Nationwide’s Additional Tier 1 trailblazer: deal terms unpicked

Author: Gemma Varriale | Published: 11 Mar 2014
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The UK lender’s debut AT1 issuance closed today, breaking new ground in the hybrid debt market. Here’s how it was structured

Nationwide today became the first building society to structure a sterling Additional Tier 1 (AT1) bond. The deal is expected to set a template for how non- joint stock banks can enter the hybrid market.

Additional Tier 1 (AT1) is a form of loss-absorbing capital that can be written down or converted into equity if a firm runs into trouble.

As a mutual, Nationwide has no equity into which the bonds can convert. Because of this, the development of a new instrument known as core capital deferred shares (CCDS) was crucial to the UK lender’s entrance into the market.

"A core capital deferred share [CCDS] is an equity instrument that behaves like a corporate share and so counts as common equity Tier 1 under the new European capital rules in force in the UK," said Jonathan Mellor, a partner with Allen & Overy in London. "A lot of work went into developing that instrument, with Nationwide ultimately issuing the shares in December last year."

The bonds will automatically convert into CCDS if Nationwide’s ratio of common equity Tier 1 to risk weighted assets drops below seven percent.

According to Mellor, the unique issue was working out the conversion mechanics and what events might lead to an adjustment to the conversion price. These issues had not been thought about before in the context of a building society.

Key deal terms at a glance

  • Description: reset perpetual contingent convertible Additional Tier 1 capital securities
  • Capital Treatment: AT1
  • Coupon amount: seven percent
  • Closing date: March 11 2014
  • Transaction size: £1,000,000,000
  • Maturity: perpetual
  • Denomination: £100,000 and higher integral multiples of £1000 in excess thereof
  • Rating – Fitch: BB+ (EXP)
  • Rating - Standard & Poor’s: BB+ (EXP)
  • Listing: SIX Swiss Exchange
  • Tax residency: UK
  • Governing law: English
  • Call option: June 20 2019
  • Subordination: ranks junior to claims of creditors, pari passu among themselves, and senior to all claims under any deferred share
  • Point of non-viability: this is governed by the EU Bank Recovery and Resolution Directive (BRRD). The draft BRRD contains a power allowing resolution authorities to write-down or convert capital instruments to ensure they fully absorb losses at the point of non-viability. The draft directive is due to be implemented across the EU by December 31 2014, with the BRRD non-viability loss absorption provisions becoming effective as of January 1 2015.

A new market for bank capital

The deal is also significant because it marks the first sterling-denominated AT1 bond. With Nationwide reportedly deluged with over £9 billion worth of demand, the deal’s success has opened up the possibility of other European financials diversifying into new currencies.

"While it appears to have come out quite tight, the bond has performed well and now trades at about 6.5%," one source at a major European bank told IFLR.

"The performance of the instrument may suggest that there is a natural market for sterling AT1s although we also have to look at the strong current market," they added. "The hunt for yield continues, which partly explains the performance."

"The performance of the instrument may suggest that there is a natural market for sterling AT1s"

The investor base for contingent convertible bonds (CoCos) has grown dramatically since its modest beginnings, when hedge funds and wealthy private banking customers dominated the market.

"Now more European real money accounts are involved which makes the UK market very appealing for a potential issuer," said the market-insider. "Santander for example, given its strong UK presence, is certainly a likely candidate at one point."

The offering circular is available here.

The deal closed on March 11. Citigroup Deutsche Bank, RBS and UBS were the joint book-runners. Allen & Overy advised Nationwide. Linklaters advised the joint book-runners.

Further reading:

2014: the year of AT1

How Moody’s may change CoCo ratings

Necessity is the mother of CoCo invention

New rule could make UK a CoCo tax haven