Pricing contingent convertible bonds in African banks

Abstract

In times of financial distress, banks struggle to source additional capital from reluctant private investors. Sovereign bailouts prevent disruptive insolvencies, but distort bank incentives. Contingent convertible capital instruments (CoCos) – securities which possess a loss-absorbing mechanism in situations where the capital of the issuing bank reaches a level lower than a predefined level – offer a potential solution. Although gaining in popularity in developed economies, CoCo issuance in Africa is still in its infancy, possibly due to pricing complexity and ambiguity about conversion triggers. In this paper, the pricing of these instruments is investigated and the influence of local conditions (using data from three major African markets and an all- African index) on CoCo prices is explored. We find that the African milieu (high interest rates and equity volatility compared with the situation in developed markets) makes CoCos particularly attractive instruments for the simultaneous reduction of debt and the enhancement of capital. If CoCo issuance becomes a viable bank recapitalisation tool in Africa, these details will be valuable to future investors and issuers.