Contingent convertible debt †
3.2 Product overview
In this section, we shortly introduce how contingent capital works. CoCo bonds are issued either with a fixed maturity or in the form of consol bonds. They pay a coupon just like ordinary subordinated debt. In addition, CoCo bonds are equipped with a trigger mechanism. When the predefined trigger event occurs, the debt is either converted into equity or it is written down. There is no cash flow at conversion. The crucial difference to ordinary convertible bonds is that the conversion is mandatory in case of the trigger event. Flannery (2014) refers to this mechanism as pre-packaged reorganization.
The trigger event can be defined with respect to market based capital ratios or accounting data. In some instances, the conversion is also at the discretion of the regulatory authority.
When the CoCo bonds convert into equity, the nominal amount of outstanding shares increases at conversion. The conversion ratio determines how many shares the CoCo bond holders receive. There are two different mechanisms for contracts which are written down. The face value can either be decreased by a predetermined amount. Alternatively, the amount by which the face value is reduced can be determined at conversion. In this case, the face value is reduced by the amount which is required to revoke the trigger condition. In some instances, the write-down is only temporary and the face value is restored when the bank recovers.
Llyods was the first bank to issue CoCo bonds in 2009. Only few banks followed until the issuance of CoCo contracts finally picked up in 2013. Nordal and Stefano (2014) report a total issuance volume of EUR 73.8 billion over the time period from January 2009 until June 2014. Their sample contains 102 contracts issued by 37 banks. All contracts have a trigger mechanism based on accounting ratios. In the following, we focus on the 10 biggest issuers which account for 80% of the volume.
Roughly 28% of issued CoCos convert into equity. Table 3.1 contains the key prop-erties of these contracts. We estimate the wealth loss W L based on the approach of Berg and Kaserer (2014) with the following formula
W L= CRt
CR0· n
n+m·m·S0
F (3.1)
whereCRtdenotes the tier 1 capital ratio at which the CoCo converts,CR0 is the current value of this ratio,m denotes the number of new shares given to the CoCo bond holders, n denotes the number of shares outstanding before conversion, S0 denotes the current share price and F is the face value of the CoCo. We use data as of 31/12/2014 for time t= 0. Since the stochastic process of the capital ratio cannot be observed, we assume that the capital ratio moves in sync with the share price. Given this simplifying assumption, we compute a wealth loss between 33% and 98%. The wealth loss has been expressed in terms of face value, since quoted prices of CoCos are not readily available. However, if we assume that a CoCo is issued at par, then all CoCo bond holders incur significant losses in case of conversion.
The remaining 72% of issued CoCos, which possess a write down mechanism, are shown in table 3.2. Strictly speaking, write-down bonds are not convertible bonds. However, we include these products in the overview since they rely on the same trigger mechanism and induce similar incentives. Total-loss bonds are an extreme case of write-down bonds.
The claims are written down to zero in case of a trigger event. In other words, contingent
Table 3.1: Overview of contingent convertible bonds
The table shows all CoCo bonds converting into equity of the 10 biggest issuers since 2009.
The table reports the following information: (1) the issuer’s name and consecutive number of issuance, (2) the issuance date, (3) the currency abbreviated with FX, (4) the notional in the issuance currency, (5) the coupon in percent, (6) the maturity of the bond in years at the time of issuance, and (7) the wealth loss WL in case of conversion. The symbol∞ indicates when the CoCo is a consol bond. CR abbreviates the tier 1 capital ratio. We compute the wealth loss following the method proposed by Berg and Kaserer (2014) with data as of 31/12/2014.
Issuer Date FX Notional Coupon Years Trigger WL
Lloyds 1 Nov-09 GBP 4.65bn 7.588-16.125% 10-23 CR <5% 38%
USD 2.52bn 7.875-8.5% 11 CR <5% 38%
JPY 37.00bn 6.75-8.07% 11-13 CR <5% 38%
EUR 2.36bn 6.385-15% 10-11 CR <5% 38%
Credit Suisse 1 Feb-11 USD 2.0bn 7.875% 30 CR <7% 37%
Credit Suisse 2 Mar-12 CHF 0.75bn 7.125% 10 CR <7% 38%
Credit Suisse 3 Jul-12 USD 1.75bn 9.5% ∞ CR <7% 58%
BBVA 1 May-13 USD 1.5bn 9.0% ∞ CR <5.125% 77%
Credit Suisse 6 Oct-13 CHF 2.5bn 9.0% ∞ CR <7% 33%
USD 3.5bn 9.5% ∞ CR <7% 33%
Barclays 3 Dec-13 EUR 1.0bn 8.0% ∞ CR <7% 63%
BBVA 2 Feb-14 EUR 1.5bn 7.0% ∞ CR <5.125% 71%
Lloyds 2 Apr-14 GBP 0.75bn 7.875% ∞ CR <7% 49%
GBP 1.494bn 7.625% ∞ CR <7% 48%
GBP 1.48bn 7.0% ∞ CR <7% 48%
USD 0.75bn 6.375% ∞ CR <7% 52%
Barclays 4 Jun-14 USD 1.211bn 7.0% ∞ CR <7% 90%
GBP 0.697bn 7.0% ∞ CR <7% 98%
Barclays 5 Jul-14 EUR 1.076bn 6.5% ∞ CR <7% 61%
BBVA 3 Feb-15 EUR 1.5bn 6.75% ∞ CR <5.125% 84%
Table 3.2: Overview of contingent write-down bonds
The table shows all contingent debt contracts with a write-down feature of the 10 biggest issuers since 2009. The table reports the following information: (1) the issuer’s name and consecutive number of issuance, (2) the issuance date, (3) the currency abbreviated with FX, (4) the notional in the issuance currency, (5) the coupon in percent, (6) the maturity of the bond in years at the time of issuance, and (7) the write-down W D in percent of the face value. The symbol∞indicates when the CoCo is a consol bond. CRabbreviates the tier 1 capital ratio,ER denotes the equity ratio and SR denotes the solvency ratio.
