Stefan Morkoetter

The Impact of Counterparty Risk on Credit Default Swap Pricing Dynamics

As observed throughout the financial crisis in 2008 CDS contracts are not only exposed to the credit risk of the underlying reference entity but also to the counterparty risk of the protection seller. Conducting a panel regression analysis based on CDS contracts from 2004 to 2009 in Europe and North America for 198 reference entities we find that market-oriented counterparty risk measures are reflected in the pricing of CDS contracts. The impact of counterparty risk is decreasing with a higher creditworthiness of the underlying reference entity. We show that counterparty risk has been incorporated in the CDS spreads for North American reference entities already prior to the financial crisis, whereas for European reference entities the pricing impact only intensified with the outbreak of the financial crisis in September 2008. Market-based counterparty risk measures have a higher impact on the pricing of CDS contracts as compared to measures relying on the correlation structures of asset returns of reference entities and CDS counterparties.

Sovereign Risk and the Pricing of Corporate Credit Default Swaps

Based on an empirical analysis of European corporations, we investigate the impact of sovereign risk on the pricing of corporate credit risk. In our paper, we show that sovereign credit default swaps (CDS) are positively correlated with corresponding corporate CDS spreads and are a significant factor for corporate CDS pricing models. We also find that this impact in-creases throughout the sovereign debt crisis in 2010-2011 and is more distinctive for Euro-zone countries that were more exposed to the sovereign debt crisis than others. We further observe that this effect is particularly pronounced for corporations with a high dependency on their domestic market.

Deposit Withdrawals from Distressed Commercial Banks: The Importance of Switching Costs

We study retail deposit withdrawals from commercial banks which were differentially exposed to distress during the 2007-2009 financial crisis. We show that the propensity of households to withdraw deposits increases with the severity of bank distress. Withdrawal risk is, however, substantially mitigated by strong bank-client relationships. Considering the most distressed bank in our sample, 23 percent of its clients shifted deposits away from the bank during the crisis. Our estimates suggest that this withdrawal risk is eliminated if a client banked exclusively with this financial institution before the crisis, and is more than halved if the client had a mortgage with this bank. Our findings provide empirical support to the Basel III liquidity regulations which emphasize the role of well-established client relationships for the stability of bank funding.We study deposit withdrawals by retail customers of two large Swiss banks after these banks incurred substantial investment losses in the wake of the U.S. subprime crisis. Our analysis is based on survey data providing information on all bank relations of 1,475 households and documenting their reallocation of deposits in 2008-2009. We find that households are 16 percentage points more likely to withdraw deposits from a distressed bank than from a nondistressed bank. The propensity to withdraw deposits from a distressed bank is substantially reduced by household-level switching costs: Households which rely on a single deposit account, which do not live close to a non-distressed bank, or which maintain a credit relationship with the distressed bank, are significantly less likely to withdraw deposits. By contrast, we find that the withdrawal of deposits from distressed banks is unrelated to household coverage by deposit insurance. Our findings provide empirical support to the Basel III liquidity regulations which emphasize the role of well-established client relationships for the stability of bank funding.

Winning a Deal in Private Equity: Do Educational Networks Matter?

Networks can establish business connections and facilitate information flows. But how valuable are they in competitive settings, such as the deal generation of private equity? We find that educational ties between acquiring partner and target firm management are frequent (around 15%) and increase the odds of winning a deal (by 79%). When competing with other funds, exclusivity rather than the school’s ranking matters. In addition, educational ties also allow mitigating prevailing home bias. Yet, the pure existence of network-based relationships does not automatically lead to better deal performance.

Private Equity Performance in M&A Transactions: Empirical Evidence from the Buy and Sell Side

We assess the pricing of transactions undertaken by private equity (PE) funds in comparison to mergers and acquisitions (M&A) of strategic acquirers and sellers. Controlling for company and deal characteristics, we show that PE funds pay less, on average, than strategic buyers for comparable target corporations. We argue that this higher price sensitivity comes from PE firms’ inability to benefit from synergies and show that, in PE add-on acquisitions, this discount disappears. The PE discount is consistent for all PE firm and fund characteristics but shrinks for a subsample of minority deals. When selling their portfolio companies to strategic acquirers, PE funds sell at comparable pricing levels as strategic sellers. The PE discount prevails when PE funds sell to other PE funds (secondary deals).We assess the pricing of transactions undertaken by private equity (PE) funds in comparison to the transactions of strategic acquirers and sellers and focus on synergy gains as an explanatory factor. Controlling for company and deal characteristics, we show that PE funds pay 20% less, on average, than strategic buyers for comparable target corporations (we refer to this as the PE discount). Supplementing the existing literature on the PE discount in M&A transactions, we show that in add-on transactions, this PE discount disappears. When PE funds benefit from synergies, they are willing to pay the same price level as strategic acquirers would do in comparable transactions. In line with this synergy-related explanation, we find that PE funds sell their portfolio companies to strategic acquirers at prices comparable to those of strategic sellers. In divestitures to other PE funds (secondary deals), the PE discount prevails.

