September 13, 2016 / 4:45 PM / 4 years ago

Timing is everything as European banks ride the CoCos revival

* Low interest rates have driven feverish demand for CoCo bonds

* Cost of issuing CoCos has dropped to lowest levels this year

* Sweet spot of opportunity remains extremely fragile

By Lawrence White

LONDON, Sept 13 (Reuters) - European banks are playing a nerve-jangling waiting game in an effort to reap maximum rewards from issuing billions of dollars of so-called CoCo bonds in a frenzied market revival that could evaporate in a heartbeat.

The yields banks need to pay on contingent convertible bonds issued to bolster lenders’ capital reserves have been falling steadily as demand has soared, largely from wealthy Asian investors, but this sweet spot of opportunity is looking increasingly fragile.

Barclays, Royal Bank of Scotland, Standard Chartered and UBS are among banks that have issued Additional Tier 1 CoCos in recent weeks and investors expect 50 billion euros more to come from lenders including HSBC and BNP Paribas.

Being among the last to issue could prove prudent because the ravenous demand has driven the cost of issuing the debt to the lowest levels in more than eight months and the last bank to issue is broadly expected to achieve the best price.

RBS and Barclays issued their bonds in August at yields of 8.625 percent and 7.875 percent respectively, while DBS Group later priced a $750 million bond at a 3.6 percent, the world’s lowest coupon for a U.S. dollar Additional Tier 1 offering.

But as Federal Reserve governors in the United States clash over the merits of an interest rate rise this month and markets wobble over economic prospects, banks holding out for the absolute minimum leave themselves at the mercy of the boom-and-bust nature of investor appetite for CoCos.


Bankers said the bonds are particularly attractive to wealthy individual investors in Asia, who buy the bonds through their private bank accounts but are quick to abandon the asset class when the market environment for debt changes, exacerbating drops in the value of the bonds.

Asian buyers accounted for the second-largest allocations of Barclays’ recent CoCo issue, taking 24 percent compared with 15 percent for investors in the European Union.

“The Asian private bank bid can be fickle, they buy on leverage and are quick to dump it if things look bad so if [a CoCo bond] drops two points, it’s probably going to drop 10,” said one European banker who sells the bonds.

The dollar price of the Bank of America Contingent Capital Index, a barometer of the value of the bonds in the secondary market, reached a year-to-date high of 100.9 on Sept. 9, up from 88 in February.

Appetite for the bonds, which offer investors juicy returns in exchange for the risk that the bond stops paying out and converts to equity when a bank runs into trouble, had collapsed in February amid concerns that Germany’s Deutsche Bank might fail to make some payments on its debts.

“Demand comes and goes, from famine to feast and back to famine,” said Philippe Bodereau, managing director at bond investing giant PIMCO.

The market for CoCos remains vulnerable to shocks, bankers who sell them said, with a single mispriced deal or fresh concerns about regulatory treatment of the bonds capable of sparking a sell-off.


“Investors in February were concerned about the uncertainty as to the point at which coupon payments were going to be suspended, so the market shut down,” said Simon Ainsworth, a senior vice president at ratings agency Moody’s.

But the attraction for the more intrepid investor is plain to see. The RBS bonds issued in August offered regular coupon payments in excess of 8 percent at a time when ECB rate cuts have sent many European corporate bonds to zero or even negative yields.

Standard Chartered took advantage of its strong name recognition in Asia to target a slice of its deal specifically at private banks in the region through a so-called Reg S offering, IFR magazine reported.

Barclays sold its entire $1.5 billion issue on Aug. 23 under the same Reg S rules that exclude U.S. investors, banking on demand from Asia, sources close to the transaction said.

PIMCO’s Bodereau said that a further 50 billion euros of CoCos could be in the mix over the next two years as banks including HSBC, Barclays, Rabobank, BNP Paribas and Santander seek to raise the 1.5 percent of additional Tier 1 capital required by regulators.

The trick is to do so as late as possible but before the window slams shut, as it did in February.

“If a bank is unable to fill up its Alternative Tier 1 bucket, it would have to make up the shortfall with common equity, which could be more costly,” said Moody’s analyst Ainsworth.

Editing by Sinead Cruise and David Goodman

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