Ireland Wields Stick to Wound Bank Bondholders: Euro Credit

Brian Lenihan, Ireland's finance minister
Brian Lenihan, Ireland's finance minister. Photographer: Aidan Crawley/Bloomberg

Irish Finance Minister Brian Lenihan is about to inflict more pain on bank investors. Unless they take it, analysts say worse may follow.

Junior bondholders in Dublin-based Allied Irish Banks Plc will decide this week on an offer to buy back more than $5 billion of subordinated debt at 30 percent of face value. Analysts at BNP Paribas SA recommend investors accept the package or risk getting “the stick” after the government passed laws allowing it to reduce payments to bondholders.

“The draconian powers granted to the Irish finance minister in December are a game-changer for subordinated bondholders in Irish banks,” said Ivan Zubo, a London-based credit analyst at BNP Paribas. “Clearly, there is a risk that the more drastic powers could be used if Allied Irish needs more capital in the future.”

Costs to insure the subordinated debt of Allied Irish, the country’s second-biggest bank, was 63.5 percent upfront and 5 percent a year as of Jan. 14, meaning it cost 6.35 million euros ($8.5 million) in advance and 500,000 euros annually to protect 10 million euros of debt for five years, CMA prices in London show. That compares with 21.7 percent upfront three months ago.

Ireland is taking control of Allied Irish, making it the fourth lender seized by the state as bad debts threaten to topple the country’s financial system. Lenihan said on Jan. 12 in parliament that after Allied Irish bondholders take “whatever pain is inflicted upon them,” it will have a “material bearing” on the cost of saving the bank.

Crisis Resolution

European leaders and regulators worldwide are considering steps that would force bondholders to share a larger proportion of costs from any future banking bailouts. European Union leaders agreed last month to set up a permanent crisis resolution system to start in 2013.

After German Chancellor Angela Merkel called on bondholders to share the burden, the European Commission proposed Jan. 6 that bank regulators be allowed to write down senior debt before relying on the taxpayer to save a failing lender.

Senior bondholders aren’t currently at risk, including those holding Irish debt.

“The debate has definitely changed,” said Hank Calenti, a credit analyst at Societe Generale SA in London. “It used to be about whether the subordinated bondholders would have to pay; now it’s about whether the seniors will be hit.”

Yield Spread

The extra yield investors demand to hold Irish 10-year bonds rather than German securities of similar maturity has narrowed to 578 basis points from a euro-era record of 680 points on Nov. 30, two days after the scale of bank losses forced Ireland to accept an international bailout. The spread over German debt is still more than nine times the average of the past decade, Bloomberg data show.

The Irish rescue package agreed with the EU and the International Monetary Fund includes as much as 35 billion euros of aid for the banks. Central Bank Governor Patrick Honohan said before the bailout was inked that total loan losses at the country’s lenders, including foreign-owned banks, total at least 85 billion euros.

The government is taking a 92.8 percent stake in Allied Irish after injecting 3.7 billion euros into the lender last month. The state already took control of Anglo Irish Bank Corp., Irish Nationwide Building Society and EBS Building Society.

‘Enforce Losses’

Ireland introduced laws last month allowing it to force junior bank bondholders to share losses. The new legislation allows Lenihan to issue orders to change interest and principal payments to bondholders and suspend their rights to payment.

The Irish government “has shown its willingness to enforce losses,” Alexander Plenk, a Munich-based analyst at UniCredit SpA said in a Jan. 14 note to clients, urging debt holders to accept Allied Irish’s offer. “We recommend accepting the offer, as a second offer will be made under worse conditions.”

The central bank will review the banks’ capital again in March. That process may result in more loan-related losses and encourage the state to compel junior bondholders to take additional hits, according to Ciaran Callaghan, an analyst at NCB Stockbrokers in Dublin.

Anglo Irish, nationalized in 2009, offered in October to pay bondholders who refused to swap their securities 1 cent per 1,000-euro on the face amount of their subordinated notes. More than 90 percent of the bondholders of the notes due 2014 and 2016 agreed to swap 766.5 million euros in notes at an 80 percent discount, the Dublin-based bank said last month.

Fitch Ratings said Jan. 13 that Allied Irish’s buyback isn’t “coercive.” However, if not enough investors accept the offer, “there will be a higher likelihood that a coercive debt exchange will take place or losses will be forced onto subordinated debt holders by other legislative means,” the rating company said.

“The authorities are holding a big stick,” said Calenti. “It’s not as onerous as the Anglo stick, but it’s just as threatening. If you don’t take part in the buyback, you’re probably not going to get a whole lot more.”