Contingent convertible bonds: Optimal call strategy and the impact of refinancing

In this paper, we analyze if banks financed with contingent convertible bonds (CoCos) can rely on the classical (CoCo value minimizing) call strategy. Due to further debt positions outstanding, we can show that the optimal (equity value maximizing) call strategy can sharply differ from the simple classical approach. A crucial driver of the optimal call decision is the refinancing assumption of the call price, which determines whether an equal, an early or a late call occurs. In an empirical study comprising 79 European CoCos, we find that the critical stock price triggering a call deviates (on average) by 56.49% from the classical case, which carries over to a CoCo price deviation equal to 8.73%. Our results reveal that the classical call strategy is only justifiable in the special cases of equity injection or junior debt refinancing for a CoCo with a low face value and a late call. Otherwise, the optimal call strategy significantly differs from the classical version and requires knowledge of the particular refinancing assumption.