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JM


Total Posts: 40
Joined: Apr 2010
 
Posted: 2014-04-29 18:02

Are CoCo bonds viable complements to conventional subordinated bank debt?

Sub debt recovery comes after a credit event. With a CoCo bond the event is based on a bank’s view of its assets and liabilities.  Coco recovery consists of an equity stake (there are other variants I’m not considering). Since the trigger for a Coco bond comes before a credit event, it benefits conventional sub debt holders.  For Coco holders, you should be able to manage losses by being short the name’s shares, right?


Cheng


Total Posts: 2836
Joined: Feb 2005
 
Posted: 2014-04-30 11:54
Yes and yes imo.

Although I still struggle to understand who would buy CoCos. Coventional bond funds wouldn't want (or be able) to hold equity after the conversion. In a sense you have the worst of both worlds, the limited upside of bonds and the potential wipe-out of equity.

"Late night you party until it's light / While pointing at the sky / Wash your hands in the lake of your blood / Just before you die / Bodom beach terror!"

Peerless


Total Posts: 108
Joined: Aug 2012
 
Posted: 2014-04-30 12:14
Here's an answer taken from a presentation by W. Schoutens. As you can see, latest cocos issuances all have been largely oversubscribed.

cheers,


polysena


Total Posts: 1045
Joined: Nov 2007
 
Posted: 2014-05-01 13:58
Peerless- could you perhaps by Pm provide me the source of your excerpt cannot find it on schoutens site.. thx Poly

Свобода - это то, что у меня внутри. (Ленинград и Кипелов - "Свобода")

AndyM


Total Posts: 2319
Joined: Mar 2004
 
Posted: 2014-05-01 16:07
We'll see who the 'natural buyers' are when the shit hits the fan. To me, it seems slightly perverse to introduce additional layers of complexity to prevent perfectly straightforward instruments functioning as they're supposed to (in this case, prevent senior bonds from being touched under any circumstances, while shielding banks from having to raise equity). So, we avoid any 'unpleasant' decisions by relying on unproven instruments with unwelcome complexity and no natural buyers - sounds like a plan.

I used to be disgusted; now I try to be amused...

JM


Total Posts: 40
Joined: Apr 2010
 
Posted: 2014-05-01 21:02

The complexity is due to the subjectivity of the trigger: the bank’s own view of its balance sheet. So for example, if a CFO sees a bad year early enough, he could take the opportunity to clean the balance sheet through a ton of write-offs. The bond would trigger due to paper losses, not because of any true impairment of solvency. Further, if the interest payments on the Coco bonds themselves become burdensome, a bank can write-down assets and hit the trigger. No more CoCo interest payments and a dividend payment wouldn't be skipped.

For these reasons, I think that this kind of trigger makes them suspect. But change the trigger and it’s a different picture. The Coco structure would merely enforce the same debt-to-equity conversion (or in the case of principal write-downs, balance sheet shrinking) that the market would prescribe; it just makes the conversion obligatory on the CoCo holder.

Banks are happy to issue CoCos at around 620 bps over 7 years as compensation for this risk.  It doesn’t seem adequate unless a buyer is convinced that there is a way to hedge the downside.  Short equity would do this.   


Jaxx


Total Posts: 217
Joined: Nov 2005
 
Posted: 2014-05-02 00:19
Personally I think the idea of trying to pseudo delta hedge it is an absolute non starter.

Aside from the practicalities of the trigger and the pretty big danger in an imperfect hedge, a HF would need to leverage this position multiple times to even pretend it was viable, which negates the point of the capital structure, no?

mib


Total Posts: 354
Joined: Aug 2004
 
Posted: 2014-05-02 11:19
quite a few of these bonds are pricing 10%-20% volatilty premium vs. downside puts on the stock if one uses a structural model. Some people find this an attractive premium.

Head of Mortality Management, Capital Structure Demolition LLC

JM


Total Posts: 40
Joined: Apr 2010
 
Posted: 2014-05-03 01:29

@MIB:

Just to clarify.

Case when Coco Bond doesn't trigger = principal + coupon + accretion + option premia on short puts at strike p,

case when Coco Bond does trigger = coupon up to trigger + vol premia at strike p - realized.

The latter is an expected 1000-2000 bps.

Correct?


KangaXX


Total Posts: 292
Joined: Mar 2005
 
Posted: 2014-05-13 00:33
whatever the maths says, its a dog shit form of capital dreamt up by immoral fuckwits who figured mislabelling securities which are junior to equity was the best way to get them to yield as low as possible

The write down language in a lot of these bonds puts them ahead of equity in the firing line (ie regulator can zero the bonds while the equity and junior sub securities remain outstanding), but they are labelled LT2 which means that if an institution entered a formal insolvency process without triggering the bond by taking a write down first (eg lehman over the weekend) you would rank senior to equity and residual junior sub bonds. Why have this ambiguity at all?> So you can label a toxic bond as LT2, date it, and sell it for 5% coupon or less nowadays. Call a spade and spade.

junior equity securities trading at yields in the 3%s maybe par for the course in this market, and given we've just had an endless banking crisis shorting them may be pretty boring and painful for a while, but they still suck.








