Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi
description
Transcript of Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi
![Page 1: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/1.jpg)
Why Are Yield Spreads on Bank-Issued Subordinated Notes and
Debentures Not Sensitive to Bank Risks?
Bhanu BalasubramnianEmporia State University
Ken CyreeThe University of Mississippi
![Page 2: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/2.jpg)
Debt Market Signals
• Yield Spread = f (Term-structure, Default risk, Maturity Risk, Taxes, Liquidity Risk, Systematic Risk,
Unknown factors)
• Yield Spread on Bonds = YTM of a risky bond - YTM of a risk-free bond of similar characteristics
• When leverage (or any other risk measure) decreases, default risk decreases. In turn, yield spread should decrease and vice versa
• Change in yield spreads acts as signal for market perception of change in firm risk or default risk
![Page 3: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/3.jpg)
Debt Market Signals – Empirical Evidence • SND spreads are less risk sensitive during the 1993-97
period and market discipline is weak - Board of Governors (1999)
• Changes in yield spreads are not related to changes in firm-specific risk of banks during 1994-99 - Krishnan, Ritchken, and Thomson (2005)
• Default risk component is large in money-market securities– Covitz and Downing (2007)
• Are the long-term debt markets sensitive to all non-credit risks but not sensitive to credit risks?
![Page 4: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/4.jpg)
Research Questions• Is lack of default risk sensitivity due to omitted credit risk
factors?– Omitted factors of credit risk
– Trust-Preferred Securities (TPS)
– Too Big To Fail (TBTF) effect after LTCM crisis
– Idiosyncratic Volatility
– Omitted factors in decomposition of yield spreads
– Tax effects – Elton, Gruber, Agrawal, and Mann (2001)
• Whether or not TPS yield spreads can be used for market monitoring?
![Page 5: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/5.jpg)
Data Sources• National Association of Insurance
Commissioners (NAIC) database for bond transactions for the years 1994 – 1999
• SDC Platinum database - bond issue characteristics
• FR Y-9C reports for banks• CRSP for stock market data• H-15 Reports from St. Louis Fed for daily
Treasury rates
![Page 6: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/6.jpg)
Sample Selection• Select fixed-rate, U.S. dollar, plain-vanilla
bonds with investment grade credit ratings • No put or call options, collateral, sinking fund• Should not be convertible, Yankee, global,
serial, LBO• Only bank-issued SND transactions• With at least two years of remaining maturity• At least 10 transactions per SND issue• 6620 buys and 4072 sell transactions• 300 SND issues by 71 BHCs
![Page 7: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/7.jpg)
Decomposition of Yield SpreadsYS (i, t) = α + β (F, k) F (i, t-1) + β (M, k) M( t) + β
(L, k) L( t) + β (X, k) X (i, t) + ε (i, t) (1)
• YS (i, t) = Yield spread of bond i at time t • F (i, t-1) = Vector of firm-level default risk variables • M (t) = Vector of market variables • L (t) = Vector of liquidity variables • X (i, t) = Vector of other control variables • Non-linear GMM estimation with Newey -West
(1987) correction for autocorrelation and heteroskedasticity with five lags
![Page 8: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/8.jpg)
Table 4: Firm Specific Variables reflect default risks except ROA
Variable Estimate p-value
Loans / Total assets (LTA) % 0.4551 0.0001
Non-performing loans / Total loans (NPA) % 7.2025 <.0001
Net charge-off / Loans (CHGOFF) % -9.2037 0.2752
Commercial loans / Total loans (CNI) % 0.2973 0.0038
Off-bal. sheet items / Total assets (OFFBAL) % 0.0200 0.0010
Log (Total Assets) (LNTA) % -0.1130 <.0001
Total Assets / Total Equity (LEVERAGE) % 0.1883 0.0179
Return on Assets (ROA) % 7.6095 0.0198
Market value / Book value (MB) % -0.0853 <.0001
Std. Dev. of stock returns (VOLATILITY) % 0.8886 0.0116
![Page 9: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/9.jpg)
Results – Full Sample
• Yield Spread Levels are sensitive to firm-specific default risk variables
• Tax Effects are significant• Idiosyncratic volatility measure (σ) captures
default risks better than Market volatility measure (VIX)
• Discount for size – TBTF discount• Exception - ROA is positively related to yield
spreads
![Page 10: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/10.jpg)
LTCM Crisis and TBTF Effect
• January 1994 - June 1998 -Pre-LTCM bailout period
• July 1998 – December 1999- Post-LTCM period• Important dates – July 20, 1998, Aug 17, 1998,
September 02, 1998, September 24, 1998 • Major Crises - Mexican (Dec 94), Asian (June
97), Russian and LTCM (Aug 98), Brazilian (Nov 98)
![Page 11: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/11.jpg)
Paradigm Shift in Firm-specific Default Risk Proxies and TBTF Effect
Table 5: Panel C: Firm Specific Variables
VariablePre-LTCM Crisis Post-LTCM Crisis
Estimate p-value Estimate p-value
Loans / Total assets (LTA) 31.7902 0.0076 25.5631 0.3441
Non-per. loans / Total loans (NPA) 475.4882 0.0007 1759.2530 0.0215
Net charge-off / Loans (CHGOFF) 123.5340 0.8924 2764.0580 0.1512