Do Private Equity Funds Always Pay Less? A Synergy-Related Explanation Based on Add-on Acquisitions

We assess the pricing of transactions undertaken by private equity (PE) funds in comparison to mergers and acquisitions (M&A) of strategic acquirers and sellers. Controlling for company and deal characteristics, we show that PE funds pay less, on average, than strategic buyers for comparable target corporations. We argue that this higher price sensitivity comes from PE firms’ inability to benefit from synergies and show that, in PE add-on acquisitions, this discount disappears. The PE discount is consistent for all PE firm and fund characteristics but shrinks for a subsample of minority deals. When selling their portfolio companies to strategic acquirers, PE funds sell at comparable pricing levels as strategic sellers. The PE discount prevails when PE funds sell to other PE funds (secondary deals).We assess the pricing of transactions undertaken by private equity (PE) funds in comparison to the transactions of strategic acquirers and sellers and focus on synergy gains as an explanatory factor. Controlling for company and deal characteristics, we show that PE funds pay 20% less, on average, than strategic buyers for comparable target corporations (we refer to this as the PE discount). Supplementing the existing literature on the PE discount in M&A transactions, we show that in add-on transactions, this PE discount disappears. When PE funds benefit from synergies, they are willing to pay the same price level as strategic acquirers would do in comparable transactions. In line with this synergy-related explanation, we find that PE funds sell their portfolio companies to strategic acquirers at prices comparable to those of strategic sellers. In divestitures to other PE funds (secondary deals), the PE discount prevails.

Rating Agencies and Information Efficiency: Do Multiple Credit Ratings Pay Off?

We empirically investigate the benefits of multiple ratings not only at issuance of debt instruments but also during the subsequent monitoring phase. Using a record of monthly credit rating migration data on all U.S. residential mortgage-backed securities rated by Standard & Poors, Moodys, and Fitch between 1985 and 2012 (154,600 tranches), our results provide empirical evidence that rating agencies put more effort in rating and outlook revisions when tranches have assigned multiple ratings. Furthermore, we see that in the case of multiple ratings, agencies do a better job in discriminating tranches with respect to default risk. On the downside, we observe a shift in collateral towards senior tranches and incentives for issuers to engage in rating shopping activities, but find no evidence that rating agencies exploit such behavior to attract more rating business. Our results contribute to the literature on information production of credit ratings and extend the perspective to the monitoring period after issuance.

How Well Do GPs Bargain? Empirical Evidence on Private Equity Discounts in M&A Transactions

We assess the pricing of transactions undertaken by private equity (PE) funds in comparison to mergers and acquisitions (M&A) of strategic acquirers and sellers. Controlling for company and deal characteristics, we show that PE funds pay less, on average, than strategic buyers for comparable target corporations. We argue that this higher price sensitivity comes from PE firms’ inability to benefit from synergies and show that, in PE add-on acquisitions, this discount disappears. The PE discount is consistent for all PE firm and fund characteristics but shrinks for a subsample of minority deals. When selling their portfolio companies to strategic acquirers, PE funds sell at comparable pricing levels as strategic sellers. The PE discount prevails when PE funds sell to other PE funds (secondary deals).We assess the pricing of transactions undertaken by private equity (PE) funds in comparison to the transactions of strategic acquirers and sellers and focus on synergy gains as an explanatory factor. Controlling for company and deal characteristics, we show that PE funds pay 20% less, on average, than strategic buyers for comparable target corporations (we refer to this as the PE discount). Supplementing the existing literature on the PE discount in M&A transactions, we show that in add-on transactions, this PE discount disappears. When PE funds benefit from synergies, they are willing to pay the same price level as strategic acquirers would do in comparable transactions. In line with this synergy-related explanation, we find that PE funds sell their portfolio companies to strategic acquirers at prices comparable to those of strategic sellers. In divestitures to other PE funds (secondary deals), the PE discount prevails.

The Liquidity Dynamics of Bank Defaults

We compare liquidity patterns of 10,979 failed and non-failed US banks from 2001 to mid-2010 and detect diverging capital structures: failing banks distinctively change their liquidity position about three to five years prior to default by increasing liquid assets and decreasing liquid liabilities. The build-up of liquid assets is primarily driven by short term loans, whereas long term loan positions are significantly reduced. By abandoning (positive) term transformation throughout the intermediate period prior to a default, failing banks drift away from the traditional banking business model. We show that this liquidity shift is induced by window dressing activities towards bondholders and money market investors as well as a bad client base.

Impact of Multiple CDO Ratings on Credit Spreads

The authors analyze whether multiple ratings for CDO tranches have an impact on credit spreads and examine the various effects with regard to the number of rating agencies involved. Based on a data set of more than 5,000 CDO tranches, the authors calculate index-adjusted credit spreads to isolate the specific credit risk per CDO tranche and find a negative correlation between number of ratings and credit spreads per CDO tranche—i.e., additional ratings are accompanied by lower credit spreads. On the basis of a valuation model, the authors show that multiple ratings are a significant pricing factor and conclude that investors demand an extra risk premium due to information asymmetries between CDO issuers and investors. Any additional rating reveals incremental information to the market and increases transparency with regard to the underlying portfolio’s credit risk. However, the study does not find empirical support for the hypothesis that marginal tranche spread reduction decreases when additional rating agencies are added. Finally, the study finds evidence that second or third ratings by Fitch on average are higher when directly compared with Moody’s and/or S&P ratings per CDO tranche. This finding is in line with existing literature on corporate bonds and indicates a bias also on CDO ratings due to their solicited character.