Bright, energetic people—usually quite young—have promised to perform miracles with “other people’s money” since time immemorial.

AndyM


Total Posts: 2319
Joined: Mar 2004
 
Posted: 2014-05-14 12:48
RBS put together a report polling market views on CoCos.

I liked this quote, which I think sums up the situation: "The last coco will be issued before the first one is triggered."

I used to be disgusted; now I try to be amused...

mib


Total Posts: 354
Joined: Aug 2004
 
Posted: 2014-05-27 15:00

JM,

no, the bond pays you option premium until maturity or trigger, whichever comes first. If you price the option built into hte bond with a reasonable model, the price implies volatility higher than the regular option market. In some cases, this volatility is more than 10 vol points above the vanilla options of comparable strikes.

To realise the vol premium, one needs to delta hedge (and probably also gamma and vega hedge) the bond with the underlying stock and options on it. This is far from straightforward (as the implied coco strike is very low and depends on the particulars of your structural model.) So the questions is if 10-20 vol pts is enough of premium or too little. 


Head of Mortality Management, Capital Structure Demolition LLC

HitmanH


Total Posts: 430
Joined: Apr 2005
 
Posted: 2014-06-20 17:19
Short UBS note out yesterday -interesting about who holds them / why and risks:


First, from a positioning perspective, AT1 CoCos are a consensus long trade
generally irrespective of the issuing banks. Despite acknowledging different levels
of credit risk among banks (e.g. due to varying capital buffers over and above
CoCo trigger levels or operations in low growth vs higher growth European
countries), investors tend to be buyers of AT1 CoCos across most issuers (French,
UK, Spanish banks) as the issuing banks remain for the most part top tier/national
champion SIFIs. In our view, this reflects a high level of confidence in the European
regulators' vested interest in facilitating bank capital issuance to build up the
necessary buffers, European banks' ability to avoid incurring material capital
erosion in a more 'normal' economic downturn, and banks' unwillingness to turn
off coupons on CoCos which could send shockwaves through the rest of their
capital structure. That said, this consensus view is not espoused by all market
players, with dissenters pointing towards low levels of excess capital over and
above the combined capital buffer for some banks (which makes coupon
suspension a more credible risk) or the longer-term intent of regulators to impose losses on CoCo holders as needed (i.e. CoCos are designed to incur losses so they
should) despite potential negative signaling effects.

Second, supply and demand considerations are a key concern for CoCo investors.
Despite a broadening of the CoCo investor base recently as the reach for yield
intensifies, a number of investors still question the depth of the market and are
concerned that any selloff in CoCos would be magnified by this potential lack of
liquidity. However, issuance at a similar pace to what we've seen this year should
bring relief to CoCo investors as it would attract more investors into the asset
class. Across the national champions/major banks in Europe our capital solutions
team estimates a EUR85n shortfall vs required CRD IV AT1 capital requirements
(1.5% AT1 of RWA) and a EUR120bn shortfall vs a leverage ratio requirement of
4% (CRD IV has a 3% leverage ratio requirement however individual countries
may set higher levels). The possibility that smaller second tier banks could also
issue AT1 capital creates upside risk to these numbers. Bottom line, based on these
capital shortfalls, we expect a continuation of strong issuance of AT1 capital,
particularly in the EUR-denominated universe amid supportive capital market
conditions fostered by the ECB.

Third, differences in structures across AT1 bonds (such as high vs low triggers and
equity conversion vs principal writedown loss absorption mechanisms) tend to be
of secondary importance as a still small amount of AT1 securities outstanding limits
investors' ability and willingness to discriminate along these more structural lines.
Further, given the broader search for yield investors feel the market is not
rewarding differentiation across structures.

This latter point is symptomatic of a broader phenomenon in credit markets which
is that investors increasingly neglect the fundamentals as central banks continue to
overstimulate. Bottom line, if a selloff materializes in the next few months, AT1
CoCos and other high beta assets such as corporate HY will likely be considerably
affected. On the flip side, if the current environment of low rate and credit spread
volatility persists, the result would be further bank capital raising and corporate
releveraging. Put differently this would drive a growing divergence in
fundamentals and imply a continued convergence in valuations between AT1 bank
capital and corporate HY.

Cheng


Total Posts: 2836
Joined: Feb 2005
 
Posted: 2015-07-28 15:48
Kanga,

do you have some examples at hand of bonds that would be subordinated to equity if pooh hits the fan ? PM me if you like.

"Sad wings of destiny / Where have they gone? / I know eternally / I'll carry on" (Rob Halford, Sad Wings)

KangaXX


Total Posts: 292
Joined: Mar 2005
 
Posted: 2015-08-09 23:19
XS0989394589 is an example. Bonds which have permanent write down language (as opposed to conversion) in the event that ct1 is

Bright, energetic people—usually quite young—have promised to perform miracles with “other people’s money” since time immemorial.

Kitno


Total Posts: 346
Joined: Mar 2005
 
Posted: 2016-09-25 23:35
I am limit long with AndyM. I think these are diabolical securities whose structural failures will become apparent in the next crisis.

