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Banking	
  
Business	
                      Contingent Capital also known as
                                Contingent Convertibles (CoCo’s)
Consul.ng	
  
                                Author: Mouctar Bah                1	
  
    About	
  the	
  author:	
  Mouctar	
  Bah	
  
Experience	
  
Academic:	
  (I)	
  Master	
  in	
  Applied	
  Science	
  Economics	
  –	
  Finance	
  (Ghent	
  University	
  &	
  Solvay	
  
Business	
  School)	
  and	
  (II)	
  PhD	
  on	
  “ConFngent	
  ConverFbles”	
  (Ghent	
  University)	
  
Professional:	
  2	
  years,	
  Financial	
  Services	
  Industry	
  Consultant	
  at	
  DeloiLe	
  


Skills	
  
Asset	
  Management:	
  UCITS	
  III	
  (IV),	
  Pay-­‐Off	
  Structures,	
  Bench	
  Marking,	
  NAV	
  calculaFon	
  and	
  
Booking	
  
Risk	
  Management:	
  Basel	
  II	
  &	
  III,	
  Credit	
  Risk,	
  Market	
  Risk,	
  OperaFonal	
  Risk,	
  ICAAP	
  
Valua.on	
  Deriva.ves:	
  OpFons,	
  Swaps,	
  Forwards,	
  SwapFons,	
  Total	
  Return	
  Swaps,	
  Caps,	
  Floors,	
  
…	
  
Audit:	
  financial	
  audit,	
  process	
  audit	
  
Accoun.ng:	
  IAS	
  39	
  (IFRS	
  9),	
  Cash-­‐Flow	
  hedge,	
  Fair	
  Value	
  hedge,	
  BEGAAP	
  

Transversal	
  Skills	
  
Business	
  Analyst:	
  Trained	
  at	
  the	
  “InternaFonal	
  InsFtute	
  of	
  Learning”	
  	
  
Change	
  management:	
  Training	
  plan,	
  CommunicaFon,	
  End-­‐user	
  support	
  
Strategy:	
  Business	
  Model	
  &	
  Business	
  case,	
  Feasibility	
  plan	
                                                2
CoCos	
  vs	
  Basel	
  III	
  




                                  3	
  
Content	
  
1.  CoCos	
  in	
  the	
  news	
  

2.  Swiss	
  Regulator	
  vs	
  Basel	
  III	
  

3.  What	
  is	
  a	
  CoCo?	
  

4.  The	
  anatomy	
  of	
  a	
  CoCo	
  

5.  Forms	
  of	
  CoCos	
  

6.  CoCos	
  vs	
  Conver.bles	
  

7.  Credit	
  Suisse	
  CoCo	
  

8.  Pricing	
  a	
  CoCo	
  

9.  The	
  ideal	
  CoCo	
  

10.  Conclusion	
  
                                                   4
Content	
  
1.  CoCos	
  in	
  the	
  news	
  

2.  Swiss	
  Regulator	
  vs	
  Basel	
  III	
  

3.  What	
  is	
  a	
  CoCo?	
  

4.  The	
  anatomy	
  of	
  a	
  CoCo	
  

5.  Forms	
  of	
  CoCos	
  

6.  CoCos	
  vs	
  Conver.bles	
  

7.  Credit	
  Suisse	
  CoCo	
  

8.  Pricing	
  a	
  CoCo	
  

9.  The	
  ideal	
  CoCo	
  

10.  Conclusion	
  
                                                   5
CoCos	
  as	
  new	
  way	
  to	
  boost	
  Banking	
  Capital	
  
    November 5, 2009 7:21 pm


    UK experiment raises
    prospect of new asset class
    By Anousha Sakoui

    UK regulators have embarked on an experiment that
    could redefine the way banks are financed.
    As part of a £21bn capital raising, Lloyds Banking Group,
    in which the government has a 43 per cent stake,
    launched an offer for holders of about £16bn of
    outstanding hybrid debt to exchange into new notes
    called an enhanced capital notes (ECNs).
    !




