It is not just bank shareholders suffering at the moment. Spare a thought for investors in Tier 1 bonds, otherwise known as hybrid capital.
As you can see from the above screen shot, Barclays is trading at 15-20 on the pound and RBS even lower. To put those figures in perspective, the same bonds were trading 30 points higher three sessions ago.
Very painful for investors then. But what is also interesting – and probably not surprising given their place in the capital structure – is what these bonds are pricing in. One way of looking at it is to consider that if you can get 1-2 years of coupons on the RBS 7.0916% 49-17, it will pay for your entire investment in the bond.
However, the market seems to be betting that either these coupons won’t be paid or that RBS will be nationalised and tier one bond holders wiped out as they were in Northern Rock.
Here’s Roberto Henriques of JP Morgan on the subject of deferrals.
We remain more cautious with regard to the outlook for more deeply subordinated capital instruments such Tier I where we remain Neutral and see increased Government intervention as adding an extra layer of uncertainty with regard to coupon deferral outcomes. Quite simply, in the event of large absolute losses for the sector, potentially there may be a move towards greater sharing of these losses across the whole capital structure, which would be negative for deeply subordinated credit investors.
Meanwhile, Jim Reid of Deutsche Bank says this presents the UK government with a difficult balancing act.
They could ensure that further nationalising of banks doesn’t lead to swathes of subordinated debt defaulting. This would keep the ailing UK pension/insurance industry much healthier. However it could lead to a big fall in Sterling and the possibility of an international buyers strike on the increased UK debt.
Alternatively they could allow mass subordinated bank defaults which could bring the pension/insurance industry to its knees but probably limit the chance of a run on Sterling. There are clearly other issues but these are the extreme macro alternatives in our view. We think the authorities will probably lean towards the former than the latter but accept that much of the UK subordinated bank paper would be worth zero under a free market.
The Government will at some point have to balance the above factors with the additional one of a general lack of desire to de-stabilise these fragile markets even more. Personally we think they want to keep much of the subordinated market alive but the bigger question may be whether the currency market let’s them. Last night Mervyn King confirmed that the BoE will be buying high quality assets within “weeks and not months”. QE is alive in the UK.
Related link:
Tier 1 capital deals suffer after government action – FT