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Bondholder Haircut by Ireland May Shut Italy, Spain Funding

Bondholder Haircut by Ireland May Shut Italy, Spain Funding
The Irish Central Bank will today publish the results of stress tests, requiring the banks to raise another 27.5 billion euros of capital, according to the median estimate of 10 analysts surveyed by Bloomberg News. Photographer: Aidan Crawley/Bloomberg

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.”

Irish regulators today published the results of stress tests on the country’s banks, telling four lenders to raise 24 billion euros ($34 billion) in additional capital. 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 and is 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. 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, were lower today. Its 400 million-pound ($645 million) floating-rate note due June 2012 was quoted down 3.5 pence in the pound at 58 pence, while its 1.25 billion euros of floating-rate bonds maturing in January 2012 were down 2.5 cents at 60 cents in the euro, according to Jefferies International Ltd. prices on Bloomberg.

Eoin Dorgan, a spokesman for Finance Minister Michael Noonan, declined to comment.

The central bank in Dublin announced the results of stress tests on Ireland’s banks today. Allied Irish Banks Plc, the biggest lender during the decade-long economic boom, requires 13.3 billion euros, Bank of Ireland Plc must get 5.2 billion euros, while Irish Life & Permanent Plc and EBS Building Society make up the remainder, policy makers said.

The cost of insuring the debt of banks around Europe pared an increase after the stress-test results. The Markit iTraxx Financial Index of credit-default swaps tied to 25 banks and insurers climbed 2.5 basis points to 151, after earlier rising to the highest since March 17, according to JPMorgan Chase & Co.

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.

Pressure Growing

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.

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

‘Another Matter’

“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 to 23.5 cents in the euro, according to Jefferies. Bank of Ireland’s 747 million euros of subordinated 10 percent notes due 2020 rose 1 cent to 53.5 cents on the euro.

Allied Irish’s 1.5 billion euros of senior unsecured floating-rate notes due in September 2011 were little changed at 86 cents. The Dublin-based bank’s 750 million euros of senior unsecured 5.625 percent bonds maturing November 2014 dropped 3 cents on the euro to 72 cents, according to Jefferies.

Bank of Ireland’s 1.465 billion euros of senior unsecured floating-rate notes maturing in September 2011 were little changed at 91.5 cents and its 974 million euros of senior unsecured floating-rate bonds due April 2013 were little changed at 82.5 cents.

Equity Owner

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.

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.

5.9 Billion Euros

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.

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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