How many one-offs make a trend?

 EVERYONE agrees that taxpayers should be protected from the cost of bailing out failing banks. But imposing blanket losses on creditors is still taboo. Depositors have escaped the financial crisis largely unscathed for fear of sparking panic, which is why the idea of hitting uninsured depositors in Cypriot banks has caused policymakers angst. Derivatives counterparties have usually been made whole. Senior bondholders have generally been protected, too (although that will change with a new European “bail-in” regime, due by 2018).

There is one easy target, however. Holders of banks’ subordinated debt rank just above shareholders in the capital structure: they cannot easily claim to be shocked if they lose money. Subordinated bondholders have been hit in Ireland; Bankia, a big Spanish lender, is expected shortly to force deep losses on its junior creditors; things are unlikely to turn out well for them in Cyprus.

The most severe treatment of all was meted out to subordinated bondholders in SNS Reaal, a Dutch bank that was nationalised last month. The state expropriated the bonds outright, not only wiping out investors but also making it almost impossible for them to claim protection from credit-default swaps (CDSs), an insurance policy against default, because they no longer have any bonds to deliver.

All this bad news doesn’t seem to have much affected investors’ appetite for junior bank debt, however. CDS spreads on subordinated bank debt do not show much sign of a reaction (see chart). Demand for contingent-capital bonds (CoCos), a new debt instrument that either converts to equity or gets written down when the issuer falls low on capital, is strong. Swiss Re this month became the first insurer to issue CoCos, following the lead of Barclays, UBS and others. The Royal Bank of Scotland is expected soon to join them.

There are good and bad explanations for this insouciance. Sceptics view it as evidence of complacency. “Investors see each episode of loss as being a one-off and do not connect the dots between them,” says Matt King of Citigroup. The search for yield means investors are grabbing returns wherever they can. CoCos are being lapped up by Asian retail investors, raising questions about how much due diligence is going on.

The counter-argument is that the risks in banks are declining as they spruce up balance-sheets and the euro-zone crisis becomes less acute. With enough capital to protect investors from taking losses, the rewards for holding junior debt justify the risks. “The probability of default is down, the loss given default is up,” is how Mark Geller of Barclays puts it. Regulators may not much care either way. If banks get into trouble, subordinated-debt holders can expect to take a hit.