Creditor Participation in
European Bank Restructurings
A Corner Turned ?
Münchener Seminare
November 2013
Hans-Joachim Dübel
Finpolconsult, Berlin
Discussion Topics
• Bank liquidity and capital policies during crisis
• Creditor participation before and during restructuring/resolution
• Lessons: policies and institutions for Europe
Bank Liquidity Policies
Temporary Fix for Low Bank Capital
Euro crisis
High EUR demand by banks hit by
real estate and sovereign crisis,
pullout of banks / institutions,
Note that country ranks have
changed over time (Italy!).
ECB has been slow on bank capital
It took ECB until 2013 to call for
comprehensive recapitalizations
( ‘Asset Quality Review’),
Resistance against bail-in
Draghi letter of July 2013,
Lots of unintended consequences...
Eurosystem Net Lending / Borrowing of
Selected Countries, 2007-2009
Source: Osnabrück University.
Bank Liquidity Policies
Your Central Bank as an ATM Machine..
Laiki Bank
Laiki Bank Deposits by Source 2010-2012
Large ECB ELA borrower, at peak EUR 9.8
billion (33% of assets),
Some 50% can be estimated to have used
to pay out mostly large deposits (IBU),
senior and subordinated bond holders,
Asmussen: ‘did not reach 2/3 majority in
Gov Council to block Laiki ELA’,
some tightening of ELA rules Oct 2013
(reporting on borrower/collateral,
GC must take decision if >EUR 2 billion).
Source: Central Bank of Cyprus, Finpolconsult computations.
ELA – Emergency Liquidity Assistance,
IBU – International Business Unit.
Discredits Walter Bagehot’s Lender of Last
Resort rule?
- lend without limits, at penalty rate.
Not quite: bank capital !!
Bank Liquidity Policies
Temporary Fix for Low Bank Capital
NY Fed Term Auction Facility Lending
to German Banks, 2007-2010
Source: Federal Reserve Bank of New York,
Finpolconsult computations. Cumulative lending.
SIV – Structured Investment Vehicles,
ABCP – Asset-backed Commercial Paper,
MMF – Money Market Funds.
USD crisis
(of European banks..)
• 2008 SIV/ABCP after pullout of US
Ongoing: European banks’ role in the
global China/Petrodollar recycling,
The Fed shoots fast !!
After 2008 Steinbrueck interview
closed window for HRE/Depfa,
After the 2011 US MMF run on French
banks, the Fed passed on credit risk
to the ECB (EUR-USD swap
USD Target Debate
Bank Capital Policies
Early Bailout Cases: Hypo Real Estate/Germany
HRE Total Liability Structure
Public recapitalization 2009
Private deposit insurance fund defacto insolvency by late 2008 (“17
billion in potential losses”),
Early public capital injection and
squeeze-out of shareholders by
June 2009,
Followed by second recap in same
And creation of ‘Bad Bank’ in 2010.
Source: Bank reporting, Finpolconsult.
Bank Capital Policies
Bad Bank Is Often Stealth Public Recap
Bad Bank Model (Asset Swap Model)
Bad banks systematically untie the fate of junior (and senior unsecured) debt
from the fate of assets,
Transfer pricing chosen may be right or wrong,
Why expose government to such risk?
Bank Capital Policies
FMS Wertmanagement
Bad Bank
o By October 2010 with entire Greek exposure !!
o and with full public ownership, no transfer of junior debt (despite law):
= de-fact third – and most expensive - public recapitalization.
Bank Capital Policies
Classic Bailout: Citibank
“Indeed, I was surprised when Tim started reaching out to me directly on
the possibility of doing a good bank/bad bank structure for Citi.
Initially, he raised the idea of the FDIC setting up and funding a bad
bank, without imposing any loss absorption on shareholders and
bondholders. I was flabbergasted.
Why in the world would FDIC take all of the losses and let Citi’s private
stakeholders take all the upside with the good bank?
During the second meeting, we discussed a proposal to have the
common equity and some of the preferred shareholders help absorb
losses. Our view was that all of the private preferred shareholders should
convert and that the bondholders should take some losses as well.
..That was a nonstarter for Tim. He wanted FDIC to take a hit.
Sheila Bair ‘Bull by the Horns’
Bank Capital Policies
Classic Bailout: Hypo Real Estate/Germany
Financial result
HRE Junior Debt Structure
Shareholders received cash,
Junior creditors were almost entirely
protected, except hybrid coupons (EU
rules) and UT2 haircuts (held by retail),
Ca 18 billion in public capital
investment with perhaps 10% recovery
expectation, reduced by almost EUR 4
billion outstanding junior debt.
WestLB last minute junior bail-in did not
use the bail-in legislation.
