2014-01-28 From JPM Squaring The Circle - A Comprehensive Review of AT1 Valuation Drivers

Europe Credit Research
28 January 2014
Squaring The Circle

A Comprehensive Review of AT1 Valuation Drivers
 Using both credit and equity valuation techniques suggests that existing European Credit - Financials
AT1 instruments are, at best, fair value with certain instruments such as Roberto Henriques, CFA
AC
BBVA 9% $18P and POPSM 11.5% €18P looking outright expensive. If (44-20) 7134-1733
we take into consideration that the building block approach, a method roberto.henriques@jpmorgan.com
AC
that is increasingly used to derive AT1 valuations, has certain biases that Alan Bowe
result in a downward skew in the ‘fair value’ premium, then current (44-20) 7134-1837
alan.m.bowe@jpmorgan.com
valuation levels for the asset class become more difficult to justify from AC
Axel J Finsterbusch, CFA
a fundamental perspective. However, we note that the technical (44-20) 7134-4711
environment has favored the asset class in a search-for-yield axel.j.finsterbusch@jpmorgan.com
environment, combined with a declining opportunity set in legacy J.P. Morgan Securities plc
instruments, supporting investor demand.
 In our opinion, coupon deferral risk is not yet being factored into
valuations with AT1 trading levels currently reflecting only the buffer to
conversion rather than the buffer to the coupon deferral trigger. We
expect that with the implementation of CBR (combined buffer
requirements) in 2016 that the coupon deferral risk will have to be
increasingly priced in, suggesting a further challenge to current
valuations. Analysis of the scenarios under which coupon deferral can
occur would imply that this is likely at any point when the issuer falls
below the minimum CBR, rather than having to fall into the 1st quartile
before the MDA (maximum distributable amount) dictates a full
restriction on discretionary distributions. We highlight that the CBR
includes the countercyclical buffer in addition to the capital conservation
and any applicable systemic buffers, which can result in a relatively high
point of attachment for coupon deferral risk. In addition, we note that
Pillar II requirements for the UK banks will result in an increase in the
point where coupon deferral occurs. We also develop an equity valuation
model that produces valuation outcomes that are consistent with our
credit valuation model, reflecting the fact that both markets are driven by
common elements, namely; earnings quality/buffer volatility.
 Based on the above considerations we recommend the following trades;

1) Long SOCGEN 8.25% $18 versus short BACR 8% €20, given the
higher risks of coupon deferral for UK AT1 given Pillar II guidance, 2)
Long UCGIM 8.125% €19 versus BBVASM 9% $18, given our stated
preference for legacy Tier I, which should benefit from the issuance of
new AT1 structures, c) Long NC5 AT1 versus short NC10 AT1, given
that the phasing of CBR from 2016 will imply a lower degree of risk for
short-call AT1. From a more generic standpoint, we maintain our
preference for legacy Tier I must-pay dated Coco structures versus AT1
at current levels.
See page 69 for analyst certification and important disclosures.

J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the
firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in
making their investment decision.
www.jpmorganmarkets.com
Roberto Henriques, CFA Europe Credit Research
(44-20) 7134-1733 28 January 2014
roberto.henriques@jpmorgan.com
Table of Contents
Executive Summary .................................................................3
Trade Ideas .............................................................................................................3
Overview .................................................................................10
Is The AT1 Asset Class Fairly Valued?.................................12
Discussion Points ..................................................................................................16
Is Coupon Deferral Risk Priced In?.......................................22
Counter Cyclical Buffer ........................................................................................25
Where deferral meets trigger risk...........................................................................27
Pillar II risks in the UK .........................................................................................28
CBR: It’s A Question of Time ...............................................................................30
Coupon Deferral Versus Contingent Loss Trigger: Which Is
Priced In? ................................................................................32
Projected CET1 and capital buffers........................................................................34
Squaring The Valuation Circle: Equity Versus Credit .........39
The Implied Cost of Equity Framework .................................................................39
Summary Terms and Conditions For AT1/Coco Structures
.................................................................................................55
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(44-20) 7134-1733 28 January 2014
Executive Summary
Trade Ideas
Both our credit and equity Using both credit and equity valuation techniques suggests that existing AT1
valuation metrics would tend to instruments are, at best, fair value with certain instruments such as BBVA 9% $18P
suggest that the AT1 valuations and POPSM 11.5% €18P looking outright expensive. As such, we have a preference
look increasingly challenging to
justify
for alternative parts of the capital structure, such as legacy Tier I or, alternatively,
must-pay dated Coco structures on the basis that we think that the AT1 market
currently looks overbought. However, within the constraints of the AT1 asset class,
we note that there are some relative value opportunities; we highlight these below.
Long SOCGEN AT1 versus short BACR AT1

Given that Pillar II requirements We prefer the SOCGEN AT1 vs BACR AT1 given various technical and
for UK banks will result in a fundamental factors. One of the most important drivers of longer-term value in these
higher absolute trigger level for instruments is how the buffer to first loss will develop over time. We highlight that,
coupon deferral risk, we see a
higher risk profile for UK AT1
for BACR, there is likely to be a negative catalyst with regard to regulatory guidance
versus that of continental peers on the positioning of the Pillar II buffer requirement in the capital stack. To this
extent, we note that the PRA is currently expecting to place the Pillar II buffer (of
which 56% would have to be met with CET1) below the CBR (combined buffer
requirement), which would, in effect, raise the core solvency level at which a
mandatory deferral trigger could be reached versus other European issuers, with
these more likely to be able to meet Pillar II requirements with total capital. While
we believe that this is a more relevant risk for the longer dated BACR AT1, given the
phasing in of the CBR from 2016 onwards, we would see this as a negative catalyst
for UK bank AT1 as a whole.
While SOCGEN is likely to have We highlighted the expected level of AT1 issuance for 2014 in our publication,
met its 2014 AT1 issuance Primary Considerations: Financials Sector Outlook 2014. We noted that SOCGEN
requirement, we think there is a would have met its 2014 requirement with its current outstandings, however Barclays
higher probability of further
supply from BACR
could potentially have a need for further issuance to ensure it is comfortably above
minimum leverage ratio requirements. We note that Barclays has a legacy non-step
instrument that is due for call this year and our current assumption is that the issuer
will conduct liability management on this (and other non-steps) in order to
correspond to investors’ expectations. As such, we note more favorable supply
demand dynamics in SOCGEN.
Figure 1: JPM Equity Fair Value Yield Versus Current AT1 Yields
1.10% 16%
0.80% 12%
0.50% 8%
0.20% 4%
-0.10% 0%
BBVA Popular Barclays SocGen Credit Suisse Credit Agricole
Differential (left axis ) AT1 fair valued YTC (right axis) AT1 current YTC (right axis)
Source: Bloomberg, Company reports and J.P. Morgan estimates.
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Lastly, we note that our equity valuation model suggests that SOCGEN AT1 is
currently cheap to its equity valuation whereas the BACR AT1 is expensive, see
Figure 1. We highlight that BACR has recently tapped the equity markets and, as
such, the scope for upside surprise in the Barclays AT1 via a further capital raising
exercise would be relatively limited.
Long UCGIM 8.125 €19P T1 vs BBVA 9.0 $18P AT1

We add the UCGIM 8.125% €19P Our fair value model suggests that, in general, legacy instruments are cheap relative
to our model portfolio, we are to AT1 instruments. Specifically, we prefer to be long the legacy instruments of
already short BBVA 9% vs institutions we believe may tap the AT1 market, as we expect to see spread
SOCGEN which we will maintain
compression in the capital structure caused by the positive news of market access.
Additionally, the legacy instruments benefit from having an additional tranche of
deeply subordinated instruments in the capital structure which serve as additional
protection against downside loss. As per our 2014 outlook publication, UCGIM was
one of the issuers that were referenced (among ACAFP, SOCGEN, DB and BACR)
as having a requirement to issue AT1 in 2014. As such, we believe that the issuance
of an AT1 would be supportive of legacy Tier I valuations. We believe the catalyst is
likely over the short term following the approval of the Italian Stability Bill for 2014,
which paves the way for favorable tax treatment for AT1 instruments in Italy.
Furthermore, our analysis of UCGIM highlights that its buffer would be sufficient to
price an AT1 instrument at reasonable levels comparable to other AT1 issuers.
Figure 2: UCGIM Minimum Buffer To First Loss

8.0%
140%
7.0%
120%
6.0%
5.0% 100%
4.0% 80%
3.0% 60%
2.0% 40%
1.0% 20%
0.0% 0%
2014 2015 2016 2017 2018 2019
Expected MtM Loss Potential LGD Minimum buffer to first loss
Source: J.P. Morgan estimates.
Table 1: Current Tax Status of AT1 Structures

Country Tax Status Comment
France Deductible Instruments already in issue
Spain Deductible Instruments already in issue
Under an amendment to the Italian Stability Bill for 2014 (approved on the 16th Dec 2013) the write-down/conversion of
instruments will not be taken into account for tax purposes (allowing full notional to count as capital). Furthermore the amendment
Italy Expected deductibility clarifies the full deductibility of remuneration of the instruments (regardless of accounting treatment)
The Dutch Deputy Minister of Finance on 16 December 2013 announced that banks will be able to deduct, for tax purposes, the
Netherlands Expected deductibility returns realized on “additional Tier 1 capital” even if issued after 1 January 2014.
Portugal Expected deductibility Have had previous domestic impediments requirement an expected legislation amendment
Germany Expected deductibility Withholding tax problem, however no issue with tax deductibility
Belgium Expected deductibility Likely to come in the format of capital writedown but no outstanding problems
UK Expected deductibility Tax bill to be finalised by year end with drafts showing specific tax deductibility for AT1 instruments
Source: J.P. Morgan. Clifford Chance, KPMG
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We think BBVASM AT1 is expensive as Figure 1 highlights, having the highest

differential between the fair-value yield and the current yield for the universe of
instruments to which we applied our equity valuation model. Interestingly enough,
the output of our credit valuation model suggested that the BBVASM AT1 was at
best fair-value. If we had to incorporate an additional premium into the BBVASM
AT1 valuation for a lack of coupon protection features, then it would likely appear
expensive on our credit valuation model.
The Valuation Verdict

Our building block approach is In order to establish a theoretical fair value for AT1 structures, we aim to use at least
modular given that we can use a one legacy instrument in the building block process, which allows us to determine
multitude of starting points in whether investors are being sufficiently compensated for the incremental risks in
order to derive a fair value for an
AT1 structure
AT1versus legacy instruments. This approach is quite modular in the sense that we
can use a multitude of starting points for our analysis based on the range of existing
legacy instruments for the issuer, thereby building a comprehensive picture of the
theoretical fair value for an AT1 instrument, rather than just relying on one isolated
valuation point. In this report, for brevity, we have included only one or two building
block methods per instruments. However, we highlight that the tool box can be used
to help price from multiple starting points.
Our analysis suggests that the AT1 instruments are, at best, fair value on the
assumption that there can be ±30bps fluctuation in pricing from market
technicals. Our analysis would highlight POPSM 11.5% and BACR 8% as the
most expensive compared to legacy instruments, something that our equity-
based analysis would also corroborate.
Table 2: Output of the Building Block Valuation Approach

Trading Buffer to Buffer to
Spread JPM Fair Cheap Q3 2013 conversion conversion 5yr Sub
ISIN AT1 (bp) Value (bp) /(Expensive) FL CET1 vs FL (%) vs FL ($bn) CDS
XS0989394589 CS 7.5 USD 23P 384 445 -60 10.2% 8.1% 23.3 102
XS0867614595 SOCGEN 8.25 USD 18P 466 518 -52 9.9% 4.8% 23.0 147
USF8586CRW49 SOCGEN 7.875 USD 23P 478 541 -63 9.9% 4.8% 23.0 147
USF22797RT78 ACAFP 7.875 USD 24P 482 519 -37 8.3% 3.2% 14.1 148
US06738EAA38 BACR 8.25 USD 18P 538 567 -30 9.6% 2.6% 19.3 131
XS0926832907 BBVA 9 USD 18P 569 571 -1 9.4% 4.3% 19.0 170
XS1002801758 BACR 8 EUR 20P 573 654 -81 9.6% 2.6% 19.3 131
XS0979444402 POPSM 11.5 EUR 18P 749 884 -135 8.6% 3.5% 4.0 270
We note a high degree of We note that most of the AT1 instruments lie on a line of ‘best fit’ in Figure 3 which
correlation between the AT1 takes into consideration the size of the buffer to the contingent loss trigger event,
market level and size of the which is either conversion or writedown. This would tend to suggest that this is, for
buffer to the contingent loss
event
now, the primary driver in terms of how investors perceive the risk profile of the
asset class and, as a result, the level of premium that they require to remain invested
in AT1. We note, however, that POPSM sits quite far off this line of ‘best fit’, which
implies that the market is taking other factors into consideration in its evaluation of
the risk profile of the AT1. In our opinion, this can be explained by the implied
volatility in the buffer to conversion that the market is assuming. We proxy the
implied volatility in buffer by using the 5Yr Sub CDS and we highlight that POPSM
is materially wider than the other institutions that sit on the line of ‘best fit’, which
matches buffer to current trading level. As a result, we would not assume that the
POPSM AT1 is cheap in terms of its positioning on Figure 3 and Figure 4, but rather
that the market is not only considering the size of the absolute buffer but also the
degree of potential volatility in performance for the issuer.
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(44-20) 7134-1733 28 January 2014
Figure 3: AT1 trading levels vs Fully Loaded Buffer to conversion Figure 4: AT1 trading levels, JPM Fair Value vs Fully Loaded Buffer
and 5yr sub CDS to conversion and 5yr Sub CDS
900 900
Potential line for issuers
which higher expected Potential line for issuers
800 buffer volatility as implied 800
POPSM 11.5 EUR 18P which higher expected
by 5yr sub CDS POPSM 11.5 EUR 18P buffer volatility as implied
700 700 by 5yr sub CDS
BACR 8 EUR 20P
BBVA 9 USD 18P
600 600
BACR 8 EUR 20P BBVA 9 USD 18P BACR 8.25 USD 18P SOCGEN 8.25 USD 18P
BACR 8.25 USD 18P 500
500
ACAFP 7.875 USD 24P ACAFP 7.875 USD 24P
CS 7.5 USD 23P
SOCGEN 8.25 USD 18P SOCGEN 7.875 USD 23P
SOCGEN 7.875 USD 23P 400
400
CS 7.5 USD 23P
300
300
0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0%
0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0%
AT1 Trading price (area is 5yr sub CDS) Line of best fit (Tier I banks) Line of best fit (Tier II Banks) JPM AT1 Fair Value AT1 Trading Price Line of Best fit (JPM AT1 Fair Value)
Line of best fit (Tier II Banks) Linear (AT1 Trading Price)
Source: Bloomberg and J.P. Morgan estimates. Source: Bloomberg and J.P. Morgan estimates.
Valuation Biases
While the building block While we have relied on the building block approach as the basis for valuations, we
approach is widely used, we recognize that this approach is prone to certain biases which will potentially tend to
recognize that it is prone to skew conclusions. We highlight these biases particularly in light of the fact that this
biases which will likely tend to
skew the required risk premium
approach is increasingly used by the investor community and can lead to a validation
downward for the AT1 of pricing levels that might not reflect all risks commensurately.
instruments
 Circularity: The issuance of AT1 structures will quite logically tend to support
tighter spreads across less deeply subordinated parts of the capital structure.
However, the tighter spreads across other subordinated debt instruments of the
issuer, which result purely from AT1 issuance, skew the fair value outcome for
the AT1 downwards, suggesting that the risk premium of the AT1 should also be
more reduced than would otherwise be justified.
 Tier I versus AT1 risk profile: While valuations of legacy Tier I instruments
serve as the basis for the building block approach, we note that the risk profile of
legacy Tier I is lower than that of AT1, with the latter including absolute
discretion for coupon deferral due to the lack of dividend pushers/stoppers. As a
result, this would tend to understate the premium attributable to an AT1 under the
building block approach as the incremental coupon deferral risk may is unlikely
to be fully captured.
 Legacy Basel II Subordinate Debt: The fact that legacy subordinated debt
structures are being phased out under transitional arrangements results in a
valuation skew, with the market for the most part having become ‘bid only’. As a
result of this technical factor, the valuation points that serve as inputs into the
AT1 valuation model will end up inferring this bias for an asset class where the
technical drivers are clearly different.
The sum total of the above issues would be to bias downwards the fair-value risk
premium derived by our building block approach i.e. would tend to understate the
required premium for the risks within an AT1 structure. If we combine this with
an output of the valuation approach, which seems to suggest that the existing AT1
instruments are at best value, then it would seem to suggest that without these biases,
the asset class may actually look fully valued.
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Coupon Deferral Risk

We note that current pricing on In our opinion, the mandatory coupon deferral risk within an AT1 structure is still an
AT1 structures would seem to aspect that is relatively discarded in favor of investors focusing on the absolute
suggest that the coupon deferral contingent loss trigger risk. While this might be defensible in light of the
risk is an aspect that is being
discarded with regard to AT1
implementation of the CBR from 2016 onwards, we think it should provide an
valuations insight into how valuations over the longer term can develop for the asset class, as
the risks of mandatory coupon deferral increase and become potentially the most
significant risk driver.
Figure 5: Coupon Deferral Risk: Combined Buffer Requirements Versus Available Resources
Source: J.P. Morgan.
In our opinion, any breach of the We highlight in Figure 5 that the coupon deferral risk will occur when an issuer finds
CBR is likely to imply immediate itself in what we designate the MDA (maximum distributable amount) Zone i.e.
coupon deferral outcomes as the when it is operating below the CBR. In this scenario, the issuer has to determine its
issuer is unlikely to have any
distributable resources if the
MDA in order to assess the volume of resources available for discretionary
breach of the CBR is due to a distributions. In our opinion, there is likely to be a high degree of correlation between
P&L event a scenario where the issuer is not in compliance with the CBR and a scenario where
there are no interim or full-year profits for distribution. This would tend to render the
analysis of which quartile the issuer is in relative to its overall CBR rather
superfluous, as essentially any factor applied to a negative number will inevitably
dictate a coupon deferral outcome, irrespective of which quartile the issuer finds
itself relative to the overall CBR.
We think it likely that, even when We would assume that in a scenario where the issuer has a P&L loss that takes it into
th
an issuer is in the 99 percentile, the 99th percentile, the most likely outcome would then be coupon deferral on the
a coupon deferral outcome will basis that the issuer would not have any resources available for distribution. In our
occur on the basis of the issuer
not having any distributable
opinion, the quartile in which the issuer would find itself would only be relevant in
resources the period T+1, where, following the P&L event which dictated the lack of
distributable resources and the non-compliance with the CBR, the issuer may return
to profitability but may still be operating within the MDA Zone, in which case the
quartile it is in will dictate the potential restriction on discretionary distributions.
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We also note that the interaction We also highlight that the coupon deferral event under certain scenarios becomes an
between the specific loss almost academic outcome given that the contingent loss triggers may already have
triggers and the CBR implies been deployed. In Figure 6, we highlight that the 1st quartile occurs only after the
that the coupon deferral
outcome for an issuer in the 1
st high trigger in the relevant AT1 instrument would have been triggered, thereby
quartile is largely academic for a making the MDA calculation somewhat unnecessary at that stage.
high trigger AT1 (with a 7% core
Tier I trigger) Figure 6: Where Deferral Risk Meets Trigger Risk
We highlight that Pillar II We highlight that the UK regulatory stance on the Pillar II requirements will tend to
requirements for UK banks will increase the risk of coupon deferral outcomes relative to non-UK banks. This is due
tend to increase the risk of an to the fact that, by layering the Pillar II requirements below the CBR, the attachment
AT1 coupon deferral event by
resulting in a higher point for a
point for the CBR occurs at a higher absolute point in the core Tier I capital
potential coupon deferral trigger structure, as per Figure 7.
under CBR provisions
Figure 7: Pillar IIA Charge For UK Banks Increases The Deferral Trigger For AT1 Instruments
Having Pillar IIA charge between the

minimum capital requirements and the
Tier 2 combine buffer requirements increases Tier 2
the attachment point for the deferral
Additional Tier 1 trigger, given that 56% of the Pillar II Additional Tier 1
will need to be CET1
Bank's Own Buffer Bank's Own Buffer
Systemic Buffer Pillar 2
Countercyclical Currently there is no Systemic Buffer
Buffer expectation that the rest of the Countercyclical
European Member States will Buffer
Capital move the Pillar II charge, or
Conservation demand that it would be met Capital
Buffer with CET1 capital. Conservation
Pillar 2 Buffer
Common Equity Common Equity

UK Banks will have to disclose the Pillar
Tier I Tier I
II charge in order for investors to clearly
determine where the deferral trigger is.
Deferral Trigger (UK) Deferral Trigger (EU)
Source: J.P. Morgan. *For illustration purposes we have assumed that the banks have fully met their minimum capital requirements
with the optimal capital structure, i.e. 4.5% CET1, 1.5% AT1 and 2.0% Tier II, as such we have ordered the requirements in order of
subordination.
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Debt Versus Equity Valuation Frameworks

