Webcast: Contingent Convertibles (CoCos)
Speaker: Dr Jan De Spiegeleer
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Q&A
1. Given we are a CoCo-Bond Issuer: do you know from a regulative point of view, whether we have to value that bond, say for interest rate or liquidity risk purposes or is it because it is a market issuance (like with an ABS e.g.) that we do not have to value the Bond.
A. If you issue a CoCo bond then the DVA issue still stands. I do not see how you could impose a value to the CoCo bond if you are the issuer. It is like predicting your own default. What you are going to do is to calculate a theoretical price. You could use for example the credit derivatives / equity derivatives technique we described in our papers to price the bond (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1795092) . Using these two models you have a slightly different approach. Here you can use the implied trigger levels of similar CoCo bonds issued by similar banks to obtain a theoretical price for your own CoCo issue. Using this technique, you could use the value of an outstanding CoCo bond that you seek to replace with a new issue having the same CET1 trigger
2. How can you value a CoCo if there is no share price available, since you seem to need a forecast for the entire banks business to do so? You’re talking about Structural Models, but are they even feasible?
A. Our method needs a share price because of the embedded trigger price. I think that structural models are less than straightforward. A lot of the literature on this topic uses simplified capital structures and use examples of banks having a very straightforward debt structure. If you want to get familiar with a way to deal with CoCo bonds in a structural model, I could recommend you the article written by George Pennacchi (http://business.illinois.edu/gpennacc/ConCap030211.pdf). His paper is a good place to start.
3. Why are the investors so enthusiastic?
A. The period 2013 - first half of 2014 is one where investors have been yield hungry. In this hunt for yield they discovered this new attractive asset class. It is our opinion, that there is a too limited amount of knowledge on the buy-side. The large coupon is there for a reason: coupon cancellation, loss absorption, extension risk, etc.
Thank you to those attendees who submitted their questions.
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