Germany estimate:
EUR 50 (hybrid) + 60 (sub) billion
investors lost a fraction only,
Total loss for taxpayer could be ca EUR
100 billion.
Source: bank reporting, Finpolconsult.
Bank Capital Policies
Basel III Transition In the Middle of Crisis
Basel III (Dec 2010)
o Fights failure of Basel II to bail in junior debt,
o New core capital definition: no revaluation, all
capital is permanent, hybrid is limited.
o Strongly rising capital demands while second leg
of financial crisis unfolds,
o Incentivizes buybacks, early calls of Tier 2 and
non-eligible Tier 1 instruments.
o This is all fine for going concern banks ..
o .. while it somehow ignores progress in bank
restructuring / resolution law (UK, DE), which has
widened the bail-in definition.
o But what happens, when a bank in difficulties
starts “buying” core capital by selling extended
Source: FitchRatings (2010)
Discussion Topics
• Bank capital and liquidity policies during crisis
• Creditor participation before and during restructuring/resolution
• Lessons: policies and institutions for Europe
When Gone Concerns Buy Core Tier 1
Liability Management Exercises in Greece
Alpha Bank Liability Structure
Alpha: ‘Rationale for the Offers’, May 2013:
Eurogroup announcement of Nov 2012: “liability management exercises should be
conducted in respect of remaining subordinated debt holders so as to ensure a fair
burden sharing”
“The Offers are made in order to provide investors with an opportunity to monetise
their investments at the relevant Purchase Price on a voluntary basis.”
Sources: Alpha Bank, Finpolconsult LME deal analysis.
When Gone Concerns Buy Core Tier 1
Liability Management Exercises in Greece
Greek Bank Junior Debt Repurchases
Cash offer conditions to investors 2012, 2013
1: National Bank of Greece, 2: Alpha Bank, 3: EFG
Eurobank, 4: Piraeus Bank. EFG Eurobank
DES – debt equity swap.
Is offering between 40 and 60% in cash on subs and hybrids in
entirely voluntary LME ‘fair burden sharing’?
Greek government recap effectively replaces some 70% of GGB
losses (four large banks),
Once government is invested in shares, subordinated debt
investors can expect to be paid par  moderate acceptance,
Financial result: Junior bank debt investors are largely exempt from
GGB losses, ca EUR 2 out of 3.5 billion per Q IV 2011 = cash
Sources: bank reporting, Finpolconsult LME deal analysis.
When Gone Concerns Buy Core Tier 1
Liability Management Exercises in Cyprus
Laiki Bank
June 2012, first restructuring
Cypriot government invests EUR 1.8 billion (>10% GDP) into shares, before
hybrids and subs are haircut/converted,
Financial result:
Hybrid capital investors in are offered a voluntary equity swap, which only
by December 2012 becomes mandatory (still far too high number of
Subordinated bond investors enjoy a highly concessionary deal
(EUR 450 million subordinated bond)
• Bond offer: 72.5% exchange into senior bond with twice the interest
level of deposits (MTM~85), accepted by EUR 132 million,
• Cash offer: 55% cash offer, accepted by EUR 182 million.
Laiki Bank Subordinated Bond LME
SLE Capital Loss EUR 150 mln = 1/3
Source: Laiki Bank Reporting, Finpolconsult.
SLE – Subordinated Liability Exercise.
When Gone Concerns Buy Core Tier 1
Liability Management Exercises in Cyprus
Laiki Bank (other)
In September 2012, EUR 330 million in senior bonds matured days before the
PIMCO due diligence exercise started,
The June 2012 subordinated bond deal was partially ‘clawed back’ in March
2013 through the mandatory debt-equity swap of senior unsecured.
Bank of Cyprus
In May 2011 called a subordinated bond of EUR 200 million at par, at the first
possible date,
Note: Deutsche Bank had broken with this policy in 2008.
When Gone Concerns Buy Core Tier 1
Creditor Rotation Through LME
Bankia Funding Structure
Large volumes of senior unsecured and covered bonds sold to foreign
investors, these investors rotated with the ECB,
2006/7 subordinated debt issued mainly to professional investors.
Sources: bank reporting, Finpolconsult computations.
When Gone Concerns Buy Core Tier 1
Creditor Rotation Through LME
Bankia Funding Structure, Expanded
Since 2010, covered bonds were issued into ECB repo (i.e. disappear
from balance sheet and ECB claims appear),
Foreign bank investors recycle proceeds into ECB surplus reserves.
Sources: bank reporting, Finpolconsult computations.
When Gone Concerns Buy Core Tier 1
Creditor Rotation Through LME
Bankia Cash Flow
Cash payments to (largely professional) subordinated investors in 2010
and 2011 of ca. EUR 2 billion,
In parallel new subordinated debt and equity was issued, at this time
mostly to retail investors/households,
2012 cash paid had to be reinvested in equity (LME).
