It’s Coco-nuts!
Chasing yield, wherever it can be found, is a pastime for many baby boomers whose income returns from traditional securities and bank deposits are being decimated. The fad global and Basel III banking capital requirements are potentially legitimising some securities, that under normal interest rate settings, might not have seen the light of day.
As Basel III is being implemented across the globe, Contingent Convertible bonds aka Coco bonds are gaining greater acceptance among investors who are desperate for yield. It’s a trend that is being closely tracked and reported on by Christopher Thompson at the Financial Times.
Coco bonds can be converted into equity or written off entirely if the issuing bank’s capital drops below a pre-agreed threshold. Coco bonds, are therefore often described as ‘loss-absorbing’ debt instruments. In what might sound familiar to many Australian investors, Coco bonds are perpetual with no set maturity date and in some examples, banks can continue to pay dividends to shareholders even after the bonds are written off. In some cases Coco bonds are arguably more junior than even equity and yet, less than equity-like returns, are being demanded by investors.
The European Central Bank’s €60billion-a-month Quantitative Easing has boosted the demand for Coco bonds, but the possibility of coupon cancellation at the discretion of the issuing bank, even while dividends can continue to be paid to equity holders, is the reason that UK regulators banned the sale of Coco bonds to mass market retail investors last year. Investors have clearly been underestimating the risks.
At the end of 2014 Coco issuance by groups including HSBC, Credit Suisse, Crédit Agricole and Santander accounted for almost a tenth of all subordinated bank debt issued in Europe. It was the highest proportion on record. Chris Thompson writes; “European banks accounted for just over half of last year’s record $174bn coco issuance while Asian banks accounted for 39 per cent. To date the market has been dominated by large banks although there are signs that mid-tier financial institutions are also seeking to do deals…Banks have issued $288bn of cocos since the asset class first appeared in 2009, with deal volumes recently bolstered by return-starved investors faced with record low yields on many government and corporate bonds.”
Last month, the Australia and New Zealand Banking Group (ASX: ANZ) became the first non-Chinese bank to issue a renminbi-denominated Coco.
Roger Montgomery is the founder and Chief Investment Officer of Montgomery Investment Management. To invest with Montgomery, find out more.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Raymond Lundie
:
NAB has kicked off a Hybrid raising, will one of the team be doing a review of this product?
Roger Montgomery
:
We won’t be a buyer Raymond.
From my friend Chris Joye on the subject of Hybrids more generally: “One risk that virtually everyone has overlooked is the very real possibility that banks cut the hybrids’ entirely discretionary “distributions” (they are not “interest” that is a legal liability like you get with a deposit or bond), which is precisely what one leading bank treasurer recently told investors the bank would do in the next serious recession if they had to lower dividends to rebuild capital. This explains why another bank treasurer describes the hybrids as “cheap equity”, which is what they are formally classified as by APRA (ie, they count as going concern tier one capital).
I warned in the AFR before their ASX listing that CBA’s Perls VII, which mums and dads poured $3bn into only to suffer a 4% plus capital loss, were way too expensive with a 2.8% margin over the bank bill swap rate. Perls VII is now paying more than 3.6% over bills”
Wayne A
:
These could actually be a pretty good idea if investors understood what they were buying and took the risks knowingly. Mind you, I’d far prefer the banks to act responsibly and carry an appropriate level of capital in the first place.
Another concern, and we saw this post GFC, is that even highly intelligent people who rolled the dice and took their chances with questionable investment vehicles tend to look for someone else to carry the can when it all goes pear-shaped. In the absence of being able to milk the issuing entity for compensation, that someone becomes the government, aka their fellow taxpayer.
Kelvin Ng
:
Thanks Roger. This makes the common equity of the big 4 banks in Australia and Telstra look like bargains (which they’re not). Its truly nuts!
Kelvin
Roger Montgomery
:
agreed Kelvin