On March 30, 2023, presenter Zhenyu Wang gave the lecture “CoCo Bonds: Are They Debt or Equity? Do They Help Financial Stability?” The lecture was moderated by Kristoph Kleiner.
Zhenyu’s slides can be found here
Below you will find the Q&A from the seminar:
 Initial proposals for contingent convertibles (CoCos) envisioned that these bonds would convert to equity when the issuing bank’s stock price declined to a prespecified trigger and could replace or supplement deposit insurance. After the Credit Suisse experience is there any future for CoCo bonds?
A large part of the AT1 CoCo bonds do not have the clause of 100% permanent write-down. Investors later realized it, and the AT1 price came back substantially, although not completely. I cannot predict the future of CoCo bonds, but banks should not be surprised to find CoCo bonds not as cheap as in the past as funding source.
 For investors to bear the risk of conersion and wipeout, how much spread these Coco bonds were paying over comparable standard bonds issued by Credit suisse?
As far as I know, the yield of Credit Suisse AT1 CoCo bonds were comparable to high-risk subordinate debt before the takeover deal. After the takeover deal, we saw large drop in the price of AT1 CoCo bonds and then recovered partially. Those with wipeout clause probably should carry higher yield than subordinate bonds. As to those that convert to shares, the yield spread should depend on conversion ratio. As I have discussed, the terms of a CoCo bond can be set to be dilutive or subsidizing for equity holders. This can imply higher or lower yield spread comparing to nonconvertible bonds.
 For the Credit Suisse AT1 bond — was it possible for it to convert to equity? Or was only a write-down possible?
Sorry if my question was unclear. I wasn’t asking about which type of trigger should be used. Rather it is for a regulator trigger, what factors does the regulator consider?
The terms of Credit Suisse AT1 bonds specify write-down instead of conversion. They are not convertible to shares, according to some prospectus I have seen. I do not know the factors that Swiss regulator used in determining when to pull the trigger. In prospectus, the trigger is called “viability event”. It is when the regulator believes the bank is no longer a viable going concern. I agree it will be helpful to know how regulators decide whether a bank is a going/gone concern.
 If interest rates increase overtime like what is happening now, for the coco bonds, is it better to leave it as a bond or trigger it to become equity given the fact that bond prices and stock prices go down if interest rates increase.
The triggers in CoCo bonds are mandatory, not options, except that regulator trigger is the option of the regulator. A bank cannot decide a bond to be triggered or not. As we have seen, regulator pull the trigger only when the bank is about to collapse. In this sense, regulators do not seem to have much option either.
 Are the taxpayer risks in the takeover really due to the fact that the AT1 was written down while there was still value in the equity? Would the deal have occured without taxpayer risk if CS had issued equity rather than AT1 bonds?
The taxpayer risks are due to the risks of the bank, not due to wiping out the AT1 bonds. The wipeout helps increasing equity value and may help avoid nationalizing or liquating the bank. Nationalization or liquidation may cause more damage to taxpayer. If this is true, the wipeout of AT1 bonds may help reducing taxpayer risks in the deal. However, it doesn’t insulate taxpayers from the bank risk, given the fact that government credit line and guarantee are needed in the deal.
 Great seminar, Zhenyu; thanks. Suppose that one confines CoCos to regulatory trigger based on a resolution or merger, and allow only write-down, not conversion to equity. Do you think that would qualify as tax deductible under IRS rules?
A great question. I should note that I don’t have expertise on taxation. My answer to this question is highly speculative. It appears you are right that using just regulator trigger and write-down avoids confronting IRC 163(l). However, since such security appears to be a junior claim to equity, IRS may simply rule it as equity. Again, this questions needs opinion from corporate tax experts.
 For the Credit Suisse case, whether the 17 billion coco bondholders receive equity or they receive nothing after the wipeout?
They receive nothing in the deal brokered by Swiss government. They may receive something if the deal does not go through and Credit Suisse goes into bankruptcy.
 How this wipe-out event affect the welfare of debtholder and shareholder of Credit Suisse?
The wipeout lowers the welfare of AT1 debtholders, but it increases the welfare of senior debt holders and equity holders.
