Investors brace for painful Irish bank bond swaps

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Author: STEVE SLATER | REUTERS

Friday 26 November 2010

DUBLIN: Expectations rose on Friday that top bondholders in Irish banks will be offered the chance to swap billions of euros of debt for new bonds, realizing a loss and taking a share of Ireland’s pain but avoiding a potentially worse fate.

Such tenders have been used successfully by Irish and other European banks during the financial crisis. These have allowed them to buy back bonds at a premium to their market price but at a discount to nominal value, saving them money and forcing bond investors to take a so-called “haircut.”
There was more bad news when Standard & Poor’s cut Irish banks long-term credit ratings, saying: “The stand-alone creditworthiness of the four domestically owned Irish banks has weakened.”
S&P cut nationalized Anglo Irish Bank’s rating by six notches due to the threat the Irish government may reconsider its supportive position on 4 billion euros ($5.3 billion) of senior debt that isn’t guaranteed by the government.
Also vulnerable to haircuts are 6 billion euros of unsecured senior debt at Allied Irish Banks and 5 billion at Bank of Ireland, analysts said.
Expectations increased that senior bondholders at the top three banks would have to bear some of the distress after The Irish Times said the IMF and European Union have been examining ways of spreading the bailout costs.
Investor nervousness grew after the report, with prices of Irish and European bank bonds falling sharply. There were no bids for AIB or Bank of Ireland senior debt, with liquidity in the market drying up.
An EU source familiar with the talks said talks between Dublin and the IMF/EU team provisionally concluded and there was no requirement for senior bondholders to take a haircut.
A exchange offer would be among the least painful options for the bank bondholders. Another scheme being considered involves swapping bank debt into equity. Investors could also be given the choice of injecting fresh capital or facing a cut in their investment, The Irish Times said.
Whether senior bondholders are forced to take a hit is a hot topic after several European politicians said they should share the cost of the bailout.
“Clearly things are coming to a head in Europe and there’s a debate, particularly in regard to the Irish banks, that bondholders may need to be subject to burden sharing,” said Mark Dowding, senior portfolio manager at Bluebay Asset Management in London, who helps oversee $22 billion in assets.
“In the first instance it may be offered as a debt swap. But if there’s not sufficient take up there may be more of an enforced effort,” Dowding said.
However, such a dramatic move could further undermine confidence in banks in Portugal and Spain, by showing all investors are vulnerable. And it could make it tougher for Irish banks to fill a future funding gap estimated at about 160 billion euros.
German Chancellor Angela Merkel has repeatedly said bondholders should share the pain when a country hits trouble, but only for bonds issued from as early as 2011. An 85 billion euro rescue package is expected to be unveiled, possibly this weekend, to cover Ireland’s funding costs and the cost of “overcapitalizing” the banks.
Ireland says it will honor its obligations to senior bank bondholders, despite forcing a haircut on subordinated debt holders in Anglo Irish and Irish Nationwide.
But the main opposition party Fine Gael, which will likely lead a new government next year, has said all bondholders should share the burden of bailing out the banks.
In meetings with the IMF/EU team, representatives of the two main Irish opposition parties gave notice their parties would seek to reopen the issue of how senior bondholders are handled if they win an election next year, according to the EU source.
Bank of Ireland, which has boosted capital by 1.7 billion euros from bond offers in the last two years, had 31 billion euros of senior debt and asset-backed securities at end-June.
AIB has made 1.6 billion euros, including 445 million earlier this year after swapping lower Tier 2 debt at an average haircut of about 20 percent to face value. Anglo has about 6.5 billion euros of senior debt.

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