Pop goes the Coco November 13, 2009 at 5:32 am
One more thought about contingent convertibles. Clearly as designed having one of these convert is a really bad sign: they are designed to convert only in event of severe stress. Indeed the Lloyds structure was tweaked to go from converting at a Basel ratio of 6% to 5%, in order to make conversion less likely. This of course makes the instrument more attractive to investors. But I think from a stability perspective, it is a bad thing. What we want instead is a structure that converts gently and much more often. That way, conversion is not confidence sapping.
How about this. Ten year structure. Each month, a percentage max(0%, 12 x (12% – Basel ratio)) converts. The monthly observations fits with regulatory capital reporting. It means that even mild losses cause a topping up of capital to occur. Of course you can tweak the thresholds and multipliers, but the basic idea of an instrument that converts early and often is I think much better than one that converts only in an emergency – and by so doing, screams this is an emergency.
Dear Sir,
I could’t find a way to email you so my apologies for posting here, although it is directly on this subject. The message is below.
Regards
Will
Below is a link to another (but prior) variation on the Coco theme. It has the advantages that it directly facilitates new bank lending, has highly investors that are highly incentivized to invest even in a downturn and who do not have to be paid excessive coupon, and does not need to explicitly convert, thus avoiding signalling problems. It is potentially a better form of bank capital than equity.
http://williamwild.blogspot.com/2009/09/evolution-of-idea-part-2.html