The banking sell off has a lot of people worried about CoCos. What are they and why do they matter?
After being clobbered on fears of a slowing economy — and the Federal Reserve’s potential reaction to it — U.S. bank investors are starting to focus on the potential for silver linings.
The two words on everyone lips are “quantitative easing,” or the Federal Reserve’s program to stimulate the economy by buying up the very government bonds it already sold.
Although the practice is controversial, banks would benefit big time because they would act as the prime sellers to the Fed. It’s guaranteed cash in their coffers.
Talk of a fourth round of quantitative easing, known in Wall Street jargon as “QE4,” helped push U.S. bank stocks higher Tuesday. JPMorgan Chase (JPM) shares traded up 1.29% to $58.23 a share in mid-day trading. Citigroup (C) shares trended higher by 4% to $39.08, while shares of Wells Fargo (WFC) rose 2.3% to $48.41 a share.
“There’s a lot of talk about negative rates in the U.S., but our best guess is we get QE4 (maybe in April/May) before rates go negative,” banking analyst Matthew O’Connor wrote in a research note Tuesday. “This would help protect bank profits while still boosting market liquidity and likely driving tighter credit spreads,” the Deutsche Bank analyst said.
European bank stocks continued to get hammered, however, due to their own unique set of risks.
Banks globally are facing fears of an economic slowdown and rising defaults, especially in oil and energy loans. But European banks are dealing with several added pressure, including negative interest rates and fears that they could default on their CoCos, a type of bond that became popular with European banks in the aftermath of the financial crisis.
Shares of Deutsche Bank AG (DB) fell 1.27% to $17.16 a share on Tuesday while Credit Suisse (CS) stock dropped 1.8% to $13.57 a share.
Also on Tuesday, a prominent research firm reminded investors to draw a distinction between U.S. banks’ preferred stocks and European banks’ CoCos.
“We view the recent selloff in U.S. bank preferreds as an opportunity,” CreditSights wrote in a report Tuesday. “U.S. banks have much healthier credit profiles compared to certain European banks,” CreditSights said. And their preferreds are “structurally different” from European banks’ CoCos, which are also known as Addition Tier One securities, or AT1s, the research firm said.