I hadn't heard about them until today, thanks to mk, but it's something sort of like this: Banks love convertible bonds because they allow the bank to do three things - (1) sell a bond that gets them equity (2) create a stock option that doesn't count as a stock option until you convert the bond (3) tell bondholders "fuck you, you own stock now" whenever they want. Investors hate convertible bonds because they allow the bank to do those three things. As a consequence, banks have to pay high rates on convertible bonds and bond investors can sue and say "fuck you, we don't want your fucking stock, keep paying us our income on this stupid bond" and it goes to the courts or arbiters or whoever and everybody dukes it out in front of lawyers. So the finance industry created this thing called a "Contingent Convertible Bond" - which Bloomberg evocatively calls a "high yield hand grenade" - where it isn't up to the bank saying when your bond poof becomes a troubled asset, it's up to some pre-arranged contingency such as "our capital rate has dropped below 7%, fuck you you own stock." Basically, a convertible bond (which has been lambasted as a bad thing to own for like 30 years) has its "fuck you" conversion pre-wired to a market condition or a business downturn - in effect, reducing the recourse bond-holders have against the bond-issuer. Which is not to say lawsuits don't happen. You're going to hear a lot about them - maybe - for the same reason you had to learn what a CDO or a ninja loan is. Financially speaking, a CoCo bond is a colossally bad idea made alluring through the application of usurious interest rates. Usurious interest rates are great when you're earning them and really really shitty when you aren't anymore. And, considering the lack of long-term memory and utter opacity of the bond market, chances are good that in addition to the shit Lloyds and Deutsche Bank are dealing with right now, everyone else will, too. From that Bloomberg article: That's as of October 2014. Basically, roughly a quarter of Europe's capital program is propped up by troubled assets... and the trouble those assets have is toxic and cumulative. At least, that's my understanding.Even with their explosive growth, CoCos account for less than a quarter of the roughly 200 billion euros ($258 billion) in bank capital that euro zone banks have raised to stay afloat from mid-2013 to the end of last year.
Herein lies a MASSIVE problem: Risk calculations are performed as if the risk associated with one asset is decoupled from the risk of seemingly unrelated assets. We should have learned back in 2007-9 that risks are not independent, especially when we put layers upon layers of debts, equities, derivatives, etc, that are all based on the same underlying asset (in the case of a bank, of course, this is its deposits and loans, which represent for the majors about 1% of their business). In order to truly understand risk, we would need a super computer model that could account for all the information of the financial system, which is of course completely impossible, given that people issuing securities clearly often don't understand them, let alone me or you. Thus I leave you with James Carville:You're going to hear a lot about them - maybe - for the same reason you had to learn what a CDO or a ninja loan is. Financially speaking, a CoCo bond is a colossally bad idea made alluring through the application of usurious interest rates. Usurious interest rates are great when you're earning them and really really shitty when you aren't anymore. And, considering the lack of long-term memory and utter opacity of the bond market, chances are good that in addition to the shit Lloyds and Deutsche Bank are dealing with right now, everyone else will, too.
I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.