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FT.com - European coco bond investors harvest big gains - Total returns for index of riskiest bank debt near 30 per cent for past year
Investors in European coco bonds have made significant gains during the past year, reflecting a rebound in sentiment from early 2016, when the asset class was severely tested given its exposure to the continent’s banks. Total returns on the main Markit index for the asset class are close to 30 per cent since the market collapsed last February.
Despite the gains that investors have seen during the past year, many European cocos, which typically come with fixed coupons of 6 to 8 per cent, are still trading below their original sale price.Investors argue that while the rally in prices has been “significant”, the bonds, which comprise a market of about €100bn in Europe, still represent a buying opportunity. “We still think the asset class is incredibly attractive — yes there has been a strong rally, but we still think there’s significant value in that asset class,” said James MacDonald, a financial analyst at BlueBay. Bonds from issuers such as Deutsche Bank and Banco Popular are still trading at a discount to par. A Deutsche Bank bond at the heart of a sell-off in early 2016 is still trading at 92 cents on the euro, compared to 71 cents last February. Earlier this month, analysts at Morgan Stanley suggested the good performance in the asset class, also known as “additional tier 1” (AT1) capital, “still has legs”, saying they look cheap compared to high yield and corporate bonds. However, they noted in research that they “expect to temper this position as we approach the Dutch elections, with a clear view that any type of negative headline will hurt AT1s fastest and hardest”.
European coco bonds, which are the riskiest class of bank debt and designed to take losses at times of distress, collapsed in price early last year as fears over the future of the continent’s banking sector mounted. The original coco sell-off centred around the prospect of missed coupons on a Deutsche Bank bond, as well as uncertainty over regulatory rules for triggering coupon cancellation. Losses are imposed when a bank’s capital falls beneath a certain threshold. Since then, regulators have moved to clarify their approach, effectively reducing the potential level at which bonds are forced to stop payments and helping to fuel a recovery in prices. “People got very excited about what we saw happening in the AT1 asset class in February, but I definitely don’t think it was an isolated event . . . actually when you look at a lot of other asset classes over the year, the volatility was pretty low in comparison,” said Mr MacDonald, pointing to mark-to-market losses on long-dated gilts later in the year. The debt, which contributes towards a bank’s capital requirements, typically moves in tandem with bank equities, which have also staged a recovery over the past year. The Euro Stoxx banks index is up 28 per cent since last February’s lows. Unlike bonds sold by non-financial corporates or sovereigns, coco bonds are not being bought as part of the European Central Bank’s quantitative easing programme. The bonds are perpetual with an option to be called by the issuer after several years, and investors suggest that the yields on the debt are still at higher spreads over the risk-free rate than they have been in the past.
Investors in European coco bonds have made significant gains during the past year, reflecting a rebound in sentiment from early 2016, when the asset class was severely tested given its exposure to the continent’s banks. Total returns on the main Markit index for the asset class are close to 30 per cent since the market collapsed last February.
Despite the gains that investors have seen during the past year, many European cocos, which typically come with fixed coupons of 6 to 8 per cent, are still trading below their original sale price.Investors argue that while the rally in prices has been “significant”, the bonds, which comprise a market of about €100bn in Europe, still represent a buying opportunity. “We still think the asset class is incredibly attractive — yes there has been a strong rally, but we still think there’s significant value in that asset class,” said James MacDonald, a financial analyst at BlueBay. Bonds from issuers such as Deutsche Bank and Banco Popular are still trading at a discount to par. A Deutsche Bank bond at the heart of a sell-off in early 2016 is still trading at 92 cents on the euro, compared to 71 cents last February. Earlier this month, analysts at Morgan Stanley suggested the good performance in the asset class, also known as “additional tier 1” (AT1) capital, “still has legs”, saying they look cheap compared to high yield and corporate bonds. However, they noted in research that they “expect to temper this position as we approach the Dutch elections, with a clear view that any type of negative headline will hurt AT1s fastest and hardest”.
European coco bonds, which are the riskiest class of bank debt and designed to take losses at times of distress, collapsed in price early last year as fears over the future of the continent’s banking sector mounted. The original coco sell-off centred around the prospect of missed coupons on a Deutsche Bank bond, as well as uncertainty over regulatory rules for triggering coupon cancellation. Losses are imposed when a bank’s capital falls beneath a certain threshold. Since then, regulators have moved to clarify their approach, effectively reducing the potential level at which bonds are forced to stop payments and helping to fuel a recovery in prices. “People got very excited about what we saw happening in the AT1 asset class in February, but I definitely don’t think it was an isolated event . . . actually when you look at a lot of other asset classes over the year, the volatility was pretty low in comparison,” said Mr MacDonald, pointing to mark-to-market losses on long-dated gilts later in the year. The debt, which contributes towards a bank’s capital requirements, typically moves in tandem with bank equities, which have also staged a recovery over the past year. The Euro Stoxx banks index is up 28 per cent since last February’s lows. Unlike bonds sold by non-financial corporates or sovereigns, coco bonds are not being bought as part of the European Central Bank’s quantitative easing programme. The bonds are perpetual with an option to be called by the issuer after several years, and investors suggest that the yields on the debt are still at higher spreads over the risk-free rate than they have been in the past.
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