 1. How would you price the CoCo Bonds outstanding in the market? Are they investible at a price or not investible at any price? 2. How to stop another bank run like SVB? Do we need another TARP? Is major banks putting deposits in smaller banks an effective confidence-restoring mechamism? 3. Is this time different from 2008?
1. There have been tools developed for pricing CoCo bonds. CoCo bonds with different terms (such as conversion or write-down) should be priced differently. Perhaps a challenging part is how to price regulator trigger. I think many outstanding CoCo bonds can be investible if their price is low enough. 2. The deposits run from mid-size and small banks is an urgent (and long-run) challenge in banking. But I don’t see how TARP can help directly and timely. 3. Many people have given excellent discussions in major newspapers on the difference between the current crises and the crises in 2008. I would like to avoid repeating here.
 Does the failure of CoCo tell use something about the corporate governance of the specific bank? Are US bank better governed?
As I discussed, we are unclear about CoCo’s effects on the incentives of bank management. I think the main reason for the absence of CoCo bonds in US is that CoCo is not capital in US regulation, not that US banks have better governance. I knew major US banks, e.g., Goldman Sachs, pushed regulators to allow CoCo to be regulatory capital. I would give credit to US regulators, instead of US banks, for excluding CoCo bonds from regulatory capital.
 do you think the lower technical trigger level is meant to give regulators more flexibility, given you cite historical bank failure ratios above the trigger? do you think this benefits the structure?
The 7% CET1 ratio trigger is in fact viewed, and referred to as, “high trigger” in banking industry. The problem demonstrated in my talk is less about how high or how low the trigger is. Banks keep their CET1 ratios quite stable. I don’t feel that the ineffectiveness of tier 1 ratio trigger is a benefit in the financial system. It appears not informative about the health of banks
 Any other bond types that can have similar effects?
I think the answer depends on the effects in your mind.
 If CoCo bonds were issued in the US, what is the risk that taxpayers would be on the hook to bail out substantial holders? We’ve seen the FDIC arbitrarily go beyond their stated limit with SVB and Signature, so what would stop the government from bailing out CoCo holders?
I don’t think US government would bailout CoCo bond holders. After 2008, it seems politically troubling if government bails out any bond holders. The US government said it protects only depositors. It is even controversial to bail out large depositors.
 Other than market equity prices (and CET1 ratio), what other factors would regulators consider when deciding whether to trigger the CoCo?
As far as I know, U.S. regulators mainly considered tier 1 ratio trigger, regulator trigger, and market equity value trigger. However, some alternative triggers, such as CDS trigger and dual price index trigger, have been proposed by academics. I knew some U.S. regulatory agency were aware those alternative triggers.
 If it had been the case that the CoCo bond had been converted to equity, would that have changed the final outcome? If I understand correctly, converting those to an equity claim would have resulted in sharing the ultimate loss to a greater degree across both groups without reducing the incentive for buyers to hold CoCo bonds to such a degree.
For this question, maybe we can try the math in the case of Credit Suisse. If the 16-billion-franc AT1 CoCo bonds were converted to certain new common equity shares, the total value of equity (the value of prior shares plus the value of newly converted shares) after conversion would be same as I have calculated in my talk, but the per share value should be lower. Then, one UBS share would exchange for more Credit Suisse shares in the takeover deal. The rest of the story would perhaps be same, except that the prior shareholders would not have benefited from the wipeout.
Zhenyu Wang has been Professor of Finance in the Kelley School of Business at Indiana University since 2012. He also holds the Edward E. Edwards Professorship. Before coming to Indiana, Professor Wang was a vice president in the Federal Reserve Bank of New York, where he served as the head of Financial Intermediation Function. He directly participated, and contributed crucially, in designing the Term Auction Facility, reforming the collateral management system of Discount Window, executing the aid to JPMorgan’s acquisition of Bear Stearns, setting up Maiden Line II and III portfolios of AIG’s securities, setting the financial terms of TARP, and formulating post-crisis bank capital regulations. Professor Wang has published research on equity, fixed income, derivative securities, asset management, bank regulation, and financial econometrics. His research on asset pricing produced the widely used Jagannathan-Wang model. His research on contingent capital was influential in U.S. and European bank capital regulations and in the Basel III Accord.
For further information on the webinar please contact Professor Jun Yang, Director of the Institute for Corporate Governance at email@example.com.