Commercial loans / Total loans (CNI) 15.9458 0.1346 32.4829 0.1587
Off-bal. items / Total assets (OFFBAL) 0.9969 0.1596 2.5581 0.0072
Log (Total Assets) (LNTA) -11.3074 <.0001 -23.2922 <.0001
Assets / Equity (LEVERAGE) 20.5950 0.0118 8.0460 0.6849
Return on Assets (ROA) 277.3742 0.4406 1938.2410 0.0193
Market value / Book value (MB) -6.5626 0.0004 -8.7271 0.0033
Std. Dev. of returns (VOLATILITY) 94.8226 0.0570 -60.8598 0.2945
![Page 12: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/12.jpg)
Default Risk Reduction Due to TPS
• SND issued by all banks as at the end of 1998 $102.8 billion, of which, $100 billion was issued by the top 50 banks
• TPS is the least expensive source of external Tier 1 capital
• Over 800 banks have issued TPS for a total of $85 billion between 1996 and 2004; $28 billion between 1996 and 1999 by the top 50 banks
![Page 13: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/13.jpg)
Leverage is not a significant determinant of yield spread even prior to LTCM bailout but after TPS issuance
VariablePre-TPS Post-TPS pre-LTCM Post-TPS post-LTCM
Estimate p-value Estimate p-value Estimate p-value
LTA 52.1058 0.0005 64.7671 0.0467 13.7311 0.6362
NPA 452.8539 0.0019 262.9285 0.6540 2270.5670 0.0234
CHGOFF) -714.7270 0.5415 -1001.8100 0.6388 2617.7570 0.2406
CNI 2.0294 0.8867 44.9515 0.1169 40.3863 0.1372
OFFBAL 1.3892 0.1068 -0.3551 0.8322 2.3734 0.0153
LNTA -14.8392 <.0001 -12.4138 0.0357 -28.3796 <.0001
LEVERAGE 35.7267 0.0008 27.3064 0.1117 -3.1101 0.8850
ROA 1082.2780 0.0178 548.6316 0.5427 2215.3660 0.0125
MB -18.4576 <.0001 -5.8614 0.0717 -8.1716 0.0118
VOLATILITY -8.2015 0.9096 193.7806 0.0062 -28.9854 0.6205
![Page 14: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/14.jpg)
TPS Spreads are sensitive to on-balance sheet default risk proxies
Variable Estimate p-value
Intercept 415.37 0.0648
Net charge-off / Loans (CHGOFF) 10405.00 0.0646
Off-balance sheet items / Total assets (OFFBAL) -2.08 0.4007
Log (Total Assets) (LNTA) -5.02 0.5397
Total Assets / Total Equity (LEVERAGE) 91.22 0.0128
Return on Assets (ROA) -4087.45 0.0521
No. of observations 58
Adj. R-Sq. 0.5238
F-Statistics 5.18 <.0001
![Page 15: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/15.jpg)
Changes in Determinants of Yield Spreads
• To trace the changes in determinants of yield spreads – Analyze four sub-periods around LTCM crisis
• August 97 – February 98 - tranquil period• March 98 – June 98, the period when bond
market volatility increased • July 98 – September 98, the period when bond
markets became extremely volatile • October 98 - December 99, the post-LTCM
bailout period
![Page 16: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/16.jpg)
Leverage is irrelevant; ROA is a risk proxy; Markets recognize off-balance sheet risks;
TBTF Discount increases
VariableAug97-Feb98 Mar98-June98 July98-Sep98 Oct98-Dec99
Estimate p-value Estimate p-value Estimate p-value Estimate p-value
LTA 0.29 0.3983 1.32 0.1197 0.04 0.9540 0.35 0.2217
NPA -5.03 0.6505 29.84 0.0190 -9.23 0.5279 21.99 0.0081
CHGOFF 57.53 0.6915 42.45 0.5676 24.01 0.6743 54.06 0.0062
OFFBAL 0.00 0.9975 0.01 0.5653 0.04 0.1916 0.02 0.0407
LNTA -0.07 0.4162 -0.15 0.2262 -0.28 0.0695 -0.25 <.0001
LEVERAGE 0.24 0.2974 -0.20 0.6847 -0.71 0.0786 0.34 0.1263
ROA 6.74 0.5700 -15.23 0.0085 -81.11 0.0588 17.80 0.0295
MB -0.10 0.0193 0.06 0.4068 0.12 0.1480 -0.09 0.0090
VOLATILITY 1.67 0.0802 1.95 0.0378 0.74 0.6524 -0.32 0.5930
![Page 17: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/17.jpg)
Monthly Average Yield Spread on BBB-rated SND
0.00
50.00
100.00
150.00
200.00
250.00
Month-Year
Yie
ld S
pre
ad i
n b
asis
po
ints
TPS
LTCM
![Page 18: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/18.jpg)
WSJ 04/17/2008–Ahead of the Tape
![Page 19: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/19.jpg)
Results• Yield spread levels on SND are sensitive to conventional risk
measures prior to TPS issuance by banks
• Risk sensitivity of conventional risk measures decrease after the introduction of TPS
• No TBTF effect before the LTCM bailout but size discount doubles after the LTCM bailout
• Idiosyncratic volatility is a better proxy for firm-specific risks
• Omitting the tax effects in yield spreads leads to measurement errors
• Yield spreads on TPS provide market signals
![Page 20: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/20.jpg)
Results
• Bond markets are sensitive to default risks, but paradigm changes in the determinants of yield spreads after LTCM bailout
• Default risk proxies vary with time and available information– Leverage is not a proxy – ROA is a proxy for changes in risk-taking– Off-balance sheet items is a proxy
![Page 21: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/21.jpg)
Policy Implications• Implicit guarantees and market discipline
• Can TPS provide better market signals? – Needs further investigation after TARP
• Disclosure Levels of off-balance sheet items
• Can TPS and SND be capital securities without risk of capital loss?
• Risk-weighting of earnings for CAMELS
![Page 22: Bhanu Balasubramnian Emporia State University Ken Cyree The University of Mississippi](https://reader036.fdocuments.us/reader036/viewer/2022062410/5681587d550346895dc5dd0d/html5/thumbnails/22.jpg)
Thank You
Questions?
Suggestions?