CoCo the Clown no longer ..... new issue gets a big welcome.

Tuesday 15th March 2016

CoCo the Clown no longer ..... new issue gets a big welcome.

ref :- "Investors Snap Up UBS CoCos" , The Wall Street Journal, online

One tends not to go too far wrong underestimating the length of traders' memories. As recently as February, concerns over the health of some major European banks in an era of negative interest rates were leading a market rout. Feeling the most pain were our old friends, bank-issued "CoCos" (aka Contingent Convertible Bonds, aka Additional Tier 1 Bonds). You remember these fellas ..... as a response to the 2008 Financial Crisis they were designed to convert from bonds to shares at a certain trigger price, and in the event of a bank crash for example they allow for losses to be absorbed by investors rather than by Joe Taxpayer. With that in mind, they offer a much higher yield than a normal bond.

Just a few weeks ago, amid fears that a major European bank might struggle to make it's upcoming coupon (interest) payments, Cocos issued by that particular bank were trading at about 70c on the dollar and it seemed that the benefits of owning a high-yielding instrument in a low-yield environment may have blinded investors to the riskier elements of this new form of debt. The bank in question was able to act decisively to calm investor fears but it appeared likely that the old CoCo might never be looked at in the same way again, or at least not for a while.

What fools we were ..... Yesterday, in the first issue of a CoCo since those ructions, UBS sold $1.5 billion in an issue that received about $8.0 billion in orders  --  in other words, more than 5 times oversubscribed. The strong demand meant that UBS were able to attach a coupon to the bonds of 6.875%, which is a fair bit lower than they had originally thought they would have to pay. It's also no more than they had to pay in an almost identical issue last summer before CoCos had their flirtation with disrepute.

Is the rehabilitation of CoCos just a function of the fact that the yields they offer are ultimately just too tempting for investors to resist when compared to such low returns elsewhere? Of course, to a degree ..... but even the most absent-minded investor cannot have forgotten the reason why those yields are so much higher already. So what has restored the faith ? The answer to that is the ECB action taken last week. Not only was the QE bond-purchasing programme expanded by 20bn euros a month, it was also modified to include corporate bonds and ECB boss Mario Draghi went out of his way to mention bank bonds in particular.

So the Coco market is once again open for business and new issues, of which there might be plenty as they form part of banks regulatory capital requirements. And the risks? The cost of insuring against a major European bank default is back to where it was at the start of the year  --  it's as if the events of  February never happened. The question is ..... is that something we should be worried about?