(The author is a Reuters Breakingviews columnist. The opinions
expressed are his own)

By Neil Unmack

LONDON, May 1 (Reuters Breakingviews) – A bank from the euro
zone’s debt-challenged periphery has been the first to issue a
new breed of loss-absorbing bonds. It is proof that central
bank-whipped bondholders, shrugging off the euro crisis, are
desperate for yield. A 9 percent coupon looks juicy, but it pays
investors less than equity, with no upside.

The new $1.5 billion bond from BBVA (BBVA.MC: Quote, Profile, Research) is a
milestone. It’s the first issued by a European bank to meet
Basle III rules for Tier 1 capital. The rules for so-called
hybrids were tightened after the 2008 financial crisis. Banks
must have full discretion to pay coupons – or not. Bonds must be
perpetual, and not include incentive for the bank to repay them
early, such as a coupon increase. And if the bank gets into
trouble, the bonds must absorb losses – in this case a
conversion into equity – once the lender’s capital ratio falls
below a pre-set trigger level.

When regulators began setting the rules for new
“superhybrids”, observers wondered if bond investors would ever
buy them. They now have the answer: over 400 investors placed
nearly $10 billion of orders for the BBVA instrument. Other
banks will follow. By raising this additional Tier 1, banks can
boost capital ratios without diluting shareholders, and deduct
interest payments from their tax bill. The deal also allows BBVA
to boost its core Tier 1 ratio by 30 basis points, to 11.5
percent, because of a different treatment of deductions made
against core Tier 1.

The deal’s success illustrates the brilliance of central
bank policy in forcing investors to take risk. Investors are
willing to shrug off the euro zone crisis, thanks to Mario
Draghi’s promise to, maybe, one day, buy sovereign bonds. And
central banks’ willingness to hold rates low and print money is
forcing investors to scour for yield. From a bond investors’
perceptive, the coupon of 9 percent is appealing. Spanish
government debt is hovering at around 4 percent. The snag is
that nothing can stop BBVA from not paying that coupon if the
economy sours.

The real winners are BBVA shareholders. Post-tax the deal
equates to a cost of equity of about 6 percent, half BBVA’s cost
of capital. By buying the bond, investors have shown their
confidence that Spain and BBVA in particular, are over the
worst. They should have bought BBVA stock. Its return on equity
in the first quarter: 16.2 percent.

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CONTEXT NEWS:

– BBVA’s inaugural Additional Tier 1 bond got off to a
strong start on April 30 as investors piled into the new deal
despite a complicated structure that drew criticism from market
observers.

– Spain’s second largest bank attracted orders in excess of
USD9.25bn for its perpetual non-call five-year bond and the
coupon was fixed at 9%. The bond will be sized in the
USD1.25bn-USD1.5bn range.

– Lead managers BBVA, Bank of America Merrill Lynch, Goldman
Sachs and UBS began marketing the deal on Monday at 9.5% area,
according to a market source, and this was then revised to 9.25%
area during Tuesday’s bookbuilding.
- For previous columns by the author, Reuters customers can
click on [UNMACK/]

(Editing by Pierre Briançon and David Evans)

((neil.unmack@thomsonreuters.com))

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Keywords: BREAKINGVIEWS BBVA/

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The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Who should lose money when banks fail? Talk of making deposits senior to bondholders might reassure savers rattled by losses in the Cyprus bailout, and avoid bank runs. But it could lead to unhealthy arbitrage between loans and deposits. Vigilance is needed, and lots of “bail-in-able” capital.

Banks in Cyprus had too little capital to support too many deposits. But the precedent may create anxiety among large depositors elsewhere, whenever a bank gets into trouble. If nothing were done, bank runs could become more frequent. European lawmakers want to prevent that.

One option is to refine the hierarchy of losses when banks fail. Insured deposits are already excluded from bail-in. The next step might be to rank uninsured deposits, accounts with more than 100,000 euros, above senior debt, loosely mimicking the U.S. practice.

That’s fair, since the senior unsecured bondholders are paid to take credit risk, while depositors aren’t. However, money that used to go into unsecured bonds could now go into long-term funding instruments that look like senior debt, but rank like uninsured deposits. Weak banks may be more heavily incentivised to borrow through secured debt, such as covered bonds, which are also exempted from bail-in.

