Creditor Participation in
Eurozone Bank Restructurings
A Corner Turned
June 2013
Hans-Joachim Duebel
Finpolconsult, Berlin
Discussion Topics
• Changing definitions of bank capital
o Basel III migration and its impact on gone concern banks
• Creditor participation before restructuring
o Voluntary Liability Management Exercises
o Share buybacks, early bond calls
• Creditor participation during restructuring/resolution
o Mandatory Liability Management Exercises / Bail-in
o Good Bank resolution approach (vs. Bad Bank)
o Fiscal expenditure vs. cost
• Law-making process
• Conclusion for the Banking Union project
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Re-definition of Bank Capital
Right Strategy, But A Big Tactical Problem
• Basel II reform needs
o EUR 1 trillion in subordinated debt and hybrid
capital per 2007.
o Most of which was not
used for recapitalization.
Germany: EUR 50 (hybrid) + 60
(sub) bln investors lost a
fraction only.
o Reasons:
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weak instruments create
legal ambiguity
(contractual, revaluation
and termination clauses,
tied to GAAP),
connected insiders
demand Open Bank
Assistance (“Unser
/nuestro /μας Lehman”),
Insufficient options for
bank supervisors outside
the insolvency scenario.
Basel III (Dec 2010)
o New Core Tier 1 definition: no
revaluation, all capital is permanent,
hybrid is limited.
o Strongly rising CT 1 demands while
second leg of financial crisis unfolds.
o Incentivizes buybacks, early calls of
Tier 2 and non-eligible Tier 1 instruments.
• The PROBLEM:
o This is all fine for going
concern banks ..
o .. while it somehow ignores
progress in bank restructuring / resolution law (UK, DE).
o But what happens, when a
gone concern bank starts
“buying” core capital by
selling extended capital?
Source: FitchRatings (2010)
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When Gone Concerns Buy Core Tier 1
Liability Management Exercises in Greece
Alpha Bank Liability Structure
Alpha Bank 2012 and 2013 LME
(assuming full exercise of 2013 offers)
‘Rationale for the Offers’, May 2013:
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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.”
Is offering 48% in cash on subs and hybrids in entirely voluntary LME ‘fair burden
sharing’?
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Greek government to replace 85% of this lost capital (ca EUR 390 million, if 2013 full partic.).
Sub and hybrid investors are largely exempt from GGB losses.
Sources: Alpha Bank, Finpolconsult LME deal analysis.
Greek Bank Subordinated Debt
Piraeus Bank
Pull to Par !
Alpha Bank
Expected gross 600 million CT1
effect (disregarding the
opportunity cost) from voluntary
LME looks ambitious. Piraeus May
sub LME had 10% acceptance.
EFG Eurobank*
*Nationalized EFT Eurobank is
the only core bank that has
offered a debt equity swap
per May 2013 to sub bond
investors, but it was voluntary.
Other banks offered cash LME
(Alpha 55c, Piraeus 55c).
Alpha, Piraeus and NBG also
offered cash to hybrid capital
investors (35-40c).
Compare to Anglo Irish 2010
sub LME : investors demanded
35-40%, government offered
20%, demanding exit consent
to punish holdouts.
Comparable legal situation
(offshore trust SPV-Issued)
“Liquidity management
exercises” (Nov 12 CB report)
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Source: Onvista.de.
When Gone Concerns Buy Core Tier 1
Liability Management Exercises in Cyprus
Laiki Bank Subordinated Eurobond with 2016 maturity
2012 voluntary LME followed by 2013 restructuring (‘mandatory LME’, SLE)
June 2012 highly concessionary offers
•
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Bond offer: 72.5% exchange into senior bond with twice the interest level of deposits (MTM~85)
i.e. de-facto PAR payout, assuming SUC remained uncut; similar deal: MPS in Italy mid-12.
Cash offer: 55% cash offer ca Alpha Bank (but without a far-reaching Eurozone promise!)
Cypriotic government put EUR 1.8 billion (>10% GDP) into share capital to support
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Government injected before hybrids and subs (both temporal and in terms of insolvency rank).
Hybrid investors in June 2012 were given a voluntary equity swap offer and too many shares.
In September 2012, EUR 330 million in senior bonds matured.
Bank of Cyprus: in May 2011 called a subordinated bond of EUR 200 million at par, at the first
possible date (Deuba broke with this policy 2008).
Sources: Laiki Bank, Finpolconsult LME deal analysis.
Laiki Bank Sub Bond LME
Capital Impact
June 12 LME deal was partially ‘clawed’ back in March 13 through debt-equity swaps
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However, the loss of SLE (and senior bond) capital hit Laiki depositors disproportionally through the
credit enhancement effect.
