Can Contingent Convertibles Help Private Asset Managers Fund Their Acquisition of Non-Performing Loans from Portuguese Banks?

Abstract

This paper analyzes the capital structure of private asset managers in which theacquisition of nonperforming loans (NPLs) is funded with Contingent Convertibles(CoCos) placed with investors. The paper develops a model based on NPL transferprices and residual recovery rates to assess capital structures consisting of CoCos andequity. The CoCos would contain put and call options to write down losses and write upprofits, respectively, arising from liquidation and restructuring procedures. The paperconcludes that the protection mechanism provided by debt write-downs embedded inCoCos and the incentives to investors provided by debt write-ups could help bridge thegap between Portuguese banks' NPL bid prices and private equity firms' ask prices.

Keywords: Financial soundness indicators, Bank capital, Financial crises, Credit, Interest rates, Asset managers, contingent convertibles, asset pricing, nonperforming loans, AMs, recovery rate, write-downs, write-up, NPL

JEL Classification: G13, G32, G33, E01, G21, K2, G12, E63