Moreover, the amount of senior debt left to absorb losses is already shrinking, as banks borrowed more heavily during the crisis from deposits or central banks. Much of it will mature before 2015, the earliest the bail-in regime would be introduced.

Such arbitrages should be a zero sum game. The more banks issue of higher-ranking or secured debt, the higher the return investors in senior unsecured bonds should demand, as every euro of protected or preferential debt means higher losses in a default. But history suggests that banks will not volunteer to be cautious and that relying on markets to discipline banks is risky.

National regulators will have to decide the minimum amount of “bail-in-able” debt banks must hold. Unless they provide enough, they may once again be faced with the choice of burning depositors, or bailing them out. Depositors should not assume Cyprus is a one-off.

(The author is a Reuters Breakingviews columnist. The opinions
expressed are his own.)

By Neil Unmack

LONDON, April 18 (Reuters Breakingviews) – Who should lose
money when banks fail? Talk of making deposits senior to
bondholders might reassure savers rattled by losses in the
Cyprus bailout, and avoid bank runs. But it could lead to
unhealthy arbitrage between loans and deposits. Vigilance is
needed, and lots of “bail-in-able” capital.

Banks in Cyprus had too little capital to support too many
deposits. But the precedent may create anxiety among large
depositors elsewhere, whenever a bank gets into trouble. If
nothing were done, bank runs could become more frequent.
European lawmakers want to prevent that.

One option is to refine the hierarchy of losses when banks
fail. Insured deposits are already excluded from bail-in. The
next step might be to rank uninsured deposits, accounts with
more than 100,000 euros, above senior debt, loosely mimicking
the U.S. practice.

That’s fair, since the senior unsecured bondholders are paid
to take credit risk, while depositors aren’t. However, money
that used to go into unsecured bonds could now go into long-term
funding instruments that look like senior debt, but rank like
uninsured deposits. Weak banks may be more heavily incentivised
to borrow through secured debt, such as covered bonds, which are
also exempted from bail-in.

Moreover, the amount of senior debt left to absorb losses is
already shrinking, as banks borrowed more heavily during the
crisis from deposits or central banks. Much of it will mature
before 2015, the earliest the bail-in regime would be
introduced.

Such arbitrages should be a zero sum game. The more banks
issue of higher-ranking or secured debt, the higher the return
investors in senior unsecured bonds should demand, as every euro
of protected or preferential debt means higher losses in a
default. But history suggests that banks will not volunteer to
be cautious and that relying on markets to discipline banks is
risky.

National regulators will have to decide the minimum amount
of “bail-in-able” debt banks must hold. Unless they provide
enough, they may once again be faced with the choice of burning
depositors, or bailing them out. Depositors should not assume
Cyprus is a one-off.

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CONTEXT NEWS

– European lawmakers are considering amending a draft
European law on bank failures to provide greater protection to
holders of uninsured deposits, Bloomberg reported on April 9.
The move follows comments by European Central Bank president
Mario Draghi on April 4, highlighting the need for a
“distinction” between senior bondholders and uninsured
depositors in European bail-in regimes.

– “The [U.S.] Federal Deposit Insurance Corporation makes an
explicit distinction between uninsured depositors which, in
general, are not touched, and bondholders”, Draghi said at a
press conference. “I think that the same distinction should be
present in the European Commission’s draft directive. I think
this is another lesson we can draw from Cyprus.”

– Uninsured depositors in Bank of Cyprus BOC.CY and Laiki
CPBC.CY will be forced to take losses under the country’s 10
billion euro bailout.

– For previous columns by the author, Reuters customers can
click on [UNMACK/]

(Editing by Edward Hadas and Sarah Bailey)

((neil.unmack@thomsonreuters.com))

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Keywords: BREAKINGVIEWS BANKS/BAILOUTS/

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and the Reuters sphere logo are registered trademarks and trademarks of
the Reuters group of companies around the world.

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Euro zone finance ministers took the risk of sending the Cypriot economy back to the stone age, with a tough bank restructuring and conservative approach on how much debt the country could take on. They now have a chance to show their sensitive side by giving Portugal and Ireland an extension on their bailout loans. They should seize it: playing hardball again would be self-defeating.