A: Predetermined write-down
Issuer Date FX Notional Coupon Years Trigger WD
Rabobank 1 Mar-10 EUR 1.25bn 6.875% 10 ER <7% 75%
UBS 1 Feb-12 USD 2.0bn 7.25% 10 CR <5% 100%
UBS 2 Aug-12 USD 2.0bn 7.625% 10 CR <5% 100%
Barclays 1 Nov-12 USD 3.0bn 7.625% 10 CR <7% 100%
KBC Groep 1 Jan-13 USD 1.0bn 8.0% 10 CR <7% 100%
Swiss Re Mar-13 USD 0.75bn 6.375% 11.5 SR <125% 100%
Barclays 2 Apr-13 USD 1.0bn 7.75% 10 CR <7% 100%
UBS 3 May-13 USD 1.5bn 7.625% 10 CR <5% 100%
Credit Suisse 4 Aug-13 USD 2.5bn 6.5% 10 CR <5% 100%
Credit Agricole 1 Sep-13 USD 1.0bn 8.125% 20 CR <7% 100%
Credit Suisse 5 Sep-13 EUR 1.25bn 5.75% 12 CR <5% 100%
Credit Suisse 7 Dec-13 USD 2.25bn 7.5% ∞ CR <5.125% 100%
UBS 4 Feb-14 EUR 2.0bn 4.75% 12 CR <5% 100%
UBS 5 May-14 USD 2.5bn 5.125% 10 CR <5% 100%
Credit Suisse 8 Jun-14 USD 2.5bn 6.25% ∞ CR <5.125% 100%
UBS 6 Feb-15 EUR 1.0bn 5.75% ∞ CR <5.125% 100%
USD 1.25bn 7.125% ∞ CR <7% 100%
USD 1.25bn 7.0% ∞ CR <5.125% 100%
B: Discretionary write-down
Issuer Date FX Notional Coupon Years Trigger
Rabobank 2 Nov-11 USD 2.0bn 8.375% ∞ CR <8%
Rabobank 3 Nov-11 USD 2.0bn 8.4% ∞ CR <8%
Société Générale 1 Sep-13 USD 1.25bn 8.25% ∞ CR <5.125%
Société Générale 2 Dec-13 USD 0.973bn 7.875% ∞ CR <5.125%
Société Générale 3 Dec-13 USD 1.75bn 7.875% ∞ CR <5.125%
Credit Agricole 2 Jan-14 USD 1.75bn 7.875% ∞ CR <5.125%
KBC Groep 2 Mar-14 EUR 1.4bn 5.625% ∞ CR <5.125%
Credit Agricole 3 Apr-14 GBP 0.5bn 7.5% ∞ CR <5.125%
EUR 1.0bn 6.5% ∞ CR <5.125%
Société Générale 4 Apr-14 EUR 1.0bn 6.75% ∞ CR <5.125%
Deutsche Bank 1 May-14 EUR 1.75bn 6.0% ∞ CR <5.125%
USD 1.25bn 6.25% ∞ CR <5.125%
GBP 0.65bn 7.125% ∞ CR <5.125%
Credit Agricole 4 Sep-14 USD 1.25bn 6.625% ∞ CR <5.125%
Deutsche Bank 2 Nov-14 USD 1.5bn 7.5% ∞ CR <5.125%
Rabobank 4 Jan-15 EUR 1.5bn 5.5% ∞ CR <7%
In all cases, bond holders incur a wealth loss. Holders of CoCos converting into equity incur this loss by receiving a share of the firm which is worth less than the value of the plain bond. The holders of write-down bonds incur the loss by a reduction of the face value. Total-loss bond holders are completely wiped out. In return, debt hold-ers demand higher coupon payments well above those of ordinary subordinated debt (Nordal and Stefano, 2014).
Apparently, banks show a preference for low conversion ratios and a preference for issuing total-loss bonds. In section 3.4.2, we provide a rationale for this behavior and demonstrate the incentive effects induced by this particular design.