Reuters: Bankruptcy News: Spain to protect hybrid holders

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Spain to protect hybrid holders Sep 7th 2012, 12:09 Fri Sep 7, 2012 8:09am EDT (This story originally appeared on IFRe.com, a Thomson Reuters publication) * Spanish bank sub debt may incur losses even before more junior notes are wiped out By Christopher Spink LONDON, Sept 7 (IFR) - New Spanish regulations are set to turn on their head the usual rules of seniority inherent in debt restructuring, with holders of restructured subordinated debt issued by the country's banks potentially suffering even though owners of hybrid instruments escape being fully wiped out. A Royal Decree published on August 31 outlined a raft of special financial sector insolvency reforms that will determine how stakeholders of institutions that needed fresh capital might be restructured. The decree made plain that existing common equity holders will suffer the first loss and will have to be wiped out before the value of other instruments start to be written down. But the new legislation seems to suggest that further losses would be split "proportionately" between the next most junior instruments (hybrids such as convertible or preference shares) and subordinated debt. In a normal bankruptcy process, hybrid instruments are fully written down before junior bonds are affected. "The new law lacks clarity on this point," said Francisco San Miguel, partner at Spanish law firm Uria Menendez. "Rather than a hybrid being written off entirely before the subordinated instrument takes losses, it suggests that a hybrid might take a haircut of only 60% to its principal and the subordinated bond would have a haircut of below 60%." The legislation also states that senior bondholders will not be affected by any liability exercises. The decree was enacted as part of the conditions for Spain to receive EUR100bn from the European Financial Stability Facility to recapitalise its more stressed banks. These conditions were set out in a memorandum of understanding between Spain and the EU authorities on July 20. "What is the intention of the 'proportionality' phrase?" asked Inigo Berricano, partner at law firm Linklaters. "Is the government mainly concerned about the impact on retail investors who invested in preferred shares? It's clear that shareholders bear the first loss. Normally, hybrids would then take the next loss and after that subordinated debt." If burden-sharing is inflicted in this unusual manner then there could be litigation from institutional investors that own subordinated debt, he added. However, the legislation is clear that investors, bailed-in either voluntarily or mandatorily, should not suffer a worse loss than if the institution was liquidated. "You may be relying on the valuation of a third party in that circumstance but litigators seeking compensation may find that an angle to dispute," said Berricano. HOW MUCH? Exactly how much capital ailing Spanish banks require should be revealed later this month when the results of detailed audits of individual banks are set to be published. Four banks already owned by the Spanish bank restructuring fund FROB (Bankia, NCG, Catalunyacaixa and Banco Valencia) will require capital and an additional 10 institutions may do so as well. The four FROB banks have EUR6.55bn of Lower Tier 2 debt outstanding. The legislation also produced, as expected under July's European agreement, the broad framework for an asset management company, or "bad bank", that will take on the problematic assets of any banks that require FROB money. However, some vital details were missing on what assets might be transferred and at what price. "There is still a lot of detail to come on the bad bank," said San Miguel. "There were some words from the economy minister that real estate assets may be transferred at 'market' value but the price is ultimately to be set by the Bank of Spain." He added: "This is likely to take into account two earlier Royal Decrees this year which imposed provisioning requirements on real estate loans. The prices should not be too far from those resulting values." Berricano agreed: "Secondary legislation needs to be enacted to set up the asset management company. This should say how assets will be valued." The legislation is likely to be enacted in November. This delicate task could be vital if private capital is to be attracted back to Spain. "The eventual price is very relevant," said San Miguel. "I understand that in Ireland the prices were too high and that has delayed subsequent sales of assets. People are looking at parts of Spanish banks but private investors are likely to wait and see how the new regime is put into effect." LIABILITY The new financial sector resolution reforms were also intended to incorporate the principles of bailing in bondholders and other measures as set out in the EU draft directive on banking resolution and recovery published in early June. "It is clear in the preamble to the new law that it is trying to implement the reforms in advance of the draft directive but recognises that the law may be changed when the final directive is approved," said Berricano. The directive is also unclear on how stakeholders in banks needing restructuring might ultimately be bailed in, beyond saying that all but secured bondholders might be vulnerable. This uncertainty could work to Spain's advantage because it could carry out liability exercises in the next few months before the EU decides on the final content of the directive. (Reporting by Christopher Spink, Editing by Matthew Davies) Link this Share this Digg this Email Reprints

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