Seniority destruction through resolution and covering November 14, 2010 at 6:06 am

The Bond Vigilantes point out that in the new post-Basel III world, bank capital structure may well get a lot simpler:

deposits, covered bonds, senior notes, CoCo’s and equity

The covered bonds will be needed to meet funding requirements, but of course this process removes assets which would otherwise be available to meet senior creditors. As the vigilantes point out, if bank resolution regimes make senior creditors share the pain, then this will have the effect of making bank senior debt a good deal less attractive:

If you imagine a situation (shouldn’t be too hard) where a bank gets into difficulty, its CoCo’s are triggered but still falls into bankruptcy. The equity will be wiped out leaving a senior debt holder not only at the bottom of the pile in a liquidation, but also with a claim over fewer assets than they historically would have had, since most of the mortgages would have been pledged to the covered bond pools.

2 Responses to “Seniority destruction through resolution and covering”

  1. […] Seniority destruction and the capital […]

  2. several issues at stake here, but it does seems that everyone is aiming for a SSR (standard resolution regime?) and that bail-ins is the word of the end of year. Implying senior bonds might pay. all is based on the german restructuring mechanism basically and relates to the “titanic effect” mentioned on the blog elsewhere.
    Reality is , it is all gimmics and time-buying, nothing else. remove the tier 1 and replace it by co-cos…add a different level of seniority and you have the same thing again.

    Markets work well and the capital structure of banks is well designed. Regulators are falling into the trap of trying to establish firm rules that will give leeway to speculation later on (if you impose absolute tresholds/ constraints…funds will easily bet against that)

    reality is …we should let the market act… the market is more reactive and reallocates capital much better than any rule…and senior bondholders should not be taken in hostage…some regulators think that it is a lesser evil to pay, that given the time it will take , especially if not retroactive (only for new debt issued) , it will buy time…again..buy time…
    well..markets don t need this lack of clarity…they need ot be let to work…