Lisbon and Dublin have asked their partners to extend the maturity of their bailout debt by up to 15 years – terms similar to those extended to Greece last year. Both countries face steep debt maturities this decade and think an extension will help them regain market access.

Ireland’s request is the cheekier of the two. It’s hard to make the case that the extension would make or break the country’s market access; its 10-year borrowing costs are comfortably lower than both Spain’s and Italy’s. Extending debt would allow Dublin to lock in cheap funding, and free up some of a 20 billion euro cash buffer that sits idle in the country’s coffer.

The benefits of an extension are greater for Portugal. Lisbon can raise funds, but European lenders worry it is over-reliant on hedge funds. Ten-year yields, at over 6 percent, are too high. Markets worry about growth, and the political sustainability of its austerity programme, particularly after the constitutional court rejected a raft of spending cuts. A maturity extension would make the programme more palatable to voters.

Neither country is likely to get the 15 years they ask for. The Eurogroup seems to have settled on a compromise of seven years. Even this may be opposed by Germany, which has argued an extension would need Bundestag approval and may demand further commitment to reform.

Extending the loans won’t cost very much, and the commitment to provide cheap funds for longer should make markets more generous to Lisbon. That would take Portugal closer to Ireland, Spain and Italy, which have sufficient market access for investors to believe that the ECB might one day start buying their bonds. The extension is a no-brainer: without it, Portugal is more likely to need further help at a later stage. And, after Cyprus, showing a little solidarity will be a good public relations exercise for the euro zone.

(The author is a Reuters Breakingviews columnist. The opinions
expressed are his own.)

By Neil Unmack

LONDON, March 28 (Reuters Breakingviews) – European
officials are hurriedly denying that the Cypriot bail-in is a
“template”. Markets know otherwise. The good bank/bad bank model
adopted in Cyprus shows how banks can be recapitalised without
government funds whilst protecting insured depositors – thanks
to senior bondholders and uninsured depositors taking losses.
It’s the right model for the future. For now, it worsens life
for Europe’s weak banks.

Credit spreads jumped on Cyprus’ first bailout proposal even
though it spared senior bondholders. They rose further after
senior debt was bailed in as part of the revised bailout
proposal, which the head of the Eurogroup of finance ministers
commended as the way to tackle bank failures. Investors cannot
afford to believe the swift retraction of that comment. Indeed,
the back-peddling has not brought spreads down.

Hopes for direct recapitalisation of banks by the European
Stability Mechanism bailout fund are history. Investors
naturally worry that senior debt could end up recovering very
little after default, possibly nothing, particularly if banks
now fund themselves more heavily through non-bail-inable debt,
such as insured deposits and central-bank funds.

Bank credit spreads may not have much further to go. Fitch
Ratings reckons the historic five-year average bank-failure rate
is just over 7 percent. A credit default swap spread of just
over 140 basis points should therefore compensate for the credit
risk, assuming zero recovery. The Markit iTraxx index puts the
cost of insuring senor-ranking financial debt at about 200 basis
points over five years – comfortably pricing in the risks for
the providers of credit protection, at least for the strongest
banks.

Bail-in was always a question of when, not if. The end
result should be safer, smaller banks, stronger governments and
fewer taxpayer-funded bailouts. But in the short term, it will
exacerbate euro zone tensions. Weaker banks, particularly those
in southern Europe, face higher funding costs and greater
pressure to shrink, hurting the economy. A new sovereign-bank
doom loop could emerge. Corporate depositors in peripheral
economies know they risk bail-in if their government seeks a
bailout and is forced, like Cyprus, to haircut them. They may
panic when sovereign yields rise, causing runs – and bailouts.

For the euro zone to hang together, extra support – be it
cheap liquidity, or bond buying or bailouts – is inevitable. The
European Central Bank is going to have to work harder.

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CONTEXT NEWS

– The Markit iTraxx index of credit default swaps tied to
senior financial institutions’ debt reached 200 basis points on
March 27, up from 143 basis points on March 15, before the
Cypriot bailout and the highest level since October last year.
The index largely comprises swaps ties to bank debt. A rise in
credit-default swaps signals an increase in perceived riskiness.

