June 15, 2012 / 10:12 AM / 7 years ago

Hard for Spain to share pain with bank bondholders

MADRID, June 15 (Reuters) - The high level of ordinary Spaniards owning bonds in the country’s banks will make it politically difficult to impose losses on debt-holders after a bailout of the banks, meaning the government and its rescuers could have to foot more of the bill.

Spain struck a deal with the European Union on Saturday to receive a loan of up to 100 billion euros ($126 billion) to prop up banks that can no longer handle losses from a property crash and were unlikely to survive a second recession in three years.

While the details of the rescue package and its impact on bondholders have yet to be worked out, analysts have started to speculate that subordinated debt holders will have to contribute to the recapitalisation effort.

“It would be very surprising if sovereign bond holders in Greece had to lose money, and then Spain gets a bailout and the banks don’t incur losses for their bonds,” said Gary Jenkins, director at Swordfish Research.

But losses are unlikely to be imposed on senior bondholders because of European rules safeguarding these investors.

The European bailout funds will be channeled through the Spanish bank rescue fund, the FROB, which will inject capital into the weakest lenders. The FROB has used equity or convertible bonds to refinance banks up to now.

It is still unclear what conditions will be attached to the loans to cover capital needs which total around 60-70 billion euros, according to a source close to an audit of Spanish banks due to be completed on Monday.

Forcing losses on junior bondholders is currently illegal in Spain, but legislation could be rushed through in an emergency situation, as it was in Ireland, lawyers and economists say.

However unlike Ireland, where junior bondholders suffered losses of up to 90 percent at Allied Irish Banks and Bank of Ireland during state bail-out processes, a large part of Spanish banks’ subordinated debt was sold to bank customers as savings products.

Barclays estimates 62 percent of subordinated bank debt is held by retail investors in Spain, stripping out Santander and BBVA, compared to 34 percent in Ireland.

Santander and BBVA are unlikely to need recapitalising because of healthy revenue streams from their overseas businesses. Credit rating agency Fitch ranks these two banks one notch above the sovereign in credit-worthiness.


“Bondholders are usually other institutions, but in Spanish banks many of the junior bondholders are retail investors,” said Olly Burrows, credit analyst at Rabobank.

“Making ordinary tax payers take losses on their investments may be politically more difficult.”

According to Thomson Reuters data, Spanish banks have $31 billion (25 billion euros) of subordinated debt outstanding, of which around a third has been issued by the two biggest banks, Santander and BBVA. This does not include bonds issued directly through banks’ retail networks.

Any squeezing of retail junior bondholders would come on top of several scandals involving bank clients losing out on products sold through branches in recent years.

Many retail depositors bought preference shares - a type of hybrid debt, half way between debt and equity - as safe, high-yield investments, only to see them turn into risky equity on conversion.

The sale of billions of euros worth of these products in recent years has allowed lenders to boost capital and meet funding needs at a time when money markets are virtually closed to them.

A judge in Galicia is investigating alleged mis-selling of preference shares by savings bank NovaCaixaGalicia.

Banks are even converting preference shares to deposits in a bid to hold on to customers. Caja Espana-Duero has offered to swap preferential shares for five-year deposits. Liberbank and Banco Mare Nostrum have offered similar deals.

Branch managers at nationalised lender Bankia sold bank shares to clients as part of a stock market listing in July, with investors losing more than 70 percent of their money in a matter of days when the state took over the bank.

Shareholders are seeking compensation via the courts.

While Spain could try to change European rules to allow it to impose losses on senior debt-holders, the prospects do not look encouraging.

Ireland lobbied the European Central Bank (ECB) to allow it to hit senior bondholders at failed lender Anglo Irish Bank in 2011, but the ECB refused to give its blessing.

A legislative draft published by the European Commission allows for senior debtholders to take losses. However, that will not be implemented until 2018.

“Nothing has happened in Ireland even though politicians there were itching for bondholders to take a loss so we still think the line would be drawn in the sand when it comes to senior,” said Robert Montague, senior investment management at European Credit Management.

$1 = 0.7953 euros Editing by Mark Potter

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