Barclays’ fresh out of the oven contingent capital conundrum

We read that Barclays’ successfully issued $3bn in 10 years Contingent Capital Notes, with a coupon of 7.625%. Under the terms of the deal, that the bonds will be automatically written down to zero if the bank's Common Equity Tier 1 ratio falls below 7% of its risk-weighted capital.

We also read some estimates of that Barclays’ would have to lose about $16bn in capital before falling under the 7% trigger.

But, losing capital is not the only way this sort of trigger can be pulled in a risk-weighted world. Suppose Barclays’ management, next month, brings to the board the following proposal which includes an important shift of bank assets:

Management proposal to the Board of Director of Barclays

Friends, you know that one of the very few possibilities our dear Britain has to pull out of its current doldrums is to allow the small businesses and entrepreneurs to help out more. And in this respect we have now decided to try to do our part and sell a substantial amount of our UK government debt and instead invest these funds aggressively in small and well analyzed loans to our more risky daring and risk-taking community.

But, and here is the question, since UK government debt carries a risk-weight of zero and these small businesses and entrepreneurs have a risk-weight of 100% doing the above would cause our Common Equity Tier 1 ratio to fall below 7% and therefore trigger what converts into a zero liability our recent contingent capital notes issue. What are we to do?

The bondholders would clearly hate it but from the perspective of the shareholders this would imply an immediate very real profit of $3bn that, though we have to sort out the tax implications, can undoubtedly come in real handy. On a side note we are also checking on whether this extraordinary liability write down profit signifies having to pay higher bonuses to those who brought us the contingent capital notes’ deal.

An alternative we are also exploring is to see if the regulators, even if on a just a short term basis, would increase somewhat the risk-weights on all what is currently weighted between zero to and 20 percent. For instance a risk weigh of only 10 percent on UK public debt would probably suffice to trigger. For anyone of you who could worry about what that would mean to our UK public debt exposure, that would still mean we need to hold less than 1 percent in capital against UK public debt, which means that we could still leverage our capital more than a hundred times with UK public debt. Unfortunately, our first contacts with regulators about this possibility have not been very productive. It seems they feel a bit uncomfortable with the idea of them taking the blame for the fall of the bondholders.

We leave now this decision entirely in your hands though of course it is an appropriate moment to remind all that we owe ourselves primarily to our nation and our shareholders and of the fact that we are paying a not so insignificant coupon of 7.625% on those notes. 

Signed: The management 

Question: Would that not be the mother of the hot potatoes?

PS. The profitable trigger pull could also be caused by changes in accounting criteria… ours or theirs.

PS. This is a comment on which I sincerely hope I am profoundly mistaken in my analysis, and would love to hear an explanation about how it will really work.