– Jeroen Dijsselbloem, head of the Eurogroup of finance
ministers, said in a March 25 interview with Reuters that the
resolution of Cypriot banks would be a template for
restructuring euro zone banks. The terms of the bailout require
uninsured depositors and unsecured bondholders of Laiki
CPBC.CY to take a haircut, or so-called bail-in. He later
rowed back from the comment.

– “If there is a risk in a bank, our first question should
be ‘Okay, what are you in the bank going to do about that? What
can you do to recapitalise yourself?” Dijsselbloem said in an
interview with Reuters. “If the bank can’t do it, then we’ll
talk to the shareholders and the bondholders, we’ll ask them to
contribute in recapitalising the bank, and if necessary the
uninsured deposit holders”, he said.

– Reuters: Cyprus reopens banks under tight restrictions
[ID:nL5N0CK115]

– For previous columns by the author, Reuters customers can
click on [UNMACK/]

(Editing by Chris Hughes and Sarah Bailey)

((neil.unmack@thomsonreuters.com))

((Reuters messaging:
neil.unmack.thomsonreuters.com@reuters.net))
Keywords: BREAKINGVIEWS CYPRUS/BAIL INS

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Reuters content, including by caching, framing, or similar means, is
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and the Reuters sphere logo are registered trademarks and trademarks of
the Reuters group of companies around the world.

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Is the European Central Bank ready to start a Cyp-riot? It has threatened to cut off Cyprus’ banks if Nicosia doesn’t take a bailout, potentially triggering the country’s exit from the euro. The ECB has threatened to cut off banks and countries before but backed off. This time it may be serious.

The ECB has not explicitly threatened to throw Cyprus out of the euro zone. Rather, it has said it will only lend to solvent institutions and that a bailout would ensure the solvency of Cyprus’ banking system. Cutting off the banks could be the first step to an exit. Without an extension of the ECB’s 9 billion euros of so-called emergency liquidity assistance (ELA), the banks would collapse, forcing the government to impose capital controls or print money.

The Cypriot parliament’s rejection of the euro zone’s bailout proposal agreed last Friday night has put the ECB on the spot. And it is easy to see Nicosia being tempted to call the central bank’s bluff. The reality is that pulling ELA isn’t easy. The ECB governing council needs a two-thirds majority to stop the operation, so just eight out of 23 members could keep liquidity flowing.

And some members may have doubts. The argument that the ECB can’t lend to insolvent banks looks lame. The ELA given to now insolvent Anglo Irish Bank was three times that provided in Cyprus. If the ECB had to fund all the country’s deposits, its total exposure would be less than its Italian government bond holdings. Balance that with the unpredictable fallout from a Cypriot exit. Depositors might flee banks across the periphery. The ECB would have to pump liquidity into the banking system and buy government bonds. That’s tricky while there is no government in Italy.

Still, providing liquidity to a government that refused to cooperate would be a dangerous precedent. An exit from the single currency is probably manageable given Cyprus’ small size – gross domestic product is less than 0.2 percent of the euro zone total. Moreover, it is not necessarily the case that an exit would increase the chances of Italy or Portugal leaving – Nicosia’s economic and political situation is unique. The sight of a painful departure may even quell euro scepticism in the periphery.

The ECB doesn’t need to decide until Cyprus’ banks are close to re-opening. Even then, there may be a way of buying time, such as short-term capital controls. Still, the threat is real even if an exit is undesirable. And its credibility makes Cyprus more likely to step back from the brink.

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Italian bond spreads have risen nearly one percentage point since Italy’s election. It could have been worse – and considering the risks, it should.

Political reform is a prerequisite if the country is to come out of its economic predicament: only a strong government can implement the fundamental changes that are still needed to boost growth in the long term. There is no doubt that Italy is headed for new elections this year. The question is whether the next parliament will be elected under the current bankrupt system, or under one that could help build a stable majority.

The best chance for reform would be a scenario involving comedian Beppe Grillo’s 5-Star Movement whereby a centre-left government he openly or tacitly supports implements part of his platform: it includes electoral reform, cutting down the number of deputies, and serious measures against corruption and conflicts of interest. Pier Luigi Bersani, head of the centre-left party, hinted at an alliance with the 5-Star Movement last week. Grillo, so far, has turned him down.