German Kreditwesengesetz has added to pre-restructuring intervention options, including into LME.
Apparently this is still not universally an option for regulators, or options are not exercised.
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Source: Laiki Bank Reporting, Finpolconsult.
Laiki Bank Loss of Bail-inable Capital
Role of ECB Liquidity Policy
Laiki Bank ELA Uses
Some 50% of ELA that Laiki received can
be estimated to have used to pay out
mostly large deposits (IBU), senior and
subordinated bond holders.
Letter from Anastasiades to Draghi
strongly criticizes ECBs role. Asmussen:
‘did not reach 2/3 majority in board to
block.’
The insider run preceeded the bail-in
debate (Nov12-Mar13)!
De-facto deposit insurance? (analogy to
US 1933 Emergency Banking Act)
Laiki Bank Deposits by Source
Source: http://static.cyprus.com/Laiki-ELA.jpg, Central Bank of Cyprus, Finpolconsult computations.
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When Gone Concerns Buy Core Tier 1
Liability Management Exercises in Spain
Bankia Liability Structure
Banco de Valencia Liability Structure
Voluntary LMEs became a popular sport in Spain
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Late 2011 to June 2012 all banks got involved. Great diversity of offers.
Private banks partly aggressive (Santander with lg. haircuts) partly concessionary (Popular).
Some Cajas rather aggressive (Bankia voluntary DES, overleaf).
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Liberbank with EUR 1.2 billion capital gap in October offered in June 2012 to swap EUR 627 mln
hybrids (‘preferentes’) into 5 year deposits without haircut.
Late sweet Caja LME offers can be seen as having shifted mood in banking program sponsor
countries in direction of SLE. Liberbank LMEs were intercepted by the Spain MoU.
Yet, many Cajas offered or tried to offer concessionary deals to investors
•
Sources: Banco de Valencia, Bankia reporting, Finpolconsult computations. Note: senior bonds include covered bonds,
which however largely disappear from reporting as a technical effect from large scale repo with the ECB.
Share Buyback as a Costly Policy to
Support Equity LME
March 2012 large Spanish banks offered
debt-equity swaps (into shares or cocos)
during an intermezzo of stable share
prices:
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Stabilizing LTRO-effect in Q I 2012
Own share buybacks multiplying
previous treasury share holdings.
For gone concern banks, these
operations may both destroy investor
trust and cut bail-inable capital.
Case Bankia:
- 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.
Sources: http://ftalphaville.ft.com/2012/06/26/1056401/the-spanish-bank-buy-back-riddle/
Onvista.de.
Restructuring – Mandatory LME
Spanish or Dutch SLE version?
Spain
- Haircut & DES
• Group 1 – mandatory SLE
• Group 2 – first voluntary, then
mandatory SLE
- Pricing approach:
• “market price” (first law draft
permitted 10% over)
• liquidation value
• Ultimately ‘negotiated’?
Netherlands, SNS Reaal
– expropriation based on
- liquidation value determined by regulator
(evidence?).
Bankia SLE, Expected Loss
Laiki – Authors’ SLE Simulation of Feb 13
BOTH approaches lead to same desired Core
Tier 1 effect, yet Spain leaves possible economic
value on the table for investors.
Parallel to Coco debate:
- 0-1 (insurance) instruments bear significant
legal risk, if triggers are regulatory
- DES as dilution or thin additional capital
layer? Re-swapping/warrants?
Central question: how do we best map
uncertainty over asset values into liability
performance?
Sources: Finpolconsult
Restructuring –
Comprehensive Debt Equity Swap
Bank of Cyprus DES Approach
Bank of Cyprus Bail-inable Capital* and Capital Gap
Bank of Cyprus = extension of Spanish SLE, with more granular ranking
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No initial haircuts outside shares (hybrids), uninsured deposit swap (37.5% + x)
Allocation of sub, senior unsec, large deposits to thin equity classes, NO dilution (BIS!),
Full voting rights for these classes,
Could be combined with warrants, to avoid memory share classes, concentrate voting,
Minimal OSI; initially negative, regarding ad-hoc rank changes of public sector deposits.
Comparable U.S. case - CIT Group FDIC-supported pre-pack (2009); FSB Recs.
Model applicable to going concerns, rather uncertain moderate-sized loss.
Source: Finpolconsult. *10% standard assumption for European bail-inable deposits, Cyprus ratio ca 50%.
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Restructuring –
Good Bank Model
Laiki Bail-inable Capital* and Capital Gap
Laiki Good Bank & P&A
Cases
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Laiki Bank, standard FDIC P&A, FSB recs; combined with super-seniority of insured deposits.
Denmark standard (Amagerbanken & other small banks with property losses).
