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Hedge fund TCI lambasts unpopular CoCos
LONDON (Reuters) - A high-profile London hedge fund criticised CoCos as "expensive and uneconomic", underlining the wariness of mainstream investors about the fledgling securities once hailed as a new recapitalisation lifeline for ailing banks.
The Children's Investment Fund said in a letter that the Financial Services Authority (FSA) should tell Lloyds (LLOY.L) to swap its more than 10 billion pounds of CoCos into equity.
The CoCos, or contingent convertible capital, were costing Lloyds too much - it pays a 12 percent coupon - and were highly unlikely ever to convert into equity, TCI head Chris Hohn said in a widely publicised letter, dated June 14.
"The failure of the FSA to clarify to Lloyds Bank exactly the capital treatment of these instruments ... (has) resulted in Lloyds not knowing what they can do to eliminate these expensive and uneconomic securities, which actually serve no effective value as equity capital," Hohn said.
It was not clear whether TCI was invested in the Lloyds CoCos, or in the shares of the bank. Hohn declined to comment on any investments his fund had made.
Two investment bankers, speaking on condition of anonymity, cast doubt on Hohn's plans, saying that Lloyds was already one of the better capitalised banks and that shareholders would baulk at having earnings diluted.
Banks across the world need to ramp up their capital buffers, because the crisis has depleted their coffers and regulators want higher walls around them.
When Lloyds was struggling to stay out of a government asset-protection scheme in 2009 at the height of the crisis, it became one of the first banks to issue a CoCo, enabling it to stay out of the scheme, unlike rival RBS (RBS.L).
Markets cheered this as a welcome innovation, allowing the bank to protect its capital without having to go to shareholders, something that would have been prohibitively expensive at the time of such turmoil.
Regulators are also promoting CoCos because they are looking for ways to keep a bank afloat if it lands in trouble without calling on taxpayers for help. Cocos function as a shock-dampener between bondholders and shareholders.
But traditional investors struggle to label them as debt or equity and to gauge their risk profile accordingly, while fixed income specialists say there is little clarity about how they would behave in times of financial stress.
"The debate on bank capital is going to go on for a long time in terms of what is the appropriate capital structure," a third banker said on Tuesday.
The CoCos convert into equity if Lloyds' core capital ratio falls below 5 percent - far below the current 11 percent. Under new capital rules known as Basel III, the trigger level would be even lower, at 2 percent, Hohn said.
"They serve as no credible loss-absorbing capital whatsoever, given their low probability of ever being exercised," he said in the letter.
Only a handful of banks have issued CoCos. Credit Suisse (CSGN.VX) is another prominent user of CoCos - having sold more than 8 billion Swiss francs (5 billion pounds).
UBS (UBSN.VX) and China's ICBC (601398.SS) have issued related instruments, but these work differently because investors lose all their money if these banks land in trouble, and there is no conversion into equity. (Additional reporting by Kylie MacLellan)
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