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I should CoCo
Nov. 9th, 2010 02:57 pmI nearly fell off my chair when I read on a Reuters report that the Financial Stability Board of the G20 was recommending that banks us contingent capital (CoCos) "to improve loss absorption capacity).
A CoCo is basically a debt instrument that converts into equity when a bank gets into trouble. It is, in other words, just another version of the "hybrid" subordinated debt instruments that were popular three or four years ago.
The main function of these instruments, as I pointed out at the time, was that they could be presented as debt to one part of the system (the buyers of the instruments) and as "virtual equity" to another part (the rating agencies and the accountants).
Luckily the buyers, or, rather, non-buyers, of these instruments are a bit wiser this time round. Rather sensibly, they are pointing out that, if a debt becomes equity the second that the borrower gets into trouble, then effectively it is equity all the time, no matter what you call it when times are good.
What the investors are saying is that, since this "debt" is effectively a flash kind of preference share, they want a concomitant return for investing in it, not "debt-rates plus a bit", but "equuity rates minus a bit".
Actually, I'm not sure why I'm surprised that the FSB is recommending the use of CoCos, beause, as regulators, I shouldn't be surprised that they have no idea what is going on. Apparently they seriously thought that investors would buy these instruments at "debt-plus-a-bit" simply because it was called "debt" and paid a fixed coupon rather than a variable dividend ('fixed', that is, until the shit hits the fan --- see above). That the investors refuse to supply such cash on terms so ridiculously favourable to the sellers appears to have caught the FSB by surprise. Still, I guess these guys are used to situations such as when France's Groupama rescued Scor a few years ago (2003 or thereabouts). There was much government arm-twisting to make Groupama subscribe to a rights issue at market price.
(As it happens, Groupama made money on the deal, but that didn't make it a sensible deal to sign up to.)
These days the land of institutional investors is rather more cynical. If the banks are to get CoCos off the ground, they will need to price them realistically, rather than at the level of "this price would be nice".
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A CoCo is basically a debt instrument that converts into equity when a bank gets into trouble. It is, in other words, just another version of the "hybrid" subordinated debt instruments that were popular three or four years ago.
The main function of these instruments, as I pointed out at the time, was that they could be presented as debt to one part of the system (the buyers of the instruments) and as "virtual equity" to another part (the rating agencies and the accountants).
Luckily the buyers, or, rather, non-buyers, of these instruments are a bit wiser this time round. Rather sensibly, they are pointing out that, if a debt becomes equity the second that the borrower gets into trouble, then effectively it is equity all the time, no matter what you call it when times are good.
What the investors are saying is that, since this "debt" is effectively a flash kind of preference share, they want a concomitant return for investing in it, not "debt-rates plus a bit", but "equuity rates minus a bit".
Actually, I'm not sure why I'm surprised that the FSB is recommending the use of CoCos, beause, as regulators, I shouldn't be surprised that they have no idea what is going on. Apparently they seriously thought that investors would buy these instruments at "debt-plus-a-bit" simply because it was called "debt" and paid a fixed coupon rather than a variable dividend ('fixed', that is, until the shit hits the fan --- see above). That the investors refuse to supply such cash on terms so ridiculously favourable to the sellers appears to have caught the FSB by surprise. Still, I guess these guys are used to situations such as when France's Groupama rescued Scor a few years ago (2003 or thereabouts). There was much government arm-twisting to make Groupama subscribe to a rights issue at market price.
(As it happens, Groupama made money on the deal, but that didn't make it a sensible deal to sign up to.)
These days the land of institutional investors is rather more cynical. If the banks are to get CoCos off the ground, they will need to price them realistically, rather than at the level of "this price would be nice".
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