                                March 7, 2012 6:25 pm


                                Credit Suisse to use ‘cocos’
                                to raise SFr250m
                                By Mary Watkins in London

                                Credit Suisse is looking to raise at least SFr250m
                                ($273m) using so-called “coco” bonds, in
                                the latest test for the nascent market at a time when
                                banks are increasingly looking for other ways to fortify
                                their capital strength.
                                Credit Suisse’s swiss franc contingent convertible bond
                                comes as the bank this week announced plans to
                                repurchase SFr4bn of its public tier 1 and tier 2 securities
                                and replace them with new instruments such as cocos
                                that comply with both Basel III and tough new rules set
                                by the Swiss regulator.
                                                                                               6
                                !
    Spain	
  asks	
  their	
  Banks	
  to	
  issue	
  CoCos	
  
MARKETS | 5/11/2012 @ 2:31PM | 850 views




Spain Tells Banks To Raise
Capital, Fence Off Toxic
Assets
A few days after having to bail-out BFA-Bankia, the Spanish government
announced a set of measures to beef up their financial sector which will
force banks to set aside €30 billion ($38.8 billion) to cover for possible
losses on their loan portfolios. Those institutions that can’t raise the capital
on their own will have to issue contingent convertible bonds (CoCos) to the
government at a 10% rate.
http://www.forbes.com/sites/afontevecchia/2012/05/11/markets-skeptical-of-
spains-banking-sector-overhaul/



!
                                                                                   7
Content	
  
1.  CoCos	
  in	
  the	
  news	
  

2.  Swiss	
  Regulator	
  vs	
  Basel	
  III	
  

3.  What	
  is	
  a	
  CoCo?	
  

4.  The	
  anatomy	
  of	
  a	
  CoCo	
  

5.  Forms	
  of	
  CoCos	
  

6.  CoCos	
  vs	
  Conver.bles	
  

7.  Credit	
  Suisse	
  CoCo	
  

8.  Pricing	
  a	
  CoCo	
  

9.  The	
  ideal	
  CoCo	
  

10.  Conclusion	
  
                                                   8
Swiss	
  Regulator	
  vs	
  Basel	
  III	
  




                                               9
Content	
  
1.  CoCos	
  in	
  the	
  news	
  

2.  Swiss	
  Regulator	
  vs	
  Basel	
  III	
  

3.  What	
  is	
  a	
  CoCo?	
  

4.  The	
  anatomy	
  of	
  a	
  CoCo	
  

5.  Forms	
  of	
  CoCos	
  

6.  CoCos	
  vs	
  Conver.bles	
  

7.  Credit	
  Suisse	
  CoCo	
  

8.  Pricing	
  a	
  CoCo	
  

9.  The	
  ideal	
  CoCo	
  

10.  Conclusion	
  
                                                   10
What	
  is	
  a	
  CoCo?	
  

A	
  CoCo	
  is	
  debt	
  that	
  converts	
  to	
  equity	
  or	
  
suffers	
  a	
  write-­‐down	
  a]er	
  some	
  triggering	
  
event.	
  




                                                                        11
Content	
  
1.  CoCos	
  in	
  the	
  news	
  

2.  Swiss	
  Regulator	
  vs	
  Basel	
  III	
  

3.  What	
  is	
  a	
  CoCo?	
  

4.  The	
  anatomy	
  of	
  a	
  CoCo	
  

5.  Forms	
  of	
  CoCos	
  

6.  CoCos	
  vs	
  Conver.bles	
  

7.  Credit	
  Suisse	
  CoCo	
  

8.  Pricing	
  a	
  CoCo	
  

9.  The	
  ideal	
  CoCo	
  

10.  Conclusion	
  
                                                   12
The	
  anatomy	
  of	
  a	
  CoCo	
  
                                 •  Market
                       Trigger   •  Accounting
                                 •  Regulator

