Bondholders will suffer from bank bailout rules

EU’s Bank Resolution and Recovery Directive (BRRD), due to be implemented in 2016, will most certainly adversely impact the credit standing of senior, as well as subordinated bondholders.

The treatment of large creditors in the Cypriot banks provided the first glimpse into what can happen to bond holders when a bank gets into difficulty and the government can’t afford to, or chooses not to, support the bank.

Austria’s adoption of the BRRD, a year ahead of schedule, demonstrates how such rules will work in practice.

Bond holders in Heta Asset Resolution, the bad bank formed from the former Hypo Alpe Adria, lost up to 27% of the value of their bonds when the government placed a moratorium on principal and interest on c. Euro 10bn bonds. This was triggered when a capital shortfall of up to Euro 7.6bn was uncovered in the recent stress test. Austrian tax-payers had already supported losses of Euros 5.5 bn on Hypo and the Government was not willing to pay more. Whereas such a “bail-in” of the creditors of a “bad bank” may seem more understandable than most, this situation is particularly unusual as the bonds were guaranteed by the small Austrian region of Carinthia. The largest investors in the Heta bonds are reported to be DWS Investment, Pimco, Kepler-Fonds and BlackRock.

South Africa took a similar strategy in October 2014, when it forced senior creditors (bondholders and large depositors) to take a 10% haircut as part of the rescue of African Bank Investments, a microfinance lender.

What wholesale debt investors – including large depositors – should expect is to be paid a material premium to reflect the degree of their subordinated ranking. With interest rates so low and the hunt for yield so intense –it seems unlikely for the moment.

Read the recent FT article on Austria’s adoption of the BRRD here