UK market for cocos to be worth £44bn

THE market for contingent convertible bonds (cocos) in the UK alone is worth at least £44bn, according to analysis by Bank of America/Merrill Lynch.

The figure is equivalent to two per cent of risk-weighted assets at the UK’s five largest banks, which is a low-ball estimate of the extra capital buffer that systemically important banks will be required to hold. It could be as high as five per cent, or £110bn.

Banks are being forced to consider unprecedented means of raising cash due to higher capital requirements. Basel III’s limited definition of qualifying capital could make cocos, which are bonds that turn into equity if a bank’s capital ratio falls below a trigger threshold, the cheapest option.

“If cocos are less expensive for the bank than other forms of capital, shareholders would probably want the board to have at least considered them,” says BoA/ML’s Daniel Bell.

Basel III demands a minimum core tier one capital ratio of seven per cent by 2019. On top of this, systemically important financial institutions (SIFIs), which will include a country’s largest banks, will have to have to hold two to five per cent extra.

Credit Suisse’s public issuance of €2bn in cocos last week was heavily over-subscribed, with yield-hungry investors snapping up the five year notes at a 7.88 per cent coupon rate.

The high demand is likely to encourage other banks to issue the notes as soon as the European Commission approves them.