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Bank debt: Senior lenders face up to reality of bail-in

Clear pathway to resolution; market ‘massively’ underpricing uncertainty.

The fallout from Cyprus’s chaotic bailout is still being chewed over by anxious FIG debt investors. In crossing the Rubicon of senior bail-in, the Cyprus precedent has split opinion.

Speaking at the International Capital Market Association AGM in Copenhagen on May 23, Benoît Coeuré, member of the executive board of the European Central Bank, said: "The idiosyncratic aspects of the bail-in by uninsured depositors in Cyprus may remain a concern for investors. Creditors need to have a clear picture of what could happen in the event of a bank failure." He was therefore unambiguous about the outlook for senior-debt investors in Europe’s banks.

"Any solution that does not imply an outright bailout seems to take creditors and markets by surprise. This will need to change. I would say that after the events of Cyprus markets should be convinced that Europe is serious and committed to bailing in and thus ending the bailout culture."

One investor who was clearly not taken by surprise is Fiona Macnab, executive director in global fixed-income at Goldman Sachs Asset Management. At a recent Association for Financial Markets in Europe meeting in London she declared: "Cyprus was not a surprise. Although bail-in is not due until 2019, we all knew there would be failures before 2019 – resolution regimes have been proposed and the pathway is clear."

But there is still some frustration among investors as to the way the wind is blowing. "We were surprised that the regulatory authorities took the decision to go down this route," said Roger Doig, credit analyst at Schroders, at the same meeting.

"In 2011 the perception entered the market that bank assets were not safe, so the ECB was required to underline that deposits within the eurozone are safe. So we have to think that legally senior unsecured, as a pari passu asset, is safe too. European banks’ loan-to-deposit ratios are mostly in excess of 100%.

"They depend on deposit funding and have large mortgage books which require term funding. It is logical to protect the senior unsecured bondholders of those banks. Things have got out of hand – particularly in the area of senior bail-in. We should stop this idea that whatever happens we should not put public money behind what are essentially utilities providing public goods [the banks]."

For others the approach is one of weary resignation. "The reality is that there are no actual proposals yet, just discussion," says Craig Abouchar, portfolio manager at Castle Hill Asset Management. "So as an investor how can you really handicap anything? The political uncertainty that exists in the market is massively underpriced by investors."

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