While, intuitively, AT1 yields and While the ‘sum of the parts’ approach offers a relatively robust valuation framework
the cost of equity should be in we highlight that many of the AT1 risks, in particular cash-flow uncertainty, are
line, we develop a valuation unique and legacy Tier 1 instruments fail to fully reflect the incremental deferral risk
framework that seeks to
understand the driver of any
of the new structures. Moreover, the issuers’ discretion on coupon payments and the
potential differential between conversion/write-down risk brings the risk and return profile of AT1 bond closer to
AT1 yields and the cost of equity that of equity instruments. Given the relatively similar risk and return profile of both
instruments, our preconception was that AT1 bonds and equity instruments would be
priced at broadly similar levels. However, market data suggest that while there is a
positive correlation between AT1 yields and the implied cost of equity, some issuers
show AT1 yields quite significantly below the cost of equity. As both instruments
may have different sensitivity in the event that an institution needs additional capital
(equity instruments will tend to price earlier dilution risk) or improving fundamentals
(AT1 return is intrinsically limited by the state coupon rate), we may see a different
degree of compression between the AT1 yields and the cost of equity. Hence, we
look at the underlying factors that could potentially explain the wide range to
dispersion that we observed between AT1 yields and the implied cost of equity.
The implied cost of equity (ICOE) is driven by expected profitability and the
market’s own assessment of the expected earnings cash-flows. The more
subordinated nature of equity instruments implies that share prices must necessarily
show a greater variability than AT1 yields. By modifying the Gordon Growth model,
we can replicate AT1 yield’s behavior to account for its lower degree of convexity
and the fact that lower-rated issuers necessarily pay a premium relative to higher-
rated peers. In turn, this valuation framework can be used to derive fair value AT1
yields, which are highlighted in Figure 8 along with current yields and the resulting
differential to our derived fair value.
Figure 8: Equity Valuation Framework Output Versus Current AT1 Yields
1.10% 16%
0.80% 12%
0.50% 8%
0.20% 4%
-0.10% 0%
Our equity valuation approach Similar to the fair value estimates based on the ‘sum of the parts’ approach, the
delivers a result consistent with implied cost of equity framework suggests that most instruments are 20-10bp above
that of the building block the fair valued levels. However, this alternative valuation approach shows that
approach, which underlines the
fact that both models are
BBVASM 9.0% is outright expensive while the SOCGEN 8.25% would be
essentially driven by earnings moderately cheap. While we acknowledge that the relatively similar valuation output
quality/capital buffer derived from using alternatives models may come as a surprise, we highlight that
each of these approaches relies on earnings quality/capital buffer volatility as a key
input, which both share a relative similar risk and return profile across both the
equity and credit markets.
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Overview
We expect an active primary Given our expectation of continued strong growth in the AT1 asset class, we review
market for AT1 in 2014 with an the valuation levels of the existing structures and analyze the risk factors that are
estimated €31bn of issuance likely to drive valuations going forwards. In our Primary Considerations: Financials
driven mainly by the requirement
to comply with the 3% leverage
Sector Outlook 2014 publication, we were estimating a total €74bn of AT1 issuance
ratio, as well as the CRD IV from a peer group of 25 European banks, with these requirements being driven by a
capital structure (1.5% of RWA) combination of leverage ratios as well as CRD IV requirements. More specifically,
for 2014, we were estimating total issuance of €31bn, as per Figure 9. We highlight
that the drivers of AT1 issuance will vary between core and periphery, with the
former being driven by the leverage requirement whereas peripheral banks will be
more focused on meeting the 1.5% CRD IV requirement after having aggressively
liability managed their legacy Tier I instruments during the crisis, thereby depleting
the stock of non-core Tier I instruments. We note that AT1 issuance to date has
tended to be driven by core banks, which are striving to meet the 3% minimum
leverage requirement.
Figure 9: Expected Issuance For CRR Requirement (1.5% Tranche) Figure 10: Expected Issuance To Meet Leverage Ratio Requirement
€Bn €Bn
7,000 35,000.
6,000 30,000.
5,000
25,000.
4,000
3,000 20,000.
2,000 15,000.
1,000 10,000.
0
5,000.
CMZB
BKTSM
PMIIM
SABSM
UBI
BES
MONTE
BANKIA
ISPIM
HSBC
UCGIM
SANTAN
KBC
BCP
BPIM
SOCGEN
BNP
BBVA
0.
MONTE CMZB* RBS BANKIA SOCGEN BNP SANTAN BARC DB ACAFP
3.5% Lev Ratio 4% Lev Ratio
Source: J.P. Morgan. Source: J.P. Morgan.
In our opinion, the revised Basel We believe the changes from our current interpretation1 of CRR leverage to Basel
guidance on the leverage ratio Jan 2014 leverage have less of an impact than the changes from the June 2013
requirement will not materially consultation from Basel to Jan 2014. While there have been concessions made with
affect our AT1 issuance
requirement estimates
regard to more granularity for off balance sheet exposures, there is also more
conditionality attached to the ability to use master netting agreements for securities
financing, which will likely mitigate the concessions given on the off balance sheet
exposures. Ultimately, while we don’t have the disclosure to determine the true
impact of the new Basel leverage proposals if they were to enter regulation
unchanged, we do not believe it will materially change our AT1 forecasts for meeting
a minimum leverage ratio given our target of 3.5% (i.e. 50bp buffer over minimums).
1
The difference between final Basel framework Leverage Ratio (LR) vs CRR LR depends largely on the interpretation of
how much Securities Financing Transactions netting is permitted under CRR (there are divergent views). Basel makes it
clear only cash payables and receivables may be netted (which could be broadly equivalent to IFRS netting), along with a
further add-on for counterparty credit risk (CCR). CRR can be read to mirror that, or alternatively to allow a much
broader scope of netting without a CCR add-on. But this factor may be mitigated by the concessions for variation margin
and clearing activities in Basel.
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Greater clarity on the tax We highlight that one of the aspects that could influence the supply of AT1 during
efficiency of coupons in certain the course of 2014 will be the greater degree of clarity with regard to the tax
jurisdictions will be a necessary treatment of coupons. While there has been some progress made in some countries
condition for issuance from
certain institutions that have
where we have seen issuance, we note that there are still some jurisdictions where we
already provided guidance on are still awaiting clarification. We highlight that, in addition to the non-dilutive
AT1 issuance, such as DB nature of the AT1 structure, the tax efficiency of the structure is an equally important
consideration for the issuer. We summarize the current status of the most important
jurisdictions with regard to clarity on the tax efficiency of coupons.
Table 3: Current Tax Status of AT1 Structures

Country Tax Status Comment
France Deductible Instruments already in issue
Spain Deductible Instruments already in issue
Under an amendment to the Italian Stability Bill for 2014 (approved on the 16th Dec 2013) the write-down/conversion of
instruments will not be taken into account for tax purposes (allowing full notional to count as capital). Furthermore the amendment
Italy Expected deductibility clarifies the full deductibility of remuneration of the instruments (regardless of accounting treatment)
The Dutch Deputy Minister of Finance on 16 December 2013 announced that banks will be able to deduct, for tax purposes, the
Netherlands Expected deductibility returns realized on “additional Tier 1 capital” even if issued after 1 January 2014.
Portugal Expected deductibility Have had previous domestic impediments requirement an expected legislation amendment
Germany Expected deductibility Withholding tax problem, however no issue with tax deductibility
Belgium Expected deductibility Likely to come in the format of capital write down but no outstanding problems
UK Expected deductibility Tax bill to be finalised by year end with drafts showing specific tax deductibility for AT1 instruments
Source: J.P. Morgan. Clifford Chance
The Thorny Issue of Valuations

Given that the AT1 market is still a nascent asset class, with valuation principles
being defined potentially more by technical factors than intrinsic risk factors, we
look at addressing a series of questions in this publication, which will give a more
holistic view of valuation. The issues surrounding valuations are all the more
pertinent given that the AT1 structure has a fairly unique set of risk drivers and
characteristics, making straight-forward relative value considerations more complex.
The question of valuations has further been exacerbated by the performance of many
debut issuers in this space, creating uncertainty with regard to the value proposition,
which remains at current levels. We will therefore sequentially answer the following
questions in order to build a better understanding of the AT1 valuation conundrum.
 Is the AT1 asset class fairly valued?
 Is coupon deferral risk priced in?
 How are combined buffer requirements going to be defined?
 To what extent is the market pricing in coupon deferral risk versus

contingent loss trigger risk?
 What relationships can we establish between the equity and AT1 market to
test valuations?
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Is The AT1 Asset Class Fairly Valued?

Our starting point on valuation is Given the robust performance of the AT1 asset class since inception, we review
the building block approach current valuation levels using a building block approach. Essentially, the building
whereby we synthetically block approach involves synthetically building in the separate risk options in an AT1
replicate the AT1 risk structure
using market inputs
by inferring them from existing markets where contingent loss options on dated,
plain vanilla host instruments are valued. After having derived a market value for the
contingent loss option, the theoretical fair value for an AT1 is derived by adding the
premium to a plain vanilla, legacy Tier I structure of the issuer, thereby deriving the
theoretical fair value of an AT1 structure. By using a consistent set of inputs in this
valuation process, we can achieve an output that will allow for relative value
recommendations. In order to determine a fair value for the AT1 instruments, we
begin by revisiting the building block approach give the relatively widespread
utilization of this methodology. We highlight that the valuations we show in this
report use only one/two build up approach per bond for simplicity; however, we
believe that investors can achieve a better proxy for fair value the more approaches
they take with regards to the building block approach.
Our ‘tool box’ permits us to price In Table 4, we present the general ‘tool box’ we have used when carrying out the
the incremental risk in switching building block approach. Due to the ability to price subordinated risk at multiple
between subordinated debt points on a relatively liquid basis, we have used Sub CDS to help make credit and
structures with different risk
profiles
curve adjustments between institutions. In the Appendix on page 49, Table 25
highlights the methodology behind our calculations in Table 4. We note that these are
not static calculations and will fluctuate with market conditions given they are
effectively derived from market prices. This dynamic model allows us to price in the
incremental risk premium required by the market to switch between different types of
AT1 structure. Interestingly, the spread to move from 5% write-down to a 7% write
down is currently more than the spread compensation to do the same move with an
equity conversion feature. This would seem intuitive given a write-down option at
7% would materially worse than an equity conversion option at 7%.
Table 4: JPM Toolbox for pricing AT1 instruments using the building block methodology
Tools 3yr Sub 5yr Sub 7yr Sub 10yr Sub
UBS CDS 64 102 123 137
CS CDS 54 100 119 130
BARC CDS 88 147 178 195
SOCGEN CDS 75 131 162 178
ACAFP CDS 86 148 180 197
BBVA CDS 115 170 198 213
ISPIM CDS 134 187 222 243
POPSM CDS 270
Adjust 10yr bullet to a 10NC5 Coco (BARC) 135
5% write-down to 5% equity convert (CS 5yr) -14
7% write-down to 7% equity convert (CS 5yr) -28
5% to 7% convert (CS 5yr) 7
5% to 7% write-down (UBS 5yr) 21
Inserting 7% phase-in trigger write-down 10NC5 (BACR) for >400bp buffer 156
The market’s preference among We observe from our ‘tool box’ that the market prefers equity conversion features at
AT1 structures is unequivocally a low strike followed by equity conversion features at a high strike, with this relative
for high-strike, equity preference being indicated by the scale of the premium demanded by investors for
conversion options, which
demand the lowest premium,
switching between these structures. This intuitively makes, sense given our
ceteris paribus assumption about the PONV (point of non viability) likely to occur marginally below
the 7% trigger, thereby implying that a 5% write-down instrument is not materially
better than a 7% write-down instrument in terms of contingent loss profile. Further,
12
(44-20) 7134-1733 28 January 2014
we highlight our assumption that there is an immaterial difference between a 5%

trigger and a 5.125% trigger and, as such, in all the calculations found in the
appendix on page 49, we have treated 5% and 5.125% as interchangeable.
Limited differentiation between contingent risk features

We highlight graphically in Figure 11 that the incremental premium investors are
effectively demanding for a 7% write-down instrument versus a 5% equity
conversion feature is effectively 35bps (currently). This could suggest that issuers
have a relatively cheap option to issue high-trigger writedown structures relative to
low-trigger AT1 equity conversion instruments, with the former being a structure
which will be more closely aligned with the strategic interests of investors given its
non-dilutive nature. Furthermore, the premium demand by investors to allow issuers
to be aligned with “best practice” by issuing high trigger structures is arguably quite
reduced with an average incremental premium of only 14bps to issue high trigger
relative to low trigger.
Figure 11: Graphical interpretation of trigger features in instruments
Source: J.P. Morgan estimates. numbers in basis points
JPM building block approach

The building block approach is In order to establish a theoretical fair value for AT1 structures, we aim to use at least
quite modular in the sense that one legacy instrument in the building block process, which allows us to determine
we can use a multitude of whether investors are being sufficiently compensated for the incremental risk versus
starting points for our analysis,
thereby building a
legacy instruments. This approach is quite modular in the sense that we can use a
comprehensive picture of the multitude of starting points for our analysis, based on the range of existing legacy
theoretical fair value of an AT1 instruments for the issuer, thereby building a comprehensive picture of the theoretical
instrument fair value for an AT1 instrument, rather than just relying on one isolated valuation
point. In this report, for brevity we have included only one or two building block
methods per instruments however, we highlight that the tool box can be used to help
price from multiple starting points.
In Table 5, we take the example of ACAFP 7.875% USD 24P starting from the
legacy PNC5 8.2% EUR T1 issued in 2008. The first step is to adjust the bond for the
difference in duration and we do this using the subordinated CDS curves (arguably
this could underestimate the risk for extending from 5yrs to 10yrs in an AT1, but we
13
(44-20) 7134-1733 28 January 2014
believe this will likely be a residual factor). Any currency differences are then
adjusted for using the cross currency spread (Bloomberg function “XCF”). We then
add the contingent feature as the next step in synthetically building up to construct
the AT1 valuation. In our building block model for institutions that have a >400bps
buffer between the trigger and current fully loaded CET1, we believe it is justifiable
to use the phase-in trigger calculated in our toolbox as a good estimate for the risk
premium for a contingent trigger. We adjust the contingent feature for a credit
adjustment using the relevant subordinated CDS spreads.
Table 5: Building block example: ACAFP 7.875% USD 24P

ACAFP 7.875 USD 24P Calc
USF22797RT78
From legacy instrument
PNC5 T1 8.2% EUR 254
duration adjustment 1.33
ACAFP PNC10 T1 EUR 338
EUR-USD xccy spread 5yr adj 8.6

ACAFP PNC10 T1 USD 347
Insert 7% phase-in trigger writedown 10NC5 (BACR) 156

BACR/ACAFP credit adj (ratio) 1.11
ACAFP 7% write-down 172
ACAFP PNC10 T1 USD 7% write-down 519
Lack of pusher xx
Trading Price 482

FV differential -37
In our building block valuation We highlight that we have treated both writedown instruments at 5.125% and
approach, we do not adjust for writedown/write-up instruments as equivalent. This is based on our view that the
the lack of coupon protection PONV will occur above the trigger level of 5.125% and, as such, any feature of a
features in AT1 (dividend
stoppers/pushers) relative to
temporary nature will become permanent due to the overriding statutory capital
legacy Tier I, partly due to the writedown law contained within the Resolution and Recovery Directive (RRD) for
timing of the CBR phase-in from European Banks. Finally, we highlight that we have derived our fair value estimate
2016 assuming there is no compensation for the lack of pusher in the AT1 instrument
versus the old legacy T1 instrument. We would argue this is incorrect, however we
can understand, given the time frame for increased deferral risk (increasing from
2016), that investors may attribute a relatively low risk premium to the lack of
coupon protection features. This may, however, become a more important risk factor
for longer dated AT1 instruments which should effectively be discounted with higher
risk premiums in their latter years where coupon deferral risk is likely to have
increased significantly.
Table 6: Building Block Output

Trading Buffer to Buffer to
Spread JPM Fair Cheap Q3 2013 conversion conversion 5yr Sub
ISIN AT1 (bp) Value (bp) /(Expensive) FL CET1 vs FL (%) vs FL ($bn) CDS
XS0989394589 CS 7.5 USD 23P 384 445 -60 10.2% 8.1% 23.3 102
XS0867614595 SOCGEN 8.25 USD 18P 466 518 -52 9.9% 4.8% 23.0 147
USF8586CRW49 SOCGEN 7.875 USD 23P 478 541 -63 9.9% 4.8% 23.0 147
USF22797RT78 ACAFP 7.875 USD 24P 482 519 -37 8.3% 3.2% 14.1 148
US06738EAA38 BACR 8.25 USD 18P 538 567 -30 9.6% 2.6% 19.3 131
XS0926832907 BBVA 9 USD 18P 569 571 -1 9.4% 4.3% 19.0 170
XS1002801758 BACR 8 EUR 20P 573 654 -81 9.6% 2.6% 19.3 131
XS0979444402 POPSM 11.5 EUR 18P 749 884 -135 8.6% 3.5% 4.0 270
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We highlight that for Barclays AT1s we have assumed an incremental charge of

75bps due to the fact that the buffer to fully loaded CET1 ratio is materially smaller
i.e. <400bps versus peers, which results from the UK regulator’s more aggressive
stance with regards to the transitioning of CRD IV requirements. We have applied
the same charge to both BACR AT1 instruments (8.25% 18P and 8% 20P). We
chose 75bp to place the instruments either side of the AT1 curve in Figure 12. We
highlight that this charge can be effectively decreased as the BACR AT1 moves
along the curve and BACR increases the buffer to conversion
Figure 12: AT1 trading levels vs Fully Loaded Buffer to conversion Figure 13: AT1 trading levels, JPM Fair Value vs Fully Loaded Buffer
and 5yr sub CDS to conversion and 5yr Sub CDS
900 900
Potentialline for issuers
which higher expected Potentialline for issuers
800 buffer volatility as implied 800
POPSM 11.5 EUR 18P which higher expected
by 5yr sub CDS POPSM 11.5 EUR 18P buffer volatility as implied
700 700 by 5yr sub CDS
BACR 8 EUR 20P
BBVA 9 USD 18P
600 600
BACR 8 EUR 20P BBVA 9 USD 18P BACR 8.25 USD 18P SOCGEN 8.25 USD 18P
BACR 8.25 USD 18P 500
500
ACAFP 7.875 USD 24P ACAFP 7.875 USD 24P
CS 7.5 USD 23P
SOCGEN 8.25 USD 18P SOCGEN 7.875 USD 23P
SOCGEN 7.875 USD 23P 400
400
CS 7.5 USD 23P
300
300
0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0%
0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0%
AT1 Trading price (area is 5yr sub CDS) Line of best fit (Tier I banks) Line of best fit (Tier II Banks) JPM AT1 Fair Value AT1 Trading Price Line of Best fit (JPM AT1 Fair Value)
Line of best fit (Tier II Banks) Linear (AT1 Trading Price)
Source: Bloomberg and J.P. Morgan estimates. Source: Bloomberg and J.P. Morgan estimates.
We note that AT1 instruments In Figure 13 we highlight that the bulk of AT1 instruments are pricing relatively
price fairly consistently to the consistently, reflecting the magnitude of the respective buffer to conversion. While
magnitude of the buffer over the we have plotted a line of best fit, we believe that the pricing points are situated close
contingent loss event
enough around the line to be considered fair value (at best). Figure 13 compares the
fully loaded ratios of banks to the AT1 trigger, for contrast we also highlight in
Figure 14 the AT1 trading levels in comparison to the JPM 2014 year-end expected
phase-in ratio.
Figure 14: AT1 trading levels vs JPM estimated phase-in minimum buffer to first loss 2014 & 5yr
sub CDS
800
POPSM 11.5 EUR 18P Potentialline for issuers
750
which higher expected
700 buffer volatilityas implied
by 5yr sub CDS
650
600
BACR 8 EUR 20P BBVA 9 USD 18P
550
BACR 8.25 USD 18P
500
SOCGEN 8.25 USD 18P ACAFP 7.875 USD 24P
450
SOCGEN 7.875 USD 23P
400
CS 7.5 USD 23P
350
300
0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0%
AT1 Trading Price (Area 5yr subCDS) Line of nest fit (Tier I Banks)
We highlight in Figure 14, that, for BARC, we have adjusted for the PRA’s phase-in
treatment in UK (i.e. fully loaded except for intra group significant investments in
financial institutions). Furthermore, we have also adjusted phase-in capital ratios
based on the assumption that most EU countries will follow the UK, France and Italy
and 100% deduct goodwill from 2014. CET1 ratios are also adjusted to assumed
deleveraging during 2014 and Bloomberg consensus 2014 earnings.
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POPSM 11.5% €18P

We highlight that while there is a We highlight that while POPSM 11.5% €18P may seem like an outlier relative to
high degree of consistency peers, we believe it simply may not lie on the same curve as the other instruments.
between theoretical fair values While the buffer is important to determine the probability of loss, we note that the
and the size of the buffer to potential volatility of this buffer may be equally important. To this extent we stress
conversion, the implied degree
that POPSM’s 5YR Sub CDS spread is materially higher than sample peers and, as
of volatility in the buffer, as
proxied by the Sub CDS, also
such, we believe the market is more concerned with the future volatility of the
has an impact on valuations conversion buffer rather than just the current magnitude of the buffer. Under these
circumstances we believe 2nd tier banks could lie on a separate curve until the
implied volatility in buffer (implied by the subordinated CDS) decreases. We note
that the curve we have determined for POPSM is for illustration purposes only and
we have place it above the current trading level of the AT1 given our fair value
analysis of the AT1 instrument. In order for POPSM to have a parallel slide
downwards, we believe it would need to materially de-risk given that, currently, it is
highly geared to the Spanish economy given its focus on SME lending. We note that
this does not prevent POPSM from moving down along its own curve by increasing
the size of the buffer. We highlight on Figure 28 that our expectation is for POPSM
to moderately increase the buffer to conversion over the medium term (on phase-in
basis). We highlight that our equity valuation model will also take into consideration
very similar inputs in that it considers volatility and quality of future earnings, in the
same way that the credit market will view volatility of the existing buffer.
Discussion Points
While, in our opinion, the building block approach is useful in terms of a relative
value ranking tool and is indeed quite widespread among the investor community, it
is also relevant to highlight some of the factors that may tend to bias the outcome of
this valuation approach.
Circularity: ‘The Tail Wagging the Dog’
Issuance of AT1 has driven One of the defining features of AT1 issuance is the positive impact it has across the
further compression in legacy remainder of the issuer’s outstanding subordinated debt, with this debt rallying on the
subordinated spreads, thereby back of the issuer placing a more deeply subordinated tranche of capital below the
impacting the inputs into the existing legacy subordinated debt. As a result, the spread on outstanding
AT1 valuation approach
subordinated debt instruments of the issuer will compress, with this being one of the
reasons why we remain constructive on legacy Basel II subordinated debt, being
Overweight both Tier I and Lower Tier II asset classes. In particular, the impact on
the legacy Tier I is particularly pronounced on the basis that the issuance of AT1 will
normally bode well for the call of the legacy Tier I instruments, as the issuer is
demonstrating an ability to replace these instruments with compliant structures.
While AT1 issuance is The main issue for our valuation framework raised by the impact of AT1 issuance on
unequivocally positive for the spreads is that the spreads of existing legacy instruments are then used as an input in
rest of the subordinated debt the valuation process for the actual AT1. As a result, the derived fair value output of
capital structure, we do not think the building block approach will be biased downwards, as the underlying constituent
that it should automatically
spreads have compressed. While a thicker tranche of capital will tend to benefit
imply more reduced premiums
for what is a very deeply
recoveries for that part of the capital structure, we note that, currently, AT1
subordinated slice of the capital instruments still represent a fairly thin sliver of the overall capital stack and, as result,
structure should not really benefit from higher implied recoveries. Further, with CRR guidance
on the required tranche size for AT1 at 1.5% of RWA, it is unlikely that this will
form a sufficiently large tranche to the extent that recoveries in the event of trigger or
regulatory intervention increases substantially. We therefore think that the benefit of
the AT1 issuance is really only for the less deeply subordinated parts of the capital
structure, and any compression in the fair-value spread for an AT1 instrument which
stems from actual AT1 issuance will result in a positive bias to fair value spreads.
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Legacy Basel II: A Bid Only Market?

