Bank bond investors should fear fast-tracked EU bail-in
* Market pricing in less than 15 pct risk of senior bail-in
* Contagion effects hugely underestimated -analysts
* Third tier banks expected to be most impacted
LONDON, Dec 12 (IFR) - European Union plans to force bond investors take their share of losses in failing banks by 2016 could risk undermining appetite for bank debt and make it more difficult for weaker lenders to fund themselves, credit market experts said.
EU plans agreed late on Wednesday mean bondholders will be on the hook two years earlier than expected for any bank that hits trouble. The so-called "bail-in" of bondholders is aimed at ensuring all investors not just shareholders bear the brunt of saving a bank, sparing taxpayers.
The credit market has not yet come to terms with the full implications of the EU bail-in plan.
Bank credit indices weakened on Thursday, with the iTraxx Senior Financial credit index 4.5bp wider at 99.5bp, compared to the main index of 125 investment grade companies widening by 1.75bp to 79.5bp.
"The first time it happens, it will be a shock. Bail-in is not priced in right now. The market is pricing less than 15 percent probability of this happening," Aaron Elliott, head of European financials credit analysis at Citigroup, said at a credit conference.
The rules aim to save money for taxpayers, but bail-in will impose higher costs on the banks. Resolution funds financed by the banks themselves will have to be established, and funded up to a level of 1 percent of covered deposits within 10 years.
The broader implications have also not been tested and there is a risk that a bail-in of bondholders in one bank will have a knock-on effect on rivals.
"If a bank failed, it could create unexpected consequences," said Andre Spicer, a professor at Cass Business School. "If one bank is bailed out, it is likely to have a contagious effect on other banks with bail-ins spreading between banks."
Senior bonds in Austria's state-owned bank Hypo Alpe Adria, for instance, have come under pressure from expectations that investors might have to take a haircut after the bank said it needed more state aid to meet minimum capital requirements.
"You've seen a ripple effect on other Austrian banks," said Robert Montague, a senior investment analyst at ECM, an asset-manager that oversees around $8.6 billion of assets.
Citi's Elliott warned that once a precedent was set, multiple bail-ins could become a reality, because banks are big holders of other banks' bonds. Such contagion could further undermine investor trust in banks.
The EU's plan applies throughout the European Union, and is expected to be passed by the EU Parliament in February.
Some analysts said the acceleration was no surprise after big depositors in banks in Cyprus had to take losses.
"The Cyprus case shows that there is political will to ensure bank creditors contribute to a bank bail-in," said Gerald Podobnik, head of capital solutions at Deutsche Bank.
"The regime is operational in 2015 and there is senior bail-in from 2016. That is quicker than expected but it is catching up with the reality on the ground."
STRONG MARKETS MASK RISKS
The accelerated timetable for implementing the bail-in plans follows a surge in demand for bank senior debt. Since September, bonds sold from BB-rated Italian and Spanish banks including Veneto Banca, Banca Popolare di Vicenza and Banca Popolare di Milano and Banco Popular Espanol have all attracted healthy demand, and not just from domestic investors.
Bankers said this positive backdrop was one reason for a relatively modest market reaction to the bail-in announcement.
"Markets are fundamentally very strong. Are investors buying senior unsecured bonds from banks expecting them to be bailed in? No," said Edward Stevenson, head of debt capital markets, financial institutions group at BNP Paribas.
And while there are worries about a snowball effect once the first bail-in occurs, no country will want to set the precedent.
"When it comes to bailing in senior debt I don't think any regulator will want to be the first to write-off bondholders," Elliott said.
Third-tier banks in weaker EU economies are likely to feel the most pressure from the bail-in rules, especially if they are forced to use asset-backed securities (ABS) and covered bonds for their senior debt funding.
They have pledged billions of collateral to get long-term funding from the European Central Bank and might find it tough to find assets to back ABS and covered bonds in the future.
"Marginal banks will find it more difficult to raise money, making their failure more likely," Spicer said.