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Irish Election May Mean More Pain for Bondholders: Euro Credit

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

Irish Finance Minister Brian Lenihan warned holders of bank bonds last month that they will have to share the pain of rescuing the country’s financial industry. When a new government takes over, more investors may get hurt.

The Fianna Fail party, formerly led by Prime Minister Brian Cowen, will lose to a Fine Gael and Labour Party coalition in an election called yesterday for Feb. 25, polls show. The two said they want to renegotiate the 67.5 billion-euro ($93 billion) bailout agreement with the European Union and International Monetary Fund so that senior bondholders are less protected.

“Those who lent recklessly as well as those who borrowed recklessly should share the burden,” Michael Noonan, finance spokesman for Fine Gael, Ireland’s biggest opposition party, said during a Jan. 25 speech in Dublin. “At present, the Irish taxpayer is expected to shoulder the entire burden.”

The extra yield investors demand to hold Irish 10-year bonds rather than German securities of similar maturity almost quadrupled to 599 basis points in the past year as costs to rescue the country’s biggest banks reached 46 billion euros. The spread over German debt is more than nine times the average of the past decade, data compiled by Bloomberg show.

Neither Fine Gael nor Labour has detailed how investors should be saddled with the burden of rescuing the lenders.

A new government may opt for discounts of as much as 90 percent on some junior debt and impose discounts on some senior bank bondholders, Hank Calenti, a London-based credit analyst at Societe Generale SA, wrote in a Jan. 28 note to clients. In a worst-case scenario, investors may face writedowns of as much as 29.3 billion euros, he said.

‘Powerful Tools’

“The incoming Irish government will inherit some powerful tools towards accomplishing a comprehensive solution to the Irish banking problem,” Calenti said, referring to new banking stabilization laws introduced in December. He recommends that Bank of Ireland Plc and Allied Irish Banks Plc bondholders purchase default insurance or sell their cash securities.

Cowen announced the election date yesterday after his coalition partner, the Green Party, pulled out of government last month. The two opposition parties lead Fianna Fail by a combined 38 percentage points, according to a Sunday Business Post poll published on Jan. 29.

Support for Fianna Fail plunged after the government was forced to ask for an international bailout.

Lenihan said in parliament on Jan. 27 that the idea of reneging on senior bank bonds is akin to “torching” a house, as neighbors, in the shape of depositors, would also flee.

Head of Class

Under Irish law, senior bondholders rank alongside depositors, Lenihan said. In terms of recovering their investment, they rank ahead of all classes of subordinated debt holders in the event of a bank being wound down.

In all, about 77 billion euros of Irish bank debt is at risk of restructuring, Societe Generale estimates. The figure drops to 41 billion euros when government-guaranteed securities, secured borrowings and loans between banks are excluded.

Those borrowings are probably safe, while the new government may seek to apply discounts on some senior unsecured and subordinated bank securities, Calenti said.

Jim Ryan, a director at Dublin-based Glas Securities, said Ireland will continue to respond to the EU and IMF.

“There is likely to be a lot of hawkish rhetoric during the election campaign, but the reality is that a new government is very unlikely to move on bank senior bondholders unilaterally,” said Ryan. “We shouldn’t underestimate how much influence the EU and the IMF now have in shaping policy, and any move to coerce bondholders into taking losses will undermine Ireland’s ability to fund.”

EU Pressure

The opposition parties say any moves to impose discounts on bank bondholders will be made with the agreement of the EU. As part of the bailout accord, the government bowed to EU pressure to protect senior bank bondholders.

The European Central Bank, which is providing about 96 billion euros in funding to prop up the country’s banks, is resisting efforts to penalize bondholders.

ECB Executive Board member Lorenzo Bini Smaghi said that any attempt by the Irish to impose losses on senior bondholders would trigger a “run” on banks. The Irish central bank has already provided banks with as much as 51 billion euros in emergency support as deposits fall.

“The amount of senior bonds is so small compared to the overall amount that if you do a haircut to the bonds, immediately you would have a run on banks by the Irish themselves,” Bini Smaghi said in an interview with Dublin-based broadcaster RTE aired on Jan. 27. “They would not trust any more that their assets held on the banks are safe.”

Allied Irish

Given the ECB’s reluctance to allow Ireland to default on senior bank debt, a new government may first target junior bank bondholders, starting with Allied Irish Banks.

The government is taking a 92.8 percent stake in Dublin-based Allied Irish after injecting 3.7 billion euros into the lender last month. It also controls Anglo Irish Bank Corp., which forced investors who refused to swap their bonds to accept 1 cent per 1,000-euro on the face amount of their subordinated notes. More than 90 percent of the holders of notes due 2014 and 2016 agreed to swap 766.5 million euros of securities at an 80 percent discount.

Half of Allied Irish’s subordinated bondholders rejected a voluntary offer last month to buy back bonds at 30 percent of their par value. The hold-outs may face the same fate as the Anglo Irish bondholders, said Tom Jenkins, an analyst at Jefferies International Ltd. in London.

“Everything points to a more coercive offer,” Jenkins said. “The taxpayer is going to be asked to commit to another very substantial cash injection, so for the voters hitting bondholders makes perfect sense.”

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