Spanish investors won’t be the last to suffer losses on bank debt as measures of sovereign and financial bond risk signal governments will shift the burden of rescuing failing lenders.
The CHART OF THE DAY shows that the Markit iTraxx Subordinated Financial Index is underperforming the Markit iTraxx SovX Western Europe Index by the most since 2010, when Ireland forced lower-ranking bondholders to share the cost of saving its banking system. The gauge of credit-default swaps on 25 banks and insurers now exceeds the sovereign benchmark by 1.67 times, up from a ratio of one to one in March.
Bank debt risk is rising at a faster pace than that for governments after Spain said it will require burden sharing measures from holders of junior debt in lenders receiving public funds. The move minimizes the cost to taxpayers and was required as a condition for international aid.
“There is a growing risk of more subordinated bail-ins elsewhere in peripheral countries,” said Georg Grodzki, the London-based head of research at Legal & General Investment Management Ltd., which manages $515 billion. The “roadmap” is “burden sharing for subordinated debt holders,” he said.
Investors are speculating contracts linked to subordinated bank debt will pay out should losses be imposed, as they did when Ireland almost wiped out junior bondholders in exchange for aid. Greece, Portugal and Cyprus also asked for support from the European Union, and Italy is struggling to avoid a bailout as the region’s crisis spreads.
Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.