Soft going-concern capital buffer? CoCo non-calls and revealed bank distress

We document a significant widening of trading spreads for contingent convertible capital securities after banks announce non-redemption. The effect is more pronounced in less capitalized and less profitable banks, and spills over to CoCos issued by other banks in the same city, especially when the non-redemption announcements are short-noticed. Non-redemption has further led to higher issuance costs and a substantial drop in new CoCo issues. Troubled banks have shifted towards cutting payouts, paring down risky assets, booking less non-performing loans and decreasing loan loss provisions to repair their risk-based capital ratios, while equity-to-asset remains below the pre-event levels afterwards. Moreover, using loan-level data for listed firms, we find a persistent decline in bank lending to smaller and non-state borrowers following non-calls. These makeshift adjustments are further reflected in a lower Z-score. By contrast, senior debtholders and depositors retain the protection and are largely intact.