Reuters: Bankruptcy News: Sub debt losses loom as Spain plans bank cleanup

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Sub debt losses loom as Spain plans bank cleanup May 2nd 2012, 12:08 Wed May 2, 2012 8:08am EDT * Disorderly bail-in seen unlikely * Losses partially priced in By Jean-Marc Poilpre LONDON, May 2 (IFR) - Institutional investors in Spanish banks' subordinated debt are unlikely to suffer the same fate as Irish bondholders although deeply discounted voluntary debt buy-backs could be on the cards, market participants said this week. As talk heats up of the country following Ireland with plans for a bad bank to clean up the sector, so have discussions around whether holders of subordinated debt will be forced to help recapitalise the banks. "Given that our estimate of capital needs of around EUR65bn, which is manageable, we don't currently expect Anglo-Irish style forced exchanges," said Satish Pulle, portfolio manager at European Credit Management. He added that some savings banks (Cajas) that need capital may well seek to share the burden at the sub level. "This could take the form of low cash price buybacks, many of which have taken place already," he said. Meanwhile, Georg Grodzki, head of credit research at Legal & General Investment Management said that some of the regional and local savings banks suffered from broken business models given the poor outlook for the housing market and stiff competition for deposits. "Rather than restructuring those banks they should be closed down, even if this was to result in losses for debtholders as is the case in, for example, Denmark and the US," he said. "Any available funds should be spent on banks with viable franchises only. Bailing in subordinated debt holders could make sense in such circumstances, although buybacks or exchanges of subordinated bonds may achieve similar capital gains without the adverse 'noise' surrounding bail-ins". Market prices are typically quoted in the mid-50s to 70s in cash price terms, reflecting a risk of discounted buy-backs. Higher prices for larger banks suggest that the risk there is seen as less imminent, even if Santander did execute a liability management exercise in November, targeting Lower Tier 2 and Upper Tier 2 securities, which was widely seen as overly aggressive. A lack of available legislation to bail-in investors is also another hurdle, although as was seen in Ireland, it does not take long for the law to be changed. However, analysts generally believe this is not the central scenario. "The EU authorities are unlikely to want any country to pre-empt the new resolution/bail-in regime in a disorderly way, so soon before its introduction across Europe," said John Raymond, an analyst at CreditSights. "However, this scenario cannot be fully ruled out. We saw in Ireland how legislation can suddenly be introduced in an emergency, and there must be a risk of it in other bail-out countries, like Portugal. But it would be hard to see it happening without Spain entering some sort of formal bail-out process." SHARING THE PAIN Retail investors have already had to contribute to the strengthening of banks' balance sheets through the conversion - sometimes optional, sometimes mandatory - of their preferred shares into equity, making it all the more difficult to leave institutional investors unscathed. "Consensus is that significant retail ownership of the Spanish sub complex would make the banks and the Spanish authorities reluctant to impose a heterodox outcome on sub bondholders (e.g. bondholder losses), for fear of provoking deposit flight," Bank of America analysts said in a note published last week. "However, it is simply not true that the Spanish banks have protected their retail investors," the analysts said, noting there are a number of on-going mis-selling scandals relating to retail clients that are now "stuck" in preferreds, or have been offered to convert into stock at low prices with substantial realised losses, or instances of banks who have mandatorily converted bonds into stock, again at a loss to retail. They advised investors to stay "Underweight" Spanish subordinated bonds. A FIG banker said that there would be huge public pressure for institutional investors to share the pain. CLEAN-UP NEEDED An IMF team said last week that a "carefully designed strategy to clean up" Spain's weak institutions quickly and adequately is essential to avoid any adverse impact on the sound banks. It also delved into the question of burden-sharing between the public and private sector to resolve the problem banks. The expression "private sector" participation was used in direct reference to the deposit insurance scheme (the FGD), which is funded by the industry. But the IMF also said greater reliance on public funding may be needed "after exhausting options for private recapitalisation." One way for Spain to recapitalise its banks could be to tap the EFSF, however European governments disagree over how funds could be channelled to banks. For some investors, Spain's longer-term prospects are not all gloomy. "The two-notch downgrade implemented by S&P last week may have positive consequences for the credit of Spain," said ECM's Pulle. "It could be a good incentive for the government to implement the structural reforms that the ECB has asked for, and to recapitalise the domestic banks," he said. "The Spanish government may have been unwilling to recapitalise banks for fear of a downgrade. S&P's downgrade could potentially free up the government to do that." (Reporting by Jean-Marc Poilpre, editing by Helene Durand and Julian Baker) Link this Share this Digg this Email Reprints

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