An investor owns a CoCo with a face value of $1,000, which pays 8% interest per year – the bondholder receives $80 a year. The stock is traded at $100 per share when the bank declares generalized credit losses. The bank`s core capital falls below 5%, turning CoCos into equities. Due to their high performance in a world of safer and more productive products, the popularity of quota convertibles has increased. This growth has increased stability and capital inflows for the banks that issue them. Many investors buy in the hope that one day the bank will buy back the debt through redemption, and until they do, they will cash in on high returns and above-average risk. Potential convertible bonds serve as additional core capital for European banks to comply with Basel III requirements. These convertible debts allow a bank to absorb the loss of non-performing loans or other burdens on the financial industry. In the banking sector, their use helps to support a bank`s balance sheets by allowing them to convert their debt into shares when certain capital conditions arise. Conditional convertible bonds were created to help underfunded banks and avoid a new financial crisis such as the 2007-08 global financial crisis.
There is a significant difference between conditional convertible bonds and periodic or simple vanilla convertible bonds. Convertible bonds have bond-type characteristics, pay a normal interest rate and have seniority when the underlying entity becomes insolvent or does not re-deploy its debts. These bonds can also convert the bond at a given exercise price into common shares, allowing them to revalue the share price. The strike price is a certain level of share price that must be triggered for the conversion to take place. Investors can benefit from convertible bonds, as bonds can be converted into shares if the company`s price rises. The convertible function allows investors to benefit from both the benefits of fixed-rate bonds and the potential for capital appreciation through higher share prices. Banks use conditional convertible bonds other than convertible bond companies. Banks have their own parameters that justify converting the bond into equities. CoCos can be triggered by the value of the bank`s core capital, by the shutdown of the supervisory authority or by the value of the bank`s underlying shares.
In addition, only one CoCo may have several triggers. Prospective convertible bonds (CoCos) extend the concept of convertible bonds by changing processing conditions. As with other debt securities, investors receive periodic fixed-rate payments over the life of the loan. Like convertible bonds, these subordinated bonds, issued by banks, have specific triggers that defer the conversion of debt to common shares.