CoCos (contingent convertibles) becoming a popular way in Europe to raise tier-1 capital.

Greetings, What started as a crude oil driven selloff in the equity markets has quickly evolved into fears around the global banking sector. Why? Here are some trends that help explain the situation. 1. Bank jitters started with Portugal’s bank called Novo Banco which was restructured forcing haircuts on senior bondholders (including Blackrock and Pimco). As analysts had suspected for some time, European senior bank bonds are not really "senior" and are in fact subordinated to depositors. The Novo Banco event brought this issue to light. Moreover not all senior bonds were treated the same. Only bonds carrying a minimum denomination of €100,000 (institutionally held) were hit. After such an event, why would any institution ever buy a senior European bank bond? 2. Bad loan balances at some European banks continued to rise. Italian banks looked especially shaky and starting in 2016 Italian bank selloff accelerated.

Source: @MarkTOByrne

3. Sovereign wealth funds of many oil producers hold significant amounts of financials shares. With fiscal situations strained, dumping public shares is a quick way to release some of those petrodollars. This is one of the links back to oil.

Source:  ‏@Schuldensuehner

4. As bank shares sold off, some became concerned about capitalization. The focus shifted to the so-called CoCos (contingent convertibles) which became a popular way in Europe to raise tier-1 capital. The securities are treated like bonds and therefore don't dilute existing shareholders. In an adverse event a regulator can force CoCos to be converted to equity - providing additional capital cushion. Now that some have raised questions about capitalization, investors became concerned about CoCos shutting off coupons in order to preserve capital. In such a situation investors are effectively short a put on the bank but are not collecting any premium (coupon). So they headed for the exists.

Source: @ericbeebo

By the way, here are the top CoCo issuers.

Source: Financial Review

Note that Pimco even created a fund to buy CoCos and similar securities.

Source: Google

5. The market especially focused on Deutsche Bank which had its first year of losses since the financial crisis. Many investors have been calling for a major restructuring at the bank for some time. With the CoCos getting hit (chart below) and shares selling off to new lows (second chart below) investors became concerned about DBs stability.

Source: @anilvohra69, @FT

Deutsche Bank (Frankfurt listed) shares

DB CDS spreads spiked.

Source: @lemasabachthani

Moreover, the CDS spreads on subordinated debt hit new records.

Source: @GuyJohnsonTV

What's particularly troubling is that DB's CDS spread is approaching that of UniCredit, a major Italian bank.

Source: @marcel_lucht, @KarelMercx, @FT

This uncertainty has spilled over into the broader financial sector - here are a couple of examples. 1. European financials.

Source: Ycharts.com

2. Japan bank shares (TOPIX bank index ETF)

Source: Google

In fact, here is Nomura. While Japan's banks are somewhat shielded from the full impact of negative rates, some reserves generated by QE going forward will have a negative impact on profitability.

Source: Google

Here are the senior and subordinated debt CDS spreads on European financials (in aggregate).

Source: Bloomberg.com, @business

One concern about this renewed pressure on banks is that it could reignite the Eurozone stability fears. For example, Greek shares fell to the lowest level since 1990 as bank shares lost almost a quarter of the value in one day.

Eurozone periphery government bond yields rose in response to these new concerns, with spreads to Bunds jumping. Here is the situation with Portugal.

Source: Investing.com

Source: @business

Eurozone core and other major economies saw their government bond yields moving sharply lower.

Source: Investing.com

Source: Investing.com

For the first time in history, the Japanese 10-year government bond yield moved into negative territory.

With the 10y JGB yield now negative, we are clearly above $6 trillion of negative yielding government bonds.

Source: @FT (this is before the 10yr JGB yield became negative)

Here is the 5yr JGB yield.

Continuing with Japan, the yen had a sharp rally, regaining its status as a "safe haven" currency (for a while the euro had that status). Dollar-yen is now back to 2014 levels, reversing a great deal of work the BoJ did to weaken the yen. By The Daily Shot