Rabobank said it took advantage of the sharp fall in prices of deeply subordinated bonds of European banks to buy additional cocos. BlueBay Asset Management is also betting on the risky bank bonds after Credit Suisse coco shareholders saw their money go up in smoke.
AT1 bonds, also known as contingent convertibles, or “cocos”, were in the spotlight on Monday when it emerged that UBS›s takeover of Credit Suisse meant that some 16 billion Swiss francs of AT1 debt would be written down to zero by order of the regulator. Several banks, fund houses and institutional investors held this debt, including Rabobank. Globally, banks have issued some $260 billion in this type of “shock absorber debt”.
Senior investment strategist Erik Schmahl of Rabo’s investment office wrote in a note Thursday that the Swiss loss was limited to «less than 0.1 per cent of the portfolio value of most customers affected».
Next up, Rabobank actually bought coco earlier this week for some of its clients’ management portfolios. “As an investor, you are firmly compensated for the risk on deeply subordinated bonds of European banks,” the bank said.
Schmahl: “Some investors suddenly wanted to get rid of their pieces. On most cocos, interest rates shot up to well above 10 per cent. On average, it was around 12 to 15 per cent. That is at least 4 per cent more than interest rates on high yield bonds, which can be vulnerable if we face a recession. If you weigh risk against return, we think you are better off with cocos than high yield bonds.”
Specifically, Rabobank has therefore increased the weight of these deeply subordinated bank bonds in the 1895 Bonds Opportunities Fund by a few per cent to 20 per cent of the fund. To this end, the bank sold high yield bonds.
BlueBay
BlueBay Asset Management, one of the largest holders of Credit Suisse AT1s, also says it is positive about cocos. Cocos offer a “very interesting” opportunity, BlueBay’s CIO Mark Dowding told Bloomberg news agency. ‹European banks are facing the best operating environment they have seen in more than a decade,› he said on Bloomberg Television on Tuesday.
On the risk of cocos, Rabobank’s Schmahl further wrote that the Swiss decision to write off cocos will not be followed soon, judging by statements from European and UK authorities. “The documentation in the eurozone and the UK also does not provide room to completely and permanently strip this type of bonds. Cocos there can either be temporarily written down or converted into shares. In the former case, they would have recovered with the go-ahead and in the latter, as an investor, you would have had a decent recovery in the form of UBS shares.”
That said, coco capital is meant to be stashed away if banks need to be bailed out, the investment strategist agrees. “Because of this higher risk, investors demand significantly higher interest rates on coco than on regular bank bonds.”