The valuation points that we We also highlight that valuations of legacy Tier I instruments reflect the fact that we
infer from the legacy capital are currently in a transition period between two regulatory regimes with the result
structures are likely skewed by that existing legacy capital instruments are in the process of being phased out.
the fact that the phasing out of
these instruments implies a
Naturally, this phasing out results in a reduction in the utility of the existing stock of
favorable impact on valuations hybrid capital instruments, a development which then has an impact on the call
behavior of these structures, as we highlighted in our recent note Bank Capital
Roadmap 2014, dated January 10, 2014. This shift in call behavior will naturally
have a positive impact on valuations, with the legacy instruments also benefitting
from the fact that they have a more benign risk profile than new generation
instruments. If we add in the fact that the stock of legacy Basel II instruments is
rapidly dwindling, we note that this will tend to exacerbate the valuation of these
assets. While these drivers are an intrinsic part of our investment thesis for being
Overweight Tier I and Lower Tier II, we note that, again, these potentially tighter
valuation points driven by the factors that are not really relevant for AT1 are
incorporated into our theoretical fair value for the asset class, thereby representing a
bias to the valuation output.
Tier 1 Versus AT1 Risk Profile

Using Tier I valuation reference As we discussed above, the basis of the ‘building block’ approach is to synthetically
points as a basis for AT1 build an AT1 fair value by adding the contingent loss option value to an existing Tier
valuations may understate the I valuation. This valuation approach is based on the principle that the synthetic AT1
risk of coupon deferral given the
complete discretion on
structure i.e. a legacy hybrid Tier I plus contingent loss premium, will replicate the
distributions in the latter risk profile of the AT1 product. However, as we have noted in previous publications,
structures, which have no the coupon deferral risk in an AT1 is completely different to that of a legacy Tier I
dividend stoppers or pushers instrument, not least given the absence of dividend pushers and stoppers language in
the new structures. As we will discuss in detail in this publication, the coupon
deferral risk in an AT1 structure is completely distinct from that of a legacy Tier I,
and potentially a risk which is not being incorporated fully into market valuations. In
terms of our valuation framework, we do, however, try to incorporate a premium for
the lack of pushers/stoppers in the new AT1 structures; however this may not be
fully representative of these risks.
Given the inherent market biases The sum total of the above considerations is one of the reasons why the valuation
that may be replicated using the framework might be biased upwards in terms of valuations with the required
building block approach, we will premium levels suggested by this framework failing to capture the risk embedded in
cross reference this output
versus the compliance with the
AT1 structures. However, we will test whether some of the elements referred to
different buffer triggers as well above are being factored into the valuation approach, by comparing the relative
as comparing it versus equity valuation ranking output of the building block approach versus a ranking based on
market outputs the level of buffer to either of the contingent loss events. Lastly, we then compare the
valuation output from the building block approach versus valuation points inferred
by the equity market, given that the bank equities and the AT1 instruments tend to
have a similar risk profile and should be impacted by similar valuation drivers.
Technical Support Factors

In addition to looking at the current AT1 valuation points, we think it is also
important to review the outlook for the asset class in terms of the technical support
factors as these are likely to have an impact on future performance. We think that this
is relatively important given that the emergence of AT1 has coincided with an
extremely benign set of circumstances where virtually all factors have been aligned
and supported the robust performance of the asset class to date.
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Broadening investor base

To date we have seen a higher In our opinion, the future development of the investor base for the AT1 asset class is
relative proportion of hedge fund key to sustaining current performance, especially if the current investor base has a
investors in the AT1 market with shorter investment horizon than traditional, institutional investors. This is important
private banking investors having
a lower level of participation
in terms of having a marginal buyer for the asset class, once some of the momentum-
compared to the dated Coco driven investors potentially take profit on current positions, in addition to providing
market an investor base for the issuance volumes that we estimate. One defining
characteristic of the current AT1 investor base versus that of the dated Coco asset
class is the relatively low degree of involvement of Asian private banking investors.
In our opinion, the participation of these investors would tend to support more stable
performance of the asset classes in which it participates, particularly compared to
hedge funds, which, we note, have had a relatively higher degree of participation in
AT1 market.
We highlight that there are both In our opinion, there are both structural and cyclical reasons why the private bank
cyclical and structural reasons investor base is less prevalent in the AT1 market. From a cyclical perspective, we
for the lower degree of highlight emerging market volatility, which would have impacted the degree of risk
participation by private banking
investors in the AT1 market
aversion of this investor base. However, from a more structural perspective, we also
note a higher degree of risk aversion from Asian private banks, which are less
inclined to offer underlying investors the same degree of leverage on AT1 structures,
which is in contrast with the dated Coco product where 60-70% lending values are
not uncommon. By contrast, we note that there is a greater reluctance to provide
leverage for AT1 structures. In addition, we note that the more complex structural
features of the AT1 instrument have resulted in these structures not being actively
marketed, with private bank investor involvement being more driven by reverse
enquiry. As a result, we think that the involvement of the private bank investor base
will tend to be relatively limited over the short to medium term.
We expect a greater degree of Crucially, the development of the AT1 asset class is going to be largely driven, in our
participation from institutional view, by the potentially increasing sponsorship of the institutional investor base, with
investors, although this their participation having increased progressively. In our opinion, this will be the key
participation is more likely to be
done within the context of
development for the AT1 asset class, in that, if our estimates on valuations prove to
specific mandates or funds be accurate, it would be difficult to imagine that such levels of issuance could be
supported without significant participation from an institutional investor base.
Interestingly enough, we note that the willingness of institutional investors to
participate in the AT1 market is more likely to be seen within the context of specific
mandates with the degree of volatility and contingent features potentially resulting in
extreme valuation outcomes that are more difficult to manage within the context of a
traditional fixed-income mandate. As a result, we see it as more likely that these
instruments will be managed within the context of a specific fund or mandate.
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(44-20) 7134-1733 28 January 2014
Figure 15: Investor participation by type of recent AT1 deals and the BARC LT2 coco for comparison
100% 3%
6% 6% 5%
7% 9% 11% 15%
90%
20% 4%
80% 17% 7%
27% 21% 19% 14%
5%
70% 10%
40% 7%
5% 9% 10%
5%
60% 10%
50% 11%
40%
73%
62% 65% 61% 61%
30% 60%
43% 47%
20%
10%
0%
BARC 7.625% USD 22 SOCGEN 8.25 USD 18P POPSM 11.5 EUR 18P BACR 8.25 USD 18P BACR 8 EUR 20P CS 7.5 USD 23P SOCGEN 7.875 USD 23P ACAFP 7.875 USD 24P
LT2 Coco
Asset managers Insurance/Pension Hedge Funds Private Banks Other Banks
Growing investor demand

Recent issues have highlighted Potentially reflecting the increased institutional investor participation in this market,
a growing demand for the asset we highlight the contrast in investor perceptions of AT1 in late 2013 compared to the
class start of 2014. We would generalize the investor mood as one of cautious optimism
over the development of the asset class in 2013. However, it seems that the
proportion of those who remain cautious has dwindled with the focus being on the
overall yield figure. We highlight that if we track the book size for the most recent
AT1 deals and compare this to the final issue size, there has been a growing bid for
the asset class among most investors.
Figure 16: Size of Book/Final Issue size for most recent AT1 deals
16.00
14.00
BACR ACAFP
12.00
CS
10.00
SOCGEN
8.00
POPSM
6.00
SOCGEN BACR
4.00
2.00
0.00
06/09/2013 10/10/2013 20/11/2013 10/12/2013 11/12/2013 18/12/2013 23/01/2014
Book size/ Issue Size
Greater participation of Analysis of the performance of the recent issuers would tend to suggest that
institutional investors in the AT1 increased demand for the asset class has not necessarily resulted in the same level of
market should provide greater outperformance. This could potentially indicate that the real level of demand,
depth to the market
although growing, might be closer to being filled with the issuance that we have seen
to date. We would, however, expect this level of demand to increase as the investor
base gains further depth with the greater participation of institutional investors. In
Figure 16, we compare the book/issue multiple to the performance of the bond 1
month later.
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Figure 17: Performance of new AT1 issues versus book/issue size

16.00 12.0%
14.00 11.5%
BACR ACAFP11.0%
12.00
CS 10.5%
10.00 10.0%
SOCGEN
8.00 9.5%
POPSM 9.0%
6.00
SOCGEN BACR 8.5%
4.00
8.0%
2.00 7.5%
0.00 7.0%
06/09/2013 10/10/2013 20/11/2013 10/12/2013 11/12/2013 18/12/2013 23/01/2014
Coupon size Book size/ Issue Size 1 month price change
AT1: The Beta Weapon of Choice

While some investors have used While some investment in the AT1 market would have been driven by valuation or
AT1 to gain beta exposure in a fundamental, issuer-specific reasons, we note that there would also have been an
rallying market, we would expect element of momentum-driven participation in a market where compression has been
these instruments to serve the
same purpose in a more volatile
the dominant theme in a yield-driven environment. As such, the momentum
market strategies on AT1 can be seen as gaining exposure to market beta in a rallying
market. While these strategies are supportive and can ultimately become self-
fulfilling, we would expect that the reverse will also be applicable in a period of
greater market volatility, where investors with a less sanguine view on the market
would potentially choose these instruments to express such views. In addition, the
level of liquidity in these recently issued instruments would also likely facilitate such
strategies, especially given the investor base. As a result, we could see more pressure
on AT1 in a more challenging market environment, where, in any case, the asset
class’s specific features should make it intrinsically higher beta.
Supply could become a As an additional consideration, we note that the initial supply in the AT1 market
challenge rather than being a proved to be a positive risk driver with every new issue providing positive impetus
positive momentum driver which for secondary market valuations. This reflected an environment where the new issue
it has been to date
pipeline provided positive momentum to a growing market where demand
outstripped supply. However, as the market matures, supply may become a challenge
to valuations rather than the positive momentum driver it has been to date. In this
context, we note our issuance expectations for 2014 and highlight that, depending on
how this supply is managed, it could have a potentially disruptive impact on
secondary market valuations.
Greater risk to AT1 from interest rates

We highlight that AT1 instruments are traded on a cash price basis with investors
mostly buying the ‘all in’ yield of the instrument. In our opinion, with AT1 spreads
now as low as 530bp on average, the room for spread compression caused by
increased risk-free rates is likely to put pressure on cash price valuations.
Anecdotally, we have noticed that very few investors hedge out the rates risk when
buying these instruments, the exception being some institutional investors who carry
out rates hedging on a broader portfolio basis. In our opinion, LT2 instruments offer
better risk reward when bought on a spread basis, due to the fact that the instruments
are already traded on a spread basis and, as such, are likely to be more resistant to
rising rates.
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We prefer EUR AT1 versus USD AT1, given the downside risk associated with a
possible US rates rise. We believe that the Eurozone is at a much lower point in the
cycle than the US and, as such, we believe that rates in the Eurozone are likely to
remain lower for longer and so capping potential volatility in comparison with USD
AT1, which could potentially see a rates rise sooner. Furthermore, we believe that the
supply demand dynamics between EUR and USD are likely to favor EUR issues over
USD issues.
Figure 18: Forward rates for US treasuries and Euro Swaps

%
4.50
4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
0.00
01/01/2014 01/01/2015 01/01/2016 01/01/2017 01/01/2018 01/01/2019 01/01/2020 01/01/2021
US Treasury Fwd Rates Euro Swaps Fwd Rate
Source: Bloomberg
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Is Coupon Deferral Risk Priced In?

Given the higher point of In our opinion, the most significant risk embedded in an AT1 instrument is coupon
attachment for coupon deferral deferral rather than specific trigger risk, given the latter is most likely to trigger at a
risk relative to the contingent lower solvency level. Essentially, the level at which mandatory coupon deferral
loss trigger event, we believe
that coupon deferral is much
becomes enforceable in the context of meeting CBR is much higher than that for the
more likely to be a driver of risk specific contingent loss feature. Consequently, we can think of the events that could
for AT1 potentially trigger a mandatory coupon deferral event as having a ‘lower severity,
higher probability’ loss outcome, versus a ‘higher severity, lower probability’ loss
outcome, with the emphasis being on the probability of these outcomes occurring and
how these should be priced accordingly. Given we consider a mandatory coupon
deferral event to be the most relevant driver of the risk profile, we will look at the
circumstances in which this can happen before discussing the evolution of regulatory
capital requirements and how the phasing of these components from 2016 onwards
can result in a meaningful shift in the probabilities of potential coupon deferral
outcomes.
Mandatory Coupon Deferral Risk

Effectively the combination of While there is complete discretion with regard to the payment of coupons for AT1
where an issuer is relative to its structures, we will focus on the basis that mandatory conditionality will be the
combined buffer requirements circumstances under which coupon deferral will occur, rather than issuers merely
and the MDA will determine if
there is any restriction with
using their discretion to defer coupon. The conditions for deferral on AT1 structures
regard to the ability of the issuer are articulated in Article 141 of the CRD IV document (‘Restrictions on
to make discretionary distributions’) with institutions that fail to meet the combined buffer requirement to
distributions calculate a Maximum Distributable Amount (‘MDA’), which becomes an explicit
precondition before the issuer can undertake any discretionary distributions to
stakeholders which include AT1 bondholders, shareholders and employees.
Effectively the combination of where an issuer is relative to its combined buffer
requirements and the MDA will determine if there is any restriction with regard to
the ability of the issuer to make discretionary distributions.
Combined Buffer Requirements

We highlight that the CBR Compliance with the CBR is the initial pre-requisite for any type of restriction on
includes the countercyclical making discretionary distributions, given that the calculation of the MDA is only
buffer requirement (as per CRD required for institutions that fail to meet these requirements. We note that CDR IV
IV), a component which has
tended to be discounted by the
details the components of the CBR in Article 128, with this being the capital
market as it has not been fully conservation buffer, the countercyclical buffer (CcyB) and any systemically driven
calibrated buffer, as below:
Article 128 (6) 'combined buffer requirement' means the total Common Equity
Tier 1 capital required to meet the requirement for the capital conservation
buffer extended by the following, as applicable:
(a) an institution-specific countercyclical capital buffer;
(b) a G-SII buffer;
(c) an O-SII buffer;
(d) a systemic risk buffer.
We highlight that the combined buffer requirements are going to be phased in from
2016 onwards, at which the point the risks of mandatory coupon deferral are going to
be more relevant.
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Maximum Distribution Amount

While the degree of compliance with the CBR determines the applicability of the
MDA, the MDA itself represents an upper bound on the value of the discretionary
distributions that can be made to AT1 bondholder, shareholder or employees. The
actual MDA itself is dependent on the volume of available internally generated
resources that could potentially be distributed. Essentially, the level of available
resources is defined in Article 141 (5) as the interim and year-end profits, which are
not included in common equity tier I capital, that have been generated since the most
recent decision on the distribution of profit or the making of a discretionary
distribution to either AT1 bondholders, shareholder or employees.
In the event where the issuer has We highlight in Figure 19 how the interaction between these two variables will
no distributable resources but impact the ability of an issuer to make these distributions, with this analysis
remains above the CBR, there is providing some insight into the types of scenarios that can drive mandatory coupon
no requirement to determine the
MDA
deferral outcomes. As per our prior assertion, it is the compliance with CBR that is
the initial driver of any mandatory coupon deferral outcome. We note that in
Scenario A in Figure 19, where the issuer’s common equity tier I (CET1) is in excess
of the CBR, there is no restriction on the issuer’s ability to make discretionary
distributions, even in a scenario where the issuer has reported a material interim or
full-year loss. Under these circumstances, the issuer will have the flexibility to make
the discretionary distribution as long as compliance with the CBR is not undermined.
Figure 19: Coupon Deferral Risk: Combined Buffer Requirements Versus Available Resources
MDA zone
When the issuer has no Essentially, the restrictions on discretionary distributions are only applicable when
distributable resources and the issuer is in breach of the CBR, which is what we designate in Figure 19 the
finds itself within the ‘MDA ‘MDA zone’. To understand the mechanics of the coupon deferral, we have split the
zone’, there will no discretionary issuers that find themselves in the ‘MDA zone’ into two separate scenarios, which
distributions regardless of which
we think have potentially contrasting outcomes. In Scenario B, we highlight that the
quartile of the CBR the issuer
finds itself in
MDA itself has little impact and we have moved immediately into a situation where
the issuer will not be allowed to effect any discretionary distributions because not
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only is it not in compliance with the CBR, but effectively has no available resources
to distribute. As such, the outcome of the MDA calculation is that when there are
zero resources available to distribute it becomes largely academic which quartile the
issuer is in, as any of the above scaling factors applied to a zero amount will
necessarily be zero, necessarily resulting a zero MDA. In our opinion, this is the
most relevant coupon deferral scenario that needs to be considered in terms of
assessing the overall degree of coupon risk. There are in our opinion two corollaries
from this statement, which we discuss below;
Scenario B is the highest probability coupon deferral outcome
Our base case is that the main In our opinion, there is likely to be a high correlation between the fact that an issuer
driver of an issuer being in the may find itself in the MDA zone and the having negative available resources, which
MDA zone is that there will have will stem from having an outsize interim or full year loss. Under such a scenario, it
been an outsize loss event, would actually be the fact that the issuer experienced a large one-off loss event that
which implies there are no
would result in its CET1 capital position being in the MDA zone. An institution
distributable resources
could end up in the zone via a non-P&L related driver, such as a one-off increase in
the level of RWA as a result of some sort of regulatory shift; however, this is the type
of outcome that we would expect to have a lower probability. We note that the way
in which the available resources are defined (i.e. as interim or full-year earnings not
included in the CET1 since the last discretionary distribution was made), will
inevitably mean that in any period where there is a loss with sufficient magnitude to
push the issuer into the MDA zone it is unlikely that the available resources will be
anything other than a materially negative amount.
Being in the 99% decile will result in full coupon deferral
We assume that any deviation We note that the MDA calculation takes into consideration the relative positioning
from CBR will be accompanied within the CBR, with the quartile in which the issuer finds itself ultimately
by a scenario of net negative determining the level of MDA that will be applied for the purpose of discretionary
interim or full-year earnings. In distributions. As a result, it is the degree of deviation from CBR that determines the
which case, the calculation of
severity of the restriction on the discretionary distribution, with CRD IV guidance
the MDA will necessarily yield a
zero amount (i.e. any scaling
indicating that it would take a significant deviation from the CBR for a complete
factor applied to a negative restriction of discretionary distributions (i.e. an issuer would have to find itself in the
amount necessarily has to yield lowest quartile of the CBR before the MDA became zero). Thus the magnitude of the
a negative MDA) deviation required would tend to suggest that this would be a lower probability event.
However, as we have postulated previously, there is likely to be a high degree of
correlation between events that result in a deviation from CBR levels and the
existence of any available resources that can be distributed. As a result, it would
follow that even if an issuer found itself in the 99th decile of the CBR (i.e. only a
slight deviation from the CBR), this would automatically lead to a full coupon
deferral, purely on the basis that in the period in which the issuer falls into the MDA
zone, it will have no distributable resources. Simply put, we assume that any
deviation from CBR will be accompanied by a scenario of net negative interim of
full-year earnings in which case the calculation of the MDA will necessarily yield a
zero amount (i.e. any scaling factor applied to a negative amount necessarily has to
yield a negative MDA).
While even 0.2 of the MDA might The flipside of this rationale is that we believe investors can take limited comfort
appear to be in excess of the from the mechanics underlying the calculation of the MDA, in that it might have
average AT1 interest cost, the been otherwise assumed that any resulting restriction would be less binding on the
ability to pay coupon would
ability to pay AT1 coupons. We think that this is a potentially flawed assumption. If
depend on having positive
distributable resources we look at the issuers average historical level of resources and then make the
assumption that, even in a scenario where an issuer found itself in the 2nd quartile, the
0.2 of the average historic distributed resources would be in excess of the absolute
AT1 interest cost.
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Scenario C: More relevant for capital conservation post loss event

