What a difference a year makes…

European coco bonds are rallying hard, just 12 months after the asset class was thrown into turmoil.

The main Markit index covering the bonds – the riskiest class of bank debt – touched its highest ever level yesterday, the latest data show. It is up nearly 30 per cent since its lows last February.

European coco bonds, which are issued by banks and designed to take losses at times of distress, collapsed in price early last year as fears over the future of the continent’s banking sector mounted.

The debt, which is also known as “additional tier 1 capital (AT1)” because it contributes towards a bank’s capital requirements, typically moves in tandem with bank equities, which have also staged a recovery over the past year. The Euro Stoxx banks index, a gauge of the share prices for major lenders, is up 28 per cent since last February’s lows.

The original coco sell-off centred around the prospect of missed coupons on a Deutsche bank AT1 bond, as well as uncertainty over regulatory rules for triggering coupon cancellation. Losses are imposed when a bank’s capital falls beneath a certain threshold.

In 2016, the bonds came under intense criticism because of their perceived capacity to heighten market distress around European banks. Since then, regulators have moved to clarify their approach, effectively reducing the potential level at which bonds are forced to stop payments.

Unlike bonds sold by non-financial corporates or sovereigns, coco bonds are not being bought as part of the European Central Bank’s quantitative easing program. They typically come with coupons of 6-8 per cent, and are perpetual with an option to be called by the issuer after several years.

Chart courtesy Bloomberg

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