Irish Bank Bonds Tumble on Concern Senior Bondholders Will Pay for Bailout

Allied Irish Banks Plc and Bank of Ireland Plc’s senior debt slumped on concern the government will force some of the cost of bailing out the country’s banks onto senior bondholders.

European Union and International Monetary Fund officials are taking legal advice on how senior bondholders can share the cost of Ireland’s 85 billion-euro ($113 billion) bailout without triggering lawsuits, the Irish Times reported today, without saying where it got the information. Negotiators plan to finalize the aid package on Nov. 28 before markets re-open after the weekend, an EU official said on condition of anonymity.

Allied Irish’s 750 million euros of 5.625 percent senior notes due 2014 fell 2 cents on the euro to 75 cents, a 2.6 percent decline, according to composite prices on Bloomberg at 4:30 p.m. in London. Bank of Ireland’s 974 million euros of 4.625 percent senior unsecured notes maturing in 2013 fell 3 cents on the euro, or 3.4 percent, to 82 cents.

“While junior bondholders always faced the prospect of taking a haircut on their investments,” senior bondholders “have been sacrosanct” until now, Eamonn Hughes, an analyst with Goodbody Stockbrokers in Dublin, said in a note to clients. “It is clear that more radical solutions than simply pumping more equity into the bank system are in the offing.”

Two years ago, the Irish government assured senior bondholders that they wouldn’t lose their money if banks failed. Holders of the debt are typically the last investors to lose out when a bank or company founders.

Allied Irish

Allied Irish has about 5.9 billion euros of senior unsecured debt and 12.1 billion euros of senior secured notes, all of which are covered bonds, according to data compiled by Bloomberg. Bank of Ireland has 5.4 billion euros of senior unsecured debt and another 5.9 billion euros of government- guaranteed bonds, the data show.

Anglo Irish Bank Corp. Ltd., which is buying back some of its subordinated securities at an 80 percent discount, also had its senior bonds tumble on speculation of burden-sharing.

Anglo Irish’s 1.25 billion euros of floating-rate notes maturing in January 2012 dropped 7 cents on the euro, or 9 percent, to 70 cents, Bloomberg composite prices show. The Dublin-based lender’s 750 million euros of FRNs due in January 2011 plunged 9 cents, or 10 percent, to 83 cents.

Anglo Irish had its long-term credit rating cut six levels by Standard & Poor’s to B, or junk, from BBB today.

Paid at Par

Holders of European senior bank bonds have been paid the par value of their investments in troubled lenders, except in the case of Iceland, Morgan Stanley analysts including Carlos Egea said in a note on Oct. 15. There, creditors of Iceland’s Kaupthing Bank hf, Glitnir Bank hf and Landsbanki Islands hf are owed as much as $86 billion. Bondholders of Lehman Brothers Holdings Inc. weren’t bailed out after the firm filed for bankruptcy in 2008.

The rescue talks taking place in Dublin have focused on how Bank of Ireland and Allied Irish may buy back or exchange subordinated debt rather than burden-sharing by senior bondholders, according to three people familiar with the situation, who declined to be identified because the discussions are private.

Allied Irish shares surged as much as 24 percent to 37 cents on speculation that burden-sharing with bondholders would help the bank avoid outright nationalization, before falling back to 34 cents in Dublin trading.

‘Benefit’ Shareholders

“While shareholders would still get diluted, Allied Irish could avoid being nationalized, which would potentially benefit investors” as the shares would still have some value and be tradable, Oliver Gilvarry, head of research at Dolmen Securities in Dublin, said in a telephone interview.

Bank of Ireland shares were 6 percent higher at 27 cents after earlier rising 9 percent. The five-member ISEQ Financial Index has fallen about 98 percent from its peak in February 2007.

To help prevent another crisis, Ireland’s government will seek to raise its banks’ so-called core Tier 1 capital ratio, a measure of financial strength, to between 10.5 percent and 12 percent, two people familiar with the situation said Nov. 24. That’s up from the central bank’s 8 percent target.

Allied Irish would require an additional 3 billion euros to the 6.6 billion-euro fundraising the government is already underwriting to meet the 12 percent target, Niall O’Connor, a London-based analyst with Credit Suisse Group AG, said in a note to clients yesterday. The government’s Allied Irish stake would rise to as much as 97 percent from 19 percent today, he said.

Default Insurance

The cost of insuring the debt of Ireland’s two biggest lenders against default soared to records today.

Credit-default swaps insuring Allied Irish’s senior bonds for five years rose 5 percentage points to 25 percent upfront and 5 percent annually, according to CMA. The upfront cost of protection on its subordinated debt climbed 3 percentage points to 67 percent.

The upfront cost of Bank of Ireland senior swaps rose 5 percentage points to 16 percent in advance, while that cost on its junior debt insurance increased 5.5 percentage points to 47.5 percent upfront.

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A basis point on a credit-default swap protecting 10 million euros of debt for five years is equivalent to 1,000 euros a year.

Forcing losses on senior bondholders “sets a nasty,” if understandable, “precedent,” Marc Ostwald, a strategist at Monument Securities Ltd. in London, said in a note today. “The constant ‘goal-post moving’ in terms of regulation” does “enormous damage to investor and entrepreneurial confidence.”

To contact the reporters on this story: Joe Brennan in Dublin at jbrennan29@bloomberg.net; John Glover in London at johnglover@bloomberg.net

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net

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