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.