Bondholder Haircut by Ireland May Shut Italy, Spain Funding

Ireland making good on its threat to impose losses on senior bank bondholders would precipitate a funding crisis for lenders across southern Europe, according to CreditSights Inc.

“The fallout would be big and it would be bad,” said John Raymond, a London-based analyst at the independent research firm. “The senior unsecured market would shut down, at least for a while. Right now, the bigger and better Spanish and Italian banks can still access the market. That could end.”

The Irish Central Bank will today publish the results of stress tests, requiring the banks to raise another 27.5 billion euros ($39 billion) of capital, according to the median estimate of 10 analysts surveyed by Bloomberg News. At the same time, the nation’s new government, led by Enda Kenny, is seeking to extract better terms on its bailout loan and secure medium-term funding from the European Central Bank to avoid a fire sale of lenders’ assets, threatening to burn bondholders.

Irish banks had about 16.4 billion euros of senior unsecured, unguaranteed bonds and another 20.9 billion euros of government-guaranteed notes outstanding as of Feb. 18, according to the Central Bank of Ireland. While governments have typically stepped in to prop up distressed lenders before senior creditors lose money, that has been changing after the cost to taxpayers of the 2008 financial crisis.

Bonds Decline

Bonds of Anglo Irish Bank Corp., the lender that’s received more than 29 billion euros of government cash and is being wound down, declined. The company’s 400 million-pound ($645 million) floating-rate note due June 2012 was quoted down 3.5 pence in the pound at 58 pence, according to Jefferies International Ltd. prices on Bloomberg. Its 1.25 billion euros of floating-rate bonds maturing in January next year were down 2.5 cents at 60 cents in the euro, according to Jefferies.

Senior bonds of Allied Irish Banks Plc (ALBK) and Bank of Ireland Plc, the two biggest lenders, were little changed ahead of a speech by Finance Minister Michael Noonan this afternoon.

Eoin Dorgan, a spokesman for Noonan, declined to comment before the minister speaks.

Pressure on bondholders to share the burden of banks’ losses is growing. In Denmark, the government inflicted so- called haircuts on senior creditors and depositors of regional lender Amagerbanken A/S, which failed after losing money on investments including real-estate loans. Moody’s Investors Service cut ratings of five Danish banks, including Danske Bank A/S, the country’s biggest, pushing up funding costs. Ireland’s government has similar powers to Denmark’s under the terms of its banking act.

Subordinated Debt

In the short term, subordinated debt is a more-likely candidate for burden sharing than senior bonds, said Tom Jenkins, an analyst at Jefferies International Ltd. in London.

“Subordinated debt is another matter,” he said. “A coercive tender for the sub out there would be no surprise at all and that’s reflected in its price.”

Allied Irish’s 650 million euros of 12.5 percent subordinated bonds maturing in 2019 declined 0.5 cents and were at 23.5 cents in the euro, according to Jefferies. Bank of Ireland’s 747 million euros of subordinated 10 percent notes due 2020 were little changed at 52.5 cents on the euro.

Ireland owns all of the equity of Anglo Irish, Irish Nationwide Building Society and EBS Building Society, and is taking a stake of at least 93 percent in Allied Irish. The state may also be forced to take ownership of Bank of Ireland and Irish Life & Permanent Plc, the last of the country’s biggest lenders to escape state control, following the stress tests.

Senior Creditors

The level of government-owned equity is important if senior creditors are to be forced to take losses because junior investors have to be wiped out first, according to Roger Doig, who helps manage the equivalent of about $46 billion in fixed income as an analyst at Schroders Plc in London.

“As a government, you could only haircut entities you own the equity of,” Doig said. “You can’t keep equity outstanding and haircut the seniors -- that would breach the principle of seniority.”

Anglo Irish has about 3 billion euros of senior unsecured debt and a similar amount of government-guaranteed notes, according to central bank data. The two building societies have about 1 billion euros of senior unsecured bonds and about 1 billion euros of government-guaranteed notes, the data show.

Throwing Allied Irish into the mix would add 5.9 billion euros of senior unsecured and 6 billion euros of government- guaranteed bonds. That would bring the total senior unsecured debt to about 10 billion euros, plus another 10 billion euros of government-guaranteed notes.

Guarantee Triggered

The government’s guarantee would be triggered if the senior bonds were written down, forcing the administration to pay off those notes, according to Stephen Lyons, an analyst at Dublin- based securities firm Davy. Added to that, the senior bonds were largely issued under English law, meaning bondholders would have recourse to the English courts for protection, he said.

Irish threats to haircut senior creditors are a negotiating ploy, he said.

“What we give up is the threat of burden sharing,” he said. “By focusing the headlights on the need for burden sharing, we get the funding line we need for the banks. That prevents a fire sale which would trigger losses. It’s a threat we can’t use but can trade -- it focuses negotiations on a bank funding line.”

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