Iceland Passes Last Hurdle in $11.4 Billion Depositor Payout

Iceland will start paying out as much as $11.4 billion in foreign depositor claims after the country’s top court upheld an emergency law that leaves bank bondholders in the lurch and protects ordinary account holders.

The decision by Iceland’s Supreme Court to rule in favor of a crisis bill enacted three years ago “marks the endpoint” to a dispute with the U.K. and the Netherlands triggered by the island’s 2008 financial collapse, Economy Minister Arni Pall Arnason said. The ruling will help repair relations with the two countries, whose depositors risked losing their savings when Iceland’s second-biggest bank collapsed, he said.

“It’s clear from these rulings that all depositors, regardless of nationality, residency, nature or amount of their deposit, will get their money back in full,” Arnason said in an interview in Reykjavik. Repayment may start within weeks, he said.

Iceland’s banks defaulted on $85 billion at the end of 2008, as the government ring-fenced lenders’ domestic operations in an effort to protect the $12 billion economy from total collapse. The local assets of Landsbanki Islands hf, Kaupthing Bank hf and Glitnir Bank hf were taken over by the state, which has since created new banks from the lenders. Bondholders, including Royal Bank of Scotland Plc, BNP Paribas SA and Deutsche Bank AG, are still trying to recoup their funds.

Full Amount

The British Financial Services Compensation Scheme, which compensated U.K. Icesave depositors in full, will probably get its first payments “in a matter of weeks,” Arnason said. Dutch depositors, who had up to 100,000 euros in savings covered by their central bank, will be repaid in full once final “technicalities” are solved, he said. “This isn’t a question of months but rather weeks, as I understand it.”

Credit default swaps on five-year debt sold by the government of Iceland eased seven basis points to 291 on Oct. 28. The contracts, which trade lower than the average for the euro area, have eased from a high of 1,473 basis points just after the island’s banks collapsed in October 2008, according to CMA prices. The krona gained as much as 1.2 percent against the euro today before trading 0.4 percent higher at 159.10 as of 12:11 in Reykjavik.

‘Substantial Claims’

The Dutch Central Bank expects a “substantial sum” to be paid out this year to deposit holders of Landsbanki’s Icesave unit, the bank said after the Supreme Court announced its decision. The claim of deposit holders in the Netherlands totals 1.6 billion euros ($2.27 billion), according to the central bank.

While the court’s decision frees up funds to end the three- year depositor dispute, it may revive bondholder efforts to push their claims.

“Should any of the creditors of Landsbanki, Kaupthing or Glitnir decide to take the emergency legislation up with the European Court of Human Rights, that’s simply something we’ll deal with when the time comes,” Arnason said. “It will be very difficult for the creditors to bring credible claims before the European Court of Human Rights.”

The European Free Trade Association’s Surveillance Authority in December said that Iceland’s decision to impose emergency legislation was “compatible” with its agreement with the European Economic Area.

‘Constitutionally Obliged’

Given the risks to the economy at the time, “parliament was not only permitted, but also constitutionally obliged, to take care of the welfare of the general public,” according to the text of one of the Oct. 28 rulings. “It has been shown that the legislature, in the actions it took, didn’t overstep its authority.”

The EFTA Surveillance Authority concluded that “depositors are in a different situation than general creditors and in greater need of protection in the event of insolvency of a bank,” according to a Dec. 15 statement.

Glitnir bonds are trading at 25 cents on the euro, Kaupthing notes trade at 24 cents on the euro and Landsbanki bondholders can expect to receive 5 cents on the euro, according to the latest prices quoted on the website of Reykjavik-based brokerage H.F. Verdbref.

The winding-up committee of Landsbanki, whose failure triggered the depositor claims dispute that came to be known as Icesave, has 500 billion kronur ($4.4 billion) in ready cash, committee attorney Herdis Hallmarsdottir said at a press briefing. A preliminary repayment plan will be made at a Nov. 17 creditors meeting, she said.

Ready Cash

“Close to 40 percent of depositor claims can be covered by the cash now at hand and whatever is outstanding will be remunerated once the rest of Landsbanki’s assets have been liquidated,” Arnason said. The bank’s resolution committee said Sept. 1 that its assets were valued at 1.3 trillion kronur, or about $11.4 billion.

The government’s decision in 2008 to ignore the banks’ obligations to bondholders and shield the economy from a payout several times the size of its national output helped spur Iceland’s recovery, according to Nobel Laureate Paul Krugman, who has contrasted the rebound with the fate of euro member Ireland.

Iceland, which completed a 33-month International Monetary Fund program in August, will see its economy grow at more than double the pace of the euro-area average next year, the IMF said in September. Iceland returned to international bond markets in June as investors sought twice the $1 billion the government offered. It costs 40 percent less to insure against an Icelandic default than a credit event on debt from Italy, the third- largest economy in the euro area.

The October 2008 emergency bill covered all deposits in the north Atlantic island’s domestic banks, amounting to just over $20 billion.

To contact the reporter on this story: Omar R. Valdimarsson in Reykjavik valdimarsson@bloomberg.net

To contact the editor responsible for this story: Tasneem Brogger at tbrogger@bloomberg.net