Wednesday, May 15, 2013

Euro-Style Bail-In Plan Means Bondholder Wipe-Out: Brazil Credit

(Bloomberg) Brazil is drafting rules that would wipe out some creditors of failing banks in an effort to avoid taxpayer rescues, echoing European proposals to make bondholders shoulder more costs after three bailouts in as many years.

The central bank said May 6 it had prepared a draft of a “bail-in” proposal that would impose losses on holders of subordinated and unsecured bonds in case of insolvency and use their investments to revive the lenders. The measure would boost funding costs for the nation’s investment-grade banks, which currently pay a near record-low 3.77 percent on average to borrow dollars in the bond market, according to Carlos Thadeu de Freitas Gomes, a former central bank director.

The proposal, similar to one being considered by European Union lawmakers, comes after seven Brazilian banks became insolvent in the past three years and the deposit insurance fund spent 3.8 billion reais ($1.9 billion) to rescue Banco Panamericano SA. The rules would clarify risks for investors, save taxpayer money, and shield policy makers from political pressure to rescue lenders that took excessive risks, even as it pushes up costs for financial firms, said Freitas, now the chief economist at the National Commerce Confederation.

“It’ll help establish order and more transparency,” Freitas said in a telephone interview from Rio de Janeiro. “Investors know that, if there is a bankruptcy, they will have to cover the costs.”
Guiding Principles

Brazil’s insurance deposit fund, known as FGC, didn’t respond to e-mail and telephone requests for details on money it committed to help rescue financial institutions that became insolvent. The central bank’s press office said it was unable to provide that information.

While yields on bank bonds jumped in the weeks following Banco Panamericano’s bailout, funding costs are now lower than those of investment-grade banks in Mexico, which currently pay about 4 percent on average to borrow dollars in the bond market.

Authorities have dealt with distressed banks on a case-by-case basis in recent years, operating without any public guiding principles on which should be rescued, said Maria Celina Vansetti-Hutchins, a managing director at Moody’s Investors Service in New York City.

The central bank says its proposal is almost ready to be sent to Congress for debate.
Defining Liability

Of the lenders that became insolvent since 2010, three were liquidated, three were rescued and sold, and the fate of another is still to be determined.

Banco Panamericano received cash injections and a line of credit from state-owned minority shareholder Caixa Economica Federal and then was bought in January 2011 by Banco BTG Pactual SA (BPAC3), which took a 1.3 billion real loan from the non-government deposit-insurance fund. Bondholders suffered no losses.

In contrast, Banco Cruzeiro do Sul SA was wound down by the central bank in September 2012 after it failed to find a buyer, sticking investors holding $1.6 billion of bonds with the biggest corporate default in Latin America in a decade.

Regulators found “serious” violations and unfunded liabilities at the Sao Paulo-based lender that made it impossible to resume normal operations, the central bank said in September.

The draft proposal from the central bank would shift the burden of saving troubled banks from regulators to bondholders, said Moody’s Vansetti-Hutchins.

“It defines the liability of the government in regards to the management of the financial system,” Vansetti-Hutchins said in a telephone interview.
Protecting Taxpayers

The FGC now secures deposits up to 70,000 reais, and there is a proposal to increase that amount to 250,000 reais. While deposits of more than 100,000 euros faced losses in Cyprus’ rescue package this year, those FGC-protected funds would not be tapped in the event of a bank insolvency. Forcing depositors in Brazil to take losses would be a last resort, according to the bill.

Authorities are also signaling their intention to protect taxpayers from losses tied to the troubled banks, said Franklin Santarelli, a managing director at Fitch Ratings Ltd.

“The idea that they have to aid any bank is over,” Santarelli said in a telephone interview from New York. “Whether that includes banks of systemic importance is another question.”
‘Bail-In Powers’

European Union lawmakers will begin voting this month on a bill that would grant “bail-in powers” to regulators, after the region’s banking crisis prompted wide-spread criticism against the use of public money to prop up banks.

The Dutch government’s unprecedented expropriation of SNS Reaal NV’s subordinated debt when the bank was nationalized this year wiped out creditors holding about 900 million euros ($1.2 billion) of the Utrecht, Netherlands-based lender’s debt securities. It was the first time European authorities have immediately wiped out holders of dated subordinated bonds of a bailed-out bank, according to data compiled by Bloomberg.

The amount paid by borrowers will continue to be determined in large part by banks’ financial stability, not the bail-in measure, according to Mauricio Costa de Moura, the chief of staff for the Brazilian central bank’s office on financial system organization.

“If you are going to put money in a company that you are not sure about, you are going to ask for a greater premium whether or not the bail-in option exists,” Moura said in an interview in Brasilia on May 7. “If you are going to put your resources in a solid institution, you are not going to pay more because there’s a possibility of a bail-in in the future.”
Yield Spread

The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries widened three basis points, or 0.03 percentage point, to 167 basis points at 3:51 p.m. in New York, according to JPMorgan Chase & Co. indexes.

The cost to protect Brazilian bonds against default for five years rose one basis point to 119 basis points. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if a borrower fails to adhere to its debt agreements.

The real depreciated 0.2 percent to 2.0245 per U.S. dollar Swap rates due in January 2014 increased one basis point to 7.97 percent.

The proposed bankruptcy legislation may prompt bank creditors to demand more compensation when they invest because they could lose their money in a recapitalization, according to Klaus Spielkamp, a fixed-income trader at Bulltick Capital Markets.

“Once the market realizes the lower protection they have on their investments, they will demand higher returns,” Spielkamp said in a telephone interview from Miami. “The creditor will be more restrictive.”

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