this risk to be unlikely for banks that enjoy high systemic support

From Zero Hedge:

"Moody's Says Bank Bondholders Will Not Suffer Haircuts

Posted by Tyler Durden at 6:20 PM

You know the joke about Moody's fooling none of the people none of the time? Well, they are trying to make some bold predictions about financial companies' bondholders. And based on what they are saying senior and subordinated bank creditors should be worried... very worried...

In a piece entitled "Senior Bank Bank Holders - At Risk Or Not" Moody's analyst Sean Jones (not be confused with Egan-Jones' cofounder Bruce Jones) "considers this risk to be unlikely for banks that enjoy high systemic support. Such actions would run counter to the overall policy objectives underlying the provision of support to the banking system."

The problem with Sean's assumption is that for him to be correct, and for the massively upside down banking balance sheet to get fixed as some point, the government would have to fill the insolvency delta in the asset shortfall through either through above-market asset purchases or new cash from equity raises. If Citi's recent bailout is any example, the administration has made it all too clear it will not pursue any of these actions, thus leaving creeping equitization as the only option (of course, absent nationalization), which is why Zero Hedge disagrees with Moody's on this one (and many more), and as I wrote previously, bank sub debt holders also do not share Sean's optimism.

Jones does cover some bases in case unbridled optimism (Moody's trademark) is not the right play anymore: "Even at banks that are very likely to receive support, there remain the risks of coupon suspensions or of distressed exchanges for preferred shares."

Moody's full statement on potential bondholder risks is presented below.

Senior Bank Bond Holders -- at Risk or Not?

Over the past week, a growing number of bondholders have expressed concerns that they risk being forced to incur losses because of government pressure on the banks that receive public assistance. This concern has been fueled both by widespread media attention and by some members of Congress.

Nevertheless, we consider this risk to be unlikely for banks that enjoy high systemic support. Such actions would run counter to the overall policy objectives underlying the provision of support to the banking system. Having said this, risks to bondholders do indeed increase for lower priority capital instruments and for those that hold the debt of weaker banks that are less important to the nation’s financial system.

The US banks that we believe benefit from very high systemic support are the Bank of America, Bank of New York, Citigroup, JPMorgan Chase, and Wells Fargo; for these institutions, we see the likelihood of senior or senior subordinated creditors taking losses as being very modest. If senior or senior subordinated creditors were made to suffer losses, the risk that systemic credit flow would contract increases, thus prompting further market turmoil and economic damage. Such an outcome is directly contrary to the Administration’s policy goals, which are to instill confidence in the financial industry and to restore the flow of credit in the economy.

Of course, we do differentiate, or notch, ratings to reflect the relative positioning of various security classes. This is done based upon their positions in the capital structure or in the legal framework of an entity. Subordinated creditors are clearly in an inferior position to senior debtholders, and those owning holding company obligations are certainly behind bank creditors in priority. In both cases, however, we believe all of these creditors should benefit from some systemic support, albeit to different degrees.

Even at banks that are very likely to receive support, there remain the risks of coupon suspensions or of distressed exchanges for preferred shares. This situation is especially true for those institutions whose noncumulative preferred coupon payments impair their abilities to replenish capital from earnings. Consequently, the notching among these instruments and senior and subordinated debt ratings is likely to widen in cases where a bank’s financial strength rating declines.

Sean Jones
Senior Vice President"

Me:

Don said...

"The US banks that we believe benefit from very high systemic support are the Bank of America, Bank of New York, Citigroup, JPMorgan Chase, and Wells Fargo; for these institutions, we see the likelihood of senior or senior subordinated creditors taking losses as being very modest."

Although I see your point, I'm going to go with Moody's on this as a political prediction.

Don the libertarian Democrat

March 17, 2009 1:17 PM

I still think that senior unsecured debt of most major banks is probably safe

From Felix Salmon:

"Bank Funding Datapoint of the Day

Bloomberg reports:

Contracts on the Markit iTraxx Financial index of credit-default swaps linked to the senior debt of 25 banks and insurers were more expensive today than the Markit iTraxx Europe corporate index. That hasn't happened since Lehman Brothers Holdings Inc. went bankrupt in September and, before that, JPMorgan's takeover of Bear Stearns, according to BNP Paribas. It reflects "systemic stress" in the financial system.

So much for rallying confidence in the banking system. This is senior debt we're talking about here, not subordinated debt (which often doubles as regulatory equity). Another word for senior debt is "wholesale funding": if a bank doesn't have a large deposit base, then it makes its money on the spread between its senior debt and the rate at which companies and other clients borrow from it. If that spread is now negative, then it's hard to see how the banking system as a whole can be nearly as profitable as the likes of John Hempton seem to think. (Yes, I know I'm conflating CDS spreads with actual funding costs. I suspect that the actual funding spreads are if anything wider than the CDS spreads.)

Indeed, far from seeing profits, the markets seem to be forecasting outright defaults, certainly on the subordinated debt, and possibly on the senior unsecured as well:

"The current prices imply that the companies' equity is worthless, the government's investment is worthless and subordinated debt holders will lose some of their investment," said David Darst, an analyst at FTN Equity Capital Markets in Nashville, Tennessee.

What's more, if bank-debt spreads stay at their present level for any length of time, they're likely to become increasingly self-fulfilling. Right now, these prices represent significant unrealized losses for people who bought at par. But increasingly they're going to start representing significant potential gains for people who are buying at today's levels and hoping to be paid off at par -- paid off, that is, essentially by taxpayers. Since those people can be broadly characterized as hedge-fund managers, one can foresee a lot of Congressional pushback if a large number of hedgies start pulling in tens of millions of dollars just by playing the moral hazard trade. Or, to put it another way, it's a lot easier to impose a haircut when a haircut is priced in than when it isn't.

I still think that senior unsecured debt of most major banks is probably safe, although the WaMu precedent does give me pause. But anything which can be considered equity is increasingly looking like fair game."

Me:

"But anything which can be considered equity is increasingly looking like fair game."

Fair game? More like game over. I'm ready to throw in the towel. William Gross has won this round. Some of these bondholders are going down with the system. They're taking us with them if they can. Some of them are countries, after all. Let's just guarantee these bondholders and regroup, if we've got the brass. They were toying with us. They hold all the cards right now anyway. It's time to start humming "Brazil".

By DonthelibertarianDemocrat Posted: Mar 11 2009 6:59pm ET