                                     •  Debt to equity
                          Conversi   •  Redeem in
                          on ratio      cash
                                     •  Write-down

                                 •  Spot price
                      Conversi   •  Inception
                      on price      price
                                 •  Average price
                                                         13
Trigger	
  
              Market trigger
              •  Share price


              Accounting trigger
              •  CET1
              •  Equity Capital ratio

              Regulator
              •  Pulls the trigger



                                        14
Conversion	
  ra.o	
  &	
  price	
  

v Cr	
  =	
  N/Cp	
  
v Cp	
  =	
  Conversion	
  price	
  on	
  trigger	
  
v N	
  =	
  Bond	
  nominal	
  value	
  
v 	
  Cr	
  =	
  Conversion	
  ra.o	
  



	
                                                       15
Content	
  
1.  CoCos	
  in	
  the	
  news	
  

2.  Swiss	
  Regulator	
  vs	
  Basel	
  III	
  

3.  What	
  is	
  a	
  CoCo?	
  

4.  The	
  anatomy	
  of	
  a	
  CoCo	
  

5.  Forms	
  of	
  CoCos	
  

6.  CoCos	
  vs	
  Conver.bles	
  

7.  Credit	
  Suisse	
  CoCo	
  

8.  Pricing	
  a	
  CoCo	
  

9.  The	
  ideal	
  CoCo	
  

10.  Conclusion	
  
                                                   16
Exis.ng/proposed	
  forms	
  of	
  CoCo’s	
  

v Standard	
  CoCo’s:	
  accounFng	
  trigger	
  and	
  is	
  converted	
  
   in	
  equity	
  

v Bail-­‐in	
  Bonds:	
  accounFng	
  trigger	
  and	
  is	
  wriLen-­‐
   down	
  

v Call	
  Op.on	
  Enhanced	
  Reverse	
  Conver.ble	
  (COERC):	
  
   market	
  trigger	
  and	
  is	
  converted	
  in	
  equity	
  
         	
  


                                                                               17
Content	
  
1.  CoCos	
  in	
  the	
  news	
  

2.  Swiss	
  Regulator	
  vs	
  Basel	
  III	
  

3.  What	
  is	
  a	
  CoCo?	
  

4.  The	
  anatomy	
  of	
  a	
  CoCo	
  

5.  Forms	
  of	
  CoCos	
  

6.  CoCos	
  vs	
  Conver.bles	
  

7.  Credit	
  Suisse	
  CoCo	
  

8.  Pricing	
  a	
  CoCo	
  

9.  The	
  ideal	
  CoCo	
  

10.  Conclusion	
  
                                                   18
       CoCos	
  vs	
  Conver.ble	
  Bonds	
  

v Difference	
  between	
  a	
  CoCo	
  &	
  Conver.ble	
  Bonds	
  
v Current	
  trend	
  in	
  the	
  hybrid’s	
  world	
  




	
  


                                                                       19
A	
  variety	
  of	
  issued	
  CoCos	
  




                                            20
Content	
  
1.  CoCos	
  in	
  the	
  news	
  

2.  Swiss	
  Regulator	
  vs	
  Basel	
  III	
  

3.  What	
  is	
  a	
  CoCo?	
  

4.  The	
  anatomy	
  of	
  a	
  CoCo	
  

5.  Forms	
  of	
  CoCos	
  

6.  CoCos	
  vs	
  Conver.bles	
  

7.  Credit	
  Suisse	
  CoCo	
  

8.  Pricing	
  a	
  CoCo	
  

9.  The	
  ideal	
  CoCo	
  

10.  Conclusion	
  
                                                   21
Credit	
  Suisse's	
  CoCo	
  
v Issue	
  date	
  :	
  February	
  2011	
  
v Coupon	
  rate	
  :	
  7.875%	
  
v Conversion	
  floor	
  :	
  $	
  20	
  
v Conversion	
  Trigger	
  :	
  Tier	
  1	
  ra.o	
  of	
  7%	
  
v Regulators	
  can	
  pull	
  trigger	
  if	
  necessary	
  
v Maturity	
  :	
  30	
  years	
  
v Amount	
  :	
  2	
  billion	
  
	
  


