How confusing is this?
LONDON, Nov 11 (Reuters) – Bank of America Merrill Lynch reversed its position for a second time on Wednesday to decide its bond indexes would not include new contingent capital securities, devised for UK bank Lloyds.
The bank had said on Tuesday that it would include the contingent capital — now known as CoCos or Contingent Convertibles — in its benchmark indices.
But apparently BofAML has reversed its decision on the basis that:
“The preponderance of feedback that we have received from investors who are measured against our indices indicates that most do not view the new contingent capital securities as part of their investment universe,” Bank of America Merrill Lynch said in a research note.
Remember Lloyds is offering to exchange as much as £7bn of CoCos (ECNs in Lloyds’ parlance) for existing subordinated debt, as part of its fundraising announced last week. The CoCos automatically convert into equity if Lloyds’ core Tier 1 capital ratio falls below 5 per cent.
That conversion is a bit of a problem for some of the traditional buyers of hybrid capital, who may not be allowed to own equity (ever). Thus, presumably, why they don’t want the new notes included in fixed income indices. The concern is that if there was a cataclysmic banking event and CoCo triggers were breached, bond investors would have to immediately sell them once they turned into equity — creating a sort of reinforcing death spiral.
Lloyds’ issue has a bit of an advantage, of course. As some analysts have noted, the bank is making investors an `offer they can’t refuse’, thanks to pressure from the European Commission on hybrid bonds. But the indexing issue suggests CoCos may have a tougher time at other banks.
Here’s a bit more detail from BNP Paribas:
The inclusion of the new contingent capital securities into fixed income indices has been a closely followed issue with most investors we have spoken to largely with the view that these securities should be excluded from joining the indices. While we wait for a formal announcement from iBoxx regarding how they treat these securities within the current rules, from market sources we have learnt that contingent capital will be excluded from Barclays (ex-Lehman) indices. Merrill Lynch initially said that these will not be included in its indices, but changed this decision to include them on Tuesday which was followed by yet another u-turn on Wednesday to exclude them again. But in the process, Merrill has also conversion T1 securities that are already in the index.
. . . We agree with our bank analysts’ point that it looks more as an excuse for Merrill to change its view on ECN inclusion again than a serious reason to remove existing bonds from their indices. There will be a handful of T1 bonds that will match this criteria such as the LLOYDS € 7.375% and £ 7.834% bond, but again we concur with our bank analyst that by the time a bank would be in breach of regulatory minima set in the mandatory conversion clause, the bank may be close to default or in liquidation mode by that stage which looks like an extreme scenario. But if such securities do end up being excluded, it will create some selling pressure from the benchmark investor base. At present iBoxx has not indicated to go down the same path as Merrill, but that may emerge when they make a formal announcement regarding the new contingent capital securities.proposed to review the exclusion of similar mandatory.
Related links:
I should not have CoCo-ed? – FT Alphaville
Wall Street and Fed in discussions over CoCos – FT
CoCo bonds `no panacea,’ report warns – FT
CoCos – Happy or Sad? – The Long Room