3 Issuing costs of state guaranteed bonds - Financial Risk and ...

3 Issuing costs of state guaranteed bonds
possibility that, in addition to the baseline impact of state guarantees, there is an incremental
effect relating to certain classes of bond ratings. Empirically, we add to the main empirical
specification that uses a guarantee (GUARANTEEi) variable and a bond rating (RATINGi) variable,
interaction terms between use of guarantee and bond ratings.
Table 6 presents the results of this analysis. The figures represent the total impact of state
guarantees (baseline impact plus rating upgrade effect).
Table 6: Baseline impact and ratings upgrade effect, by bond ratings, bps (n=390)
Bond rating Mean 95% lower CI 95% upper CI Range
AAA -37.54 -112.6 37.6 150.2
AA+ 12.24 -61.4 85.9 147.3
BBB+ -147.8*** -262.9 -32.6 230.2
BBB -255.6*** -402.9 -108.3 294.6
BBB- -274.5*** -402.5 -146.5 256.0
Note: Issuing costs is measured by the z-spread (for fixed rate bonds) and the zero discount margin (for non-fixed rate bonds) based on
the CBBT pricing source. Issuing costs for each rating is expressed relative to the average reduction across all guarantors based on the
methodology suggested in Suits (1984). Rating classes not shown were omitted from estimation due to multi-collinearity.
State guarantees have a sizeable statistically significant impact on the issuing costs of bonds rated
BBB-/BBB/BBB+, in the order of over 200bps. And as might be expected, state guarantees had a
relatively small and statistically insignificant impact on higher rated bonds.
The intuition behind the rating upgrade effect is as follows. An example is a comparison between a
relatively risky bond (e.g. rated BBB) and a relatively safe bond (e.g. AAA) that both received state
guarantees. We might expect a rating upgrade effect for the riskier bond because the state
guarantee reduces the credit risk embedded within it by more than the baseline state guarantee
impact alone. This is less likely to be the case for the safer bond, as receiving a state guarantee
may not transform the credit risk embedded in this bond incrementally by as much.
3.5.7 Impacts by bank rating
Following a similar approach to the section above, we estimated the ratings upgrade effect using
bank rather than bond ratings. The baseline impact was estimated to be 47.5bps. However, we did
not find any statistically significant additional impact through the ratings upgrade effect. These
results are shown in Table 7 below.
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