BIS published a working paper on the issuance of contingent convertible capital securities (CoCos) and bank fragility. The promise of CoCos as a bail-in solution has been the subject of considerable theoretical analysis and debate, but little is known about their effects in practice. In this paper, BIS undertakes the first comprehensive empirical analysis of bank CoCos, which represent a market segment comprising over 730 instruments totaling USD 521 billion.
The working paper describes the current state of CoCo issuance and presents an overview of the sample data set. The data set used consists exclusively of CoCos issued by banks and excludes those issued by insurance companies and other non-bank financial institutions. The focus is on CoCos that have at least one (mechanical or discretionary) contractual trigger. The paper highlights that two sets of empirical exercises were conducted. The first exercise examined the determinants of CoCo issuance while the second exercise evaluated the impact of CoCo issuance on the credit default swap (CDS) spreads and equity prices of issuing banks. The empirical analysis leads to the following four main findings:
- The propensity to issue a CoCo is higher for larger and better-capitalized banks
- CoCo issues result in statistically significant declines in issuers' CDS spreads, indicating that they generate risk-reduction benefits and lower costs of debt. This is especially true for CoCos that convert into equity, have mechanical triggers, and are classified as Additional Tier 1 instruments
- CoCos with only discretionary triggers do not have a significant impact on CDS spreads
- CoCo issues have no statistically significant impact on stock prices, except for principal write-down CoCos with a high trigger level, which have a positive effect
CoCos are hybrid capital securities that absorb losses when the capital of the issuing bank falls below a certain level. CoCos can absorb losses either by converting into common equity or by suffering a principal write-down.
Related Link: Working Paper (PDF)
Keywords: International, Banking, CoCo, Basel III, Bank Capital Regulation, BIS
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