Hybrid Bonds as a strategy of sequential finance in the banking sector

Abstract

Up to this point, the literature on the issuance of convertible bonds has neglected financial institutions. Contrary to firms, banks not only can issue convertible bonds but also, after the subprime crises, contingent convertible (CoCo) bonds emerged as an alternative. Hence, the purpose of this study is threefold: first, we expand the literature on the motivation to issue convertible bonds in the banking sector; second, we introduce a new proxy (Loans-Deposits Flow) to measure the reinvestment in this sector; and third, we analyze the differences in the motivation for issuing CoCo bonds when compared to convertible bonds. Our results show that the theory of sequential financing is not confirmed for CoCo bonds in the banking sector. Additionally, we provide evidence that banks issue CoCo bonds for regulatory purposes (to increase their capital), while convertibles are issued to allow banks to expand their investments and loan portfolios. The results are robust to several specifications including a propensity-score matching and a difference-in-difference analysis.

Keywords: Hybrid bonds, Convertible bonds, CoCo bonds, call provision, sequential finance.

JEL Classification: G01, G21, G23