Finance

Marcus Ashworth is a Bloomberg Gadfly columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

(Updated )

CoCos are coming.

Investors have piled in to Banca Intesa Sanpaolo SpA's new deeply subordinated bank capital bond, providing the unexpected spectacle of an Italian bank getting 5 billion euros ($5.3 billion) of orders for a 1.25 billion-euro issue just weeks after the government bailed out Monte Dei Paschi di Siena SpA. We thought the world was going to end, but it turns out banking armageddon is so 2016.

It's not just the money. The idea that buyers would queue up for a contingent convertible security (CoCo), would have been unthinkable not too long ago, given that this is the very type of bond that gave Deutsche Bank AG and everyone else a terrible scare in February last year. 

CoCos Are Back
Hybrid securities used by banks to bolster capital are powering back to life after a scare early last year
Source: Bank of America Merrill Lynch, Bloomberg

We've got here through a combination of the European Central Bank both sticking to its guns and changing the rulebook, and Intesa capitalizing on its relative strength to time a good deal. 

Intesa's paying a 7.75 percent coupon, a tantalizing hook even though it's down from initial guidance of 8-8.125 percent. This is still a good omen for its struggling rival lenders, showing that the fallout from the Monte Paschi bailout is relatively contained. Intesa's on track to issue more of the securities this year, and should find it has a lot of company.

Post-crisis the preferred route to resolve failing banks without using state funds has been for banks to issue CoCos. These help firms meet European Central Bank capital requirements for total loss-absorbing capacity, and they're designed to ensure orderly recapitalization by converting to equity when the core equity tier 1 (CET1) ratio of an issuing bank falls below a pre-determined threshold. This is regulators' much-beloved "bail-in" process at work.

The key to the huge demand for Intesa's deal was that the CET1 trigger was just 5.125 percent, well below the 13.1 percent ratio Intesa currently sports. That leaves a lot of road to run before holders of these securities find themselves on the hook. That's a much bigger gap than seen on CoCos issued in recent years, where short paths to the trigger leave investors worried they could be bailed in, with their holdings converted to equity just at the worst moment.

Deutsche Bank's problems this time last year effectively curtailed issuance in this area for much of the European banking sector for most of 2016. The prospect that a multi-billion-dollar fine from the U.S. Department of Justice could wipe out the reserves of Germany’s national champion and keep it from paying the optional coupon on its CoCos gave investors serious worries about other European banks.

Picking Themselves Up Off the Floor
Italy's two largest banks are shrugging off the Monte Paschi contagion
Source: Bloomberg

The settlement of that DoJ fine, along with the fact that much heavy lifting has taken place lifting CET1 ratios across the sector, sets the stage for a return to 2015 levels of issuance.

The ECB also made life easier for everyone, and in mid-December lowered caps on Maximum Distributable Amounts -- in other words, letting banks push more money out the door through optional coupon payments, dividends or bonuses. The nub of it is that banks can run down to 8.3 percent of CET1 capital before money has to stop leaving the business, versus 10.2 percent under previous ECB guidance. The margin of error has widened for everyone, and investors can have more confidence they'll keep receiving juicy coupons instead of getting stuck with equity they don't want. 

The water's looking tempting for investors again. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

(Corrects amount of 2017 Intesa issuance in fifth paragraph from 4 billion euros.)

To contact the author of this story:
Marcus Ashworth in London at mashworth4@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net