In Europe, It’s All About The Bank (Run)
by Tyler Durden
The word ‘encumbrance’ has received a lot of headlines in the last few months – and rightfully so – after we pointed out the impact that LTROs had in subordinating senior creditors of European banks. As Morgan Stanley points out, this is a considerable problem for bondholders as ‘in a wind-down scenario, senior unsecured holders have recourse to fewer assets and hence face a higher loss given default (LGD)’. In understanding just how bad things are for European banks, it is important to focus on ‘how much loss-absorbing capital there is beneath you in the bank’s liability stack, as this is the capital that will take losses before senior creditors in the event of a bail-in’ which means looking at Deposits as well as encumbrance.
Last night we showed the Loan-to-Deposit ratios for various banks across Europe and Morgan Stanley takes up the offensive noting that the encumbrance effect from depositor preference changes (i.e. withdrawal) is the real threat. While the relative size of the deposit bases of the dozen or so banks that are analyzed below is stunning (with MS estimating best-case recovery in a bank default at around 80% and worst-case a total loss – implying of course that equity is entirely worthless – which we largely knew) and what is very apparent from the pictorial representations of banks’ liability structures is that rather than encumbrance from covered bonds/LTRO etc. the bigger issue for encumbrance of senior unsecured investors is the potential threat from depositor ‘runs’.