Tuesday, 12 May 2009

Trigger convertibles

This is an idea of Steve Randy Waldman's, and I like it.

The basic idea is that you have a deferrable CB. That is, a fixed rate bond which pays coupons, but where the issuer can defer the coupon without it being a default event. Many preference shares are like this, for instance.

The bond is also convertible into shares. Unlike a normal CB, though, the bond is convertible after deferral at a fixed discount to the then current stock price. Thus it is a trigger CB - the trigger being the deferral. (One could have other triggers too, such as quarterly net earnings being sufficiently negative, or Tier 1 capital ratios falling too far. You could also have conventional conversion features too.)

The attractive part, akin to contingent capital, is that the holder is incentivised to fund fresh equity issuance just when the issuer needs it. The issuer pays something for the option to raise equity, but not nearly as much as it would have to pay for real equity capital. If the issuer wants to be sure of the capital, conversion after the trigger is hit would be mandatory: if they thought that the discount was incentive enough, it would be optional, with a correspondingly lower coupon on the bond.

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