In our opinion the ceiling In our opinion, Scenario C is less relevant than might otherwise be assumed on the
imposed by the MDA calculation basis that in the period during which an issuer moves into the MDA zone, there are
on discretionary distributions is unlikely to be any available resources to distribute, thus rendering superfluous any
more relevant in periods
following a potential one-off loss
calculation of MDA or of the extent to which the issuer is not in compliance. It
event would therefore appear that the mechanics of the MDA calculation are less relevant
in determining the ability of the issuer to make discretionary distributions. In our
opinion, however, the calculation of the MDA is likely to be greater in the periods
subsequent to the one where the loss event occurred; more specifically, within the
capital conservation plan that the issuer will need to present to the competent
authority as per Article 142 of CRD IV. In order to demonstrate the mechanics
behind this assertion, we will assume that in the period ‘T + 0’, the issuer has a large
one-off loss that takes its core equity Tier I into the MDA zone. Regardless of where
the issuer is in relation to the CBR, we assume that the large one-off loss that has
resulted in this situation will imply that the result of the MDA calculation will not
allow for any discretionary distribution for that period. However, the MDA
calculation is likely to be more relevant within the context of the periods following
the initial loss event (T+0), especially if the loss event proves to be a one-off, with
the issuer returning to profitability. As a result, the calculation of the MDA in the
period T+1 will give more relevance to the relative positioning within the CBR in
terms of quartiles, on the basis that the issuer will actually have positive available
resources. Naturally, the resulting MDA amount will define the maximum amount of
resources that can be allocated to the discretionary distributions to shareholders,
employees and AT1 bondholders. The decision on which stakeholders benefit from
the allocation of the MDA will be driven by each issuer’s strategic priorities.
Counter Cyclical Buffer
We highlight that the CcyB is In our opinion, the market has not focused extensively on the CcyB given that it is
unequivocally part of the still being defined and calibrated. Additionally, some issuers in the AT1 market have
combined buffer requirements tended to ignore the potential impact of the CcyB on the CBR, potentially inferring
within the context of CRV IV
that it is less relevant for determining buffer requirements. However, we highlight
that the CcyB is unequivocally part of the combined buffer requirements within the
context of CRV IV. We will therefore focus on the definition and calibration of the
CcyB in the different jurisdictions.
Definition
Each member state shall designate a public authority that is responsible for setting
the counter cyclical buffer rate for that state. The buffer is expected to reflect the
credit cycle and the risks due to excess credit growth in the member state. It will be
based on the deviation of the ratio of credit-to-GDP from its long-term trend. The
counter cyclical buffer is expected to fall between 0-2.5% with intervals of 0.25%.
We highlight that it is possible for member states to set a counter cyclical buffer
above 2.5%; however, this must be justified with consideration of guidance from the
ESRB among others.
Estimating the countercyclical buffer

In order to determine the CBR for each institution, we need to define three
magnitudes:
1) The capital conservation buffer: 2.5%
2) The countercyclical buffer: 0-2.5%
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3) The overall systemic risk buffer: 0-5%2 (G-SII, O-SII & Systemic risk
buffer)
We note that the capital conservation buffer is known and there is guidance on the
systemic risk buffer for the G-SIIs. As such, we can calculate the full CBR for the G-
SIIs if we can estimate the countercyclical buffer for these institutions. In order to do
this, careful consideration must be given with regard to the jurisdictions in which the
relevant G-SII operates. Each jurisdiction is expected to have a different
countercyclical buffer depending on the relevant economic credit cycle. The
countercyclical buffer for each institution will be calculated as the weighed average
of the countercyclical buffer rates that apply in the jurisdictions where the relevant
credit exposures of the institution are located/applied.
Table 7: JPM Grid for determination of CCyB

No. of Standard deviations away from mean CCyB
-2.0 0.00%
-1.5 0.00%
-1.0 0.25%
-0.5 0.50%
0.0 0.75%
0.5 1.00%
1.0 1.25%
1.5 1.50%
2.0 1.75%
2.5 2.00%
3.0 2.25%
3.5 2.50%
In order to estimate the current countercyclical buffers for institutions, we have used
the 12-month annual GDP growth rates in the relevant countries, see Table 23 in the
Appendix. We have also calculated the ratio of 12-month lending to non-financial
corporate growth rate in the same countries. From this, we can calculate a credit-to-
GDP metric and also determine the long-term average for this metric. Our data set
allows us to go back 10yrs (less for some countries) and we show the data in Table
24 in the appendix.
We highlight that the countercyclical buffers we have estimated are based upon the
current deviation of this ratio away from its long-term average with an assumption
about the future countercyclical buffer based upon the observed trend these figures
are given in Table 8. We have used a sliding scale to determine what counter cyclical
buffer to allocate to each country given the number of standard deviations the credit-
to-GDP ratio is away from its mean, see Table 7. We have taken guidance from the
PRA’s statement regarding the CCyB in which it stated: “The size of the
countercyclical buffer is assumed to be half a percentage point on average over the
cycle” in CP 5/13. However, we highlight the PRA is not the authority expected to
make this determination and, instead, note that this task is expected to be given to the
Financial Policy Committee (FPC), an independent committee at the Bank of
England. In our opinion, the counter cyclical buffer guidance from the PRA could
underestimate the final countercyclical buffer across jurisdictions with particular
attention being paid toward Switzerland where the countercyclical buffer was
recently raised from 1% to 2%.
2
Can be greater than 5% in certain circumstances, the overall value will be determined by the
interactions of the G-SII, O-SII and the systemic risk buffer (which are all separately defined
terms).
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Table 8: Countercyclical buffer calculations for relevant jurisdictions based on credit-to-GDP

%
Mean 2004- Standard 2013 Credit- Deviation No. of Stdev 2019 JPM
Country 2013 deviation to-GDP ratio from mean from mean Trend 2013 CCyB assumed CCyB
Austria 1.20% 3.36% -1.10% -2.29% - 0.68 Trough 0.50% 1.00%
Belgium 5.65% 6.80% 21.83% 16.18% 2.38 Upwards 1.75% 2.50%
Brazil -0.07% 15.40% 5.14% 5.21% 0.34 Upwards 1.00% 0.50%
Estonia -0.08% 0.92% 1.05% 1.12% 1.22 Upwards 1.25% 1.75%
France 13.42% 41.72% 7.85% -5.57% - 0.13 Downwards 0.75% 0.75%
Germany 0.93% 4.56% -1.21% -2.14% - 0.47 Trough 0.50% 0.75%
Greece -6.69% 25.67% 0.82% 7.51% 0.29 Downwards 1.00% 0.50%
Ireland 1.67% 15.51% -7.62% -9.29% - 0.60 Recovering 0.50% 0.75%
Italy 2.60% 2.92% 1.22% -1.39% - 0.48 Upwards 0.50% 0.75%
Luxembourg -6.59% 13.83% -7.43% -0.84% - 0.06 Upwards 0.75% 1.25%
Netherlands 1.78% 2.63% -0.81% -2.59% - 0.99 Recovering 0.25% 0.50%
Portugal 2.43% 2.60% 3.03% 0.60% 0.23 Upwards 1.00% 1.25%
Russia 3.93% 3.58% 8.09% 4.16% 1.16 Upwards 1.25% 1.75%
Slovenia 2.07% 3.24% 3.08% 1.01% 0.31 Upwards 1.00% 0.50%
South Africa 2.94% 1.37% 2.87% -0.07% - 0.05 Downward 0.75% 0.50%
Spain -4.96% 37.93% 9.28% 14.25% 0.38 Upwards 1.00% 1.25%
UK -0.58% 6.44% -1.05% -0.47% - 0.07 Recovering 0.75% 1.00%
US 1.62% 3.63% 1.03% -0.60% - 0.16 Recovering 0.75% 1.00%
Source: IMF
Taking these countercyclical buffer assumptions, we can then calculate the weighted
average countercyclical buffer for banking institutions. We highlight these estimates
in Table 9. We note that, due to the relatively diverse nature of the banking
institutions that are most likely to issue AT1 during 1H 2014 or that have already
issued AT1, the CCyB by 2019 has an average of just 94bps (2013 average of 79bp).
This is much lower than the maximum potential of 2.5%; however, it does increase
the Deferral Trigger as part of the CBR.
Table 9: JPM Estimated Countercyclical buffers for 2013 and 2019

Bank 2013 JPM 2019
BBVA 0.97% 1.06%
SocGen 0.94% 0.91%
Popular 1.00% 1.25%
Barclays 0.75% 0.95%
CS 0.78% 1.00%
Acafp 0.96% 0.84%
Santan 0.85% 0.95%
Unicredit 0.54% 0.80%
Intesa 0.54% 0.76%
DB 0.63% 0.87%
Lloyds 0.72% 0.97%
Average 0.79% 0.94%
Where deferral meets trigger risk

We think that the interaction While we have highlighted that the MDA calculation is less than efficient in terms of
between the MDA calculation determining the scale of the restriction on discretionary distributions, especially in
and contingent loss trigger in the period during which the loss event occurs, we note that there are other drivers of
the AT1 may tend to undermine
the effectiveness of the
potential loss that investors need to consider when they are approaching the lower
mandatory coupon deferral quartiles of the CBR. In Figure 20 we highlight the interaction between the point
trigger where an issuer might find itself within the MDA zone and the contingent loss
triggers within AT1 structures. We note that in a scenario where an issuer has to
reach the lower quartiles of the CBR, it is very likely that the issuer will be
approaching CET1 solvency levels, which will be very close to triggering the
contingent loss features. For example, we highlight that an issuer that found itself
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(44-20) 7134-1733 28 January 2014
within the 4th quartile of the MDA zone would effectively already have triggered on
a 7% CET1 trigger AT1. Hence, the relevance of determining the MDA within the
context of a 4th quartile event would seem as somewhat academic especially if the
instrument has already experienced a loss event, either through conversion or write-
down.
Figure 20: Where Deferral Risk Meets Trigger Risk
In Figure 20, we show a generic capital stack in line with CRD IV guidance.
Although some of the components are not yet fully defined and, as such, can have an
impact on the attachment points of the CBR quartiles on the capital structure. We
note that, to date, for the instruments that have been issued, issuers have excluded the
countercyclical buffer requirement from the determination of how much available
buffer is available. While this is defensible on the basis that the countercyclical
buffer has not been fully defined in terms of the required magnitude, we highlight
that this has to be implemented by 2016, when the phasing of the CBR will be
implemented. We think that this has created a lack of clarity with regard to whether
the countercyclical buffer will form part of the combined buffer requirements.
However, we highlight that Article 128 (6) of CRD IV is very prescriptive in terms
of the constituents of the CBR, with the countercyclical buffer being an integral part
of this requirement. Further, we note that, the under CRVD IV, European banks will
be required to apply the buffer rate designated by the competent authority with the
transitional provisions allowing member states to cap the countercyclical buffer at
0.625% in 2016, which then rises sequentially to 1.25% in 2017 and 1.875% in 2018.
Pillar II risks in the UK

We highlight that there are potentially larger risks facing UK issued AT1 instruments
than their European equivalents. These stem from the potential placement of the
Pillar II requirements from regulators in the relevant member state and its effect on
the Deferral Trigger (DT). In Figure 21, we contrast the placement of the Pillar II
requirement and its impact on the level of the DT. We note that, for the same
institution, the DT would be higher if that institution were resident in the UK due to
the need for Pillar IIA requirement to be met with at least 56% CET1 (i.e. the same
ratio of CET1 to total capital found in the Pillar I requirements, equal in quality of
capital).
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What is Pillar II?

Pillar II refers to the capacity for national supervisors to impose a wide range of
measures – including additional capital and liquidity requirements – on an
individual and on consolidated bases in order to address higher-than-normal risk.
Pillar II is governed by the Directive of CRD IV and, as such, is implemented on a
national basis and therefore can vary by jurisdiction. Pillar II is required to meet
risks that are not captured or which are only partially captured in the Pillar I
framework (minimum capital requirements). Pillar II requirements are set on the
basis of a supervisory review and evaluation process that assesses how institutions
are complying with EU banking law, the risks they face and the risks they pose to
the financial system. Following this review, supervisors decide whether, e.g., the
institution's risk management arrangements and level of own funds ensure a sound
management and coverage of the risks they face and pose.
Pillar IIA
In the UK, Pillar II has been split into Pillar IIA and IIB. Pillar IIA is currently set
as an individual guidance on the capital that the PRA considers a firm should
hold, in addition to meeting its Pillar I requirements, in order to comply with the
overall financial adequacy rule.
Pillar IIB – The PRA buffer

The PRA buffer is for firms with particularly vulnerable business models. We
expect it to replace the capital planning buffer and to be set based on a range of
factors not limited to firm-specific stress tests. We expect Pillar IIB requirements
to overlap with the capital conservation buffer (CCB) and the systemic risk
buffers; however, we expect no overlap with the counter cyclical buffer (CCyB).
As such, we expect the PRA buffer to be a net amount after taking into account
the CCB and systemic risk of the institution.
Figure 21: Pillar IIA charge for the UK banks potentially increases the Deferral Trigger for UK AT1
instruments
Having Pillar IIA charge between the

minimum capital requirements and
Tier 2 combined buffer requirements Tier 2
increases the attachment point for the
Additional Tier 1 deferral trigger, given that 56% of the Additional Tier 1
Pillar II will need to be CET1
Bank's Own Buffer Bank's Own Buffer
Systemic Buffer Pillar 2
Countercyclical Currently there is no Systemic Buffer
Buffer expectation that the rest of the Countercyclical
European member states will Buffer
Capital move the Pillar II charge, or
Conservation demand that it would be met Capital
Buffer Conservation
with CET1 capital.
Pillar 2 Buffer
Common Equity Common Equity

UK Banks will have to disclose the Pillar
Tier I Tier I
II charge in order for investors to clearly
determine where the Deferral Trigger is.
Deferral Trigger (UK) Deferral Trigger (EU)
Source: J.P. Morgan. *For illustration purposes we have assumed that the banks have fully met their minimum capital requirements
with the optimal capital structure, i.e. 4.5% CET1, 1.5% AT1 and 2.0% Tier II, as such we have ordered the requirements in order of
subordination.
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We note that the PRA intends to have firms to meet the Pillar IIA requirements with
at least 56% CET1, no more than 44% in AT1 and at most 25% in T2 capital by 1st
Jan 2015. Importantly the PRA believes that the Pillar IIA capital requirement should
sit below the CRR combined buffer. We note (and many banks were concerned) that
this would mean distribution constraints (i.e. the deferral trigger) would apply at a
significantly higher level of CET1. This would likely mean that banks would have to
disclose the level of Pillar IIA capital required. In CP 7/13, the PRA maintained the
view that the Pillar IIA requirement should sit between the CRR combined buffer
and the minimum capital requirements. The PRA expects to consult on its approach
to Pillar II during the course of 2014 and we believe this creates a potential negative
catalyst for all UK AT1 currently and potentially in issue when this issue is clarified.
We do not see the same risks in Europe where it we expect Pillar II requirements will
be satisfied with total capital.
CBR: It’s A Question of Time

While we have placed a significant amount of emphasis on the coupon deferral risk
outcomes for AT1 structures, we note that these risks are not immediate given the
phasing-in schedule for the CBR is only from 2016 onwards. Hence, the mandatory
coupon deferral risks that are defined within the context of the application of the
MDA are unlikely to be binding until such as time as the CBR requirements are
phased in. As a result, during the interim period, prior to which the CBR
requirements are being phased in, the risks in AT1 structures will be confined to the
contingent loss trigger or to risk of regulatory intervention under the point of non
viability. Given that European banks remain focused on balance sheet deleveraging,
with capital raising a priority, it is likely that the probability of a contingent loss
trigger event for a benchmark issue will recede as the regulatory solvency levels
trend upwards with the implementation of CRD IV.
Table 10: Combined Buffer Requirement Implementation

2014 2015 2016 2017 2018 2019
Minimum Cote Tier I 4.00% 4.50% 4.50% 4.50% 4.50% 4.50%
Minimum Tier I 5.50% 6.00% 6.00% 6.00% 6.00% 6.00%
Minimum Total Capital 8.00% 8.00% 8.00% 8.00% 8.00% 8.00%
Capital Conservation Buffer 0.625% 1.250% 1.875% 2.500%
Counter Cyclical Buffer (max) 0.625% 1.250% 1.875% 2.500%
G-SII 25% of buffer 50% of buffer 75% of buffer 100% of buffer
Threshold Levels
Distribution Threshold ex CcyB 4.00% 4.50% 5.13% 5.75% 6.38% 7.00%
Distribution Threshold inc CcyB 4.00% 4.50% 5.750% 7.000% 8.250% 9.500%
Distribution Threshold for G-SII (2%) incl CcyB 6.250% 8.000% 9.750% 11.500%
Source: BIS, J.P. Morgan.
In Table 10, we highlight how the CBR will be phased in, resulting in the increase in
the distribution threshold, which is essentially the minimum volume of CET1 that the
issuer requires to avoid going into the MDA zone. In our opinion, this highlights how
high this level of absolute capital may be for issuers that happen to have additional
buffer requirements. We contrast these required levels of CET1 capital for the
distribution buffer with the levels of capital where the contingent loss features are
likely to be actioned, which would range from 5.125% to 7% CET1. This clearly
contrasts with the volume of CET1 capital that is required to maintain the issuer in
order to avoid a contingent loss trigger event. In order to have an idea of the impact
of the Basel III implementation on the various triggers, we will look at a specific
example to determine the absolute and relative sizes of the buffers above both the
contingent loss trigger threshold (7% CET1) and the coupon deferral trigger
threshold (CET I > CBR).
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Table 11: Barclays – Basel III Minimum Capital Requirements
2014E 2015E 2016E 2017E 2018E 2019E

Minimum Cote Tier I 4.000% 4.500% 4.500% 4.500% 4.500% 4.500%
Pillar II Requirement 0.000% 1.000% 1.000% 1.000% 1.000% 1.000%
Capital Conservation Buffer 0.000% 0.000% 0.625% 1.250% 1.875% 2.500%
Countercyclical buffer 0.0% 0.0% 0.2% 0.5% 0.7% 0.9%
G-SII buffer 0.000% 0.000% 0.500% 1.000% 1.500% 2.000%
CET1 Capital Requirement 4.000% 5.500% 6.825% 8.250% 9.575% 10.900%
Basel III CET I (E) 10.5% 10.9% 11.0% 11.2% 11.3% 11.5%
CET I Threshold Buffers (in %)

Threshold to 7% CET I Trigger 3.50% 3.90% 4.00% 4.20% 4.30% 4.50%
Threshold to MDA Deferral N/A N/A 4.18% 2.95% 1.73% 0.60%
Source: J.P. Morgan estimates, Company data, BIS
Barclays – The Demands of a UK G-SII

We look at Barclays as we think it one of the issuers that is likely to face higher
overall minimum CET1 capital requirements, given its definition as a G-SII, in
addition to which it is also subject to the UK’s relatively demanding regulatory
regime. More specifically, within the more demanding capital requirements that the
UK banks are likely to face, we would highlight the fact that the PRA has proposed
that Pillar II requirements be placed below the CBR in the capital stack, thereby
raising the absolute level at which a potential coupon deferral can occur. In Table 11,
we compare the phasing-in of the minimum capital requirements and how these will
interact with the levels at which either the contingent trigger will be reached or
whether the conditions for coupon will be reached. While the latter risk is not
relevant pre-2016, we note that the buffer to coupon deferral becomes the most
relevant risk for a Barclays AT1 instrument with the level of buffer which the issuer
has to protect against a potential coupon deferral event being much lower than the
buffer to protect against a potential contingent loss feature.
Figure 22: Barclays – buffers above loss-absorbing events in % CET I Figure 23: Barclays – buffers above loss absorbing events in £Bn
% £Bn
5.00% 30,000
4.50%
4.00% 25,000
3.50% 20,000
3.00%
2.50% 15,000
2.00%
1.50% 10,000
1.00% 5,000
0.50%
0.00% 0
2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019
Conversion buffer Coupon buffer Conversion buffer Coupon buffer
Source: J.P. Morgan estimates, Company data. Source: J.P. Morgan estimates, Company data.
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Coupon Deferral Versus Contingent Loss

Trigger: Which Is Priced In?
While coupon deferral is a While we have focused on the risks that arise from the implementation of the CBR
higher probability outcome than from 2016 onwards, it is useful to think about how this risk measures up against the
the contingent loss trigger loss that can arise from the triggering of the contingent loss feature. We have
event, we note that the severity
of the loss with coupon deferral
demonstrated that the probability of a coupon deferral event is higher than that of a
is likely to be lower contingent loss trigger event due to the CBR trigger for coupon deferral being higher
than the trigger for the contingent loss event, implying that the available buffer that
protects against a coupon deferral outcome is necessarily going to be lower than the
buffer which protects against trigger risk. However, we note that the degree of
severity of loss with a contingent loss event will be much more pronounced than a
coupon deferral event, with the former implying a semi-permanent loss in the value
of the principal of the instrument, whereas coupon deferral would suggest a
temporary interruption in the coupon cash-flow stream. The question that we have to
try and answer is how the different probabilities and severities of these loss events
can influence the pricing of an AT1 structure.
Figure 24: Historical: Groupama Tier 1 Bond Pricing