                                                                     22
Credit	
  Suisse	
  CoCo	
  




                               23
Credit	
  Suisse	
  CDS	
  5Y	
  




                                    24
Content	
  
1.  CoCos	
  in	
  the	
  news	
  

2.  Swiss	
  Regulator	
  vs	
  Basel	
  III	
  

3.  What	
  is	
  a	
  CoCo?	
  

4.  The	
  anatomy	
  of	
  a	
  CoCo	
  

5.  Forms	
  of	
  CoCos	
  

6.  CoCos	
  vs	
  Conver.bles	
  

7.  Credit	
  Suisse	
  CoCo	
  

8.  Pricing	
  a	
  CoCo	
  

9.  The	
  ideal	
  CoCo	
  

10.  Conclusion	
  
                                                   25
          CoCos Pricing Methodologies
                           methods*	
  
   CoCo	
  –	
  Pricing	
  costs ?
     What does the stuff




                                              16
*Source: Wim Schoutens and George Pennacchi
                                              26
          Deriva.ves	
  model	
  
Credit	
  Derivatives Method : Conversion in Shares
  Credit
                       Rule of Thumb Pricing for a CoCo Spread:

        CoCo spread = (1- Stock price at trigger S*/Conversion price Cp) x λtrigger

                  CoCo spread = (1 – RCoCo) x λtrigger
                                           Expected Loss         1y trigger probability




                                                                                      18



                                                                                           27
Equity	
  Deriva.ves	
  model	
  
 CoCos : Equity Derivatives Approach
We break down a CoCo bond into different derivative instruments:

•    Face Value at Maturity + Coupons                              BOND

•    Conversion into Stock at Trigger                              DOWN-AND-IN FORWARD

•    Cancellation of Coupons at Trigger                            BINARY DOWN-AND-IN BARRIERS

                                                                               Trigger : STOCK HITS
                                                                               LOW BARRIER
CoCo = A (ZCB & Coupon Stream) + B (DIBForward) + C (stream of BinaryDIB)
                                                                               • You get
                                                                               Stock/Forward (ST) you
                                                                               pay Cp (strike)

                                                                               • Your Coupons are
                                                                               cancelled


                                                                                                19

                                                                                                      28
Brownian	
  Mo.on	
  Process	
  




                                   29
Structural	
  Model	
  

  Assets	
  Follow	
  a	
  jump	
  diffusion	
  process	
  




                                                             30
Jump	
  Diffusion	
  Process	
  




                                  31
Content	
  
1.  CoCos	
  in	
  the	
  news	
  

2.  Swiss	
  Regulator	
  vs	
  Basel	
  III	
  

3.  What	
  is	
  a	
  CoCo?	
  

4.  The	
  anatomy	
  of	
  a	
  CoCo	
  

5.  Forms	
  of	
  CoCos	
  

6.  CoCos	
  vs	
  Conver.bles	
  

7.  Credit	
  Suisse	
  CoCo	
  

8.  Pricing	
  a	
  CoCo	
  

9.  The	
  ideal	
  CoCo	
  

10.  Conclusion	
  
                                                   32
The	
  ideal	
  CoCo	
  
v  Avoids	
  bankruptcy:	
  going	
  concern	
  rather	
  than	
  gone	
  concern.	
  
v  Based	
  on	
  market-­‐based	
  triggers	
  as	
  opposed	
  to	
  regulatory	
  capital	
  raFos	
  or	
  
    regulatory	
  discreFon.	
  