Sources: bank reporting, Finpolconsult computations.
Share Buyback as a Costly Policy to
Support Equity LME
Stabilizing LTRO-effect in Q I 2012 for
share prices was used by Spanish banks
for share buybacks.
Offered hybrid investors shares at high
exercise prices into collapsing share
price trajectory, benefiting insiders
who sold immediately.
Bank may have lost EUR three-digit
millions in cash (Core Tier 1)
Reports for total year 2012 75 million loss
from own share dealing operations.
When Gone Concerns Buy Core Tier 1
Creditor Rotation Through LME
SNS Reaal Cash Flow
SNS Reaal
2008 public (senior) hybrid capital injection.
In 2009 the profit situation was still seen as healthy enough for SNS to buy back EUR 250 million
of the hybrids, most of which from government, and retire other junior debt,
In 2010, SNS Bank placed a EUR 500 million subordinated bond with a 10-year maturity,
2011 large cash LME over EUR 420 million of old subordinated debt,
2012 first possible call of 2003 issued hybrid capital securities exercised.
Sources: bank reporting, Finpolconsult computations.
Restructuring –
Debt Equity Swap or Haircuts?
Spain (Bankia)
- Haircut & DES
• Group 1 – mandatory SLE,
• Group 2 – first voluntary,
then mandatory SLE.
- Pricing approach:
• “market price” (first law draft
permitted 10% over) vs.
• liquidation value,
• Ultimately ‘negotiated’.
Netherlands (SNS Reaal)
– Expropriation
• 100% haircut,
• liquidation value.
Both approaches lead to same
desired Core Tier 1 effect.
Source: Finpolconsult
SLE – Subordinated Liability Exercise
Coco – Contingent Convertibles
CDS – Credit Default Swaps.
Bankia: Haircut & Debt Equity Swap Combined
Debt equity swap leaves possible
economic upside on the table for
investors, tied to asset performance.
Parallel to Coco debate:
• 0-1 (insurance) instruments carry
significant legal risk, esp. if triggers
are regulatory.
• CDS written by bond investors on
initial bank portfolio,
• Example: KfW credit-linked notes
Restructuring –
Comprehensive Debt Equity Swap
Bank of Cyprus – Debt Equity Swap
Bank of Cyprus = extension of Spanish junior debt bail-in to senior unsecured
- No initial haircuts of debt !! swap.
- Allocation of sub, senior unsec, large deposits to thin equity classes,
- Full voting rights for these classes,
- High interest rates for preferred shares if bank performs,
- Current main shareholder is Laiki Bank unwinding vehicle (18%),
- Issue: ad-hoc seniority given to Cyprus public sector and ECB.
Source: Finpolconsult.
Restructuring –
Good Bank Model (FDIC Standard)
Laiki - Good Bank, Purchase and Assumption (P&A)
Laiki Bank, Good Bank & P&A combined with super-seniority of insured deposits.
o Denmark (Amagerbanken), Greece (ATE, Hellenic Postbank).
Problem as with all P&A is determination of sales price during stress. The larger the
bank, the greater valuation risk (e.g. U.S. Washington Mutual).
Response: Iceland - bridge banks to be sold later.
Would have required public funding in the case of Laiki.
Did Greek subsidiary P&A to Piraeus cut losses or profit?
Source: Finpolconsult.
Fiscal Expenditure
Private Sector Involvement, 3 Countries
Spanish Banking Program, Group 1*
Greek Banking Program**
Cyprus Banking Program***
2012/13 summary: three countries =
three approaches.
Complete individual pathdependency, only MoU changed
was Cyprus,
Greek OSI ratios >> Spain,
Cyprus outlier
(but not for smaller banks).
Source: Central banks, Analistas Financieras Institucionales, Finpolconsult. Gap based on target CT1, ‘internal includes proceeds from sales, accounting
issues (DTA)’ *pre-Sareb, **without impact of Good Bank-Bad Bank splits on non-core banks, ***assumes some OSI in debt-equity swaps.
Fiscal Expenditure
Expanded Country Sample
Estimated Private Sector Involvement in
Capital Gap Financing
Creditor participation ratios increasing over time , however with outliers:
Amagerbanken an early case (fall 2010) with senior unsecured creditor participation,
o Note: In fall 2010, Ireland was not permitted to bail-in senior debt at Anglo Irish
Bank, while Denmark did so,
Dexia a late case (second recap 2012), even after Spain, with large junior
bondholder bailout, junior debt investors will receive in total some EUR 2 billion.
Source: Finpolconsult.
