Asset class status beckons for CoCos as €100bn issuance wave predicted

4 min read

IFR Editor-at-large Keith Mullin

IFR Editor-at-large Keith Mullin

On the surface that’s pretty brave given that many market participants struggle to look beyond the next week. But on the flip side, making long-term predictions means no one can ever say you were wrong … well not today anyway. But he did offer some food for thought. He covered the range of sub debt and hybrid instruments but I was particularly taken with his comments on CoCos.

Pulle said he would not be surprised to see €100bn of CoCo issuance over the next five years, with, he hopes, write-off structures limited to low trigger CoCos and equity conversion to high-trigger CoCos because he feels this mix better aligns incentives of equity investors, management, CoCo holders and regulators.

Now €100bn is a punchy number. If he’d made that prediction even 18 months ago, I would have thought it slightly “out there”. But as he points out, it is very clear that the instrument is gaining traction with regulators, issuers and investors.

I’ve been chairing IFR’s Hybrid Capital Conference for years and CoCos have been a main topic of conversation for the past three. The investor session has always come across as a bit of a deal breaker for the instrument in that the credit investors who speak on our panels have pretty steadfastly and consistently said they would never buy permanent write-down or equity conversion instruments and that they couldn’t see the instrument taking off.

To counter-balance the buyside negativity, hybrid debt originators at investment banks have long postulated the emergence of a new class of investor prepared to buy them, with the right kind of mandates. But as the market had never really been tested, it was always theoretical.

As new jurisdictions come on stream and issuers look to meet capital needs through special features, the market still has the feel of one that’s being structurally tested but we’ve seen enough now to give them the stamp of approval. And of course at €100bn-plus, CoCos become an asset class in their own right which gives them a certain kind of respectability that will drive ever more traffic towards them.

Embedded into financial psyche

Just think about the instances in which CoCos have been mentioned or used in the past few weeks; it’s been pretty remarkable how the instrument has become progressively embedded into the financial psyche. The Bank of Ireland government exit CoCo was a good trade for the State and the sort of structure that could act as a blueprint for RBS and for Spanish banks in 18–24 months, Pulle says.

My IFR colleagues tell me RBS is about to announce that it is looking to issue a CoCo, following the lead taken by Barclays where CEO Antony Jenkins seems sufficiently comfortable with the instrument that he’s talked about building a layer of contingent capital over the next few years in an environment where loss-absorbing capital will cover about 2% of group RWA.

In a very different twist, Deutsche Bank is looking to CoCos to meet its US leverage ratio via an inter-company debt arrangement; Danish regulators are close to allowing 7% trigger CoCos; while UBS is paying 30% of bonuses in loss-absorbing bonds via its Deferred Capital Contingent Plan.

In terms of investor demand, I suspect many of the buyside naysayers have changed tack: Swiss Re’s US$750m total-loss 6.5% yield CoCo that printed on March 5 attracted more than US$5.25bn of demand; while the BoI deal saw €5bn in orders. KBC’s US$1bn January offering really set the standard, though, generating a gargantuan US$8.5bn book.

And of course, the CoCo that Barclays did in November pulled in US$17bn of orders despite its punchy structure. Investors on strike? Not even close. The desperate yield hunting we’ve seen in credit markets certainly adds to their allure and as long as these tight conditions exist, I can see issuers pushing the envelope on structure. And with the kinds of oversubscription we’re seeing in new-issue books, who can blame them?

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