100
90
-70%
80
70
60
50
40
30
20
23/01/2009 23/01/2010 23/01/2011 23/01/2012 23/01/2013 23/01/2014
CAMA 6.928% 17P
Source: Bloomberg
The example of a single coupon We will start with the loss event that has the highest probability of occurring, which
deferral event with Groupama by virtue of the smaller size of the buffer will necessarily be the coupon deferral
shows the impact that this can event when the CBR is phased in from 2016 onwards. While we have noted that the
have on market value
triggering of a coupon deferral outcome might result in only a temporary reduction in
the coupon cash-flow stream, i.e. the loss of a few coupons, the reality is that the
potential decline in the cash price of the AT1 instrument is likely to reflect a loss far
greater than that. A good example of this would be the evolution of the market value
of Groupama Tier I instruments, which experienced a fall of 70% in the cash price
when the issuer announced that it would be deferring the coupon on these
instruments on the back of solvency concerns.
We think that, in the case of a We think that such potential moves in the value of such structures are due to the fact
coupon deferral event, the that the coupon deferral and contingent loss features cannot really be seen as
market will reassess the independent value drivers. This is due to the fact that once the coupon deferral event
probabilities of the contingent
loss trigger event happening,
happens, the market will have to reassess the probability of the contingent loss
thereby having an outsize trigger happening, which will necessarily have increased as the available buffer was
impact on the valuation of the reduced as the issuer went into the MDA zone. As a result, the coupon deferral event
AT1 represents a precursor event for the market to price in a greater degree of severity of
loss, culminating potentially in the actual triggering of the contingent loss feature.
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(44-20) 7134-1733 28 January 2014
Hence, in our opinion, focusing on the coupon deferral trigger can actually capture
the inherent risk profile of an AT1 on the basis that there is a dynamic interaction
between the coupon deferral and the contingent loss feature in an AT1 and, as such,
they should not be seen in isolation.
Phased-in CET1 ratios

In order to forecast the phased-in CET1 ratios for institutions that have issued AT1,
or which we believe will issue AT1 in the near term, we have taken Basel III RWAs
and applied the expected deleveraging over the coming years while, at the same time,
assuming loan growth resumes at a pace similar to the GDP growth in the relevant
jurisdictions. Furthermore, we have taken Bloomberg consensus earnings and payout
ratios and applied these during the forecast period as well as phasing in the
deductions such that by YE 2018, the institutions are reporting fully loaded CET1
ratios. We highlight that the CET1 deductions assume that most EU jurisdictions will
follow the example of the UK, France and Italy and apply a 100% deduction for
goodwill from CET1 ratios. In the UK, we have used fully loaded ratios except for
deductions caused by significant investments in financial institutions as highlighted
in the PRA’s CP 7/13.
Deferral Trigger
We define the deferral trigger as the top of the combined buffer requirement (CBR)
because if the institution were to have a negative P&L event while below this level
then the institution would be forced to defer is discretionary distributions by the
regulator as the available resources would effectively be negative. In order to
calculate the deferral trigger, we need to make assumptions about the level of the
CBR.
Capital conservation buffer

No assumptions need to be made about the capital conservation buffer as we
know it is phased in to a maximum of 2.5% from 2016 to 2019.
Systemic risk buffer

We have assumed that the optional systemic risk buffer remains at zero for
those institutions that have not been allocated as a G-SII status. This
effectively benefits POPSM and we would highlight that the deferral trigger
for POPSM could increase from our estimates if the designated authority in
Spain decide to apply an O-SII charge to POPSM. For the other G-SIIs, we
have assumed there are no changes to the Financial Stability Board’s (FSB)
latest publication in November 2013 and we assume this remains constant
through to 2019, although, in practice, the G-SII list will be updated
annually.
Counter cyclical buffer

In order to determine the counter cyclical buffer we carried out the
calculations as laid out on page 26.
Once we have the CBR, we make the assumption that all the banks we cover will by
2016 have issued enough AT1 and T2 to fill the 1.5% and 2% buckets respectively to
meet minimum capital requirements, this means that any excess CET1 above 4.5%
can go to meet the CBR rather than meeting the 1.5% AT1 bucket with additional
equity, which would mean there is less CET1 to meet the CBR. (Remember capital
that is being used to meet minimum capital requirements cannot be used to meet the
CBR). As such, we can define our Deferral Trigger as 4.5% plus the CBR with the
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CBR being phased in from 2016 (the same point at which the restrictions on
distributions are expected to become live).
The Results
We present the overall results in Figure 25 and Figure 26 with the curve representing
the limiting factor for first loss, whether it is caused by principle impairment or
coupon deferral. We have kept the same scale for comparative reasons, however, this
does mean that CS falls off the chart until 2017. We highlight here that ISPIM does
comparatively well given its curve remains relatively stable through the life of the
phase-in period. We note for some of the issuers the exercise is purely theoretical
given they are yet to issue AT1; however, given our expectations this year, we have
included them. We note that we assume a standard 5.125% trigger for the AT1
instruments for the issuers that are yet to issue.
Figure 25: JPM estimate for minimum buffer to first loss Figure 26: JPM estimate for minimum buffer to first loss
8.0% 8.0%
DB ACAFP
7.0% ISPIM 7.0%
BBVA LLOYDS ISPIM 6.0%
6.0% SOCGEN Z+450bp
LLOYDS 5.0% POPSM
UCGIM Z+547bp SOCGEN
5.0% SANTAN
BBVA 4.0%
4.0% 3.0% POPSM Z+729bp
Z+532bp DB
3.0% BACR 2.0%
UCGIM ACAFP Z+476bp
2.0% 1.0%
SANTAN
1.0% BACR 0.0%
2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019
BBVA BACR DB LLOYDS ISPIM UCGIM SOCGEN POPSM ACAFP SANTAN CS
Source: J.P. Morgan estimates. Source: J.P. Morgan estimates.
From the issuers that have issued we like the curves of SOCGEN (page 35) over
BACR (page 36), given the relative changes in the buffer to first loss over the life of
the instruments. We note that SOCGEN’s buffer to first loss remains above 350bps
to 2018 while Barclays’ (due to the more aggressive stance of the PRA) falls to
270bps by 2018. We believe these are important considerations for longer-term
investors who are not just playing the momentum and are hedging out the interest-
rate risk.
The following section sets out our expected evolution of CRD IV transitional CET1
ratios and CBR based on today's understanding of the implementation of CRD IV for
our sample of banks.
Projected CET1 and capital buffers

Table 12: JPM projected SOCGEN capital buffers
SOCGEN 2014E 2015E 2016E 2017E 2018E 2019E
Transitional B3 core capital ratio 10.8% 11.1% 11.2% 11.3% 11.5% 11.7%
Minimum Common Equity Tier 1 capital 4.0% 4.5% 4.5% 4.5% 4.5% 4.5%
Capital conservation buffer 0.0% 0.0% 0.6% 1.3% 1.9% 2.5%
G-SII buffer 0.0% 0.0% 0.3% 0.5% 0.8% 1.0%
Total requirements 4.0% 4.5% 5.6% 6.7% 7.8% 8.9%
Coupon buffer 5.6% 4.6% 3.7% 2.8%
Conversion buffer 5.6% 5.9% 6.1% 6.2% 6.4% 6.5%
Minimum buffer to loss 5.6% 5.9% 5.6% 4.6% 3.7% 2.8%
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Figure 27:SOCGEN minimum buffer to first loss Figure 28: POPSM minimum buffer to first loss
8.0% 8.0%
140% 140%
7.0% 7.0%
120% 120%
6.0% 6.0%
5.0% 100% 5.0% 100%
4.0% 80% 4.0% 80%
3.0% 60% 3.0% 60%
2.0% 40% 2.0% 40%
1.0% 20% 1.0% 20%
0.0% 0% 0.0% 0%
2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019
Expected MtM Loss Potential LGD Minimum buffer to first loss Expected MtM Loss Potential LGD Minimum buffer to first loss
Table 13: JPM projected POPSM capital buffers

POPSM 2014E 2015E 2016E 2017E 2018E 2019E
G-SII buffer 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Coupon buffer 5.8% 5.0% 4.2% 3.6%
Table 14: JPM projected BBVA capital buffers

BBVA 2014E 2015E 2016E 2017E 2018E 2019E
G-SII buffer 0.0% 0.0% 0.3% 0.5% 0.8% 1.0%
Coupon buffer 6.4% 5.5% 4.6% 4.1%
Figure 29:BBVA minimum buffer to first loss Figure 30: ACAFP minimum buffer to first loss
8.0% 8.0%
140% 140%
7.0% 7.0%
120% 120%
6.0% 6.0%
5.0% 100% 5.0% 100%
4.0% 80% 4.0% 80%
3.0% 60% 3.0% 60%
2.0% 40% 2.0% 40%
1.0% 20% 1.0% 20%
0.0% 0% 0.0% 0%
2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019
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Table 15: JPM projected ACAFP capital buffers

ACAFP 2014E 2015E 2016E 2017E 2018E 2019E
G-SII buffer 0.0% 0.0% 0.4% 0.8% 1.1% 1.5%
Coupon buffer 5.7% 4.3% 3.0% 1.9%
Table 16: JPM projected BACR capital buffers

BACR 2014E 2015E 2016E 2017E 2018E 2019E
G-SII buffer 0.0% 0.0% 0.5% 1.0% 1.5% 2.0%
Coupon buffer 5.2% 4.0% 2.7% 1.6%
Figure 31:BACR minimum buffer to first loss Figure 32: SANTAN minimum buffer to first loss
8.0% 8.0%
140% 140%
7.0% 7.0%
120% 120%
6.0% 6.0%
5.0% 100% 5.0% 100%
4.0% 80% 4.0% 80%
3.0% 60% 3.0% 60%
2.0% 40% 2.0% 40%
1.0% 20% 1.0% 20%
0.0% 0% 0.0% 0%
2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019
Table 17: JPM projected SANTAN capital buffers

SANTAN 2014E 2015E 2016E 2017E 2018E 2019E
G-SII buffer 0.0% 0.0% 0.3% 0.5% 0.8% 1.0%
Coupon buffer 4.3% 2.9% 1.6% 0.9%
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Table 18: JPM projected DB capital buffers

DB 2014E 2015E 2016E 2017E 2018E 2019E
G-SII buffer 0.0% 0.0% 0.5% 1.0% 1.5% 2.0%
Coupon buffer 6.9% 5.8% 4.8% 4.0%
Figure 33:DB minimum buffer to first loss Figure 34: LLOYDS minimum buffer to first loss
8.0% 8.0%
140% 140%
7.0% 7.0%
120% 120%
6.0% 6.0%
5.0% 100% 5.0% 100%
4.0% 80% 4.0% 80%
3.0% 60% 3.0% 60%
2.0% 40% 2.0% 40%
1.0% 20% 1.0% 20%
0.0% 0% 0.0% 0%
2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019
Table 19: JPM projected LLOYDS capital buffers

LLOYDS 2014E 2015E 2016E 2017E 2018E 2019E
G-SII buffer 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Coupon buffer 6.5% 5.8% 5.1% 4.5%
Table 20: JPM projected ISPIM capital buffers

ISPIM 2014E 2015E 2016E 2017E 2018E 2019E
G-SII buffer 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Coupon buffer 7.2% 6.9% 6.5% 6.2%
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Figure 35:ISPIM minimum buffer to first loss Figure 36: UCGIM minimum buffer to first loss
8.0% 8.0%
140% 140%
7.0% 7.0%
120% 120%
6.0% 6.0%
5.0% 100% 5.0% 100%
4.0% 80% 4.0% 80%
3.0% 60% 3.0% 60%
2.0% 40% 2.0% 40%
1.0% 20% 1.0% 20%
0.0% 0% 0.0% 0%
2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019
Table 21: JPM projected UCGIM capital buffers

UCGIM 2014E 2015E 2016E 2017E 2018E 2019E
G-SII buffer 0.0% 0.0% 0.3% 0.5% 0.8% 1.0%
Coupon buffer 5.0% 3.9% 2.8% 1.9%
Figure 37: JPM projected CS capital buffers

16.0%
140%
14.0%
120%
12.0%
10.0% 100%
8.0% 80%
6.0% 60%
4.0% 40%
2.0% 20%
0.0% 0%
2014 2015 2016 2017 2018 2019
Expected MtM Loss Potential LGD Minimum buffer to first loss
Source: J.P. Morgan estimates.*Due to the existence of the high trigger coco’s the limiting factors is the coupon deferral risk.
Table 22: JPM projected CS capital buffers

CS 2014E 2015E 2016E 2017E 2018E 2019E
G-SII buffer 0.0% 0.0% 0.4% 0.8% 1.1% 1.5%
Coupon buffer 8.3% 6.2% 4.2% 3.4%
Source: J.P. Morgan estimates.*conversion buffer takes into account the 3% of high trigger Coco’s CS has in its balance sheet.
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Squaring The Valuation Circle: Equity

Versus Credit
The 'sum of the parts' approach
In our opinion, one of the interesting aspects of the AT1 asset class is that it brings
may fail to reflect the closer elements of the fixed income and equity world into a single instrument and
incremental deferral risks of AT1 may offer opportunities to investors across both asset classes. By virtue of our
background and the market into which these instruments are being placed, we have
necessarily used valuation techniques from the credit world in terms of building a
valuation framework, such as the ‘sum of the parts’ approach. However, we have
also noted some of the methodological flaws of this approach, not least the fact that
some of the valuation biases that are inherent to other parts of the capital structure
are replicated in our valuation approach. This is due to the fact that, while we
synthetically build a theoretical valuation approach based on using the valuations for
contingent loss options from associated markets, such as the dated Coco market, we
have to question whether some of the valuation biases present in these markets skew
our theoretical valuation. We also note that some of the risks in AT1 are all but
unique in the world of subordinated bank capital, such as the coupon deferral risk,
which, in AT1, has a different risk profile to that of legacy Tier I instruments,
making it more difficult to infer valuations from existing structures. All of these
represent challenges for a valuation approach based purely on inputs from the credit
world.
Given the relative similar risk

Given the above considerations, we think it is useful to look at the information we
and return profile of AT1 and can infer from the equity market in terms of valuations for components of the bank
equity instruments, we aim to capital structure that are ever closer in terms of risk profile. This is due to the fact
use equity market data as an that the risk profile in terms of cash-flow certainty and principal value loss are much
alternative valuation framework closer in AT1 than was the case for the legacy Tier I instruments. In our first
publication on the valuation of AT1 structures, Thoughts on AT1 Structures, dated
September 13, 2013, we assumed that there would be a closer correlation between
the implied cost of equity for an issuer and the AT1 yield level. With the benefit of
having more data points and AT1 structures we will revisit this relationship in order
to establish whether this can be used as the basis for a relative value approach across
the capital structure.
The Implied Cost of Equity Framework
Our base case assumption for our relative analysis is that an AT1 instrument and an
equity have a broadly similar risk profile. Not only can this assumption be validated
by the understanding of the key features of an AT1 instrument and how these
increasingly mimic those of an equity instrument, analysis across the universe of
instruments that have been issued to date, shows there is a positive relationship
between the implied cost of equity and the AT1 yield, suggesting there are potential
common drivers behind these variables. This positive relationship between implied
cost of equity and the AT1 yield levels for the issuer universe is highlighted in Figure
38. Generally, we note that a reduction in the implied cost of equity has been
accompanied by a reduction in the level of AT1 yield. We highlight that we are not
The positive relationship looking to establish a causal relationship between the two variables, in the sense that
between AT1 yields and the we would not assume that the pricing information from one market is actively being
implied cost of equity suggests used to derive and potentially influence required returns in the another market.
that the instruments share
common drivers
Instead, we are looking for common drivers that can potentially be used to validate
and compare across the two markets. We would also highlight that the relationship
between these variables is positive in the context of the current market moves, where
we have seen sustained reductions across both the cost of equity and the AT1 yields,
which is in line with markets that are in ‘risk-on’ mode until recently.
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Figure 38: Implied Cost of Equity Versus AT1 Yields

14.0
BBVA SOCGEN POPSM CS BACR
13.0
12.0
11.0
10.0
9.0
8.0
7.0
However, there is a significant 6.0

6.0 8.0 10.0 12.0 14.0 16.0 18.0
range of levels across AT1
yields and issuers show a Source: J.P. Morgan estimates.
varying degree of compression
relative to the implied cost of
equity
Having established a positive relationship between the implied cost of equity and the
AT1 yield, we will now look at how close the absolute levels of the implied cost of
equity and the AT1 yields compare. While our initial expectation would be that the
AT1 yield would necessarily correspond to the implied cost of equity, we find that
there is a meaningful range of levels across the universe of AT1 instruments. While
some of the issuers have AT1 yields that are broadly in line with their implied cost of
equity (POPSM and BBVASM), we note that other issuers have an implied cost of
equity that deviates quite significantly from the AT1 yield (BACR, SOCGEN). In
Figure 39, we show the differential between the ICOE and the AT1 yield as a
multiple (ICOE/AT1 Yield). Given that the relationship is not as immediate as we
would have assumed, we have to look at the underlying factors influencing the ICOE
and see if we can establish these and the AT1 Yield.
Figure 39: ICOE/AT

LHS ICOE and AT1 Yield in %, RHS ICOE/AT1 Yield
16.0 2.25
14.0 2.00
Given that the instruments share
many of the same drivers, 12.0
1.75
comparing the most common 10.0
1.50
valuation metrics – AT1 yields 8.0
and P/B multiples – could 1.25
6.0
potentially offer some insights 1.00
behind the common AT1 and 4.0
equity factors 2.0 0.75
0.0 0.50
BBVA 9% $18 SOCGEN 8.25 POPSM 11.5% 18 CS 7.5% $23 BACR 8.25% $18 BACR 8% 20 ACAFP 7.875%
$18 $24
ICOE AT1 YTP ICOE / AT1 YTP
Source: J.P. Morgan estimates, Company data.
As the instruments share many of the same risk and return factors, a comparison of
the main valuation metrics of each instrument – YTC and P/B multiples – could
potentially offer some insights on the common fundamental drivers behind them.
While our initial assumption is that AT1s and equity instruments share many of the
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same drivers Figure 40 highlights an inverse function3 between AT1 yields and P/B
multiples. In turn, these equations explicitly align fundamental factors behind equity
valuations, such as expected profitability and equity market valuations, and AT1
yields. However, the estimated relationships portray a less convex curve than that of
equity instruments, consistent with the more senior ranking of AT1 instruments.
Figure 40: P/B vs. AT1 YTC (AT1 yield curves)

14 Popular
y = 9.5319x-1.001
12 Barc (USD) R² = 0.5776 BBVA
y = 7.0025x-0.546 y = 10.154x-0.742
AT1 YTC (%)
10 R² = 0.5574 R² = 0.6975
8
6 SocGen Credit Agricole Barc (EUR) Credit Suisse
y = 5.6115x-1.383 y = 7.467x -0.573 y = 7.1074x-0.373 y = 7.5981x-0.42
4 R² = 0.6952 R² = 0.6401 R² = 0.6743
R² = 0.4905
0.6 0.8 1.0 1.2 1.4 1.6
P/B multiple
While high P/B multiples show BBVA SocGen Popular Barclays (USD) Barclays (EUR) Credit Suisse Credit Agricole
that equity and AT1 converge to
broadly similar valuation levels, Source: Bloomberg, Company reports and J.P. Morgan estimates.
compression dynamics change
when a given low P/B multiple is As described in page 45, one of the drivers of the ICOE is the actual equity valuation,
surpassed, as both instruments which is captured by the P/B multiple. As we look to establish a potential
begin to price a broadly similar
outcome.
relationship between that ICOE/AT1 yield, we will graph these against the P/B
multiple for each respective issuer, which effectively incorporates all information
disclosed in Figure 38 and Figure 40. We highlight this in Figure 41 and Figure 42
in, which the compression/decompression dynamics vary at different market
valuations.
3
As shown in page 45, the Gordon Growth model implies an inverse function between the
implied cost of equity and P/B multiples.
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Figure 41: Compression/decompression profiles (I) Figure 42: Compression/decompression profiles (II)
2.4 2.4
1.8 1.8
1.2 1.2
0.6 0.6
0.0 0.0
0.60 0.80 1.00 1.20 1.40 1.60 0.60 0.80 1.00 1.20 1.40 1.60
BBVA POPSM CS Barc (USD) Barc (EUR) SocGen
Source: Bloomberg, Company reports and J.P. Morgan estimates. Source: Bloomberg, Company reports and J.P. Morgan estimates.
Market data would tend to suggest a negative relationship However, SocGen, trading at low multiples, shows a
for most issuers; equity-AT1 compression at higher positive slope curve and low P/B multiple results in equity-
multiples and decompression at lower valuations. Richer AT1 compression rather than an incremental cost/yield
equity valuation usually suggests increasing return through differentiation. Hence, equity-AT1 compression dynamics
higher ordinary dividend payments, while AT1s cash-flow is may behave differently after a relative low P/B multiple is
limited by the coupon rate. Hence, high P/B multiples surpassed as AT1 may trade wider and closer to the implied
should result in equity-AT1 compression due to tighter cost when a broadly similar outcome is expected for both
implied cost of equity and relative unchanged AT1 yields. instruments.
Having compared the main valuation metrics observed in both markets, we now
review the mechanics behind the implied cost of equity calculations and their
expected behavior under a different set of scenarios. The aim is to uncover those
common fundamental drivers that explain the relationship highlighted in Figure 41
and Figure 42, while understanding the compression/decompression profile of
equity-AT1 instruments and exploring its usefulness as an additional valuation point
for AT1 instruments.
With the aim of understanding Understanding the implied cost of equity
equity-AT1 compression profiles
As a proxy for the cost of equity, the Gordon Growth model shows that consensus
and their usefulness as an
alternative valuation framework,
earnings yields provide a reasonable approximation as it incorporates retained profits
we review the mechanics behind in addition to the expected dividend cash-flow4. However, the implied cost of equity
the implied cost of equity (ICOE) is the result of the interrelationship of multiple factors and equation 1 can be
calculations expanded to include price-to-book (P/B) multiples. As one of the most common
equity valuation metrics, the inclusion of P/B multiples in the model should foster
the understanding of the interrelationship between both markets.
EPS RoE
= = (1)
P P
B
Based on equation 1, Figure 43 shows the ICOE vs. P/B relation for a wide range of
market valuations. As any other discount cash-flow model, the Gordon Growth model
shows a convex relation between the ICOE and P/B multiples, resulting in higher ICOE
volatility at lower multiples. While the model is quite simple, a better understanding of
the mechanics behind equation 1 is useful to portray the relationship between the banks'
fundamental and compression/decompression patterns.
4
= →r = →r = =
42
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Figure 43: P/B vs. Implied cost of equity (The ICOE curve)
40%
Implied cost of equity

