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 3
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!). • Eurosystem Net Lending / Borrowing of Selected Countries, 2007 -2009 ECB has been slow on bank capital o It took ECB until 2013 to call for comprehensive recapitalizations ( ‘Asset Quality Review’), o Resistance against bail-in Draghi letter of July 2013, o Lots of unintended consequences. . . Source: Osnabrück University. 4
Bank Liquidity Policies Your Central Bank as an ATM Machine. . 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 !! 5
Bank Liquidity Policies Temporary Fix for Low Bank Capital NY Fed Term Auction Facility Lending to German Banks, 2007 -2010 USD crisis (of European banks. . ) • 2008 SIV/ABCP after pullout of US MMFs, • Ongoing: European banks’ role in the global China/Petrodollar recycling, • The Fed shoots fast !! o After 2008 Steinbrueck interview closed window for HRE/Depfa, Source: Federal Reserve Bank of New York, Finpolconsult computations. Cumulative lending. SIV – Structured Investment Vehicles, ABCP – Asset-backed Commercial Paper, MMF – Money Market Funds. o After the 2011 US MMF run on French banks, the Fed passed on credit risk to the ECB (EUR-USD swap agreement). 6
USD Target Debate 7
Bank Capital Policies Early Bailout Cases: Hypo Real Estate/Germany HRE Total Liability Structure • Public recapitalization 2009 o Private deposit insurance fund defacto insolvency by late 2008 (“ 17 billion in potential losses”), o Early public capital injection and squeeze-out of shareholders by June 2009, o Followed by second recap in same year, o And creation of ‘Bad Bank’ in 2010. Source: Bank reporting, Finpolconsult. 8
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? 9
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. 10
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’ 11
Bank Capital Policies Classic Bailout: Hypo Real Estate/Germany • Financial result o Shareholders received cash, o Junior creditors were almost entirely protected, except hybrid coupons (EU rules) and UT 2 haircuts (held by retail), o Ca 18 billion in public capital investment with perhaps 10% recovery expectation, reduced by almost EUR 4 billion outstanding junior debt. • HRE Junior Debt Structure Landesbanken o West. LB 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. 12 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. The PROBLEM: o This is all fine for going concern banks. . o. . while it somehow ignores progress in bank Source: Fitch. Ratings (2010) 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 capital? 13
Discussion Topics • Bank capital and liquidity policies during crisis • Creditor participation before and during restructuring/resolution • Lessons: policies and institutions for Europe 14
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 payment. 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 shares). 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. 18
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 Bankia • • 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 Bankia • • 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 Bankia • • • 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. 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.
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. Alternatives? • CDS written by bond investors on initial bank portfolio, • Example: Kf. W credit-linked notes program.
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. 26 Source: Finpolconsult.
Restructuring – Good Bank Model (FDIC Standard) Laiki - Good Bank, Purchase and Assumption (P&A) Cases • • • 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. * 27
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 Mo. U 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 CT 1, ‘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. 28
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. 29 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 Italy), • Restructuring delay, may hit the wrong creditors Bankia, but did not deter SNS Reaal. 30 Source: Finpolconsult.
Fiscal Expenditure vs. Cost Loss Expectation of Recaps Fiscal Loss Based on 2012 Book Value Question: - 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. Result: • 7 sample bank aggregate fiscal loss would have eaten up 30%-35% of ESM capital. 31 Source: Bank reporting, national central banks, Finpolconsult.
Fiscal Expenditure vs. Cost Loss Expectation, Extended Country Sample Fiscal Loss Based on 2012 CT 1 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%. 32 Source: Bank reporting, national central banks, Finpolconsult.
Fiscal Cost of Bank Resolution Methodology Example, 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 collateralized, • ECB ELA at least super-senior (Cyprus), • Hybrid capital safer than shares, • Share injection after bail-in safer than before bail-in, • DESs share economic value with investors, haircuts don’t. Spain - 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). 33
Discussion Topics • Bank capital and liquidity policies during crisis • Creditor participation before and during restructuring/resolution • Lessons: policies and institutions for Europe 34
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 recapitalization’), • 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!) 35
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 collapse, 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 supervision. 36
EU ‘FDIC’ Concept (Source DG Markt) Single Resolution Fund manages ECB COM notify National Supervisors Single Resolution Board supervise instructs puts under resolution / sets resolution framework contribute provid National Resolution Authorities es fun ding resolve Failed bank All banks Internal Market 37 16/03/2018
Lessons Learned Junior Bond Capital Availability Reconcile Basel and fiscal definitions of bank capital !! 38
Challenges Ahead • Securities portfolios o Self-inflicted ‘sovereign-bank’ doom-loop by banks rejecting diversification, o ECB has not enforced diversification, LTRO without conditionality, o Whichever-is-lower ratings are accepted usually Canadian DBRS, o Arbitrary repo policies (e. g. Cyprus sov). Irish Mortgage Portfolio Funding, Stylized • Loan portfolios o ‘Kick-the-can’ corporate loans (EBIT<interest; 40 -50% in ES, IT, PT), o Insufficient mortgage profitability related to indexed loans (Euribor, ECB refi), o 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. 39
USD Target Debate 40
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