European Bank Bondholders May Look to Ireland for Hints of Fate

Ireland's Finance Minister Michael Noonan
That “reinforces the robust and conservative nature” of a capital review by the country’s authorities in March, Irish Finance Minister Michael Noonan said last night. Photographer: Joshua Roberts/Bloomberg

European lenders looking to raise 106 billion euros ($148 billion) might turn to Ireland, the home of the region’s worst banking crisis, for a blueprint.

Goldman Sachs Group Inc. said today “liability management exercises” are one avenue for recapitalizing Europe’s banks under rules laid out by regulators late yesterday in response to the euro area’s sovereign debt crisis. That’s code for sharing losses with junior bank bondholders, a strategy pioneered by the Irish to cut the cost of saving their financial system.

“There’s a range of options for the European banks, like asset sales and liability management exercises,” Eamonn Hughes, banking analyst at Goodbody Stockbrokers in Dublin, said today. “They can look for a few hints from Ireland’s experience. Ireland is a test case for capital raising.”

Ireland has raised 15 billion euros, equal to about 10 percent of the country’s economic output, since 2009 from sharing losses with investors after the collapse of the real estate market sank the financial industry. Ireland introduced emergency laws last year allowing the state to impose losses on junior holders of bank bonds.

As part of their package aimed at tackling the debt crisis agreed during the night, European leaders said in a joint statement today that banks in the euro region should raise capital including “through restructuring and conversion of debt to equity instruments.”

Taking Hints

“Policy makers seem determined to use subordinated debt instruments to help recap the banks,” Richard Thomas, London-based analyst at Bank of America Corp.’s Merrill Lynch, said in a note. “Whether banks take the hint is another matter.”

The European Banking Authority estimates Spanish banks require 26.2 billion euros of extra money and Italian banks 14.8 billion euros. It gave them until Dec. 25 to submit money-raising plans to national supervisors.

Banks that fail to raise enough capital in the markets will first tap national governments, falling back on the European Financial Stability Facility rescue fund only as a last resort.

Irish banks don’t need to raise extra capital, the banking authority said. That “reinforces the robust and conservative nature” of a capital review by the country’s authorities in March, Irish Finance Minister Michael Noonan said last night.

In all, Ireland has injected about 62 billion euros into its financial system and the government now controls five of the country’s six biggest lenders. In the March stress tests, banks were ordered to raise 24 billion euros. The state’s contribution was reduced to about 17 billion euros, partly because losses were imposed on junior bondholders.

Learning Lessons

“I’d say they’d be looking very closely at what we’ve done,” said Michael Torpey, a banking official at Ireland’s Finance Ministry, told reporters in Dublin today. “If I was sitting in another country, I’d be saying, ‘Let’s see what lessons we can learn. We don’t have to copy them exactly.’”

Allied Irish Banks Plc, now 99 percent state-owned, said in July it would raise about 2 billion euros from buying back subordinated bonds after inflicting losses of as much as 90 percent on investors. Had holders not accepted, the new laws meant they faced losing virtually all their investment.

It may not be that bad for European bank bondholders, because withholding dividends and selling assets may reduce the amount financial companies need to raise.

“We do expect more liability management trades but suspect that the levels of capital needing to be raised aren’t sufficiently challenging to mean very negative outcomes for bondholders in most cases,” said Thomas at Bank of America.

Torpey said the approach in various countries may vary with the depth of their banking problems compared with Ireland. The collapse of country’s financial system forced Ireland to seek an international bailout last year.

“If I was sitting in one of the other countries, one of the questions you’d ask is what is the scale of capital raising,” Torpey said. “If there are countries which have problems that are as deep, then they have to be prepared to look at solutions that are as severe.”

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