* Weaker credits to struggle to get market access

* Novo Banco senior bail-in rattles investors

* Uncertainty around how write-downs will be applied in future

LONDON, Jan 8 (IFR) - Europe’s small peripheral lenders’ already strained access to senior funding was dealt a severe blow by Portugal’s decision to bail in five senior bonds at the end of 2015, with many market participants now convinced that such issuers will face a buyers’ strike.

The Bank of Portugal shocked the market in late December when it transferred almost 2bn of Novo Banco senior debt to bad bank Banco Espirito Santo, thereby imposing huge losses on investors.

“What happened in Portugal will make it tricky for second-tier banks to access the market,” said a fund manager.

“As an investor, you have a choice between senior exposure in a weaker name or going down the capital structure in a name like HSBC or Citigroup. Do I think HSBC is going to be a bail-in story next year? No. But a second-tier Italian bank?”

Lower-rated peripheral credits had some market access in 2015 but, even before the Novo Banco event, getting deals away was difficult.

Spain’s Banco Sabadell, rated Ba1/BB+/A, pulled a 500m four-year senior bond last summer after failing to get enough demand, while Italy’s Veneto Banca, rated B+/BB could not print a senior it had mandated banks to arrange.

Market participants say that financial institutions facing any questions around solvency or liquidity will either struggle to close deals or have to pay up hugely, potentially making funding simply too expensive.

“What happened with Novo Banco puts a question mark around weaker credits and it will be very difficult for these sub-investment-grade banks to access the market,” said a senior syndicate banker.

“I think it’s different this time and these banks will have to pay a huge premium to get deals done.”

LOSSES

The prices of some of Europe’s weaker-rated banks’ bonds collapsed in secondary market trading following the Novo Banco news and, while they have regained some ground, investors are still nursing severe losses.

A 750m senior for Italy’s Banco Popolare di Vicenza priced in March 2015 has lost almost 14 price points in secondary and was quoted at 85.4 on Friday morning, giving a 6.878% yield. Another Vicenza trade was quoted at an 8.38% yield, up from the 3.693% where it priced a year ago.

This is perhaps no surprise given how challenged the bank’s capital position is. It had a Common Equity Tier 1 ratio of 6.81% at the end of June 2015.

DUMBFOUNDED

The main worry now for investors, after what happened at Novo Banco, is the complete lack of certainty around how they will be treated when banks fail.

While the Novo Banco’s 1.4bn capital shortfall had been well-flagged and investors thought there could be some losses imposed on senior, it was the apparent randomness around how bonds were chosen to recapitalise the bank that left many dumbfounded.

“This is just another event that makes you feel bad about being an institutional creditor of a bank,” said Robert Kendrick, a credit analyst at Schroders.

“You can spend all the time you want analysing the various bail-in frameworks across Europe but if a bank gets into trouble, you’re simply a voiceless investor and it can get awkward very quickly.”

The European Union resolution directive - the rules that govern EU bank work-outs - is very clear in its wording and states that no creditor should incur greater losses than it would have incurred if the institution had been wound up under normal insolvency proceedings.

According to Novo Banco’s financial statements, it had 7.35bn of bonds outstanding at the end of June, yet only the 6.875% July 2016s, 6.9% June 2024s, 4.75% January 2018s, 4% January 2019s and 2.625% May 2017s were chosen to help the recapitalisation.

Market participants have speculated that the bonds were chosen because they were done under domestic law - and were therefore less at risk of legal challenges - and had high denominations, making it unlikely that they were held by retail investors.

Because just a few bonds were chosen, the pain for investors is more concentrated than if the losses had been spread evenly across all of Novo Banco’s senior debt.

“It creates uncertainty on how bail-in will work in practice. It is still a brand new power and investors are still trying to get their head around that,” said Nicolas Trindade, senior credit portfolio manager at AXA Investment Managers.

While market participants agree that the impact of the Novo Banco controversy will be felt most strongly by Europe’s most challenged financial institutions, they also argue that it will have broader repercussions.

“It sets a bad precedent for regulatory behaviour and a violation of the pari passu principle,” said the syndicate banker. “Bottom line is, it doesn’t matter what label a bond has - TLAC, MREL, subordinated, senior - if the regulators want to go after you, they will.” (Reporting by Helene Durand, Additional reporting by Alice Gledhill, Editing by Matthew Davies)