On Behavior of the Hybrid Securities When Issuer Is in Distress: The Volkswagen AG Case

Abstract

Hybrid securities provide long term funding for financially sound issuers. The coupon deferral option and their perpetuity offer an issuer flexibility of equity without shareholder dilution. The authors present the case study of Volkswagen (VW) hybrid securities where authors compare the market performance of various financial instruments in the scenario of a corporate governance scandal. Analysis covers the interrelation between prices and yields of VW corporate hybrids and senior bonds in reaction to emissions scandal revealed in September 2015. To one’s surprise the prices of more risky equity-like VW hybrids fell less than prices of VW senior bonds. First, we explain this phenomenon through analysis of price, yield and bond duration. Then we estimate the term structure of the discount factors for senior bonds. We study six series of perpetuals issued by VW group. For each hybrid we consider a virtual bond (Proxy) with maturity at its first call day and the same nominals and coupons, paid at the same day of a year as corresponding hybrid. We observe that difference between spreads for different times to maturity is moderate and the spreads for longer times to maturity are bigger. In crisis periods the difference much increases several times and we observe a reverse effect. The spreads for shorter maturities are greater. As the first corporate hybrids were issued around 2003 and the dominant issuers are ‘blue chip’ companies, the VW case creates the first opportunity to observe real-world behavior of such securities class when an issuer is likely to defer scheduled coupon payments.

Keywords: hybrid securities, Volkswagen, yield to call, duration, spreads

JEL Classification: G10, G32