Journal of Advances in Economics and Finance

Download PDF (204.6 KB) PP. 175 - 184 Pub. Date: August 1, 2017

DOI: 10.22606/jaef.2017.23003

• George M. von Furstenberg^*
  Indiana University

This article lays out key features of cocos debt securities and how the choice of their trigger levels and conversion terms into common equity tier 1 (CET1) affect the principal stakeholders in the issuing banks. Some of the choices favor pre-existing shareholders and others the new shareholders by conversion. Conversion of cocoses need not be dilutive; they also do not have to prove subordinate to the most junior inconvertible debt, as frequently assumed. The goal here is to help correct such misconceptions by demonstrating that expected outcomes are shaped by the issuers of cocos and not inherent features of the instrument. Balance-sheet analysis will show that conversion is a zero-sum activity so that what the former cocos holders lose pre-existing shareholders gain, and vice versa. However, the size of net gains and net losses, and who should bear them, are contentious. If management is properly incentivized to keep cocos as additional tier 1 (AT1) capital on the balance sheet the bonds could furnish CET1 in a financial crisis when such capital is most needed and least available.

Contingent convertible bonds, CoCos, capital requirements for banks, hybrids, financial crisis, Basel III

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