Announcement Effects of Contingent Convertible Securities: Evidence from the Global Banking Industry

• Date: 01 January 2017
• Author: Christian Ehmann,Kristian Blickle,Manuel Ammann
• Published date: 01 January 2017
• DOI: http://doi.org/10.1111/eufm.12092

Announcement Effects of Contingent

Convertible Securities: Evidence from

the Global Banking Industry

Manuel Ammann

University of St. Gallen, Swiss Institute of Banking and Finance, Rosenbergstrasse 52, 9000 St. Gallen,

Switzerland

E-mail: manuel.ammann@unisg.ch

Kristian Blickle

University of St. Gallen, Swiss Institute of Banking and Finance, Rosenbergstrasse 52, 9000 St. Gallen,

Switzerland

E-mail: kristian.blickle@unisg.ch

Christian Ehmann

University of St. Gallen, Swiss Institute of Banking and Finance, Rosenbergstrasse 52, 9000 St. Gallen,

Switzerland

E-mail: christian.ehmann@unisg.ch

Abstract

This paper investigates the announcement effects of CoCo bonds issued by global

banks between January 2009 and June 2014. Using a sample of 34 financial

institutions, we examine abnormal stock price reactions and CDS spread changes

before and after the announcement dates. We find that the announcement of CoCos

correlates with positive abnormal stock returns and negative CDS spread changes

in the immediate post-announcement period. We explain these effects with a set of

theories including the lowered probability of costly bankruptcy proceedings, a

signaling framework based on pecking order theory and the cost advantage of

CoCos over equity (tax shield).

Keywords: contingent convertible securities, CoCo bonds, announcement effects,

event study

JEL classification: G01, G14, G21

The authors would like to thank the participants of the University of St. Gallen research

seminar, the participants of the 10

th

Annual Business Research Conference at Imperial

College, London, Stephan H€

ochst and Robert Van Kleeck from Assenagon Asset

Management, Stefan Weber from Swisscanto Asset Management and an anonymous

referee for their helpful comments. Correspondence: Christian Ehmann.

European Financial Management, Vol. 23, No. 1, 2017, 127–152

doi: 10.1111/eufm.12092

© 2016 John Wiley & Sons, Ltd.

1. Introduction

During the 2007/08 financial crisis, public-sector capital was frequently used as a fail-

safe to prevent the collapse of systemically relevant financial institutions. Increased

government debt levels, disgruntled tax payers and a distortion of bankers’economic

incentives were the ultimate consequences of such support mechanisms. Contingent

convertible debt securities, or CoCo bonds, have been regarded as an innovative remedy

to mitigate those problems. By automatically being written down or converting into

equity capital in the event of certain pre-defined triggers, these hybrid securities

ameliorate an entity’s capital position at critical times. CoCo bonds have enjoyed interest

from both regulators and bank managers since their conceptual creation. In many

jurisdictions adopting Basel III, CoCo bonds can be used as core capital to meet

regulatory requirements. The advent of the CoCo bond and the concomitant discussions

of a ‘bail-in’could be seen as marking a shift in the way regulators plan to treat

destabilised financial institutions in the future.

Accordingly, total global issue volumes of CoCo bonds have reached approxi-

mately 115 billion USD since January 2009. While the market for CoCos is still

relatively small, comp ared to the volumes of bank- issued (non-continge nt)

subordinated debt and se nior unsecured debt instr uments, it is steadily grow ing. In

2013, 26 global financial institutions issued 34 CoCo bonds with a total face value of

around 40 billion USD. In the first half of 2014 alone, issue volumes alrea dy reached

36.5 billion USD. In comp arison, according to inf ormation provided by D ealogic, the

total volume of equity issued by global financial corporations amounted to

approximately 154 billion USD in 2014. In the period from January to May 2014,

European banks issued around 36 billion USD of new equity, as stated by the

Financial Times (2014). Hence, the importance of CoCo bond issues, compared to

initial or seasoned equity issues undertaken by financial intermediaries, is clearly on

the rise. Appendix 1 shows the volumes of global contingent convertible bond issues

from 1 January 2009 until 30 June 2014. According to an industry report released by

Standard and Poor’s (2010), CoCo bond volumes are expected to reach 1 trillion USD

by the year 2020.

Whereas the announcemen t effects of conventional co nvertible securities on is suer

stock prices have been wide ly discussed, research on th e announcement effects of

contingent convertible bo nds issued by banks is sti ll absent. Our study fillsthisgapin

the literature and investigates bo th the abnormal stock price and credit defa ult swap

spread reactions to the anno uncement of CoCos. We make use of a sample of 34

international banks and 8 7 distinct CoCo bond issues w ith a total nominal issue

volume of around 80 billion US D. As such, we capture a signi ficant portion of this

new security market. Follo wing the standard methodol ogy of Brown and Warner

(1985) and Campbell et al. (199 7), we conduct an event study that investigates the

reactions of the CoCo bond issuers’stock prices and CDS spreads in the immedi ate

post-announcement period.

Empirical research on conventional convertible debt securities suggests a negative

relationship between an announcement and the post-announcement abnormal stock

returns of the issuing entities. Duca et al. (2012) report significant negative

announcement effects of convertible offerings for firms in the US between 1984 and

2008. Earlier studies, such as those by Billingsley and Smith (1996), Dann and

Mikkelson (1984), Lewis et al. (1999) and Mikkelson and Partch (1986) find similar

© 2016 John Wiley & Sons, Ltd.

128 Manuel Ammann, Kristian Blickle and Christian Ehmann