Friday, 21 September 2018

Greek debt feels the heat as Europe shifts bail-in rhetoric

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Greek bank bonds dropped like a stone this week as the prospect of painful haircuts came to the fore, potentially heralding a new era for senior debt investors who have previously been protected throughout Europe’s various financial crises.

The Eurogroup’s statement after approving Greece’s €86bn third bailout increased the chances of losses being imposed on senior debt by placing senior bondholders at risk of bail-in while explicitly excluding depositors.

Greek bank debt is now quoted at cash prices of anything between 29 and 48.9 after plummeting as much as 25.5 points in a week.

 “It’s been clear to us for a while that senior debt will be in play for bail-in,” said Raphael Robelin, partner, co-chief investment officer, co-head of investment grade debt at BlueBay.     

“The template over the last five years may have been to leave senior untouched, but the Eurogroup’s statement clearly shows this is coming to an end, with senior bonds subordinated to depositors.”     

European authorities have previously bailed in subordinated debt, but stopped short of including senior debt for fear of contagion that could impact banks’ ability to raise funding.

But the taboo could be broken, with the authorities even considering using a bad bank under the recently implemented Bank Recovery and Resolution Directive (BRRD), skirting around the fact that the actual bail-in tool will not come into force until next year.

With estimates of the size of Greek banks’ capital hole as big as €15bn, there could a lot of uncertainty in the coming months.

So far, the wider financial institutions market has taken the news in its stride, with debt syndicate officials and several investors saying it would not close off European banks’ access to funding.

“Over the last three years, Greek banks have become a more specialised part of the market in terms of who owns the debt, therefore I am not really buying into any contagion risk,” said Laurent Frings, co-head of EMEA credit research at Aberdeen Asset Management.

However, others believe that what happens to Greek senior debt will have repercussions for European bank credit markets in the longer term, especially given what Barclays analysts point out is regulators’ incentive to create a precedent to maximise the scope of burden-sharing.  

BlueBay’s Robelin warned that it would lead to a repricing. “European banks’ senior debt trades too tightly given these risks, with the spread to sub debt far wider than it should be,” he said.

The average spread of bank senior debt versus subordinated credit risk is 83bp according to Markit from being as wide as 266bp at the end of November 2011.

Aberdeen’s Frings said investors increasingly realise that senior unsecured debt is becoming a riskier asset. But he argues that rather than Greece, it is regulatory initiatives such as Total Loss Absorbing Capital (TLAC) that would have more of an impact on its price.

“I do believe there are a lot of investors in Europe who believe senior is sacrosanct, but I think they are wrong.”

If the market is still grappling with how to price different classes of bank debt, what is happening in Greece should act as timely reminder of what risks there are out there.

Lab rat   

The extent of the market reaction to Greece will depend on exactly what options the authorities take.

Filippo Alloatti, a senior credit analyst at Hermes Investment Management, likened the Greek bank resolution to a laboratory rat, and RBS analysts warned in a note that they assumed a “100% haircut on both sub and senior bonds”.

Stephen Phillips, partner at law firm Orrick, highlighted potential alternatives to a simple writedown of principal.

“The question is will the Irish approach of burning (subordinated) bondholders be used, or the UK approach when dealing with the Co-op of trying to utilise as much private sector money from the bondholders as possible at the cost of relinquishing control of the bank. I prefer the latter,” he said.

No matter which option is taken, no one should be surprised by the drastic outcomes attached to all of the choices.


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