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Some pain, some gain

29 November 2012 By George Hay, Neil Unmack

Spain’s bank haircuts are part bail-in, and part bail-out. The indebted government has lopped 10 billion euros off its euro zone-funded bank rescue bill by cutting the value of its worst lenders’ hybrid debt. Yet if it hadn’t been for political considerations, the burden-sharing might have been greater.

Take Bankia, the biggest of the four so-called “Group One” banks that required the biggest slug of government support. It has handed haircuts of 14-to-46 percent of par value to the holders of its 6.5 billion euros of hybrid debt. When Ireland haircut the holders of similar instruments issued by Allied Irish Banks in January, 2011, the number was a more brutal 70 percent.
The comparative kid-gloves approach is driven by politics, itself the result of the lenders’ approach to selling their hybrid bonds. A large amount of the debt was in the form of preference shares that were sold to the banks’ depositors. Those retail investors are already battling with the consequences of austerity and the Spanish recession. The Irish hybrid debt holders, in contrast, were mostly institutional investors.

The Spanish workaround is to combine a smaller haircut with equity stakes in the bank. Taking into account the haircut and new securities, creditors will receive between 30 and 70 percent of the original investment – for the lowest-ranking prefs and perpetual securities –, and 90 percent for higher-ranking dated subordinated debt, says the Bank of Spain. That looks like a cushy deal for creditors, although giving them equity does mean they remain on the hook for further losses.

However, if the bailout, and further action from the European Central Bank, help Bankia and its peers recover, Spain’s lenient haircut and the debt-for-equity combination would look like a significant subsidy for the hybrid holders. The shares would appreciate, and the state’s stake in Bankia will be diluted.

Ultimately, Spain didn’t have any choice over whether to enforce the haircuts: they were a requirement for a 100 billion euro bank rescue package in the summer. But had it regulated its banks properly in the first place, depositors wouldn’t have bought their banks’ hybrid debt in the first place. Yet another reason why a euro zone banking union does look like a good idea.


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