econintersect.com
       
  

FREE NEWSLETTER: Econintersect sends a nightly newsletter highlighting news events of the day, and providing a summary of new articles posted on the website. Econintersect will not sell or pass your email address to others per our privacy policy. You can cancel this subscription at any time by selecting the unsubscribing link in the footer of each email.



posted on 16 February 2016

Coco Bonds: This Risky Financial Experiment Is Rattling Markets

by David Zeiler, Associate Editor, Money Morning

Money Morning Article of the Week

You wouldn't think something with a nickname like "coco bonds" would be so troublesome.

But coco bonds - short for "contingent convertible bonds" - are a major reason for the pummeling that the stocks of several major European banks have taken in 2016. Year-to-date losses range from 20% for Spain's Banco Bilbao Vizcaya Argentaria SA (NYSE ADR: BBVA) to 41% for Credit Suisse Group AG (NYSE ADR: CS).

This week, concerns related to coco bonds have chopped 8% from Deutsche Bank AG (NYSE: DB) stock, which is down 35% in 2016.

To understand why this is happening - and why it matters to U.S. investors - we need to know more about what coco bonds are and how they work.

What Are Coco Bonds?

Coco bonds emerged from the 2008 financial crisis as a way to avoid government and taxpayer bailouts of big banks.

Coco bonds

As the name implies, coco bonds are bonds - a form of debt sold to raise capital. And like other bonds, cocos pay a coupon to the bondholder. But these bonds are designed for banks and come with a catch.

As long as everything is well with the bank, the bondholder collects his payments as with any other bond, although coco bonds pay a premium, up to 6% or 7%. That makes them attractive to yield-hungry investors.

But if the bank's capital ratio falls below a set level, the bank has a couple of options, both designed to preserve capital and make government intervention unnecessary.

In some cases, the coco bond will automatically convert to shares of the bank's stock, hence the name "contingent convertible bond." The bank can also choose to skip coupon payments or even write down the principal.

Obviously, bondholders lose in all cases. Income investors don't want equity in a struggling bank with a sinking stock. A write-down would result in a partial or even total loss of the bondholder's investment. And suspended payments defeat the purpose of holding the bond, making it a non-performing investment.

This is how the European banks have gotten into trouble...

How Coco Bonds Slammed the European Banks

Late last year investors began to realize that the exposure of major banks to such risks as the drop in oil prices (they're the ones making the loans to the oil companies) and the slowdown in the Chinese economy had pushed many of the banks close to the point where they might stop paying their coco coupons.

Deutsche Bank, for example, has had to pay out billions in fines to end several legal disputes and is trying to cope with beefed up regulations that have eaten away at profits. Concerns about capital levels at Deutsche Bank have the holders of the bank's coco bonds worried that it will suspend coupon payments.

Despite assurances from Deutsche Bank's CEO, the bank's coco bonds have become undesirable. Their price has slumped 19% so far this year and is trading at $0.75 on the euro. A similar fate has befallen several other big European banks, with their coco bonds trading at steep discounts.

But while the coco bond issue is centered in Europe - U.S. banks don't use them - it has serious implications for U.S. investors as well...

Why the Coco Bond Crisis Matters to U.S. Investors

Retail investors, even in Europe, typically don't buy coco bonds. But institutional investors both in Europe and the United States, particularly those seeking yield, do buy them. That includes pension and investment funds that you may own.

And most of the European banks in the eye of the coco bond storm have an American Depository Receipt (ADR). That makes them available to U.S. investors and likely to turn up in mutual funds and exchange-traded funds that U.S. investors might buy.

But in addition to possible direct exposure, all investors need to keep an eye on potential problems with the world's major banks, particularly when a large group is involved. As investors learned the hard way in 2008, the world's big banks are central to the global financial system. Trouble there often means trouble for the markets in general.

Coco bonds also present an unusual risk in that it's a new type of investment vehicle untested in the conditions for which it was supposedly designed.

If investors are freaking out just on the hint that the major banks might suspend coupon payments, imagine what would happen in the event of a full-blown financial crisis. The ripple effects would cause stock market crashes the world over.

The coco bond experiment may be failing right before our eyes. Those institutional investors just may decide that the extra yield they get isn't worth the risk of being first in line to bail out the banks when things go south.

The Bottom Line: An investment designed to contain bank "bail-ins" to bond investors is facing its first major test - and it's not doing well. These "coco bonds" are designed to convert to some form of capital in the event a bank's reserves have dropped to a certain level. But coco bond investors in the biggest European banks are getting nervous just at the possibility of suspended coupon payments. And while the problem is focused in Europe, anything that affects major world banks is a threat to all markets - including those in the United States.

>>>>> Scroll down to view and make comments <<<<<<

Click here for Historical Investing Post Listing










Make a Comment

Econintersect wants your comments, data and opinion on the articles posted. You can also comment using Facebook directly using he comment block below.




Econintersect Investing


search_box

Print this page or create a PDF file of this page
Print Friendly and PDF


The growing use of ad blocking software is creating a shortfall in covering our fixed expenses. Please consider a donation to Econintersect to allow continuing output of quality and balanced financial and economic news and analysis.


Take a look at what is going on inside of Econintersect.com
Main Home
Analysis Blog
Why Long-Run Theories of Profit and Accumulation Fall Short
Brexit - Who Wins and Loses
News Blog
Understanding The Downward Trend In Labor Income Shares
Why Renegotiating NAFTA Could Disrupt Supply Chains
Public Relations Nightmares
Catch Me If You Can
U.S. Consumer Debt Rises Overall, Housing Debt Drops
Infographic Of The Day: Graphene Is The Game-Changing Material Of The Future
Early Headlines: CB Bal. Sheets Still Growing, GOP Doing Too Much, May Threw Ulster Under Bus, French Election, China Vs. Pollution, Venzuela Gave To Trump Inaug., And More
NOAA and JAMSTEC Issue Seasonal Updates - Winter in Doubt
Over 200,000 People Have Been Displaced From Mosul
Heat From The Atlantic Ocean Is Melting Arctic Sea Ice Further Eastwards Than Ever Before
Number Of Americans Without Healthcare Insurance Has Dropped
What We Read Today 22 April 2017
B-2 Spirit Stealth Bomber In Action
Investing Blog
The Week Ahead: Build That Wall!
How To Trade Earnings Announcements
Opinion Blog
What Does The Strong Q1 Growth Mean For China?
Marx, Orwell And State-Cartel Socialism
Precious Metals Blog
Three Gold Plays For The New Era Of Chaos
Live Markets
21Apr2017 Market Close: US Stocks Slipped Moderately, WTI Crude Slips On Renewed Concerns Of Increasing U.S. Production, Industrial Businesses' Cash Outflows Concern Investors
Amazon Books & More






.... and keep up with economic news using our dynamic economic newspapers with the largest international coverage on the internet
Asia / Pacific
Europe
Middle East / Africa
Americas
USA Government































 navigate econintersect.com

Blogs

Analysis Blog
News Blog
Investing Blog
Opinion Blog
Precious Metals Blog
Markets Blog
Video of the Day
Weather

Newspapers

Asia / Pacific
Europe
Middle East / Africa
Americas
USA Government
     

RSS Feeds / Social Media

Combined Econintersect Feed
Google+
Facebook
Twitter
Digg

Free Newsletter

Marketplace - Books & More

Economic Forecast

Content Contribution

Contact

About

  Top Economics Site

Investing.com Contributor TalkMarkets Contributor Finance Blogs Free PageRank Checker Active Search Results Google+

This Web Page by Steven Hansen ---- Copyright 2010 - 2017 Econintersect LLC - all rights reserved