When all concern is gone: the impact of call provisions on gone-concern Tier 2 bond spreads in Europe

Abstract

For the right to redeem a bond before its maturity date, an issuer usually has to pay a call premium to its investors. This article examines the effect of call provisions on callable versus non-callable Tier 2 Contingent Convertible (CoCo) bonds in the Eurozone, Norway and Switzerland on a spread to worst basis – hence, an investors’ perspective. Thereby, I consider seven types of Tier 2 security designs, while controlling for bond, issuer, regulatory and country specific variables. The empirical results for non-rated Tier 2 CoCos show statistically significant call premiums averaging 84.1 basis points (bp). Conversely, callable Tier 2 bonds with a credit rating trade at an average discount of 12.0 bp against their non-callable pendants, in an environment with low or negative yields and a low risk aversion of investors. Consistent with the signaling theory, the value of the call provision is on average lower for investment-grade Tier 2 bonds (−18.1 bp) than for non-investment-grade (8.1 bp) bail-in-able instruments.