Greece (ATE, Hellenic Postbank), Ireland (Anglo Irish), only with subordinated debt bail-in.
Problem as with all P&A is determination of sales price in stress. The larger the bank, the
greater valuation risk (Washington Mutual).
Response: Iceland - bridge banks capitalized by existing low-rank creditors/shareholders,
alternatively warrants.
Cyprus: Role of ELA backed by dubious assets? Internal hierarchies in unwinding vehicle?
Model applicable to gone concerns, rather certain large loss.
Source: Finpolconsult.
*see Bank of Cyprus.
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Restructuring -
A Critique of the European Bad Bank Model
Sareb: A Public or Private Bad Bank?
Standard Bad Bank Model (Germany)
Bad Bank = Asset Swap.
European standard until Cyprus. Spain fiscal accounting:
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EUR 51 bln in full faith-and-credit sovereign-guaranteed bonds.
What is the insolvency status of hybrid capital prioritized by private banks?
Reduced transfer prices as a result of SLE, compared e.g. to Germany 2009 (initial Spain)
(90% transfer price with gaps to be amortized by selling bank over 20 years).
Beyond fiscal arbitrage, the bad bank model is problematic with regard to bailinable creditor subsidies, esp in a low asset price inflation environment
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Major price appreciation differences between the 2010s and Sweden 1990s.
Model is basically not practiced in the United States.
There are less issues with a bad bank defined as a special (NPL) servicer .
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Fiscal Expenditure for Bank Resolution
Case Bank OSI/PSI Ratios
Spanish Banking Program, Group 1*
Greek Banking Program**
Cyprus Banking Program***
2012/13 summary: three countries, three
approaches..
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Complete individual path-dependency,
only MoU changed was Cyprus.
Greek central bank in Nov inflated creditor
participation ->10% PSI target since Jan
(reached only by 2/4 core banks).
Greek OSI/PSI 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.
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Fiscal Expenditure vs. Fiscal Cost
Loss Expectation of Recaps
Fiscal Loss Based on 2012 CT1 Book Value
Methodology:
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Subtract 2012-target date pre-provision income assumption from target CT1 2014/15.
Note: pre-provision income estimates in Greece are systematically higher than in Spain.
Question: what value of shares does government buy with a given fiscal expenditure?
Chart assumes 100% price/book ratio of acquired bank stock.
European average bank price/book ratio, however, is only 60% (and that might still be optimistic
for this sample).
Result:
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7 sample bank aggregate fiscal loss would have eaten up 30%-35% of ESM capital, depending
on the price-book ratio assumption (EUR 24.0 bln under 100% and EUR 28.2 bln under 60%).
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Source: Bank reporting, national central banks, Finpolconsult.
Holding on or Selling Now?
Greek Warrant Policy for Core Banks
Alpha Bank HFSF Warrant Pricing
Fiscal Loss Based on Target CT1 Book Value
Target CT 1 includes pre-provision income estimate for 2012 – 2014/15.
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Greek banks have optimistic PPI estimates compared to Spain, prompting government to
price warrants above stressed book values.
E.g. Alphabank at target CT 1 level + 10% (44c) = 150% 2012 book (30c).
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Greek government locks in recapitalization losses.
High multipliers of warrants attract hedge funds.
GGB haircuts treated as if they were an external shock to banks.
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Is forgiving a potentially large upside optimal fiscal policy?
Source: Bank Reporting, national central banks, Finpolconsult.
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Fiscal Cost of Bank Resolution
Accounting Issues, Spain
Spain, Banking Program Accounting under
Author’s Subjective Expected Loss Assumptions
Source: FROB, Bank of Spain, Autonomous Research,
Finpolconsult assumptions and computations.
Public debate constantly mixes up
expenditure and cost. Examples:
• ECB is both super-senior and
collateralized
• ELA at least super-senior
• Fiscal HT 1 injection is safer than pari
passu shares.
• Fiscal share injection after bail-in
differs from share injection before
bail-in (Laiki).
• Economic values for PSI will differ
from regulatory values (debt equity
swaps).
Spain observations
- Historic expenditure inflated by vast
guarantees (reduced during
restructurings) and early recaps.
- Very large ECB/ELA exposure, e.g.
Bankia alone EUR 74.5 bln
- High fiscal cost/expenditure ratio
through tendency to take first loss
positions.
- Potentially large Sareb fiscal burden
not properly accounted for
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(guarantees).
Fiscal Cost of Bank Resolution
Quasi PSI-Reversal in Greece, Cyprus MoUs
Greek program has produced
both far higher cost / GDP and
even higher cost / expenditure
than Spain.
• Cost expenditure inflated by
clear political intention to
shield system from GGB PSI
losses.
