INVESTOR CONCERNS
Others though, such as Gregory Turnbull- Schwartz, fixed income manager at Kames Capital, are very concerned about the investment grade rating.
He explains: “We do not believe that these types of instruments should have such a rating. From our point of view, CoCos are not stable and should not be in a benchmark – which could happen over the next 12 to 18 months if more deals get investment grade ratings. One of our main fears is that if any one of these issuing banks stopped paying interest, then there would be an immediate sell-off. However, the pricing of the HSBC deal was attractive and the fundamentals of the bank are strong because it has a robust diverse business model and a relatively high tangible common equity ratio.”
James Foster, fund manager of the Artemis Strategic Bond fund, which has a 3% holding in CoCos, also has reservations.
“These instruments worry me. They are volatile from an institutional point of view. For example, if there is a downturn, we could see a higher default rate and a decline in bank capital ratios which could then trigger the conversion. The other issue is that they turn the normal rules for bonds on their heads. While notionally they rank senior to equity, should something go wrong with the issuing bank then these bonds convert into equity or are written-off before existing equity holders suffer. This is an uncomfortable scenario.”
Foster also believes “as a CoCo investor, I do not have a vote and there is no one to fight my corner. Shareholders usually have a degree of self-interest in protecting bondholders, but they have no real vested interest in doing so in the case of these instruments. Regulators have no interest in protecting these bondholders’ interests, unlike a normal bond, which, if not paid, forces the bank to be wound up. Equity holders may be actively encouraging their conversion into equity to help boost the banks’ capital buffer. This then leaves investors relying on the bank’s management which would not want to see a trigger because it would imply a sign of weakness and incur reputational risk.”
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