v  Avoids	
  economically	
  unjusFfied	
  conversions	
  
v  low	
  risk-­‐easy	
  to	
  value	
  (facilitates	
  raFngs,	
  large	
  demand).	
  

v  Avoid	
  risk-­‐shi]ing	
  and	
  debt	
  overhang	
  problems	
  
v  No	
  mulFple	
  equilibria.	
  

v  No	
  negaFve	
  signal	
  around	
  issue	
  or	
  conversion	
  
v  Consistent	
  with	
  shareholder	
  value	
  maximizaFon	
  

v  ValuaFon	
  should	
  incorporate	
  jumps	
  
v  Under	
  no	
  condiFon	
  tax	
  payers	
  would	
  have	
  to	
  bail	
  out	
  CoCos	
  
                                                                                                                   33
The	
  case	
  of	
  a	
  COERC	
  
v  A	
  COERC	
  mi.gates	
  debt	
  overhang	
  and	
  should	
  be	
  airac.ve	
  to	
  all	
  
    firms	
  wishing	
  to	
  reduce	
  costs	
  of	
  financial	
  distress.	
  

v  It	
  is	
  an	
  early	
  stage	
  CoCo	
  designed	
  to	
  prevent	
  bankruptcy.	
  

v  It	
  has	
  a	
  forward-­‐looking,	
  market-­‐based	
  trigger	
  but	
  is	
  free	
  from	
  
    manipula.on	
  or	
  death	
  spirals.	
  
	
  

v  With	
  a	
  trigger	
  value	
  above	
  its	
  conversion	
  value,	
  its	
  has	
  low	
  credit	
  
    risk	
  (high	
  credit	
  ra.ng,	
  easy	
  to	
  value,	
  marketable).	
  	
  

v  It	
  preserves	
  pre-­‐emp.ve	
  rights	
  of	
  shareholders	
  by	
  protec.ng	
  
    them	
  against	
  dilu.on	
  of	
  control	
  by	
  bondholders.	
  	
  


                                                                                                               34
  Timely	
  effect	
  of	
  triggers	
  
 CoCos Triggers




• In the run-up to the financial crisis there was little difference between the Tier 1 ratios of
‘crisis’  banks  — those that would eventually be bailed-out by their governments — and
banks that would escape without intervention.
• But based on market measures — the difference was clear as early as 2006.
• According to Andrew Haldane, executive director of financial stability for the Bank of
England, the solution is clear. He wants regulators to start looking at market-based metrics
of bank solvency, and specifically, market-based Contingent Convertible capital.
                                                                                             6
                                                                                                   35
Content	
  
1.  CoCos	
  in	
  the	
  news	
  

2.  Swiss	
  Regulator	
  vs	
  Basel	
  III	
  

3.  What	
  is	
  a	
  CoCo?	
  

4.  The	
  anatomy	
  of	
  a	
  CoCo	
  

5.  Forms	
  of	
  CoCos	
  

6.  CoCos	
  vs	
  Conver.bles	
  

7.  Credit	
  Suisse	
  CoCo	
  

8.  Pricing	
  a	
  CoCo	
  

9.  The	
  ideal	
  CoCo	
  

10.  Conclusion	
  
                                                   36
    Spain	
  asks	
  their	
  Banks	
  to	
  issue	
  CoCos	
  
MARKETS | 5/11/2012 @ 2:31PM | 850 views




Spain Tells Banks To Raise
Capital, Fence Off Toxic
Assets
A few days after having to bail-out BFA-Bankia, the Spanish government
announced a set of measures to beef up their financial sector which will
force banks to set aside €30 billion ($38.8 billion) to cover for possible
losses on their loan portfolios. Those institutions that can’t raise the capital
on their own will have to issue contingent convertible bonds (CoCos) to the
government at a 10% rate.
http://www.forbes.com/sites/afontevecchia/2012/05/11/markets-skeptical-of-
spains-banking-sector-overhaul/



!
                                                                                   37
Conclusion	
  




                 38

				
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