Investors invest in debt for certainty. Equity investors invest for upside.

CoCos invert that premise. You have a debt security with a high coupon but are short an American option on prinipal writedown and cashflows. Hmmmm old school Convertible Asset Swaps or CCDS give you extra spread and you get paid for being called - not written down! OK I am (just) a tad facetious.

What's for sure is pension funds with their ALM needs shouldn't buy these nor insurers - so who should? But hey until there's a trigger we 'normalize' the buying and it's regulator sanctioned...! Just like CDOs, SIVs, ad nauseum till they popped.

Salut toi, je vais au Social Club avec des amis ce soir, c'est au 142 rue Montmartre. J'ai mis ta robe préférée. Viens me trouver.

ComteZero


Total Posts: 523
Joined: Jun 2004
 
Posted: 2016-10-13 17:24
"Investors invest in debt for certainty. Equity investors invest for upside."

old paradigm.
As a PIMCO guy recently underlined, "What a crazy world where investors buy bonds for capital gains and equities for yield..."

CoCo were designed for morons investing others money. It's the old trick of calling "bonds" something isn't. As "reverse convertible" (bond + short put on whatever has high vol, again) early 2000s (or most retail-structured products, even if some regulators now forbid use of "bond" term for retail)

As it is written below in "Who buys CoCo ? (...) However the extra yield is often attractive". All come from this sentence: 80% people in this industry only think "returns".

/* Trust is good, no trust is better. */

pj


Total Posts: 3331
Joined: Jun 2004
 
Posted: 2016-10-14 10:23
> 80% people in this industry only think "returns".
If I may, the sentence should be
80% people in this industry only think short term "returns"

Have a pal who is stuck with a portfolio with
crazy exotic structured products (which had had great teaser rates).
The guy who has bought them, got promoted, then headhunted.

I saw a dead fish on the pavement and thought 'what did you expect? There's no water 'round here stupid, shoulda stayed where it was wet.'

yanko


Total Posts: 60
Joined: Nov 2009
 
Posted: 2016-10-27 23:52
So, I'm trying to get rid of a research project about CoCo's for some time. This morning I thought I was relieved of this burden, until my counterpart pointed to the following, explaining that the top experts are apparently of the opinion that CoCo's are here to stay:

http://www.cococonference.com/

Said experts are also the conference organizers - Spiegeleer and Schoutens - the guys, who wrote that bible about all that converts - they way I see it, they are somewhat vested in the idea of CoCo's being the product of the future.

Anyway, I have been looking for a comprehensive overview of the CoCo market over the past 3-5 years - issuance per year, overall market performance, informed take on the Feb'16 meltdown and subsequent recovery, general bashing, etc. would be much appreciated.

Thanks in advance for any pointers,
yanko

Cheng


Total Posts: 2836
Joined: Feb 2005
 
Posted: 2016-10-29 11:23
Wat until the first CoCos get triggered, FI investors realize that they either lost a ton of money (more than they made through the coupons) or that they have to figure out how to book those stocks they reveived all of a sudden. Then we talk again about the (non-)future of CoCos.

"He's man, he's a kid / Wanna bang with you / Headbanging man" (Grave Digger, Headbanging Man)

rftx713


Total Posts: 95
Joined: May 2016
 
Posted: 2016-10-30 01:00
>or that they have to figure out how to book those stocks they reveived all of a sudden. Then we talk again about the (non-)future of CoCos.

Interesting point. Can you clarify? Do you mean simply the operational difficulties of debt funds taking on equity positions?

Kitno


Total Posts: 346
Joined: Mar 2005
 
Posted: 2016-10-30 01:27
I couldn't agree more with Cheng. The new endowment mortgages for the financial crisis.

rftx713, bond fund mandates preclude even the purchase of busted converts trading hundreds of bps wider than the straight bonds in the very names and duration they already own let alone equities.

I'd go further than Cheng and say there's a confidence circuit breaker in CoCos for this reason in the 65 cash handle area for very reason of what Cheng explains that you don't get in straight debt. A bit like the reverse of hitting an 80 delta in converts that your bonds are on the home run.

Salut toi, je vais au Social Club avec des amis ce soir, c'est au 142 rue Montmartre. J'ai mis ta robe préférée. Viens me trouver.

rftx713


Total Posts: 95
Joined: May 2016
 
Posted: 2016-10-31 03:44
Thanks for explaining that to me Kitno much appreciated. Interesting stuff.

yanko


Total Posts: 60
Joined: Nov 2009
 
Posted: 2017-06-07 10:18
The first CoCo bond just triggered:

BBG: Banco Popular Shares, AT1 Written Down in Resolution, SRB Says (XS1189104356)

Martinghoul


Total Posts: 859
Joined: Oct 2008
 
Posted: 2017-06-07 10:45
I apologize for my utter ignorance, but doesn't this Banco Popular event demonstrate the utter folly of CoCo's?

Insofar as I may be heard by anything, which may or may not care what I say, I ask, if it matters, that you be forgiven for anything you may have done or failed to do which requires forgiveness...
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