CROSS-SECTORSECTOR COMMENT 16 February 2016ContactsBenjamin S. Garber 1.212.553.4732 Asst Dir-Economist benjamin.garber@moodys.comABOUT CAPITAL MARKETS RESEARCHAnalyses from Moodys Capital Markets Research, Inc. (CMR) focus on explaining signals from the credit and equity markets. The publications address whether market signals, in the opinion of the groups analysts, accurately reflect the risks and investment opportunities associated with issuers and sectors. CMR research thus complements the fundamentally-oriented research offered by Moodys Investors Service (MIS), the rating agency.CMR is part of Moodys Analytics, which is one of the two operating businesses of Moodys Corporation. Moodys Analytics (including CMR) is legally and organizationally separated from Moodys Investors Service and operates on an arms length basis from the ratings business. CMR does not provide investment advisory services or products.View the CMR FAQ Contact the CMR team Follow us on TwitterMoodys Analytics markets and distributes all Moodys Capital Markets Research, Inc. materials. Moodys Capital Markets Research,Inc. is a subsidiary of Moodys Corporation. Moodys Analytics does not provide investment advisory services or products.For further detail, please see the last page.Market CommentNo Longer Cuckoo for CoCos Global risk aversion has spread to the European banking sector and the debt at the bottom of capital structures is selling off severely. Investors have quickly reassessed the virtues of contingent convertible (CoCo) securities, with which the risk of losing coupon payments is elevated under a diminishing outlook for profits and economic growth. As with other novel classes of financial securities that rapidly expanded, the future of the CoCo will be greatly influenced by its first substantial market stress test.MOODY'S ANALYTICS CROSS-SECTOR2 16 February 2016 Market Comment: No Longer Cuckoo for CoCosSpreads on CoCos have blown out Weak earnings reports from major European banks ignited a sharp decline in the value of debt and equity across their sector in early February. This shakeout was particularly pronounced for CoCos, with the spread on such debt spiking to the Barclays index record high of 600 bp on February 9 from 497 bp at the end of January (Figure 1). The market value of such debt now trades at 93% of the par value or value at maturity after never having traded below par value until one week prior. Murkiness about the conditions under which these hybrid securities will convert to equity, combined with downwardly revised global growth forecasts, weighs on CoCos valuations.Issuance of CoCos in Europe was prodded in recent years by the Basel III regulatory accords guidelines on bank capital and leverage. Yet while regulators are enamored by the flexibility provided by securities that convert from debt to equity in times of stress, investors must assess the distinct risks of such hybrids. Ranking above only common...
