Visiting Speaker Seminar - Ligang Zhong, Southwestern University of Finance and Economics

Abstract: We ask whether lenders require higher yields for financial institutions than for other corporate borrowers of similar credit quality. We are motivated to ask this question by the relatively quick speed with which some financial institutions have gone from seemingly strong financial positions to default. Several possible explanations have been provided to explain this rapid deterioration including unique characteristics of financial institutions such as high levels of leverage and refinancing risk, confidence sensitivity, government intervention, opaque asset holdings, and contagion. Since researchers frequently study financial institutions in isolation from firms from other industries, we have surprisingly little previous research on how the unique features of this industry contribute to the pricing of its securities. Using data from public bond markets over almost a thirty year period, we find that financial institution bonds are systematically priced to require a yield premium when compared to similar quality bonds from other industries. Evidence of a long-standing premium for financial institution bonds remains after controlling for bond-specific features such as covenants, maturity, and seniority, in addition to firm-specific features such as rollover risk, leverage, and proxies for opacity. Robustness tests show that our results are not driven by the period surrounding the recent financial crisis nor by institutions issuing mortgage backed securities. We find that this result is pervasive in that higher yields for financial firms persist in secondary bond market trades and newly issued syndicated loans.