Because Coco Bonds are scary
The Coco Bond case after Credit Suisse and Deutsche Bank. The article by Emanuela Rossi
The echo of the rescue of Credit Suisse by UBS for 3 billion francs continues. In particular, the cancellation of Additional Tier-1 (AT1) bonds, the so-called coco bonds, for around 16 billion francs, carried out by Finma, the independent supervisory authority on the Swiss financial market.
WHAT ARE AT1 BONDS OR COCO BONDS
The AT1 (Additional Tier-1) are contingent convertible bonds or hybrid convertible bonds which, under certain conditions, are transformed into shares and therefore into the capital of the bank that issued them. In this way the debt exposure is lightened. As explained by the Finma in Switzerland, the AT1s are designed in such a way as to be amortized or converted into basic own funds before the capital of the bank concerned is fully exhausted or amortised. In general, precisely because of the risk profile and the structure, these instruments – publicly issued by the big banks – are mostly held by institutional investors.
WITH COCO BONDS MORE FRAGILE BANKS?
What has happened in recent days has led to questions about the impact that these tools can have on bank balance sheets. According to Stefano Feltri, director of Domani , coco bonds "are the link between the crisis of 2023 and that of 2008, that is, between the collapse of today's banks and that of yesterday, at the time of Lehman Brothers". If at the time the problem was that the credit institutions ended up accumulating too much debt and then – too big to fail – the State had to intervene, with the solution of the At1 the question does not arise again also because creditors are forced "to strengthen the bank at the first signs of balance sheet fragility long before taxpayer money is put at risk.
So are banks becoming more solid or more attracted to risk? According to Feltri, it is necessary to evaluate whether – in the event of conversion – the shareholders gain or lose: if the shareholders are diluted (with the debt which is transformed into shares) they receive less dividends; if, on the other hand, it is only the creditors who lose out, then the shareholders are happy to increase the risks.
A study by the Bank of England, carried out in 2017 in relation to the English market, the largest for coco bonds, concluded that the issue of these instruments has a positive effect "on regulating the behavior of banks with respect to risk".
FINMA: RESET OF BONDS? FOLLOW RULES
As regards what happened in the case of Credit Suisse, according to the Finma, the zeroing of the value of the At1 bonds took place according to the rules since the coco bonds provide for the full cancellation of the value by contract if a triggering event occurs especially if extraordinary state support is granted. "Given that on March 19, 2023 Credit Suisse was granted liquidity support loans with a federal guarantee in the event of instability, these contractual conditions were fulfilled" the Authority clarified in a note. Also on 19 March, "the Federal Council brought into force the ordinance of necessity concerning additional liquidity-support loans and the granting by the Confederation of guarantees in the event of failure for liquidity-support loans granted by the National Bank Switzerland to systemically important banks".
Furthermore, "pursuant to the ordinance, the FINMA may order the borrower and the financial group to amortize additional basic own funds". According to director Urban Angehrn “a solution has been found to protect customers and markets. In this context, it was important that Credit Suisse's operational business was maintained smoothly and without interruptions”.
HOW MANY COCOBOND ARE IN THE SUMMER OF EUROPEAN BANKS
But how widespread are these coco bonds in Europe? According to what we read in a Bloomberg report, there are over 110 million dollars in the coffers of the main lenders.
The most exposed is HSBC with $19.7 million followed by Barclays with $16.1 million. Not far behind Ubs with 12.8 million, Bnp Paribas with 12.3 million and Société Generale with 10.7 million while it drops below ten with Santander (9.4 million), Deutsche Bank (9 million), Intesa Sanpaolo (7 .6 million), first among the Italian companies, Ing (6.7 million), Unicredit and Standard Chartered (6.4 million), BBVA (5.5 million), Lloyds (5 million), Natwest (4.7 million) , Nordea Bank (3.5 million), Skandinaviska Enskilda Banken (1.3 million).
If HSBC takes first place in the ranking for exposure, the same is not the case in that on the relationship between coco bonds and Cet1: here the palm goes to UBS (28.3%) which is closely followed by Barclays (28.2%) . More distant Société Generale (20.7%), Standard Chartered (19%), Deutsche Bank (17.7%) almost paired with Intesa Sanpaolo (17.6%). Followed by HSBC (16.6%), Natwest (15.5%), Nordea Bank (13.7%), ING (13.3%), Lloyds (13.1%), BNP Paribas (12.7%) and BBVA (12.2%). At the bottom of the ranking are Santtander (11.9%), Unicredit (11.8%) and Skandinaviska Enskilda Banken (8.9%).
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/perche-fanno-paura-i-coco-bond/ on Sun, 26 Mar 2023 05:40:16 +0000.