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New hybrid bonds
Fed and Wall St in talks over CoCos
By Nicole Bullock and Francesco Guerrera in New York
Published: November 11 2009 23:01 | Last updated: November 11 2009 23:01
The US Federal Reserve is in talks with Wall Street executives and others over whether US financial groups should raise capital through a new type of bond that converts into equity when a bank is in trouble.
The talks over the hybrid security, which was pioneered by Lloyds Banking Group of the UK last week, are in their early stages but underline regulators’ desire to find novel ways to bolster banks’ balance sheets in times of crisis. The new securities – known as contingent convertibles, or CoCos – operate as bonds in normal times, paying coupons to investors.
However, they would automatically convert into equity when the bank’s finances deteriorate below a predetermined level – such as a capital ratio benchmark or other measures linked to the institution’s assets and market value.
Supporters of CoCos say they enable a bank to raise equity capital at times of stress while at the same time ensuring it will be the investors who risk losing money if the financial group is bailed out or wound down by the government.
“Talks have been frequent in recent weeks but we are still early in the process,” a Wall Street executive, who is participating in talks with the New York Fed, said.
“However, the Fed and other regulators seem determined to see whether CoCos will work.”
The New York Fed declined to comment. However, William Dudley, its president, said in a recent speech that a CoCo-like instrument “seems to hold real promise”. “If these contingent capital buffers were large . . . then the worst aspects of the banking crisis might have been averted,” he said.
Politicians have also shown a willingness to back CoCos. A bill introduced this week by the Senate banking committee calls for banks to issue “long-term hybrid debt securities that will provide them with capital during a systemic crisis so failing institutions can provide their own life support”.
The main question over the viability of CoCos is whether there would be sufficient investor demand. The best chance for creating a large, liquid market would be to tap corporate bond investors.
Standard & Poor’s, the credit rating agency, warned on Tuesday that contingent convertibles were “not a panacea” for banks’ efforts to bolster their capital.
“We see contingent capital securities as introducing another potential tool to manage the capital base in times of stress. However, they are not being designed by banks to address the need to repair existing weak balance sheets.”
Insiders involved in the talks and observers argue that a US iteration would not necessarily follow the Lloyds’ model and that more than one structure could be used.
“It is still an amorphous concept,” said Anna Pinedo of law firm Morrison Foerster. “The Lloyds product is only one possible instrument, but we have been working with clients on other structures that would be considered contingent capital.”
Bankers and analysts argue that structures such as CoCos could help banks worldwide to refinance some $7,000bn in debt that is due to expire in the next three years.
Fed and Wall St in talks over CoCos
By Nicole Bullock and Francesco Guerrera in New York
Published: November 11 2009 23:01 | Last updated: November 11 2009 23:01
The US Federal Reserve is in talks with Wall Street executives and others over whether US financial groups should raise capital through a new type of bond that converts into equity when a bank is in trouble.
The talks over the hybrid security, which was pioneered by Lloyds Banking Group of the UK last week, are in their early stages but underline regulators’ desire to find novel ways to bolster banks’ balance sheets in times of crisis. The new securities – known as contingent convertibles, or CoCos – operate as bonds in normal times, paying coupons to investors.
However, they would automatically convert into equity when the bank’s finances deteriorate below a predetermined level – such as a capital ratio benchmark or other measures linked to the institution’s assets and market value.
Supporters of CoCos say they enable a bank to raise equity capital at times of stress while at the same time ensuring it will be the investors who risk losing money if the financial group is bailed out or wound down by the government.
“Talks have been frequent in recent weeks but we are still early in the process,” a Wall Street executive, who is participating in talks with the New York Fed, said.
“However, the Fed and other regulators seem determined to see whether CoCos will work.”
The New York Fed declined to comment. However, William Dudley, its president, said in a recent speech that a CoCo-like instrument “seems to hold real promise”. “If these contingent capital buffers were large . . . then the worst aspects of the banking crisis might have been averted,” he said.
Politicians have also shown a willingness to back CoCos. A bill introduced this week by the Senate banking committee calls for banks to issue “long-term hybrid debt securities that will provide them with capital during a systemic crisis so failing institutions can provide their own life support”.
The main question over the viability of CoCos is whether there would be sufficient investor demand. The best chance for creating a large, liquid market would be to tap corporate bond investors.
Standard & Poor’s, the credit rating agency, warned on Tuesday that contingent convertibles were “not a panacea” for banks’ efforts to bolster their capital.
“We see contingent capital securities as introducing another potential tool to manage the capital base in times of stress. However, they are not being designed by banks to address the need to repair existing weak balance sheets.”
Insiders involved in the talks and observers argue that a US iteration would not necessarily follow the Lloyds’ model and that more than one structure could be used.
“It is still an amorphous concept,” said Anna Pinedo of law firm Morrison Foerster. “The Lloyds product is only one possible instrument, but we have been working with clients on other structures that would be considered contingent capital.”
Bankers and analysts argue that structures such as CoCos could help banks worldwide to refinance some $7,000bn in debt that is due to expire in the next three years.
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