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The effect of different CoCo structures on the funding costs of a financial institution

Rooij, B. de (2017) The effect of different CoCo structures on the funding costs of a financial institution.

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Abstract:Contingent Convertible bonds (CoCos) provide additional loss absorbing capital and are favored for their regulatory treatment. Despite strict requirements to qualify as Additional Tier 1 (AT1) or Tier 2 capital, there is still significant variation in the structure of CoCos that banks have issued. The eventual impact of additional loss absorbing capital and risk shifting incentives, resulting from the specific CoCo structure used, affects the default probability of the bank. Our study shows that the overall impact of CoCo issuance on the Credit Default Swap (CDS) spread is negative and significant. Indicating that the funding costs of financial institutions that issue CoCos decrease. The reduction in CDS spreads is stronger for AT1 CoCo structures, equity-conversion mechanisms and triggers at the regulatory minimum of 5,125% in terms of the Common Equity Tier 1 (CET1) capital ratio. The negative impact on CDS spreads is larger for Other Systemically Important Banks (O-SIBs), issuers with total assets below $1.500 billion and contributions to the Tier 1 capital ratio between 0,5% and 1% in terms of Risk Weighted Assets (RWA).
Item Type:Essay (Master)
Clients:
Deloitte, Amsterdam, The Netherlands
Faculty:BMS: Behavioural, Management and Social Sciences
Subject:83 economics
Programme:Industrial Engineering and Management MSc (60029)
Link to this item:http://purl.utwente.nl/essays/71643
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