• Calculatory PSI reimbursement
between 60% (NBG) and 100%
(rest, based on 2012 CT1)
Result will likely be OSI.
Cyprus MoU II (Mar 13) saved ca
half of the fiscal cost over MoU I
(Nov 12)
• EUR 5 bln under MoU II (mostly
smaller banks & EUR 1.8 bln
Laiki) compared to
• EUR 10 bln under MoU I.
Subject to additional evaluation
of large Cypriotic banks Q II 2013.
Greece, Banking Program Accounting under Author’s
Subjective Expected Loss Assumptions
Source: Bank and press reporting, Finpolconsult assumptions and
computations. Note: very limited data officially provided by HFSF.
Without bond guarantees.
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Some Counterfactuals
Early Intervention is Key to Protect
Government and Depositors
Bankia/BFA*
Assume a 10% deposit bail-in**/ zero fiscal bail-out rule.
Then the break-even restructuring dates were:
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Alpha Bank
Laiki Bank
Bankia – Q IV 2010 … Anglo Irish bank was nationalized in Jan
2009 !!
Banco de Valencia – Q IV 2010
EFG Eurobank – Q IV 2011
Alphabank – Q I 2012
Laiki Bank – 10% deposit threshold always missed, but the
uninsured deposit ratio was 50%..
Bank of Cyprus – 10% deposit threshold always missed, but….
Piraeus – only case in a 7 bank list where the deposit insurer
would have had to disburse in a super-senior rank scenario.
Source: Bank reporting. *7 caja reporting for 2010, Bankia senior bonds minus 50% assumed covered bonds, **assumed to be
the average uninsured deposit ratio outside Cyprus. CT 1 needs include early gov recaps. Finpolconsult.
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Bank Restructuring & Resolution Law
Why does it take so long?
FDIC Least Cost Resolution Game Changer 1991
Still, the legal/regulatory delay in Europe is
disappointing:
- By mid-2012, only UK, Germany, Ireland had specific
bank resolution law
- Crisis countries had to be forced through programs
to adopt law 2012/13. Speculation on Eurozone?
- Greek law highly unsatisfactory (only SLE for
non-core banks),
- Spanish law moderately unsatisfactory (too
many regulator options),
- Cyprus law possibly goes too far.
European regional bank crisis is
comparable to U.S. S&L crisis
In the U.S, the 1991 FDIC
Improvement Act marked the
turning point – a full 9 years after
Garn St Germain:
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De-facto abolition of ‘Open
Bank Assistance (‘direct
recapitalization’ by the Eurozone)
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Adaptation of Least Cost
Resolution Approach
(in theory, never mind the RTC).
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ALL deposits became supersenior in a separate act, but
FDIC was only required to
transfer insured deposits in a
P&A.
Europe: IKB to Cyprus is 5.5 years..
(but there was a template!)
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Conclusion for Banking Union
Definition of bank capital
• Reconcile Basel III and Eurozone-fiscal definitions of bank ‘capital’,
• Revoking excessive focus on Core Tier 1 for gone concern banks is sine-qua
non (Slovenia!!), rules for voluntary LME policies.
Banking Union architecture
• Build the Second Pillar now (European FDIC, starting with resolution), crossborder supervision approach,
• ECB has massive conflicts of interest and cannot be the monopoly bank
regulator from a fiscal perspective.
Crisis management and restructuring/resolution (R&R) policies
• ‘Direct recapitalization’ so far means transfers. Establish clear rules for open
bank assistance.
• Rationalization of bail-in can only come from clearer and more granularly
structured liability side (dichotomy: capital vs liabilities is too simple),
• Avoid ad-hoc rank changes in the neighborhood of mandatory liability
management.
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Conclusion for Banking Union
Crisis mgt ctd..
• With a view on the scale of problems and the need to tap foreign investors
(Spain!) should include covered bonds into R&R (at least overcollateralization).
• Should include reconversion options to map asset value uncertainty. Optimal
class for senior bonds/uninsured deposits would be dated Upper Tier 2.
• Expropriation of subordinated debt problematic. Preferable separate share or
coco class.
• Super-seniority of deposits problematic. If so, volume should be reduced << EUR
100K, household fingerprint system (wealth preservation concept).
• Partial insurance approach to bank deposits (FDIC for the moment).
Liquidity policy
• European Central Bank to curb lending to zombie banks, enforce restructuring.
• Discussion over Target II can be retired if lending is to banks with sufficient
capital. Ex. Greek bank interbank access.
Key lessons
- Acting late costs depositors and governments dearly
- The fiscal side of the Eurozone in bank supervision, resolution and restructuring
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needs to get organized.