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Barclays CoCo - Essay Example

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In its broadest definition, a contingent capital bond is typically a hybrid security issued by banks to borrowers and absorbs losses when the bank’s capital falls…
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Barclays CoCo
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Download file to see previous pages instrument, debt is reduced, and it qualifies as a Tier 1 capital increasing the book value of the bank’s equity capital before the occurrence of the trigger event.
When a CoCo triggers, there are two things involved; the losses involved are absorbed by the CoCo either by suffering a principal write-down or by transforming into common equity. In the case of principal write-down, the bonds are written down to equity that matches the extent of liabilities released thus generating exceptional gains that are allocated to the bank’s retained earnings (Stefan, Anastasia & Bilyana, 2013). In cases where the CoCo is convertible, when a trigger is met, the bond automatically converts to common stock as a prearranged percentage.
As the CoCo bond market unceasingly grows, investors are exposed to various risks and rewards. One of the appalling risks faced by investors in CoCos is the systematic risk. The CoCos market is vulnerable. A conversion or coupon deferral may soon occur causing a fall in price upto 9% and a significant drop in conversion circa -15%. This could put CoCo holders in a worst/unfortunate position than shareholders (Stefan, Anastasia & Bilyana, 2013). Moreover, there exists information asymmetry in the CoCos market where investors have little knowledge regarding the operation of the CoCos while the issuers are fully aware of their credit fundamentals. For instance, the PONV (point of non-viability) as a language has been hard for many investors to comprehend thus upsurging the risks of them losing their cash by investing in unfeasible CoCos. According to Stefan, Anastasia and Bilyana (2013), this coupled with the complexity of CoCos, and the flawed CoCo rating methodologies presents a major risk to investors and might lead to unfathomable losses. Nevertheless, CoCos are rewarding as they provide a high yield of 4.5%-10% that is better than the average yield of circa 4.2% for high yield sectors in the U.K (Chorafas, 2015). These high returns continue ...Download file to see next pagesRead More
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