U.S. Appetite For 'CoCo' Bonds Could Be Tested Soon--Bankers

http://online.wsj.com/article/BT-CO-20110215-712432.html

• "Many are pinning their hopes on a type of security called a contingent-convertible bond, or a 'CoCo', which converts from debt to equity when certain bank metrics, such as capital reserves or share price, fall below certain levels. The reduction in debt and increase in equity delivers a shot in the arm to the financial institutions' balance sheets."
• "While buyers are paid well for investing in CoCos--one batch of CoCos averaging 10 years to maturity currently yields around 10%, a full percentage point over comparable junk debt--the jury is out on how investors may respond when CoCos come to market."
• CoCos resemble hybrid securities because they convert from a bond-like instrument to an equity-like instrument, essentially recapitalizing the firm and staving off the sort of government bailout seen in the last crisis. Yet they differ from traditional hybrids because the conversion is mandatory, not at the option of the issuer.
• The trigger depends on the borrower's creditworthiness, as determined by a measure of financial cushioning called core Tier-1 capital--the strongest capital on a firm's balance sheet. Once CoCos convert into equity, investors would start to lose their principal and could be wiped out entirely before holders of subordinated and senior unsecured debt absorb any losses.
• A key consideration for investors is where that conversion trigger is set. The lower it is, the more attractive a CoCo is to a buyer because the issuer is more likely to be on its last legs when conversion occurs.