The news that the memorandum of understanding on Spain’s bailout is to include the bail-in of subordinated bondholders is likely to trigger outrage in the country.
The terms of the agreement for banks receiving government aid state that recipients:
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“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.”
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The extent to which subordinated bank debt in Spain is held by retail investors was expected to mitigate against such a move. But the country might now follow Ireland in forcing subordinated bondholders to shoulder some of the pain. “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 so far been wary of including 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 billion outstanding preference shares were not made part of the deal and forced to convert. Bankia has an estimated €12 billion in subordinated debt, including preference shares.
Spain’s finance minister Luis de Guindos will likely have pushed hard to avoid the bail-in of subordinated creditors but it seems that Brussels did not agree.
In May, he stated: “It was an error to sell the preference shares, and we will have to look for solutions.”
According to Barclays, 62% of subordinated debt issued by Spain’s banks is in the hands of retail investors. Given that estimates of the outstanding volume of subordinated debt in the system vary from €70 billion to €100 billion, the actual impact of the bail-in on the wider bank restructuring will be limited. As in Ireland, it appears that senior bondholders in Spanish banks will not be bailed in.
“The move towards coercive liability management of subordinated debt is swifter and harsher than we had expected,” said analysts at Creditsights when the decision was announced. “We had thought subordinated debt holders would be more likely to find themselves at risk through being stranded in entities from which the better assets might be removed in a restructuring, rather than effectively forcible reductions in par value. However this does at least tie in with a theme of constant regulatory threats and surprises.” The bail-in decision will have been taken more as a demonstration that bank shareholders and creditors must take pain before the country’s taxpayers. The problem is that in Spain these two groups are one and the same.