A second scenario could see the centre-left and centre-right parties form a temporary government to pass some kind of reform before the new election. This interim period might give the parties time to reshape, and maybe come up with more credible leaders. But it would be a difficult arrangement. Silvio Berlusconi’s party and the centre-left don’t see eye to eye on corruption and conflicts of interest, among other issues.

Any deal not endorsed by Grillo would strengthen him, and it may be in his interest to go back to the polls as soon as possible, because the political gridlock is in his favour. That means that the worst possible outcome – new elections without any changes to electoral laws – remains plausible.

After the initial turmoil, Italian 10-year bond spreads stabilised at about 3.4 percentage points over German Bunds. There is obviously room for them to shoot higher.

By Neil Unmack

LONDON (Reuters Breakingviews) – Political vacuums can embolden the Italian government’s criminal investigators. Last week public prosecutors raided the premises of oil company Eni’s (ENI.MI: Quote, Profile, Research) Chief Executive Paolo Scaroni over alleged bribes. They went one step further on Tuesday by arresting Giuseppe Orsi, the chief executive and chairman of Finmeccanica (SIFI.MI: Quote, Profile, Research), another state-controlled company. The move has already started a political storm, but that shouldn’t distract the next government from selling down its stake in the defence contractor, which is Italy’s second-biggest employer.

The move is laden with political significance, coming a few weeks before parliamentary elections. A scandal at Banca Monte dei Paschi di Siena (BMPS.MI: Quote, Profile, Research) has cast a bad light on the leading centre-left Democratic Party. The Orsi arrest, which relates to payments allegedly made in 2010 when he ran the helicopter division AgustaWestland, throws the spotlight back on the opposing centre-right coalition, and in particular the Northern League party that supported his candidacy for chief executive in 2011.

For Finmeccanica, the timing is particularly bad. Orsi spearheaded an aggressive restructuring plan to cut debt and streamline the company. Plans to sell down 1 billion euros of assets last year foundered as the sale of power engineering group Ansaldo Energia stalled. The stock price suffered recently as hopes for a sale disappointed yet again, despite interest from Korea and from German engineering group Siemens (SIEGn.DE: Quote, Profile, Research).

The delay prompted Standard & Poor’s to cut the firm’s rating to below investment-grade in January. The risk is that Moody’s follows, pushing up Finmeccanica’s funding costs. Even before today’s news, the stock traded at a lowly 6.2 times estimated earnings in the next 12 months, Starmine data shows, a 45 percent discount to the average forward PE of European rivals. On Tuesday, it fell a further 6 percent.

The share-price drop reflects the risk that the political brouhaha causes further delays, or uncertainty over Finmeccanica’s strategy and direction. Although there has been little debate over the future of Finmeccanica in the electoral campaign, the transport commissioner from the centre-left party has backed calls from the CGIL union for the company to stop all asset sales.

Such a freeze would be a mistake. The state should not entrench its control over the company. It should sell it down.

CONTEXT NEWS

- Italian police arrested the chairman and chief executive of state-controlled defence group Finmeccanica on February 12 over bribes allegedly paid to Indian officials over a contract to sell 12 helicopters.

- An Indian defence ministry source said kickbacks worth 40 million euros were being investigated, Reuters reported on February 12.

- Bruno Spagnolini, head of Finmeccanica’s helicopter arm AgustaWestland, was placed under house arrest.

- Orsi’s lawyer, Ennio Amodio, said the two-year-long probe had produced no evidence of illicit payments by Orsi or ways he had profited from any payments.

- Finmeccanica expressed support for Orsi, and said that its activities and projects would continue as usual.

(Editing by Edward Hadas and Sarah Bailey)

(The author is a Reuters Breakingviews columnist. The opinions
expressed are his own)

By Neil Unmack

LONDON, Feb 12 (Reuters Breakingviews) – SNS Reaal’s (SR.AS: Quote, Profile, Research)
bondholders lost everything after the Dutch lender’s
nationalisation, and the holders of credit default swaps may not
get compensated. It’s not the first time that CDS language has
been found wanting.

SNS Reaal doesn’t have many credit default swaps on its
debt, but the Dutch government’s decision to expropriate
bondholders could be a big issue for derivatives markets.

