Market Reaction to Seasoned Equity Offerings by European Banks during the Recent Financial Crisis

Abstract: This thesis attempts to assess the short-term costs of raising new equity for European banks during the recent crisis. We analyze the effect of seasoned equity offerings (SEOs) on stock prices and CDS spreads, using an event study methodology. We find evidence that on average it was costly for European banks to raise new equity during the crisis, as stock prices reacted negatively to SEO announcements while CDS spreads did not show any significant aggregate movement. We observe that stock price reactions were more negative for issuing banks in distressed countries. In addition, our analysis shows that the credit rating of the issuing institution is an important determinant of stock market and CDS spread reaction; overall we detect that SEOs announced by sub-investment grade banks caused the sharpest declines in stock values and larger reductions in CDS spreads. This provides empirical evidence for the prevalence of a debt overhang problem for highly leveraged banks, theorized by earlier research. Our research is motivated by the recent debate regarding new regulatory capital requirements for banks and the role of financial institutions in the latest financial crisis. In this context, funding costs for banks are highly relevant since they directly impact credit supply to the real economy. If banks see raising equity as too costly, they may consider to instead improve their capital ratios by downsizing their balance sheet and this in turn can lead to a credit crunch, with a severe negative impact on economic growth.