Contingent Capital: The Case for COERCs

This paper introduces, analyzes, and values a new form of contingent convertible (CoCo), a Call Option Enhanced Reverse Convertible (COERC). Issued as a bond, it converts to new shareholders ’ equity if a bank’s market value of capital falls below a pre-specified trigger. The COERC avoids the problems with market based triggers such as “death spirals ” as a result of manipulation or panic. A bank that issues COERCs also has a smaller incentive to choose investments that are subject to large losses. Furthermore, COERCs reduce the problem of “debt overhang, ” the disincentive to replenish shareholders ’ equity following a decline. The low risk of COERCS should increase their appeal to risk-averse bondholders