Fiscal Expenditure
Expanded Country Sample
Dexia S.A. Junior Debt Structure
Deterrents to bail-in:
• First government recap often followed by second rather than bail-in –
> avoids stigma of wasting taxpayer money (HRE, Dexia),
• Fiscal capacity, program vs. non-program country (currently MPS
• Restructuring delay, may hit the wrong creditorsBankia, but did not
deter SNS Reaal.
Source: Finpolconsult.
Fiscal Expenditure vs. Cost
Loss Expectation of Recaps
Fiscal Loss Based on 2012 Book Value
- What share value does government acquire with a given expenditure?
- Chart assumes 100% price/book ratio of acquired bank stock, i.e. full capital gap
has been detected and adequately provisioned for.
7 sample bank aggregate fiscal loss would have eaten up 30%-35% of ESM
Source: Bank reporting, national central banks, Finpolconsult.
Fiscal Expenditure vs. Cost
Loss Expectation, Extended Country Sample
Fiscal Loss Based on 2012 CT1 Book Value
Additional result:
SNS Reaal with small fiscal profit, based on (possibly heroic) assumption of no
additional losses,
Deep bail-in cases (Laiki, Amagerbanken) show high loss for government as
government ‘gives up’ initial recapitalization,
Median expected loss ratio for government is 75%.
Source: Bank reporting, national central banks, Finpolconsult.
Fiscal Cost of Bank Resolution
Methodology Example, Spain
Spain, Banking Program Accounting under
Author’s Subjective Expected Loss Assumptions
Source: FROB, Bank of Spain, Autonomous Research,
Finpolconsult assumptions and computations.
DES – Debt Equity Swap
Recovery expectation matters !!
• ECB repo is both super-senior and
• ECB ELA at least super-senior
• Hybrid capital safer than shares,
• Share injection after bail-in safer
than before bail-in,
• DESs share economic value with
investors, haircuts don’t.
- Historic expenditure inflated by
large guarantees.
- Very large ECB/ELA exposure, e.g.
Bankia alone EUR 74.5 bln,
- Potential bad bank (Sareb) fiscal
cost are not properly accounted
for (guarantees).
Discussion Topics
• Bank capital and liquidity policies during crisis
• Creditor participation before and during restructuring/resolution
• Lessons: policies and institutions for Europe
Bank Restructuring & Resolution Law
What did take Europe so long?
FDIC Least Cost Resolution Game Changer 1991
In the U.S, the 1991 FDIC
Improvement Act marked the
turning point – a full 9 years after
Garn St Germain:
• Abolition of ‘Open Bank
Assistance (‘direct
• Least Cost Resolution Approach
(from taxpayer perspective),
• ALL deposits became supersenior (separate act),
• FDIC became only required to
transfer insured deposits in a
P&A bail-in of large deposits.
Europe: IKB to Cyprus is 5.5 years..
(but there was a template!)
Lessons Learned
Resolution and Restructuring
• A European Directive by 2018 is too late !
o 10 years after Lehman – exempts all likely current crisis cases,
o EU KOM rule (Aug 1, 2013) disallowing state aid without prior junior
bond bail-in less effective without the Directive (MPS case).
• Exceptions should be avoided
o At least junior bond bail-in,
o Include Covered Bonds overcollateralization,
o ‘Systemic risk’ backdoor should be closed main risk is fiscal
o ECB ‘precautionary recapitalizations’?
• Complete Banking Union architecture
o Build the European version of U.S. FDIC, to create vested interest in
shorter time to restructuring and deeper creditor participation,
o ECB has conflicts of interest as de-facto bank investor and cannot
be a monopoly bank regulator from a fiscal perspective  shared
EU ‘FDIC’ Concept
(Source DG Markt)
Single Resolution Fund
Single Resolution
puts under resolution /
sets resolution framework
Failed bank
All banks
Internal Market
Lessons Learned
Junior Bond Capital Availability
Reconcile Basel and fiscal definitions of bank capital !!
Challenges Ahead
• Securities portfolios
Self-inflicted ‘sovereign-bank’ doom-loop by
banks rejecting diversification,
ECB has not enforced diversification, LTRO
without conditionality,
Whichever-is-lower ratings are accepted usually Canadian DBRS,
Arbitrary repo policies (e.g. Cyprus sov).
Irish Mortgage Portfolio Funding, Stylized
• Loan portfolios
‘Kick-the-can’ corporate loans (EBIT<interest;
40-50% in ES, IT, PT),
Insufficient mortgage profitability related to
indexed loans (Euribor, ECB refi),
Underperformance and market risk are NOT
generally covered by Asset Quality Review.
Slow bank recapitalization due to rejection of
bail-in means that Eurosystem imbalances
could remain high.
Source: above - Osnabrück University, below - Finpolconsult.
USD Target Debate

presentation given at IFO Institute in Munich