What's going on?
The eurozone’s largest bank, Spain’s Santander, blindsided investors this week when it declined to buy back some of its debt.
What does this mean?
Following the last financial crisis, several European banks began to issue a new kind of bond: “contingent convertibles”, a.k.a. CoCos. While normal bonds get paid back after a set period, CoCos have no such end date attached. Instead, banks can periodically buy the bonds back from investors – and, in certain situations, convert them into stock. CoCos are a pretty risky bet all round, and so investors typically expect issuers to buy them back at the earliest opportunity.
After Santander issued a lovely fresh bunch of CoCos last week, investors assumed the bank would use the money raised to buy back an older $1.7 billion worth. So they were stunned when the bank neglected to do so, saying on Tuesday it would be cheaper to leave the existing CoCos outstanding than “call” them.
Why should I care?
For markets: Daredevil bonds are shaken… and, yes, stirred.
Santander clearly believes that its reputation is strong enough to withstand reneging on its “gentlemen’s agreement” with investors. And the fact that it may well be right led those investors to sell off other banks’ CoCos in case they follow Santander’s example. While bonds are generally considered a safer option than stocks, the $340 billion market for risky European debt suddenly looks even riskier – and investors will likely demand correspondingly higher interest rates in future. Over in China, meanwhile, regulators are looking into companies’ ability to finance traditional bonds, after defaults tripled in 2018.
Zooming out: Business as usual in the rest of the bond world.
Tobacco giant Altria sold $11.5 billion worth of (normal) bonds to investors on Wednesday, with the cash helping to pay for its forthcoming acquisition of a 35% stake in e-cigarette company Juul. Despite some concerns about the size of the market, company bonds clearly remain much in demand – Altria was deluged with $50 billion of orders.