Peter Hahn, former senior adviser to the Bank of England, has argued that bond managers piling into contingent convertible (CoCo) bonds will not be protected by focusing on higher quality issuers.
James Vokins, the Citywire A-rated manager of the Aviva Investors Distribution fund, has noted that order books for such bank debt – which can be converted into equity – are often 10 times oversubscribed.
Investors have been attracted to such bonds by yields of 6-7% and spreads four times above senior debt, even from strong banks like Barclays, Pimco fixed income specialist Flavio Carpenzano has explained.
But while many have acknowledged the risks inherent in CoCos, Hahn has claimed that even the supposedly safest issuance is dangerous. He recalled the actions of the US during the crash, when through the troubled asset relief program it required the recapitalisation of all banks – not just the weakest.
‘As soon as a major European bank, or some significant percentage of banking provision, appears unstable the incentive or temptation for regulators to cause across-the-board CoCo conversion will be the market talk,’ said Hahn.
‘And why not? Why would regulators want to wait? Wasn’t the lesson of 2008-2009 big swift systemic action?’
Hahn, currently a lecturer at Cass Business School, added that the next European banking crisis could therefore be ‘just so much messier than the continuing one’ due to this ‘new form of Frankenstein bond/equity directly encouraged by regulators and national treasuries’ becoming the ‘must-have product of 2014 and perhaps disaster of 2019’.