Recapitalization: Spanish bondholders braced for bail-in
Risk of senior bail-in ‘evolving’; Subordinated bail-in ‘opens Pandora’s box’
European Central Bank president Mario Draghi opened a can of worms – one that investors had hoped was sealed shut until 2018 at least – when he recently argued in favour of including senior bank creditors in burden sharing as part of Spain’s proposed bank rescue.
Draghi suggested senior bail-in should be imposed only at the point of the bank’s non-viability.
The ECB subsequently stated that "the question of burden sharing with senior bondholders is evolving at the European level, through continuing discussions on an EU resolution directive" and that "these developments will be reflected in the Irish adjustment programme".
This suggestion – coming hot on the heels of the news that subordinated bail-in of Spain’s bank bondholders is now more likely – has catapulted bail-in back to the top of the long list of things for eurozone investors to worry about.
Under the EU resolution framework, bail-in is due to come into effect in 2018, but the rapidly deteriorating situation in Spain could trigger action sooner.
Pressure for the bail-in of senior bondholders will grow if the European Stability Mechanism is allowed to recapitalize banks directly rather than via the country’s bank rescue fund, Frob. (Financial assistance to the country will initially be delivered to Frob via the European Financial Stability Facility). There will be a huge incentive for the volume of direct recapitalizations to be as small as possible and bailing in senior creditors is the obvious way to achieve this.
The expectation has been that ESM would provide aid directly once it takes over from the EFSF, but this was roundly rejected by Germany’s opposition Social Democrats in a July 19 Bundestag vote: "There will be no direct path from the Spanish aid to permanent recapitalization of banks, at least not with us," they stated.
Analysts at RBS reckon that senior bail-in is potentially feasible in Spain before 2018, as most of the senior debt outstanding is written under local law. This makes it easier for local policymakers to impose losses, as they could potentially remove the status of senior debt as pari passu with deposits.
Most senior unsecured bonds issued by banks in Greece and Ireland are written under UK law, which makes them much more difficult to bail in without EU-wide implementation of bail-in proposals.
"Senior haircuts are unlikely to happen in the near term," says Sanjay Mathur, analyst at the bank. "The recommendation has been rejected by EU finance ministers, and the European Commission has reiterated its view in the draft memorandum, which doesn’t foresee participation of senior creditors but the participation of shareholders and junior creditors."
Under the terms of the leaked memorandum of understanding on Spain’s bank recapitalization, banks receiving state aid "will contribute to the cost of restructuring as much as possible with their own resources. Actions include the sale of participations and non-core assets, run off of non-core activities, bans on dividend payments, bans on the discretionary remuneration of hybrid capital instruments and bans on non-organic growth.
"Banks and their shareholders will take losses before state-aid measures are granted and ensure loss absorption of equity and hybrid capital instruments to the full extent possible."
The extent to which subordinated bank debt in Spain is held by retail investors was expected to protect against such a move. But the country might now follow Ireland in forcing subordinated bondholders to shoulder some of the pain.
|Available for bail-in|
|Subordinated bonds outstanding|
"Many questions still need to be answered on this, but it has opened a Pandora’s box," one observer tells Euromoney. "The reaction of retail investors is going to be a big problem. This is likely to be no surprise to anyone in the credit markets though, which is why no one was buying this paper even when it was offering such high yields." Madrid has been wary of bailing in retail bondholders in bank rescues for fear of the obvious backlash – many of these investors are the bank’s own customers.
When Bankia was bailed out earlier this year, the bank’s €4.5 billion outstanding preference shares were not made part of the deal. They were subsequently held by Frob and have now been converted into common equity.
Analysts at CreditSights have calculated that haircuts of up to 22% on Bankia’s senior unsecured liabilities could have been justified if they had been subject to bail-in. They also question if losses sustained on banks entering liquidation should really be classed as a bail-in.
"If some non-viable Spanish banks were to be liquidated, with senior creditors taking losses that way, we would not categorize it as a bail-in: it is just a straightforward insolvency loss," says John Raymond, analyst at the firm.
If some Spanish banks do bail in their senior bondholders, it will be the first time this has happened in the eurozone. Danish bank Amagerbanken wrote down its senior debt by 41% in February 2011, which shut Danish banks out of the market for some considerable time thereafter.
Analysts at RBS have concluded there is €20.8 billion senior debt outstanding from banks that will require assistance under the recapitalization: Bankia, Banco de Valencia, Banco Popular, Banco Sabadell, Bankinter and CaixaBank.
Those same banks have an even larger quantity of subordinated debt outstanding – €34 billion – half of the €67 billion bank subordinated debt outstanding. Holders of both have good reason to be concerned.