Too big to fail returns

The maxim "too big to fail" - made famous by the financial crisis and the litany of banks requiring government assistance to survive - was echoing around Europe again this week.

This time it was Dutch bank SNS which was nationalised after being classified as "systemically important" by the national government on Friday. The bank's large exposure to real estate had damaged its capital position and shut it out of the wholesale funding market. Private sources of capital couldn't be found, leaving the bank in a precarious position.

The government clearly felt that a bankruptcy would be disastrous to the Dutch banking system, so nationalisation was the next logical step.

SNS had acute problems that were specific and not necessarily shared by other banks. However, the announcement by the Dutch Ministry of Finance could have implications for banks across the whole of Europe.

Alongside the nationalisation, the government has expropriated all of SNS's equity and subordinated debt, including lower tier 2 securities. There will be "nil recovery" - effectively, the bondholder no longer owns the debt. This is known as "bailing-in" - subordinated bondholders sharing the burden of the rescue.

The SNS resolution is probably the harshest treatment to bondholders of any bank rescue since the financial crisis began. Denmark has enforced bailing-in on several occasions, but only for institutions that were relatively small and posed little or no systemic risk.

SNS is rarely traded in the CDS market, but if it is determined a credit event, it could cause issues, given that all of the subordinated securities have been expropriated (deliverables, anyone?).

Moreover, the reaction in the liquid European bank CDS market suggested that investors are concerned by the news from the Netherlands. The Markit iTraxx Subordinated Financials index widened 6bps to 253.5bps, and the differential between the index and its senior sibling is at its highest for more than six weeks.

The Dutch government appears to have ruled out the baliing-in of senior bondholders, and this helped the basis to widen even more. If a core eurozone government had gone down that route, it could have had seismic effects across the banking sector.

Cyprus, a country with an even more damaged banking system, also ruled out senior bondholders sharing the burden. This is welcome news for risk assets, though the taxpayers in the countries in question may fell less happy.

Banks, particularly in the periphery, may find it more difficult to sell subordinated debt in the coming months after the SNS resolution. This will be one of the key factors to watch next week, and it will be interesting to see if credit continues to underperform equity.

Elsewhere, Dell's LBO may happen next week, if reports are to be believed, and this could be another key driver of spread direction.

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