First, the expropriation may not trigger CDS, meaning
investors wouldn’t get paid for the credit protection they
bought. Credit default swaps are triggered by specific credit
events; bankruptcy, failure to pay, or debt restructuring. Here,
the bonds were simply confiscated. This problem could be
circumvented. The committee at the International Swaps and
Derivatives Association, which rules on credit events, may take
a pragmatic rather than literal approach. Furthermore, an event
may be declared later, when the government cancels the bonds.

There is a second issue. After a CDS event is triggered, the
payout is determined through an auction of defaulted bonds, or
when the buyer of protection hands the bond to the seller in
exchange for the nominal amount of the contract. But in the SNS
case, there are no bonds left in circulation. The payout could
use SNS’s senior bonds – but these haven’t been touched by the
Dutch government and are trading above par, so it would not make
sense for protection buyers to deliver them.

This looks bad for the CDS market, particularly the $3
trillion of swaps tied to bank debt. Paying for insurance you
can’t use is not a great marketing ploy. The Dutch fiasco may
not set much of a precedent; expropriation is rare, and a future
pan-European resolution regime should clarify what happens when
banks fail. Contracts could eventually be tailored to the new
rules, although holders of old-style CDS will resist.

The SNS event highlights the balance that needs to be struck
between determining the terms of CDS contracts as precisely as
possible, and keeping them loose enough to cover unforeseen
eventualities. That can be hard in sectors, like banks, where
governments are prone to make up the rules as they go.

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CONTEXT NEWS

– The Dutch government on Feb. 1 nationalised banking group
SNS Reaal, and expropriated the shareholders and subordinated
bondholders of the group and its subsidiary, SNS Bank. The move
will result in losses on 100 percent for subordinated creditors.

– A committee of the International Swaps and Derivatives
Association has deferred a decision on whether the expropriation
will trigger SNS credit default swaps, contracts used to hedge
or speculate on corporate creditworthiness.

– Reuters: Dutch nationalise SNS Reaal bank group in $14 bln
rescue [ID:nL5N0B11LP]
- For previous columns by the author, Reuters customers can
click on [UNMACK/]

(Editing by Pierre Briançon and David Evans)

((neil.unmack@thomsonreuters.com))

((Reuters messaging:
neil.unmack.thomsonreuters.com@reuters.net))
Keywords: BREAKINGVIEWS SNS/

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 The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Buoyant markets are allowing the European Central Bank to play tough. The ECB’s governing council has rejected a plan by Dublin to restructure its 2010 bank bailout, on the grounds that it would breach its rules against funding governments. And with markets still docile from the ECB’s own bond-buying promise, the pressure to cut a special deal for Ireland is receding.

The Ireland/ECB spat hinges on the 31 billion euros of promissory notes, or IOUs, used to recapitalise Anglo Irish Bank and Irish Nationwide three years ago. Anglo, now called the Irish Bank Resolution Corporation, is currently funding itself by pledging the promissory notes for emergency liquidity assistance (ELA) through the Irish central bank, a form of lending that doesn’t directly affect the ECB’s balance sheet.

The situation is bad for everyone; the ECB doesn’t like ELA in principle. Furthermore, funding a nationalised bad bank in wind-down mode already smacks of monetary financing. The Irish government would happily hold on to the cheap funding provided by its central bank, but wants the promissory notes restructured in a friendlier way. They need to be paid down each year, hanging over its bond market, and carry an interest rate of about 8 percent. This interest rate is academic – it is paid by one branch of the government to another – but it still pushes up the government deficit, which translates into extra austerity for the Irish. Dublin’s initial proposal was to replace the IOUs with a long-term, lower-interest rate bond, which would have been cheaply funded through the ECB.

Ireland has been trying to rejig the IOUs for over a year. Its negotiating position has weakened as bond markets have become more comfortable with Irish risk. Its 10-year bonds now yield a percentage point less than Spain’s, and investors rushed to buy a five-year bond earlier this month.

Still, there are reasons to hope for a deal, the absence of which would damage the credibility of the Irish government, and weaken domestic support for the bailout. If Ireland’s current good market standing were to be eroded, the ECB might have to buy a lot more debt through its bond-buying programme, which remains controversial. That suggests there is room for a compromise, although maybe not one quite as good as Ireland would like