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Capital Markets
Bumper year for coco bond sales
From the Financial Times of Tue, 23 Dec 2014 17:14:54 GMT

European financial institutions are set to take advantage of investors’ continuing thirst for yield in the new year by issuing a bumper number of riskier loss-absorbing bonds following record volumes this year.

Contingent convertible, or coco, bond issuance has more than doubled year-on-year from $15.2bn to $33bn in Europe this year according to Dealogic, the highest total on record.

Cocos are debt instruments that can be converted into equity or written off entirely if the issuing bank’s capital drops below a pre-agreed threshold. Banks use them to raise loss-absorbing Additional Tier 1 (AT1) capital because they are often cheaper than issuing equity.

“2015 will be similar; there’s still a number of fairly large institutions, such as RBS or BNP Paribas, as well as Dutch and Nordic banks who haven’t issued,” said Simon McGeary, managing director of capital markets at Citi. “You would expect that, where they can, banks will fill their capital gaps with cocos instead of common equity, which is more expensive.”

Most coco deals occurred in the first half of the year while a predicted wave of issuance from second tier banks, especially in the periphery, has yet to materialise.

Spain’s Banco Popular, one of the few smaller peripheral banks to have issued a coco, pulled a planned second deal this year.

“For the stronger banks, it’s a question of price rather than market access,” said Mr McGeary. “The macro backdrop has got a little more challenging but broadly speaking there’s still good interest in the instrument.”

At the height of the market in May Deutsche Bank reported about €25bn of orders for its maiden €1.5bn coco bond. However, appetite waned in the second half, not least due to lower economic growth and the results of the European Central Bank’s stress tests in October.

In August, the average coco yield, which moves inversely to prices, rose above 6 per cent for the first time since February following a year low of 5.36 per cent in June, according to an index compiled by Bank of America Merrill Lynch, where it has since stayed.

Earlier this year it was revealed that institutional investors had bought most coco deals, with yield-hungry hedge funds snapping up less than a fifth of the hybrid debt.

The bonds are seen as high risk as coupons paid to coco investors are discretionary, unlike those on regular bonds, and can be cancelled by either national regulators or a bank’s management, even while dividends are paid to shareholders.

There are also concerns among some analysts that the bonds have yet to be tested in a bank default, particularly for so-called “sudden death” cocos, which write down investors’ principal.

In August UK regulators banned the sale of coco bonds to mass-market retail investors, following warnings that investors were underpricing the risks involved.

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