30%
20%
10%
0%
0.0 0.4 0.8 1.2 1.6 2.0
P/B
A P/B multiple expansion or contraction will result in movements along the curve
(Figure 44), while earnings upgrade or downgrade would shift the curve (Figure 44).
Obviously, these changes do not occur in isolation and an earnings upgrade is usually
The implied cost of equity is the
accompanied by a higher P/B multiple, while a reduction in expected profitability is
result of the interrelationship of likely to result in lower market valuations. Hence, the implied cost of equity is the
expected profitability and market result of the interplay between expected earnings and market valuations. An
valuation assessment of those increase of expected RoE, which could be driven by the acquisition of an entity in an
expected earnings cash-flows fast-growing economy, for example, may be perceived as a deterioration of overall
earnings quality and improving profit expectations may only result in a marginal
expansion of P/B multiples and a consequent increase of the ICOE due to the
perceived earnings risk (look at equation 1). Or, alternatively, lower profit
expectation, as a lender delevers and sells non-core assets, may improve earnings
quality and a proportionally small P/B multiple contraction may lead to unchanged
or, potentially, lower ICOE.
Figure 44: Movements along the curve Figure 45: Shifts of the curve
40% 60%
RoE = 10% RoE = 15% RoE = 5%
50%
30%
40%
20% 30%
20%
10%
10%
0% 0%
0.0 0.4 0.8 1.2 1.6 2.0 0.0 0.4 0.8 1.2 1.6 2.0
P/B P/B
Source: J.P. Morgan. Source: J.P. Morgan.
In addition, the ICOE fluctuates even if P/B multiples and profit expectations remain
unchanged if the ICOE curve becomes more or less convex (i.e. changes in the shape
of the curve). Following previous examples, a deterioration of earnings quality will
tend to increase the convexity of the curve (ICOE become more volatile) and,
assuming other variables remain unchanged, ICOE will increase. On the other hand,
better earnings quality will reduce convexity and decrease the ICOE. In essence, the
implied cost of equity varies as ever-changing fundamental factors and market
valuations modify the shape and the position of the ICOE curve (Figure 46).
With a better understanding of ICOE behavior, we now explore its relationship with
AT1 yields levels.
43
(44-20) 7134-1733 28 January 2014
Figure 46: The implied cost of equity

Changes in the
shape of the curve
P/B multiples Long-term

expansion or earnings upgrade
contraction. or downgrade.
The implied cost of equity varies
as ever-changing fundamental
factors and market valuations
modify the share and the
position of the ICOE curve
Movements Shifts of the

along the curve
curve
The implied cost

of equity (ICOE)
Equity-AT1 compression/decompression
As we intend to rely on the ICOE as an alternative starting point for an equity-based
valuation framework, modeling the equity-AT1 compression/decompression profile
is paramount to price AT1 structures. While market data suggests that AT1 yields
show an inverse relation with P/B multiples, the cost of the more subordinated equity
We can modify the Gordon
Growth model to reflect the
instruments has a greater sensitivity to profitability and market multiples. We can
lower volatility and convexity easily adjust equation 1 to reflect the more steady yields observed in the AT1 space
seen in AT1 yields (c) and other technical factors that may structurally benefit or put some issuers in a
disadvantage position (k)5.
k ∗ RoE
= (2)
P
B
Figure 47: The cost of AT1 and equity curves
50%
ICOE & AT1 yields
40%
30%
Equity
20%
AT1
10%
0%
0.0 0.4 0.8 1.2 1.6 2.0
P/B
5
This factor seems to reflect a premium that penalizes peripheral lenders while all core lenders
show a similar pricing advantage.
44
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Figure 47 highlights the ICOE curve along with equation 2 as an approximation of

AT1 yields. In turn, these two equations, in conjunction, can be used to understand
the drivers of equity-AT1 compression/decompression. Solving for the ratio of
ICOE/AT1 yields shows that compression between both asset classes depends on the
relative convexity of the equity and AT1 curves (Figure 47), current P/B multiple and
expected profitability.
Equity-AT1 compression However, it seems unlikely that at low P/B multiples, usually correlated with the
depends on current P/B perception of a capital shortfall and a relatively high trigger risk, equity-AT1 will
multiples, expected earnings show increasing decompression. Upon an imminent capital increase, equity investors
and AT1 convexity
will suffer dilution while AT1 bondholders could potentially suffer a write-down or a
conversion into equity and a subsequent dilution. Hence, while the dark line is
generated by equations 1 and 2, the doted line reflects the fact that low market
valuations could potentially lead to equity-AT1 compression as both instruments
price a broadly similar outcome; dilution and conversion/write down. If a trigger
event is avoided and a rights issue is successfully underwritten, equity-AT1 is likely
to show decompression as AT1 yields benefit from a thicker equity tranche and a
lower trigger/deferral risk, while ICOE would tend to remain high in anticipation of
an increase in the share count. Decompression would last as far as restructuring and
improving fundamentals are validated through higher equity market valuations as a
sound business will offer higher growth opportunities to equity investors.
Consequently, in this latter stage equity-AT1 should see compression again as AT1
bondholders’ compensation is inherently limited by the stated coupon rate.
While the implied cost of equity On the other hand, a one-off loss could potentially result in equity-AT1
framework highlights that high decompression as equity underperforms AT1s. While AT1 yields are likely to suffer
equity market valuations would under these circumstances, a P/B multiple contraction is likely to result in a larger
correspond with increasing
equity-AT1 compression,
loss for shareholders as AT1 principal is protected from any potential dilution.
valuation levels could converge However, a relatively severe loss or the perception that the balance sheet may hide
again at low P/B multiples as additional unrealized losses, would tend to result in an incremental trigger/deferral
both instruments could face a risk and push AT1 yields closer to the ICOE and result in compression, while the
similar outcome equity market assigns lower multiples valuations. If the one-off loss is follow by a
successful capital increase AT1 is likely to outperform and compress relative to
equity as capital buffers are replenished and equity investors are diluted. As
described in the previous example, this dynamic will continue until improving
fundamentals result once again result in equity-AT1 compression.
Figure 48: Compression/decompression profile

1.8
ICOE/AT1 yields
1.2
Issuers trading close to book
value would tend to show the
higher equity-AT1
decompression
0.6
0.0
0.0 0.4 0.8 1.2 1.6 2.0
P/B
45
(44-20) 7134-1733 28 January 2014
Hence, the implied cost of equity framework suggests a plausible explanation for
equity-AT1 compression/decompression across a wide range of P/B multiples and
alternative scenarios, which seems adequate to explain the differences observed
between AT1 yields and the implied cost of equity (Figure 41 and Figure 42). Having
established a relationship between both asset classes, we take this approach one step
further and infer fair value AT1 yield levels based on market data. We highlight the
relative value nature of the approach in the sense that it only allows us to assess if an
instrument is cheap or expensive relative equity market data while it fails to provide
The implied cost of equity
an absolute valuation point and may be biased by current equity market conditions.
framework suggests that
BBVASM 9.0% and POPSM Applying the implied cost of equity framework
11.5% are expensive while As per equations 1 and 2, Figure 49shows fair valued AT1YTC, current AT1 YTC
SocGen 8.25% is cheap. along with the differential between both metrics; a positive differential implies that
Barclays' AT1s instruments,
Credit Suisse 7.5% look and
the AT1 instrument is expensive relative to equity. While we acknowledge that the
Credit Agricole 7.875% look implied cost of equity framework relies on estimates that may vary as the
fairly valued fundamental conditions of an issuer change, equity market data suggests that
BBVASM 9.0% and POPSM 11.5% are expensive, while SocGen 8.25% is relatively
cheap. On the other hand, Barclays’ AT1s instruments, Credit Suisse 7.5% look and
Credit Agricole 7.875% are fairly valued.
Figure 49: Fair valued and current AT1 YTC

1.10% 16%
0.80% 12%
0.50% 8%
0.20% 4%
-0.10% 0%
Assuming that the underlying parameters of the model are stable, it is possible to
graph the fairly valued and current yields differential since issuance. While the data
shows relative high volatility due the inherent share price fluctuations, change in
AT1 yields, and reassessment of lenders’ profitability, it is possible to distinguish
relatively extensive periods during which instruments were consistently cheap
expensive.
46
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Figure 50: BBVASM 9.0% Figure 51: SocGen 8.25%

200 80
150
40
100
50 0
0 -40
-50
-80
-100
-150 -120
May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Sep-13 Nov-13 Jan-14
Figure 52: Barclays (USD) 8.25% Figure 53: Barclays (EUR) 8.0%
60 30
40 20
20
10
0
0
-20
-10
-40
-60 -20
-80 -30
Nov-13 Dec-13
Figure 54: Popular 11.5% Figure 55: Credit Suisse 7.5%

300 20
250
10
200
150 0
100 -10
50
-20
0
-50 -30
Oct-13 Dec-13 Dec-13
47
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Appendix I: Economic and credit cycle

data
Table 23: GDP 12-month annual growth rates
%
Country 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Austria 3.5 3.7 0.9 1.7 0.9 2.6 2.4 3.7 3.7 1.4 -3.8 1.8 2.8 0.9 0.4
Belgium 3.5 3.7 0.8 1.4 0.8 3.3 1.8 2.7 2.9 1.0 -2.8 2.4 1.8 -0.3 0.1
Brazil 0.3 4.3 1.3 2.7 1.1 5.7 3.2 4.0 6.1 5.2 -0.3 7.5 2.7 0.9 2.5
Estonia -0.3 10.0 7.5 7.9 7.8 6.3 8.9 10.1 7.5 -4.2 -14.1 2.6 9.6 3.9 1.5
France 3.3 3.7 1.8 0.9 0.9 2.5 1.8 2.5 2.3 -0.1 -3.1 1.7 2.0 0.0 0.2
Germany 1.7 3.3 1.6 0.0 -0.4 0.7 0.8 3.9 3.4 0.8 -5.1 3.9 3.4 0.9 0.5
Greece 3.4 3.5 4.2 3.4 5.9 4.4 2.3 5.5 3.5 -0.2 -3.1 -4.9 -7.1 -6.4 -4.2
Ireland 11.0 10.6 5.0 5.4 3.7 4.2 6.1 5.5 5.0 -2.2 -6.4 -1.1 2.2 0.2 0.6
Italy 0.3 2.2 2.4 1.5 0.3 0.7 0.9 2.3 3.1 1.6 -3.7 -1.9 -1.8 -3.4 -4.8
Luxembourg 8.4 8.4 2.5 4.1 1.7 4.4 5.3 4.9 6.6 -0.7 -4.1 2.9 1.7 0.3 0.5
Netherlands 4.7 3.9 1.9 0.1 0.3 2.2 2.0 3.4 3.9 1.8 -3.7 1.5 0.9 -1.2 -1.3
Portugal 4.1 3.9 2.0 0.8 -0.9 1.6 0.8 1.4 2.4 0.0 -2.9 1.9 -1.3 -3.2 -1.8
Russia 6.4 10.0 5.1 4.7 7.3 7.2 6.4 8.2 8.5 5.2 -7.8 4.5 4.3 3.4 1.5
Slovenia 5.3 4.3 2.9 3.8 2.9 4.4 4.0 5.9 7.0 3.4 -7.9 1.3 0.7 -2.5 -2.6
South Africa 2.4 4.2 2.7 3.7 2.9 4.6 5.3 5.6 5.5 3.6 -1.5 3.1 3.5 2.5 2.0
Spain 4.7 5.1 3.7 2.7 3.1 3.3 3.6 4.1 3.5 0.9 -3.8 -0.2 0.1 -1.6 -1.3
United Kingdom 2.9 4.4 2.2 2.3 3.9 3.2 3.2 2.8 3.4 -0.8 -5.2 1.7 1.1 0.2 1.4
United States 4.8 4.1 0.9 1.8 2.8 3.8 3.4 2.7 1.8 -0.3 -2.8 2.5 1.8 2.8 1.6
Source: IMF
Table 24: Credit-to-GDP ratios

%
Country 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Austria -5.1% 2.6% 1.8% 2.0% 8.4% 0.1% 1.7% 1.4% 0.2% -1.1%
Belgium -0.1% 2.7% 2.7% 4.4% 11.9% 3.2% 0.0% 1.5% 8.4% 21.8%
Brazil 7.1% -40.8% 2.4% 6.9% 18.5% 5.1%
Estonia 0.4% -2.3% -0.8% 0.8% 1.0%
France -2.4% -4.3% -3.9% -6.2% -0.7% -0.8% -2.3% 16.3% 7.9%
Germany -4.8% -1.9% 0.9% 2.2% 12.7% 1.0% -0.2% 0.4% 0.3% -1.2%
Greece 1.8% 4.2% 1.2% 4.9% -79.3% 2.7% -5.4% 0.4% 1.7% 0.8%
Ireland 7.5% 4.1% 6.2% 4.4% -2.6% 1.7% 33.9% -1.9% -29.0% -7.6%
Italy 6.1% 5.9% 5.5% 4.3% 4.3% 0.6% -1.1% -1.6% 1.0% 1.2%
Luxembourg -1.8% 2.0% 2.4% 3.4% -38.9% 2.4% -1.8% -2.9% -23.4% -7.4%
Netherlands 1.6% 3.1% 2.2% 4.3% 5.1% -1.4% 1.4% 4.7% -2.4% -0.8%
Portugal 1.1% 6.0% 5.2% 4.9% -0.6% -1.5% 1.2% 2.6% 3.0%
Russia 5.2% 5.6% 3.7% 2.6% 0.5% 3.5% 4.4% 5.1% -4.0% 7.1% 6.2% 5.9% 8.1%
Slovenia 5.2% 4.1% 5.0% 5.4% -0.2% 0.0% -4.7% 2.9% 3.1%
South Africa 2.6% 5.2% 1.2% 6.5% 3.0% 3.7% 4.6% 3.9% 3.8% 0.1% 1.8% 1.8% 3.9% 2.9%
Spain 5.3% 7.7% 7.6% 5.6% 7.6% 1.0% 9.7% - 9.3% 9.3%
UK 2.8% 3.6% 3.1% 1.7% 2.2% 5.5% 6.8% 5.0% -4.8% 0.5% -2.0% -2.6% -15.3% -1.0%
US 1.4% -1.8% 8.9% -1.9% 2.5% 3.0% 3.4% 6.1% -6.9% 4.7% -1.2% 3.0% 0.6% 1.0%
Source: IMF
48
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Table 25: Building Block Tool Box

Adjust 10yr bullet to a 10NC5 Coco (BARC)
US06740L8C27 BARC 10yr coco 7% write-down BACR 7.625 -22 USD 6.46
US06739FHK03 BARC 10NC5 coco 7% write-down BACR 7.75 18-23 USD 5.10
Additional Spread for 10yr bullet 1.35
5% write-down to 5% equity convert (CS 5yr)
XS0957135212 CS 10yr coco 5% convert CS 6.5 -23 USD 5.51
-spread for 10NC5 -1.35
BARC to CS credit adjustment (5yr) 0.78
-1.05
CS 10NC5 coco 5% convert 4.46
CH0214139930 UBS 10NC5 coco 5% write-down UBS 4.75 18-23 USD 4.58
UBS to CS credit adjustment (5yr) 0.02
CS 10NC5 coco 5% write-down 4.60
CS write-down-convert spread (5%) -0.14
5% to 7% convert spread (CS)
XS0595225318 CS 30NC5 coco 7% convert CS 7.875 16-41 USD 4.15
short duration, therefore increase spread by CDS curve (3-5s) 0.41
no adjustment for long back end given trading to call
CS NC5 coco 7% convert 4.53
CS 5% to 7% convert spread 0.07
5% to 7% write-down (UBS)
CH0214139930 UBS 10NC5 coco 5% write-down UBS 4.75 18-23 USD 4.58
US06739FHK03 BARC 10NC5 coco 7% write-down BACR 7.75 18-23 USD 5.10
BACR/UBS credit adjustment (5yr) -0.31
UBS 10NC5 coco 7% write-down 4.79
UBS 5% to 7% write-down spread 0.21
7% write-down to 7% equity convert (CS)
CS NC5 coco 7% convert 4.53
CS to UBS credit adjustment (5yr) -0.02
UBS NC5 coco 7% convert 4.51
7% write-down to 7% equity convert -0.28
Inserting 7% phase-in trigger write-down bullet (BACR)
XS0611398008 BACR 9yr LT2 EUR BACR 6.625 -22 EUR 3.66
EUR-USD Xccy spread 10yr adj 0.16
BACR 9yr LT2 USD 3.82
US06740L8C27 BACR 9yr Coco 7% phase USD BACR 7.625 -22 USD 6.46
Inserting 7% phase-in trigger write-down bullet 2.63
Inserting 7% phase-in trigger write-down 10NC5 (BACR)
XS0334370565 BACR 10NC5 LT2 GBP BACR 6.75 18-23 GBP 3.61
GBP-USD xcct spread 5yr adj -0.06
3.55
US06739FHK03 BACR 10NC5 Coco 7% phase USD BACR 7.75 18-23 USD 5.10
Inserting 7% phase-in trigger write-down 10NC5 1.56
49
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Table 26: Socgen AT1 building block approach

SOCGEN 8.25 USD 18P Calc SOCGEN 8.25 USD 18P Calc SOCGEN 7.875 USD 23P Calc
XS0867614595 XS0867614595 USF8586CRW49
From legacy instrument From AT1 instrument From legacy instrument
PNC4 T1 5.922% USD 308 BBVA PNC5 T1 USD 7% equity convert 571 PNC4 T1 5.922% USD 308
duration adjustment 1.25 BBVA/SOCGEN credit adj 0.86 duration adjustment 1.33
SOCGEN PNC5 T1 5.922% USD 385 SOCGEN PNC5 T1 USD 7% equity convert 494 SOCGEN PNC5 T1 5.922% USD 409
Insert 7% phase-in trigger write-down 10NC5 (BACR) 156 7% equity convert to 7% write down (CS) 28 Insert 7% phase-in trigger writedown 10NC5 (BACR) 156
BACR/SOCGEN credit adj (ratio) 1.12 CS/SOCGEN credit adj (ratio) 1.44 BACR/SOCGEN credit adj (ratio) 1.12
SOCGEN 7% write-down 174 SOCGEN 7% write-down 41 SOCGEN 7% write-down 174
7% to 5% writedown (UBS) -28 7% write-down to 5% write-down (UBS) -21 7% to 5% writedown (UBS) -28
UBS/SOCGEN credit adj (ratio) 1.47 UBS/SOCGEN credit adj (ratio) 1.47 UBS/SOCGEN credit adj (ratio) 1.47
7% to 5% writedown (SOCGEN) -42 BBVA PNC5 T1 USD 7% equity convert -47 7% to 5% writedown (SOCGEN) -42
SOCGEN PNC5 T1 USD 5% write-down 518 SOCGEN PNC10 T1 USD 5% write-down 487 SOCGEN PNC10 T1 USD 5% write-down 541
Lack of pusher xx xx Lack of pusher xx
Trading Price 466 466 478

FV differential -52 -21 -63
Conversion trigger 5.125% 5.125%

Deferral trigger (2019) (ex CcyB) 8.00% 8.00%
Fully Loaded CET1 (Q3 13) 9.90% 9.90%

RWA (Q3 13) 353 353
Target Fully Loaded CET1 10% 10.00%
Buffer to conversion (%) 4.775% 4.775%

Buffer to deferral (2019) (%) 1.90% 1.90%
Buffer to deferral based on target CET1 (%) 2.00% 2.00%
Buffer to conversion ($bn) 22.86 22.86

Buffer to deferral ($bn) 9.10 9.10
Buffer to deferral based on target CET1 ($bn) 9.58 9.58
50
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Table 27: POPSM & BBVA AT1 building block approach

BBVA 9 USD 18P** Calc POPSM 11.5 EUR 18P Calc POPSM 11.5 EUR 18P Calc
XS0926832907 XS0979444402 XS0979444402
From legacy instrument From AT1 instrument From legacy instrument
ISPIM PNC5 8.047 T1 EUR 449 BBVA PNC5 T1 USD 7% equity convert 569 ISPIM PNC5 8.047 T1 EUR 449
ISPIM/BBVA credit adj 0.91 BBVA/POPSM credit adj 1.59 ISPIM/POPSM credit adj 1.44
BBVA PNC5 T1 EUR 408 POPSM PNC5 T1 USD 905 POPSM PNC5 T1 EUR 648
EUR-USD xccy spread 5yr adj 8.6 EUR-USD xccy spread 5yr adj 8.6
BBVA PNC5 T1 USD 416 POPSM PNC5 T1 USD 7% equity convert 905 POPSM PNC5 T1 USD 657
Insert 7% phase-in trigger write-down 10NC5 (BACR) 156 Insert 7% phase-in trigger write-down 10NC5 (BACR) 156
BACR/BBVA credit adj (ratio) 1.29 BACR/POPSM credit adj (ratio) 2.06
BBVA 7% write-down (EBA trigger) 201 POPSM 7% write-down 320
7% write-down to 7% equity convert (CS) -28 7% equity convert to 5% equity convert (CS) -0.07 7% write-down to 7% equity convert (CS)/7% to 5% convert (CS) -35
CS/BBVA credit adj (ratio) 1.66 CS/POPSM credit adj (ratio) 2.65 CS/POPSM credit adj (ratio) 2.65
7% write-down to 7% equity convert (BBVA) -47 7% write-down to 7% equity convert (POPSM) -0.18 7% write-down to 7% equity convert (POPSM)/7% to 5% convert (POPSM) -93
BBVA PNC5 T1 USD 7% equity convert 571 POPSM PNC10 T1 USD 5% equity convert 905 POPSM PNC10 T1 USD 5% equity convert 884
Lack of pusher (cancels loss absorption in ISPIM T1) xx Lack of pusher (cancels loss absorption in ISPIM T1) xx
Trading Price 569 749 749

