. "This looks very expensive, notwithstanding the domestic nature of the issue, and we do not think it offers any value."

This did not deter investors who continued to look for the bonds in the secondary market, helping the transaction to trade up to 101.25/101.5. (Reporting by Helene Durand, Editing by Julian Baker)