11 February 2014

Fitch: Investors don't expect senior bail-in from ECB bank tests

European investors believe senior bank debt is unlikely to suffer default as a result of a eurozone bank failing the ECB's comprehensive assessment, according to a Fitch Ratings quarterly investor survey conducted in January.

For senior debt to be at risk the ECB's assessment would have to reveal that a bank not only "fails" the exercise, but also meets a country's conditions for resolution and there is insufficient junior debt to bail-in. Overall 69% of survey respondents do not expect senior bank debt to be likely to suffer default in this scenario, but their reasons differed. 39% do not expect senior debt to suffer default because the senior bail-in tool won't have to be in place until 2016 and there will be national or European backstops to plug the capital hole. 30% believe senior debt won't suffer unless EU backstop funds are tapped.

This leaves 31% of those polled who believe senior debt is likely to suffer losses because there will be greater urgency to implement resolution tools and avoid using national funds. 22% believe that countries are likely to accelerate senior debt bail-in, while a small number (9%) believe other resolution tools that can force losses on senior debt, such as a bridge bank, would be used instead.

The survey responses highlight uncertainty from changing legal, regulatory, political and economic dynamics with respect to potential future sovereign support for senior bank creditors. The EU has been in the forefront of the bank resolution agenda, with the final Bank Recovery and Resolution Directive due to be passed by Parliament in April. But use of resolution tools in the EU will always include an element of flexibility because one of the conditions for resolution must be that it is "in the public interest".

Fitch believes capital shortfalls identified under the ECB exercise will mostly be covered by private means. Banks unable to do this will need to turn to national backstops, which could trigger losses for junior bondholders under new EU state aid rules. For senior debt to be at risk, the assessment would have to reveal that a bank not only fails the exercise, but also has such a deep-rooted solvency problem that it meets a country's conditions for resolution and should not be licensed. Second, the country would have to be unwilling or unable to plug any shortfall still left after junior debt bail in. Even then, if European Stability Mechanism funds are provided, the potential risk would depend on conditions attached.

The survey also shows the more positive investor sentiment towards banks generally since the October survey has been maintained. The sector stays the second most favoured marginal investment choice (behind high yield). This contrasts sharply with a more cautious stance on the various non-financial corporate segments.

Full press release

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