FV differential -1 -156 -135
Conversion trigger 5.125%* 5.125%

Fully Loaded CET1 (Q3 13) 9.40%^ 8.60%

RWA (Q3 13) 326 83.4
Target Fully Loaded CET1 10.00% 9%


Source: J.P. Morgan.*CT1 trigger of 7% until EBA requirement falls away, ^proforma for CNCB transaction, **This instrument was also priced using UCGIM 8.125% €19P which gave an extremely similar result, we have left ISPIM here for illustration purposes
51
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Table 28: BACR and ACAFP AT1 building block approach

BACR 8.25 USD 18P Calc BACR 8 EUR 20P Calc
US06738EAA38 XS1002801758
From legacy instrument From legacy instrument
BACR PNC4 T1 7.4342% USD 293 BACR PNC4 T1 7.4342% USD 308
duration adjustment 1.27 duration adjustment 1.33
BACR PNC5 T1 USD 373 BACR PNC7 T1 USD 409
Insert 7% phase-in trigger write-down 10NC5 (BACR) 156 Insert 7% phase-in trigger write-down 10NC5 (BACR) 156
7% write-down to 7% equity convert (CS) -28 7% write-down to 7% equity convert (CS) -28
CS/BACR credit adj (ratio) 1.29 CS/BACR credit adj (ratio) 1.30
7% write-down to 7% equity convert (BACR) -36 7% write-down to 7% equity convert (BACR) -37
BACR PNC5 7% equity convert (phase in) 567 BACR PNC7 7% equity convert (phase in) 654
Lack of stopper xx Lack of stopper xx
JPMe small buffer charge 75 75
Trading Price 538 573

FV differential -30 -81


RWA (Q3 13) 448 448
Target Fully Loaded CET1 10.50% 10.50%


52
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Table 29: CS and ACAFP AT1 building block approach

CS 7.5 USD 23P Calc ACAFP 7.875 USD 24P Calc
XS0989394589 USF22797RT78
From legacy instrument From legacy instrument
CS PNC5 5.86% USD 264 PNC5 T1 8.2% EUR 254
duration adjustment 1.34 duration adjustment 1.33
CS PNC10 T1 USD 354 ACAFP PNC10 T1 EUR 338
Insert 7% phase-in trigger writedown 10NC5 (BACR) 156
BACR/CS credit adj (ratio) 0.78 EUR-USD xccy spread 5yr adj 8.6
CS 7% write-down 121 ACAFP PNC10 T1 USD 347
7% to 5% writedown (UBS) -28 Insert 7% phase-in trigger writedown 10NC5 (BACR) 156
UBS/CS credit adj (ratio) 1.05 BACR/ACAFP credit adj (ratio) 1.11
7% to 5% writedown (CS) -30 ACAFP 7% write-down 172
CS PNC10 T1 USD 5% write-down 445 ACAFP PNC10 T1 USD 7% write-down 519
Lack of pusher xx Lack of pusher xx
Trading Price 384 Trading Price 482

FV differential -60 FV differential -37


RWA (Q3 13) 261 326
Target Fully Loaded CET1 10.0% 9.50%


53
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Table 30: FSB G-SIB list

Bucket G-SIB
5 (Empty)
(3.5%)
4 HSBC
(2.5%) JP Morgan Chase
3 Barclays
(2.0%) BNP Paribas
Citigroup
Deutsche Bank
2 Bank of America
(1.5%) Credit Suisse
Goldman Sachs
Group Crédit Agricole
Mitsubishi UFJ FG
Morgan Stanley
Royal Bank of Scotland
UBS
1 Bank of China
(1.0%) Bank of New York Mellon
BBVA
Groupe BPCE
Industrial and Commercial Bank of China Limited
ING Bank
Mizuho FG
Nordea
Santander
Société Générale
Standard Chartered
State Street
Sumitomo Mitsui FG
Unicredit Group
Wells Fargo
Source: FSB
54
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Summary Terms and Conditions For AT1/Coco Structures

ISIN XS0459086582 XS0747231362
Issue Date 01/12/2009 22/02/2012
Issuer LBG CAPITAL NO.1 PLC UBS AG JERSEY BRANCH
Ticker LLOYDS UBS
Coupon 7.5884 7.25
Coupon Type FIXED VARIABLE
Call Date 22/02/2017
Maturity 12/05/2020 22/02/2022
Type Bullet Callable Bullet
Ccy GBP USD
Amt 732 2,000
USD Equiv 1,158 2,000
Issuing Spread 5yr+606.1bp
Back End N/A 5yr+606.1bp
Host LT2 LT2
Trigger type Core Tier 1 (Basel 2.5) Core Tier I (phase in)/CET1
Trigger level 5% 5%
Other Trigger RRD in risk factors Swiss Non-Viability
Conversion Form Conversion to Equity/Floor Price 59.2p Write-down to zero
Regulatory Call Instrument Specific 101 (reg change)/par (full disqualification)
Call Notice 10 - 21 days 30 - 60 Days notice
Contingency Event Trigger Event
i) if capital ratio falls below 5% on publication of capital ratio, AND UBS has not declared to pay in any way
Trigger Event on any core capital instruments/repurchased or redeemed any core capital instruments during 1 month
i) if consolidated Core Tier I ratio of LBG is less than 5% period before publication of capital ratio (subject to permitted transactions
Viability Event Viability Event
1) Notification by regulator that writedown of BCNs, T1s and T2s by T&Cs or by law is occurring to improve
capital adequacy because other measures are inadequate or unfeasible to avoid insolvency, bankruptcy or
inability to pay debt/carry on business.
2) Receive irrevocable extraordinary support from the public sector beyond ordinary course that will have
No Viability Language effect to improve capital adequacy
Comment Core Tier I capital defined as the definition given by the FSA as at 1 May 2009
Regulatory Capital Capital Event if cannot be treated as both i) T2 and/or ii) Buffer capital under national regulations
Event Requirement Change event occurs if amount of buffer capital required by FINMA is reduced and UBS
exceeds minima
Capital disqualification event if i) ECNs no longer eligible in whole or in part as LT2 capital or ii) if Alignment event will allow call at 101 or adjustments if instrument regulations loosen to allow better
the ECNs cease to be taken into account in whole or in part as Core Tier I under FSA stress tests (cheaper) structures (in theory)
If high trigger coco's are issued then these won't convert until a high trigger conversion notice has been
Conversion occurs as a whole made
Conversion falls away following certain events Substitution or Variation event, investor must be no worse off
Accrued interest is paid Claim in liquidation subject to contingent write-down event even if after event of default
Law English/Scots law (subordination) Swiss
Comments Must pay Must pay
55
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ISIN US90261AAB89 CH0214139930

Issue Date 17/08/2012 22/05/2013
Issuer UBS AG STAMFORD CT UBS AG
Ticker UBS UBS
Coupon 7.625 4.75
Maturity 17/08/2022 22/05/2023
Type Bullet Callable Bullet
Ccy USD USD
Amt 2,000 1,500
USD Equiv 2,000 1,500
Issuing Spread 10yr+598bp 5yr+376.5bp
Back End N/A 5yr+376.5bp
Host LT2 LT2
Trigger type Core Tier I (phase in)/CET1 Core Tier I (phase in)/CET1
Trigger level 5% 5%
Other Trigger Swiss Non-Viability Swiss Non-Viability
Conversion Form Write-down to zero Write-down to zero
Regulatory Call 101 (reg change)/par (full disqualification) 101 (reg change)/par (full disqualification)
Call Notice 30 - 60 Days notice 30 - 60 Days notice
Contingency Event Trigger Event Trigger Event
i) if capital ratio falls below 5% on publication of capital ratio, AND UBS has not declared to pay in i) if capital ratio falls below 5% on publication of capital ratio, AND UBS has not declared to pay in any way
any way on any core capital instruments/repurchased or redeemed any core capital instruments on any core capital instruments/repurchased or redeemed any core capital instruments during 1 month
during 1 month period before publication of capital ratio (subject to permitted transactions period before publication of capital ratio (subject to permitted transactions
Viability Event Viability Event Viability Event
1) Notification by regulator that write-down BCNs, T1s and T2s by T&Cs or by law is occurring to 1) Notification by regulator that write-down BCNs, T1s and T2s by T&Cs or by law is occurring to improve
improve capital adequacy because other measures are inadequate or unfeasible to avoid capital adequacy because other measures are inadequate or unfeasible to avoid insolvency, bankruptcy or
insolvency, bankruptcy or inability to pay debt/carry on business. inability to pay debt/carry on business.
2) Receive irrevocable extraordinary support from the public sector beyond ordinary course that will 2) Receive irrevocable extraordinary support from the public sector beyond ordinary course that will have
have effect to improve capital adequacy effect to improve capital adequacy
Comment
Regulatory Capital Capital Event if cannot be treated as both i) T2 and/or ii) Buffer capital under national regulations Capital Event if cannot be treated as both i) T2 and/or ii) Buffer capital under national regulations
Event Requirement Change event occurs if amount of buffer capital required by FINMA is reduced and Requirement Change event occurs if amount of buffer capital required by FINMA is reduced and UBS
UBS exceeds minima exceeds minima
Alignment event will allow call at 101 or adjustments if instrument regulations loosen to allow better Alignment event will allow call at 101 or adjustments if instrument regulations loosen to allow better
(cheaper) structures (in theory) (cheaper) structures (in theory)
If high trigger coco's are issued then these won't convert until a high trigger conversion notice has If high trigger coco's are issued then these won't convert until a high trigger conversion notice has been
been made made
Substitution or Variation event, investor must be no worse off Substitution or Variation event, investor must be no worse off
Claim in liquidation subject to contingent write-down event even if after event of default Claim in liquidation subject to contingent write-down event even if after event of default
Law Swiss Swiss
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ISIN XS0595225318 CH0181115681

Issue Date 24/02/2011 22/03/2012
Issuer CSG GUERNSEY I LTD CSG GUERNSEY IV LTD
Ticker CS CS
Coupon 7.875 7.125
Coupon Type VARIABLE VARIABLE
Call Date 24/08/2016 22/03/2017
Maturity 24/02/2041 22/03/2022
Type Callable Bullet Callable Bullet
Ccy USD CHF
Amt 2,000 750
USD Equiv 2,000 805
Back End 5yr+522bp 5yr+668.5bp
Host LT2 LT2
Trigger level 7% 7%
Other Trigger Swiss Non-Viability Swiss Non-Viability
Conversion Form Conversion to Equity/Floor price $20 Conversion to Equity/Floor price $20
Regulatory Call 102 102
Call Notice Min 30 days Min 30 days
Contingency Event Contingency Event Contingency Event
i) if capital ratio falls below 7% in quarterly financial report, subject to B3 implementation event i) if capital ratio falls below 7% in quarterly financial report, subject to B3 implementation event
1) Notification by regulator that write-down BCNs, T1s and T2s by T&Cs or by law is occurring to improve
Viability Event capital adequacy because other measures are inadequate or unfeasible to avoid insolvency, bankruptcy or
1) Notification by regulator that write-down BCNs, T1s and T2s by T&Cs or by law is occurring to inability to pay debt/carry on business.
improve capital adequacy because other measures are inadequate or unfeasible to avoid 2) Receive irrevocable extraordinary support from the public sector beyond ordinary course that will have
insolvency, bankruptcy or inability to pay debt/carry on business. effect to improve capital adequacy
2) Receive irrevocable extraordinary support from the public sector beyond ordinary course that will 3) Capital ratio in any interim capital report is below 5% and Progressive capital notes would have to
have effect to improve capital adequacy convert if it were not for conversion of the BCN
Comment If at anytime a contingency or viability event occurs, instruments AUTOMATICALLY convert to
equity If at anytime a contingency or viability event occurs, instruments AUTOMATICALLY convert to equity
Regulatory Capital Capital Event if cannot be treated as both i) T2 under BIS and ii) Buffer capital under national
Event regulations Capital Event if cannot be treated as both i) T2 under BIS and ii) Buffer capital under national regulations
Conversion occurs as a whole Conversion occurs as a whole
Substitution or Variation event, investor must be no worse off Substitution or Variation event, investor must be no worse off
Law English/Guernsey (subordination) Swiss/Guernsey (subordination)
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ISIN XS0703303262 XS0496281618

Issue Date 09/11/2011 19/03/2010
Issuer RABOBANK NEDERLAND RABOBANK NEDERLAND
Ticker RABOBK RABOBK
Coupon 8.4 6.875
Coupon Type VARIABLE FIXED
Maturity Perp 19/03/2020
Type Callable Perp Bullet
Ccy USD EUR
Amt 2,000 1,250
USD Equiv 2,000 1,661
Back End 5yr+749bp N/A
Host T1 Senior
Trigger type Equity Capital Equity Capital
Trigger level 8% 7%
Other Trigger RRD in risk factors RRD in risk factors
Conversion Form Permanent write-down, on multiple occasions Permanent write-down to 25%
Regulatory Call (Tax) Make-whole at B+100bps
Call Notice 30 - 60 Days notice
Contingency Event Loss absorption Event
i) if the equity capital ratio falls below 8% due to loss or if regulator believes ratio will fall below 8% Trigger Event
in near term i) if the equity capital ratio falls below 7% at any time apart from 25 business days before maturity
Viability Event No Viability Language No Viability Language
Comment Mandatory deferral linked to distributable items Write down to 25% and redeemed
Regulatory Capital
Event If capital securities can no longer be included in FULL in consolidated Tier I capital of group Only Tax call possible
Expected to exercise call option on or after 26th Jan 2041 (subject to replacement), can be
redeemed at a written down value Write-down occurs as a whole
Variation language however terms must not be materially less favorable A second test equity capital ratio test is undertaken 20 business days after
No Stoppers No accrued interest paid
Law Netherlands Netherlands
Comments Discretionary Coupons Must pay
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ISIN XS0583302996 US06740L8C27

Issue Date 26/01/2011 21/11/2012
Issuer RABOBANK NEDERLAND BARCLAYS BANK PLC
Ticker RABOBK BACR
Coupon 8.375 7.625
Maturity Perp 21/11/2022
Type Callable Perp Bullet
Ccy USD USD
Amt 2,000 3,000
USD Equiv 2,000 3,000
Back End 5yr+642.5bp N/A
Host T1 LT2
Trigger type Equity Capital Core Tier I (phase in)/CET1
Trigger level 8% 7%
Conversion Form Permanent write-down, on multiple occasions Write-down to zero
Regulatory Call At prevailing principle price Par
Contingency Event Loss absorption Event
i) if the equity capital ratio falls below 8% due to loss or if regulator believes ratio will fall below 8% Automatic Transfer Event
in near term i) if capital ratio falls below 7% in quarterly financial report or extra ordinary reporting event
Comment Mandatory deferral linked to solvency/distributable items/capital ratio less than 8%/regulator inc
stress tests
Regulatory Capital If notes of FULLY excluded from the groups T2 capital for the CAD of FSA or any other regulation/directive
Event If capital securities can no longer be included in FULL in consolidated Tier I capital of group adopted by EU
Expected to exercise call option on or after 26th Jan 2041 (subject to replacement), can be
redeemed at a written down value Transfer occurs as a whole
Variation language however terms must not be materially less favorable No Variation language
Dividend stopper & Capital Stopper until next interest payment or redemption/reduction of principle
in full Accrued interest is paid
Law Netherlands New York/English (subordination)
Comments Discretionary Coupons Must pay
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ISIN US06739FHK03 XS0862044798

Issue Date 10/04/2013 15/01/2013
Issuer BARCLAYS BANK PLC BANK OF IRELAND
Ticker BACR BKIR
Coupon 7.75 10
Maturity 10/04/2023 30/07/2016
Type Callable Bullet Bullet
Ccy USD EUR
Amt 1,000 1,000
USD Equiv 1,000 1,329
Issuing Spread 5yr+683.3bp N/A
Back End 5yr+683.3bp N/A
Host LT2 LT2
Trigger level 7% 8.25%
Conversion Form Write-down to zero Conversion to Equity
Regulatory Call Par Par
Contingency Event Automatic Transfer Event Conversion Event
i) if capital ratio falls below 7% in quarterly financial report or extra ordinary reporting event i) if capital ratio falls below 8.25% in quarterly financial report or extra ordinary reporting event
Viability Event No Viability Language
Comment
Regulatory Capital
Event
Accrued interest is paid upon conversion
Law
Comments Must Pay Must Pay
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ISIN BE6248510610 XS0926832907

Issue Date 25/01/2013 09/05/2013
Issuer KBC BANK NV BANCO BILBAO VIZCAYA ARG
Ticker KBC BBVASM
Coupon 8 9
Call Date 25/01/2018 09/05/2018
Maturity 25/01/2023 Perp
Type Callable Bullet Callable Perp
Ccy USD USD
Amt 1,000 1,500
USD Equiv 1,000 1,500
Issuing Spread 5yr+709.7bp 5yr+807bp
Back End 5yr+709.7bp 5yr+807bp
Host LT2 AT1
Trigger type Core Tier I (phase in)/CET1 CET1 Phase, EBA (7%), Tier I (6%), Capital Principal (7%)
Trigger level 7% 5.125%/7%
Other Trigger RRD in risk factors PON
Regulatory Call Par Par
Contingency Event Trigger Event - individual and consolidated
i) CET1, ii) Capital Principal, iii) EBA CT1, iv) Tier 1 (Spanish definition) If at any time the bank is no longer
required to maintain any of the ratios specified in the definition of Trigger Event at the any minimum
threshold, such ratio and threshold will cease to constitute a Trigger Event from such time, provided such
Trigger Event ratio and threshold are not otherwise required under Applicable Banking Regulations for the Preferred
i) if the equity capital ratio falls below 7% at any time in report or extra ordinary reporting event Securities to qualify as Tier 1 Capital, Capital Principal and/or BCCS.
Comment
Regulatory Capital The securities are redeemable if, as a result of change in Spanish Law, Applicable Banking Regulation or
Event If Fully Excluded as Tier II capital any change in the application or official interpretation thereof, they cease to qualify as Tier 1 Capital
No Variation language
Accrued interest is paid
Law English/Belgian (subordination) Spanish
Comments Must Pay May Pay
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ISIN XS0957135212 XS0867614595

Issue Date 08/08/2013 06/09/2013
Issuer CREDIT SUISSE SOCIETE GENERALE
Ticker CS SOCGEN
Coupon 6.5 8.25
Maturity 08/08/2023 #N/A Field Not Applicable
Type Bullet Callable Perp
Ccy USD USD
Amt 2,500 1,250
Back End 10yr+380bp 5yr+639.4bp
Host LT2 AT1
Trigger type CET1 phase CET1 Phase
Trigger level 5% 5.125%
Other Trigger Swiss Non-Viability RRD in risk factors
Conversion Form Write-down to zero Write down / Write up
Regulatory Call Par/ Par
Call Notice 30 Days notice 30 - 45 Days notice
Contingency Event Capital Ratio Event
Contingency Event i) EBA CT1 group < 5.125% if before CRD IV
i) if sum of CET1 ratio and high trigger capital ratio falls below 5% in quarterly financial report, ii) CET1 of group < 5.125% if after CRD IV
subject to B3 implementation event. Can agree with regulator to take other actions instead of write Write down amount -
down i) amount which would be sufficient to cure the Capital Ratio Event
Write down is to zero ii) amount required to reduce principal to 1cent if it cannot cure the capital ratio event
1) Notification by regulator that write-down BCNs, T1s and T2s by T&Cs or by law is occurring to Return to Financial Health
improve capital adequacy because other measures are inadequate or unfeasible to avoid if a positive consolidated net income is recorded, issuer may AT FULL DISCRETION may increase principal
insolvency, bankruptcy or inability to pay debt/carry on business. amount PRO RATA with other notes and any other temp write-down instruments - must not exceed max
2) Receive irrevocable extraordinary support from the public sector beyond ordinary course that will distributable amount or write up amount,
have effect to improve capital adequacy Max write up amt - net income * notional/total Tier I (i.e. % of loss absorbing capital)
Comment Full discretionary non cumulative coupon, if before CRD IV mandatory deferral upon breach of regulatory
ratios. If after CRD IV mandatory deferral if all distributions on own funds instruments would exceed
distributable items AND interest is only paid if payment would not cause the maximum distributable amount
If at anytime a contingency or viability event occurs, instruments AUTOMATICALLY written off to be exceeded
Regulatory Capital Capital Event:
Event i) ceases eligible in THEIR ENTIRETY as BOTH Tier II capital and Progressive Component Capital
ii) changes that don't result in a capital event i) but has an effect to reduce the overall minimum Capital Event: not foreseeable at issue, reg changes, are fully or partially excluded from Tier I capital as
progressive component capital amount long as it is not due to limits (if before CRD IV) at Par
Tax Event Tax Event
Substitution and Variation Substitution and Variation
Given capital or tax event substitution or vary can occur to remain compliant securities. Terms Given capital or tax event substitution or vary can occur to remain qualifying notes, (could restrict special
cannot be economically less favorable (determined by the issuer) and have equal rating redemption events).terms not otherwise materially less favorable to holders
Coupon can be paid whilst written down - on reduced notional
Law Switzerland English/French
ISIN USF22797QT87 XS0972523947
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Issue Date 19/09/2013 18/09/2013

