Contingent Convertibles - CoCos

Loading the player...

What are 'Contingent Convertibles - CoCos'

Contingent convertibles (CoCos) are similar to traditional convertible bonds in that there is a strike price, which is the cost of the stock when the bond converts into stock. What differs is that there is another threshold in addition to the strike price, which triggers the conversion when certain capital conditions are met. Issuing contingent bonds is more advantageous to companies than issuing regular convertibles.

BREAKING DOWN 'Contingent Convertibles - CoCos'

Contingent convertibles, also known as CoCos, became popular in 2014 to help banks meet Basel III capital requirements. These bonds were the perfect product for undercapitalized banks in markets across the globe, including the United Kingdom, China and Switzerland, since they come with an embedded option that allows banks to meet capital requirements and limit capital distributions at the same time. The popularity in contingent convertibles has also grown with the stability of the banks issuing them.

Contingent Convertibles vs. Vanilla Convertibles

There is a significant difference between contingent convertibles and regular or plain vanilla convertibles. Convertible bonds have bond-like characteristics, in that they pay a regular rate of interest and have seniority in case of default. They also give the holder the ability to participate in share price appreciation by allowing conversion to common shares at a certain strike price. In other words, the bond holder receives stock in exchange for the bond at a time when the stock price is going up. In fact, the bond holder can only convert to common shares once the share price reaches a certain point. Investors like to buy stock in a company with rising share prices.

Contingent convertibles offer investors a different scenario. The logic behind contingency convertibles is somewhat inverted. Instead of converting bonds to common shares based solely on stock price appreciation, investors in contingent convertibles agree to take equity in exchange for debt when the bank's capital ratio falls below a certain point.

For example, a bank may issue contingent convertibles with a trigger set to core tier one capital instead of a strike price. If core tier one capital falls below 5 percent, the convertibles automatically convert to equity and the bank has higher capital ratios. In other words, you receive common shares when the bank needs to convert debt to equity as capital thresholds become too high. This may not be an ideal time to purchase the stock. At the same time that the conversion happens, dividend payments are cancelled, limiting capital distributions. In this way, contingent convertibles can seem like an upside down investment to the average convertible bond investor.

RELATED TERMS
  1. Convertible Security

    An investment that can be changed into another form. The most ...
  2. Deferred Equity

    A type of security, such as preferred shares or convertible bonds, ...
  3. Market Conversion Price

    An investor's effective cost to purchase common stock when it ...
  4. Conversion Price

    The price per share at which a convertible security, such as ...
  5. Convertible Bond

    A bond that can be converted into a predetermined amount of the ...
  6. Revertible

    Refers to a special kind of convertible corporate bond that automatically ...
Related Articles
  1. Managing Wealth

    20 Investments: Convertible Security

    What Is It? A convertible, sometimes called a CV, is either a convertible bond or a preferred stock convertible. A convertible bond is a bond that can be converted into the company's common stock. ...
  2. Financial Advisor

    Worried About Stocks? Try on Convertibles

    Convertibles are a good hedge against equity market risk (if you're o.k. with losing a bit of upside potential).
  3. Markets

    What is a Contingent Convertible (Coco)?

    A contingent convertible, or coco, is a security that’s similar to a traditional convertible bond, but with one important difference.
  4. Managing Wealth

    Convertible Bonds: An Introduction

    Find out about the nuts and bolts, pros and cons of investing in bonds.
  5. ETFs & Mutual Funds

    3 Best High-Yielding Convertible Bond ETFs (CWB, ICVT)

    Discover how convertible bond ETFs can offer investors growth and income while hedging fixed income portfolios in a rising rate environment.
  6. ETFs & Mutual Funds

    3 Best High-Yielding Convertible Bond Mutual Funds (LACFX, FACVX)

    Discover an often overlooked asset class and how your portfolio can benefit from it, and learn about three of the highest-yielding options available.
  7. Managing Wealth

    Convertible Bonds: Pros And Cons For Companies And Investors

    Find out why businesses choose this type of financing and what effect this has on investors.
  8. Managing Wealth

    Contingent Convertible Bonds: Bumpy Ride Ahead

    European banks' CoCos are in crisis. What investors who hold these high-reward but high-risk bonds should know.
  9. Trading

    The Mandatory Convertible: A "Must Have" For Your Portfolio?

    Mandatory convertibles are a little understood security with some distinct advantages. Find out if they are right for you.
  10. ETFs & Mutual Funds

    The Top 3 Convertible Bond ETFs for 2016 (CWB, ICVT)

    Obtain detailed information on the exchange-traded funds (ETFs) available for traders seeking ETF exposure to convertible bond investments.
RELATED FAQS
  1. What is the difference between convertible and reverse convertible bonds?

    The difference between a regular convertible bond and a reverse convertible bond is the options attached to the bond. While ... Read Answer >>
  2. Why do some investors prefer convertible over “straight” bonds?

  3. What does it mean when an investor moves a bond to equity?

  4. Why would a corporation issue convertible bonds?

    Discover how corporations issue convertible bonds to take advantage of much lower interest rates as a result of a conversion ... Read Answer >>
  5. Do convertible bonds have voting rights?

    Convertible bonds usually have no voting rights until they are converted. Even after conversion, they may not be granted ... Read Answer >>
  6. What is a convertible bond?

    A convertible bond is a bond issued by a corporation that, unlike a regular bond, gives the bondholder the option to trade ... Read Answer >>
Hot Definitions
  1. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  2. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
  3. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  4. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  5. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
  6. Underweight

    1. A situation where a portfolio does not hold a sufficient amount of a particular security when compared to the security's ...
Trading Center