Outside finance, “Coco” is variously a clown, a comforting drink or the wife of a US rapper. Inside, though, contingent convertible bonds, or CoCos, are a quirky device that might help bank regulators sleep at night, if they appeal to investors. These securities convert into equity when a predetermined measure of a bank’s strength is breached, providing a cushion against failure. Lloyds Banking Group has increased its CoCo issue to £9bn. The concept also featured in the latest US regulatory reform plans.
The trigger is key – as is a yield sufficient to compensate for the danger of being flipped into equity. Lloyds’ securities, which convert when core tier one capital falls below 5 per cent, may prove a poor guide. The bank is swapping existing bonds, on which it no longer pays coupons, for the CoCos – meaning investors risk being left with orphan assets if they refuse. So they may overlook that regulators are rethinking what counts as tier one.