Issuer CREDIT AGRICOLE SA CREDIT SUISSE
Ticker ACAFP CS
Coupon 8.125 5.75
Call Date 19/09/2018 18/09/2020
Maturity 19/09/2033 18/09/2025
Type Callable bullet Callable Bullet
Ccy USD EUR
Amt 1,000 1,250
USD Equiv 1,000 1,705
Issuing Spread 5yr+628.3bo 7yr+400bp
Host LT2 LT2
Trigger type CET1 Phase CET1 phase + high trigger
Trigger level 7.000% 5.000%
Other Trigger RRD in risk factors Swiss Non-Viability
Conversion Form Write-down to zero Write-down to zero
Regulatory Call Par Par/
Call Notice 30 - 45 Days notice 30 Days notice
Contingency Event Contingency Event
Trigger Event i) if sum of CET1 ratio and high trigger capital ratio falls below 5% in quarterly financial report, subject to B3
i) if the Common equity capital ratio of the GROUP falls below 7% at any time , however no trigger implementation event. Can agree with regulator to take other actions instead of write down
event can occur on the date that a ratings methodology event notice becomes effective Write down is to zero
1) Notification by regulator that write-down BCNs, T1s and T2s by T&Cs or by law is occurring to improve
capital adequacy because other measures are inadequate or unfeasible to avoid insolvency, bankruptcy or
inability to pay debt/carry on business.
2) Receive irrevocable extraordinary support from the public sector beyond ordinary course that will have
effect to improve capital adequacy
3) Capital ratio in any interim capital report is below 5% and Progressive capital notes would have to
No Viability Language convert if it were not for conversion of the BCN
Comment
Regulatory Capital Capital Event: not foreseeable at issue, reg changes, are fully excluded from Tier Ii capital as
Event long as it is not due to limits at Par, callable at any time
Tax Event
Ratings Methodology Event Capital Event
A change in methodology of S&P that was not reasonable foreseeable at issue as a result of which a) notes cease to be eligible in their entirety to be treated as both i) Tier II capital under BIS regs and ii)
the equity content is materially reduced - callable after first reset date or - next interest payment Progressive component capital under national regulations (par)
date after 30days notice loss absorption feature drops out, rate drops by 150bps and b) if the minimum progressive component capital amount is reduced (103)
become redeemable after first call
Accrued interest is paid upon write-down
Law English/French Swiss
Comments Must Pay Must Pay
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ISIN CH0221803791 XS0979444402

Issue Date 04/09/2013 10/10/2013
Issuer CREDIT SUISSE GROUP AG BANCO POPULAR ESPANOL SA
Ticker CS POPSM
Coupon 6 11.5
Call Date 04/09/2018 10/10/2018
Maturity Perp Perp
Type Callable Perp Callable Perp
Ccy CHF EUR
Amt 290 500
USD Equiv 321 682
Issuing Spread 5yr+520.3bp 5yr+1023.7bp
Back End 5yr+520.3bp 5yr+1023.7bp
Host AT1 AT1
Trigger type CET1 phase + high trigger CET1 phase
Other Trigger Swiss Non-Viability
Regulatory Call Par/ Par/
Call Notice 30 Days notice 30 Days notice
Contingency Event Contingency Event Trigger event means the occurrence at any time of any of the following events: 1. The CET1 ratio is less
i) if sum of CET1 ratio and high trigger capital ratio falls below 5.125% in quarterly financial report, than 5.125% 2. The Tier 1 ratio is less than 6% and the bank of the group, as the case may be, has
subject to B3 implementation event. Can agree with regulator to take other actions instead of write reported losses in respect of each of its four most recent quarterly reporting periods with the result that the
down capital and reserves of the Bank of the Group have been reduced by one-third or more from the amount of
Write down is to zero such capital and reserves at the beginning of the first quarterly financial reporting periods.
1) Notification by regulator that writedown BCNs, T1s and T2s by T&Cs or by law is occurring to
improve capital adequacy because other measures are inadequate or unfeasible to avoid
insolvency, bankruptcy or inability to pay debt/carry on business.
2) Receive irrevocable extraordinary support from the public sector beyond ordinary course that will
have effect to improve capital adequacy
3) Capital ratio in any interim capital report is below 5% and Progressive capital notes would have
to convert if it were not for conversion of the BCN No Viability Language
Comment
Regulatory Capital Capital Event
Event Capital Event Reg (6.3) and tax (6.4) call. Reg call: cease to qualify as Tier 1 capital in whole but not in part as a result of
a) notes cease to be eligible in their entirety to be treated as both i) Tier II capital under BIS regs a change in Spanish law, applicable banking regulation or official interpretation. Under reg call the bonds
and ii) Progressive component capital under national regulations (par) may be redeemed in whole but not in part.
b) if the minimum progressive component capital amount is reduced (103)
Law Switzerland
64
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ISIN US06738EAA38 XS1002801758

Issue Date 20/11/2013 10/12/2013
Issuer BARCLAYS PLC BARCLAYS PLC
Ticker BACR BACR
Coupon 8.25 8
Call Date 15/12/2018 15/12/2020
Maturity Perp Perp
Ccy USD EUR
Amt 2,000 1,000
Issuing Spread 2,000 1,364
Host 5yr+670.5bp 5yr+675bp
Trigger type AT1 AT1
Trigger level CET1 fully loaded CET1 fully loaded
Other Trigger 7.000% 7.000%
Conversion Form Contractual PONV Contractual PONV
Regulatory Call Conversion to Equity (1.65£) Conversion to Equity (1.65£)
Call Notice Par/ Par/
Contingency Event 30 - 60 Days notice 30 - 60 Days notice
Viability Event Trigger Event Trigger Event
i) shall occur if the fully loaded CET1 ratio is less than 7.00%, conversion price fixed at 2.64$$ (was i) shall occur if the fully loaded CET1 ratio is less than 7.00%, conversion price fixed at 1.99EUR (was =
= 1.65££) 1.65££)
Comment No Viability Language No Viability Language
Regulatory Capital Conversion Shares Offer: The issuer can elect that the shares from conversion are offered to the Conversion Shares Offer: The issuer can elect that the shares from conversion are offered to the ordinary
Event ordinary share holders of Barclays PLC at the conversion exchange price, therefore AT1 holders share holders of Barclays PLC at the conversion exchange price, therefore AT1 holders could receive cash.
could receive cash. Takes place in first 40 days after trigger Takes place in first 40 days after trigger
5 days minimum notice for coupon payment 5 days minimum notice for coupon payment
Law NY/English with contractual Bail-in acknowledgement NY/English with contractual Bail-in acknowledgement
Comments Discretionary Coupons Discretionary Coupons
65
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ISIN XS0989394589 USF8586CRW49

Issue Date 11/12/2013 18/12/2013
Issuer CREDIT SUISSE GROUP AG SOCIETE GENERALE
Ticker CS SOCGEN
Coupon 7.5 7.875
Call Date 11/12/2023 18/12/2023
Maturity Perp Perp
Ccy USD USD
Amt 2,250 1,750
Issuing Spread 10yr+459.8bp 10yr+497.9bp
Back End 5yr+459.8bp 5yr+497.9bp
Host AT1 AT1
Trigger type CET1 phase + high trigger CET1 phase
Other Trigger Swiss Non-Viability RRD in risk factors
Conversion Form Write-down to zero Write down / Write up
Regulatory Call Par/103 Par
Call Notice 30 Days notice 30 - 45 Days notice
Contingency Event i) EBA CT1 group < 5.125% if before CRD IV
i) if sum of CET1 ratio and high trigger capital ratio falls below 5.125% in quarterly financial report, ii) CET1 of group < 5.125% if after CRD IV
subject to B3 implementation event. Can agree with regulator to take other actions instead of write Write down amount -
down i) amount which would be sufficient to cure the Capital Ratio Event
Write down is to zero ii) amount required to reduce principal to 1cent if it cannot cure the capital ratio event
Viability Event Viability Event (can be overwritten if no longer required by law)
1) Notification by regulator that writedown BCNs, T1s and T2s by T&Cs or by law is occurring to
improve capital adequacy because other measures are inadequate or unfeasible to avoid
insolvency, bankruptcy or inability to pay debt/carry on business. Return to Financial Health
2) Receive irrevocable extraordinary support from the public sector beyond ordinary course that will if a positive consolidated net income is recorded, issuer may AT FULL DISCRETION may increase principal
have effect to improve capital adequacy amount PRO RATA with other notes and any other temp writedown instruments - must not exceed max
3) Capital ratio in any interim capital report is below 5% and Progressive capital notes would have distributable amount or write up amount,
to convert if it were not for conversion of the BCN Max write up amt - net income * notional/total Tier I (i.e. % of loss absorbing capital)
Comment Full discretionary non cumulative coupon, if before CRD IV mandatory deferral upon breach of regulatory
ratios. If after CRD IV mandatory deferral if all distributions on own funds instruments would exceed
distributable items AND interest is only paid if payment would not cause the maximum distributable amount
Contains dividend stopper to be exceeded
Regulatory Capital Capital Event: not foreseeable at issue, reg changes, are fully or partially excluded from Tier I capital as
Event long as it is not due to limits (if before CRD IV) at Par
Tax Event
Capital Event Substitution and Variation
a) notes cease to be eligible in their entirety to be treated as both i) Tier II capital under BIS regs Given capital or tax event substitution or vary can occur to remain qualifying notes, (could restrict special
and ii) Progressive component capital under national regulations (par) redemption events).terms not otherwise materially less favourable to holders
b) if the minimum progressive component capital amount is reduced (103)
Law Swiss English/French subordination
Comments Discretionary Coupons Discretionary Coupons - Coupon can be paid whilst written down - on reduced notional
ISIN USF22797RT78
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Issue Date 23/01/2014

Issuer CREDIT AGRICOLE SA
Ticker ACAFP
Coupon 7.875
Coupon Type VARIABLE
Maturity Perp
Type Callable Perp
Ccy USD
Amt 1,750
USD Equiv 1,750
Back End 5yr+489.8bp
Host AT1
Trigger type CET1 phase
Trigger level 7% group/5.125% CASA
Other Trigger RRD in risk factors
Conversion Form Write down / Write up
Regulatory Call Par
Call Notice 30 - 45 Days notice
If CASA CET1 ratio falls or remains below 5.125% OR CA Group CET1 ratio falls or remains below
7% on a quarterly or extraordinary calculation date.
Loss absorption through reduction of principle to the amount necessary to reinstate relevant ratios,
pro rata with other instruments.
Following a write-down, interest will accrue on the Current Principal Amount of the Notes
Write-up: if positive consolidated net income of CASA is recorded at the issuers sole discretion pro
rata with similar instruments and subject to the MDA
Viability Event Non contractual viability event but subject to statutory bail in laws
Comment
Regulatory Capital Substitution and modification
Event Following Capital, Tax or Alignment event but terms must not be materially less favourable to
holders.
“Capital Event” means that a change that was not reasonably foreseeable by the Issuer at the
Issue Date, the Notes are fully excluded from the Tier 1 Capital of the Issuer, provided that such
exclusion is not as a result of any applicable limits on the amount of Additional Tier 1 Capital
contained in Applicable Banking Regulations.
Law NY/English with contractual Bail-in acknowledgement, Subordination French Law
Comments Coupon can be paid whilst written down - on reduced notional
Discretionary Coupons
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Appendix II: REFERENCE GLOSSARY

Table 31: Glossary
Text Link to Reference Document Relevant Article(s) Topic
Capital requirements for European institutions and investment firms,
applies directly in every member state imposing a harmonising single
set of rules across the EU thus leaving no scope for arbitrary
CRR Capital Requirements Regulation N/A interpretation.
A directive which will have to be incorporated into national laws of
CRD Capital Requirements Directive N/A member states.
CBR Combined Buffer Requirement Chapter 4, Article 128-141 Capital buffers which can place restrictions on institutions if breached
MCR Minimum Capital Requirements Article 92+/107+/465+ Minimum capital requirements and transitional arrangements
CET1 Common Equity Tier I
AT1 Additional Tier I
T2 Tier II
Ensuring the institution has enough liquid assets to cover outflows in a
LCR Liquidity Coverage Requirement Article 415+/509+ stress scenario
Ensuring long term obligations are met with a diversity of stable funding
NSFR Net Stable Funding Requirement Article 413+/510+ instruments both under normal and stressed conditions
Grandfathering Capital Requirements Regulation Article 483-491 Grandfathering of capital instruments under CRD IV
Transitional
Arrangement Capital Requirements Regulation Article 465-468 Transitional arrangements for capital requirements
Globally Systemically Important
G-SII Institutions Article 131+/133+ Part of the CBR
O-SII Other Systemically Important Institutions Article 131+/133+ Part of the CBR
CCyB Counter Cyclical Buffer Article 135+ Part of the CBR
CCB Capital Conservation Buffer Article 129+ Part of the CBR
Distribution Threshold Capital conservation measures Article 141+ Restrictions on distributions for breaching the CBR
Amounts that can be used to pay AT1, Dividends and Variable
MDA Maximum Distributable Amount Article 141 remuneration
MDA Zone
The point at which if the institution has losses it will be prevented from
DT Deferral Trigger paying coupon due to regulatory restrictions
The amount of capital available above the Deferral Trigger which can
CB Coupon Buffer provide a capital cushion for coupons.
Available Resources The resources available for the calculation of the MDA.
Implementing CRD IV in the UK,
CP 7/13 feedback and final rules PRA final rules for implementing CRD IV in the UK, update on CP 5/13
CP 5/13 Implementing CRD IV in the UK PRA consultation paper on implementing CRD IV in the UK.
Source: CRR, CRD, European Commission, PRA, + including following articles
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Analyst Certification: The research analyst(s) denoted by an “AC” on the cover of this report certifies (or, where multiple research
analysts are primarily responsible for this report, the research analyst denoted by an “AC” on the cover or within the document
individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views
expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of
any of the research analyst's compensation was, is, or will be directly or indirectly related to the specific recommendations or views
expressed by the research analyst(s) in this report. For all Korea-based research analysts listed on the front cover, they also certify, as per
KOFIA requirements, that their analysis was made in good faith and that the views reflect their own opinion, without undue influence or
intervention.
Important Disclosures
 Market Maker/ Liquidity Provider: J.P. Morgan Securities plc and/or an affiliate is a market maker and/or liquidity provider in
Société Générale, Barclays, UniCredit, BBVA, Credit Suisse Group, Credit Agricole, Banco Popular.
 Lead or Co-manager: J.P. Morgan acted as lead or co-manager in a public offering of equity and/or debt securities for Société
Générale, Barclays, UniCredit, Credit Suisse Group, Credit Agricole within the past 12 months.
 Other Significant Financial Interests: J.P. Morgan owns a position of 1 million USD or more in the debt securities of Société
Générale, Barclays, UniCredit, BBVA, Credit Suisse Group, Credit Agricole, Banco Popular.
 ‘J.P. Morgan is acting as financial advisor to Alpha Bank who on October 1st 2012 has entered into exclusive negotiations with Credit
Agricole S.A. on the acquisition of Emporiki Bank.’
Company-Specific Disclosures: Important disclosures, including price charts, are available for compendium reports and all J.P. Morgan–
covered companies by visiting https://jpmm.com/research/disclosures, calling 1-800-477-0406, or e-mailing
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screen companies not covered by J.P. Morgan. For important disclosures for these companies, please call 1-800-477-0406 or e-mail
research.disclosure.inquiries@jpmorgan.com.
Société Générale - J.P. Morgan Recommendation History
Date Issuer Rating Primary Indicative Instrument

09 Sep 11 Overweight 5y Senior CDS
Recommendation changes made by J.P. Morgan Credit Research Analysts in the subject company over the past 12 months (or, if no recommendation
changes were made in that period, the most recent change).
Note: Effective September 30, 2013, J.P. Morgan changed its Credit Research Ratings System.
Barclays - J.P. Morgan Recommendation History

17 Jun 11 Underweight 5yr CDS
UniCredit - J.P. Morgan Recommendation History

27 May 11 Overweight 5yr CDS
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BBVA - J.P. Morgan Recommendation History

12 Feb 08 Neutral 5YR CDS
Credit Suisse Group - J.P. Morgan Recommendation History

26 Sep 07 Neutral CDS
Credit Agricole - J.P. Morgan Recommendation History

09 Sep 11 Underweight 5y Senior CDS
Banco Popular - J.P. Morgan Recommendation History

04 Sep 13 Underweight 5yr Senior CDS
13 Nov 13 Neutral 5yr Senior CDS
Explanation of Credit Research Ratings:

Ratings System: J.P. Morgan uses the following issuer portfolio weightings: Overweight (over the next three months, the recommended
risk position is expected to outperform the relevant index, sector, or benchmark), Neutral (over the next three months, the recommended
risk position is expected to perform in line with the relevant index, sector, or benchmark), and Underweight (over the next three months,
the recommended risk position is expected to underperform the relevant index, sector, or benchmark). J.P. Morgan Emerging Markets
Sovereign Research uses Marketweight, which is equivalent to Neutral. NR is Not Rated. In this case, J.P. Morgan has removed the rating
for this security because of either a lack of a sufficient fundamental basis or for legal, regulatory or policy reasons. The previous rating no
longer should be relied upon. An NR designation is not a recommendation or a rating. NC is Not Covered. An NC designation is not a
rating or a recommendation. Analysts can rate the issuer, the individual bonds of the issuer, or both. An issuer recommendation applies to
all of the bonds at the same level of the issuer’s capital structure, unless we specify a different recommendation for the individual security.
For CDS, we use the following rating system: Long Risk (over the next three months, the credit return on the recommended position is
expected to exceed the relevant index, sector or benchmark), Neutral (over the next three months, the credit return on the recommended
position is expected to match the relevant index, sector or benchmark), and Short Risk (over the next three months, the credit return on the
recommended position is expected to underperform the relevant index, sector or benchmark).
Valuation & Methodology: In J.P. Morgan's credit research, we assign a rating to each issuer (Overweight, Underweight or Neutral)
based on our credit view of the issuer and the relative value of its securities, taking into account the ratings assigned to the issuer by credit
rating agencies and the market prices for the issuer's securities. Our credit view of an issuer is based upon our opinion as to whether the
issuer will be able service its debt obligations when they become due and payable. We assess this by analyzing, among other things, the
issuer's credit position using standard credit ratios such as cash flow to debt and fixed charge coverage (including and excluding capital
investment). We also analyze the issuer's ability to generate cash flow by reviewing standard operational measures for comparable
70
(44-20) 7134-1733 28 January 2014
companies in the sector, such as revenue and earnings growth rates, margins, and the composition of the issuer's balance sheet relative to
the operational leverage in its business.
J.P. Morgan Credit Research Ratings Distribution, as of January 1, 2014

Overweight Neutral Underweight
Global Credit Research Universe 25% 56% 19%
IB clients* 64% 58% 52%
Note: The Credit Research Rating Distribution is at the issuer level. Please note that issuers with an NR or an NC designation are not included in the
table above.
*Percentage of investment banking clients in each rating category.
Analysts' Compensation: The research analysts responsible for the preparation of this report receive compensation based upon various
factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues.
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Europe Credit Research

Squaring The Circle

 Based on the above considerations we recommend the following trades;

See page 69 for analyst certification and important disclosures.

Long SOCGEN AT1 versus short BACR AT1

Source: Bloomberg, Company reports and J.P. Morgan estimates.

Long UCGIM 8.125 €19P T1 vs BBVA 9.0 $18P AT1

Figure 2: UCGIM Minimum Buffer To First Loss

Source: J.P. Morgan estimates.

Table 1: Current Tax Status of AT1 Structures

We think BBVASM AT1 is expensive as Figure 1 highlights, having the highest

The Valuation Verdict

Table 2: Output of the Building Block Valuation Approach

Coupon Deferral Risk

Source: J.P. Morgan.

Source: J.P. Morgan.

Having Pillar IIA charge between the

Common Equity Common Equity

Debt Versus Equity Valuation Frameworks

Source: Bloomberg, Company reports and J.P. Morgan estimates.

3.5% Lev Ratio 4% Lev Ratio

Source: J.P. Morgan. Source: J.P. Morgan.

Table 3: Current Tax Status of AT1 Structures

The Thorny Issue of Valuations

 Is the AT1 asset class fairly valued?

 Is coupon deferral risk priced in?

 How are combined buffer requirements going to be defined?

 To what extent is the market pricing in coupon deferral risk versus

Is The AT1 Asset Class Fairly Valued?

we highlight our assumption that there is an immaterial difference between a 5%

Limited differentiation between contingent risk features

Figure 11: Graphical interpretation of trigger features in instruments

Source: J.P. Morgan estimates. numbers in basis points

JPM building block approach

Table 5: Building block example: ACAFP 7.875% USD 24P

EUR-USD xccy spread 5yr adj 8.6

Insert 7% phase-in trigger writedown 10NC5 (BACR) 156

Trading Price 482

Table 6: Building Block Output

We highlight that for Barclays AT1s we have assumed an incremental charge of

Source: J.P. Morgan.

POPSM 11.5% €18P

Legacy Basel II: A Bid Only Market?

Tier 1 Versus AT1 Risk Profile

Technical Support Factors

Broadening investor base

Source: J.P. Morgan.

Growing investor demand

Source: J.P. Morgan.

Figure 17: Performance of new AT1 issues versus book/issue size

Source: J.P. Morgan.

AT1: The Beta Weapon of Choice

Greater risk to AT1 from interest rates

Figure 18: Forward rates for US treasuries and Euro Swaps

Is Coupon Deferral Risk Priced In?

Mandatory Coupon Deferral Risk

Combined Buffer Requirements

Maximum Distribution Amount

Source: J.P. Morgan.

Scenario C: More relevant for capital conservation post loss event

Estimating the countercyclical buffer

1) The capital conservation buffer: 2.5%

2) The countercyclical buffer: 0-2.5%