Tide running out on protecting bank bondholders: first sub debt and then senior

Five years after the beginning of the financial crisis, it appears that a major change is occurring as financial regulators are no longer protecting troubled Eurozone bank bondholders.

Please recall that at the start of the financial crisis, as a part of the policy of financial failure containment, deposit insurance was effectively extended all the way down the bank capital structured to the unsecured debt holders.

According to a Reuters article, this protection of the bank bondholders is disappearing.

Junior bondholders have been dealt yet another blow this week as Spain's Banco de Valencia is poised to write off as much as 90% of the value of its subordinated debt in a bid to restructure without having to rely on public aid. 

The near wipeout in the instruments follows hot on the heels of the nationalisation of Dutch Bank SNS Reaal late last month and a shock decision to leave junior bondholders with nothing at all.... 

Compatriot Bankia, meanwhile, is in the process of thrashing out a similarly aggressive restructuring that could leave investors, including retail accounts, with equity rather than cash in the failed bank. 

Bankers say the bold move by regulators could now extend to senior bondholders, who so far - except for those in Denmark - have been left untouched in European bank restructurings... 

If bank debt holders are no longer going to be protected from losses by the regulators, why would anyone want to be a bank debt holder?

As the Bank of England's Andrew Haldane observed, banks are 'black boxes'.  Why would anyone want to gamble on the contents of a black box bank?

The Dutch Finance Minister, Jeroen Dijsselbloem, considered including senior bondholders in the SNS expropriation, but backed off, fearing an unfavourable market reaction. 

"Theoretically, even more creditors of SNS Reaal and SNS Bank might have been expropriated, that is, creditors on an equal footing with depositors: the ordinary creditors," he said in a letter to parliament explaining the move. 

"This includes uncovered bank bonds, also known as 'senior bonds'. This option was dropped, however, because of expected adverse effects on financial stability."

The answer to who would gamble on the contents of a black box bank is no-one.

Up until recently, investors would have been forgiven for thinking their money was safer in the hands of a peripheral bank like Valencia with a wary regulator that is more likely to leave investors with something rather than nothing. 

Peripheral countries had shown themselves to be terrified of contagion.... 

But the tide seems to be changing for peripheral banks that are taking aggressive action to avoid going cap in hand to their taxpayers.