CandleFocus Glossary Editor
What are Contingent Convertibles (CoCos)?
A Contingent Convertible (CoCo) bond is a type of securities instrument that combines elements of both debt and capital instruments. They are also commonly known as “deeply subordinated debt instruments” or “contingent-capital bonds”. CoCos offer investors a higher return than traditional bonds, while providing protection to the issuer.
CoCos are bonds with a built-in conversion feature. The bond contract provides that in the event that a predetermined trigger is met, the bond will automatically convert into shares of equity of the issuing company. This conversion feature is designed to provide the issuing company with additional capital in the event that the financial situation of the issuer deteriorates. CoCos can be structured in different ways, but the main design feature of all CoCos is that they are subordinated to other debt holders and have a strike price, that at which point the bond converts into common stock.
CoCos have become popular among banks as a way to shore up their Tier 1 balance sheets. The conversion can act as an early warning sign for regulators, activating when the banks’ balance sheets weaken, alerting them to any potential risks posed by the issuer. This gives investors from the safety of knowing that their capital is protected, even in the event of a financial crisis.
For banks, the higher cash flows generated by CoCos, which are typically higher than traditional bonds, provides them with additional funds that can be used to increase lending and support growth. Furthermore, because CoCos are subordinated to other debt, they do not need to be repaid if the bank is struggling financially, meaning they provide a form of relief. This can be of particular benefit to banks in a stressed or weak financial environment.
In conclusion, Contingent Convertibles (CoCos) offer an attractive combination of benefits both to investors and to the issuing party. The strike price and conversion feature allows investors to gain further value and protection, while the issuing party can benefit from having additional capital in a crisis. In this way, CoCos can be seen as a unique financial instrument that serves both parties’ interests and provides an effective solution for banks looking to shore up their balance sheets.
A Contingent Convertible (CoCo) bond is a type of securities instrument that combines elements of both debt and capital instruments. They are also commonly known as “deeply subordinated debt instruments” or “contingent-capital bonds”. CoCos offer investors a higher return than traditional bonds, while providing protection to the issuer.
CoCos are bonds with a built-in conversion feature. The bond contract provides that in the event that a predetermined trigger is met, the bond will automatically convert into shares of equity of the issuing company. This conversion feature is designed to provide the issuing company with additional capital in the event that the financial situation of the issuer deteriorates. CoCos can be structured in different ways, but the main design feature of all CoCos is that they are subordinated to other debt holders and have a strike price, that at which point the bond converts into common stock.
CoCos have become popular among banks as a way to shore up their Tier 1 balance sheets. The conversion can act as an early warning sign for regulators, activating when the banks’ balance sheets weaken, alerting them to any potential risks posed by the issuer. This gives investors from the safety of knowing that their capital is protected, even in the event of a financial crisis.
For banks, the higher cash flows generated by CoCos, which are typically higher than traditional bonds, provides them with additional funds that can be used to increase lending and support growth. Furthermore, because CoCos are subordinated to other debt, they do not need to be repaid if the bank is struggling financially, meaning they provide a form of relief. This can be of particular benefit to banks in a stressed or weak financial environment.
In conclusion, Contingent Convertibles (CoCos) offer an attractive combination of benefits both to investors and to the issuing party. The strike price and conversion feature allows investors to gain further value and protection, while the issuing party can benefit from having additional capital in a crisis. In this way, CoCos can be seen as a unique financial instrument that serves both parties’ interests and provides an effective solution for banks looking to shore up their balance sheets.