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Irish Bonds Tempt Buyers Again After Banks Blow Up: Euro Credit

Irish Bonds Tempt Buyers Again After Banks Blow Up
Bank of Ireland Plc’s state-guaranteed bond maturing in 2015 is yielding about 711 basis points more than the equivalent Irish government security. Photographer: Aidan Crawley/Bloomberg

Ireland, whose financial system came closer to collapse than that of any euro nation, may now entice investors back to its bank bonds.

Bank of Ireland Plc’s state-guaranteed bond maturing in 2015 is yielding about 726 basis points more than the equivalent Irish government security. Debt due the same year of state-controlled Irish Life & Permanent Plc yields about 899 basis points more than the equivalent Irish bond.

“I’m keen to buy as much of this stuff as I can,” Bill Blain, co-head of special situations strategy at Newedge U.K. Financial Ltd., said on Jan. 4. “If you think the euro crisis is going to get fixed, the banks are the way to play it.”

Faced with the worst economic crisis in its modern history, Ireland guaranteed most of the debts of its banks in 2008 before imposing losses on holders of junior bank bonds. The government balked at doing the same for investors in senior debt following pressure from the European Central Bank. A variant of the original guarantee was extended until the end of June.

About 38 billion euros ($48.8 billion) of bank bonds are now backed by the Irish government, according to the country’s National Treasury Management Agency.

“There is a perception out there that there is still a significant risk with these securities, which aren’t as liquid as sovereign debt,” said Colm Ryan, co-head of fixed income at Goodbody Stockbrokers in Dublin. “There’s a massive trading opportunity with these bonds.”

Sovereign Gains

The yield on two-year government notes has dropped to 7.30 percent from a record 23.2 percent in July, helped in part by the ECB buying Irish sovereign debt. The difference in yield between Irish and German two-year bonds has narrowed to 749 basis points from a record 2,203 on July 28.

As recently as Jan. 4, the ECB bought Irish government bonds, said two people with knowledge of the transactions. They declined to be identified because the trades are confidential.

Bank of Ireland’s 2.5 billion-euro government-guaranteed senior unsecured notes due January 2015 yield 15.2 percent, according to data compiled by Bloomberg. Similar 2 billion euro notes from Irish Life & Permanent yield about 17 percent.

While there’s no directly equivalent Irish government bond, a similar security based on the Irish yield curve of 2014 and 2016 maturities would yield 8 percent.

Risk Reward

“Essentially, you are getting more than twice the yield for the same amount of risk,” said Fergal O’Leary, a director at Dublin-based fixed-income firm Glas Securities. “The government bond is undoubtedly more liquid than the guaranteed bank security, but that just doesn’t justify the current scale of the yield premium.”

Other investors are still reticent given what happened to junior holders of bank bonds.

Haig Bathgate, chief investment officer at Turcan Connell, an Edinburgh-based manager of about 1 billion pounds ($1.5 billion) for mainly wealthy clients, said more losses for bondholders are still possible. He bought and sold Irish government bonds last year, he said.

“I don’t see how they will be able to maintain that guarantee, or at least there’s a risk that they won’t, and certainly the chances of a default on the bank debt are significantly more than on the sovereigns,” Bathgate said by e-mail yesterday. “The risk return just doesn’t add up.”

The spread, or difference between yields, on the Bank of Ireland notes and the equivalent Irish government bonds is at 726 basis points, down from 750 on Dec. 29. The gap between the Irish Life & Permanent notes and the sovereign bonds reached a record 940 basis points on Jan. 4.

‘Banking Heist’

The Bank of Ireland notes currently trade at 76 percent of face value, while the Irish Life notes are at 72 percent, Bloomberg data show.

The losses Ireland forced junior bank bond holders to take still resonate with investors and made many wary of getting back into the market, Blain said.

“The reason there is such a divergence between the banks and sovereign is that investors are innately suspicious of Ireland after what I call the great banking heist,” he said. “Some people have just closed the door on Irish banks.”

About 15 billion euros was raised by “burning subordinated bondholders” within the past three years, Finance Minister Michael Noonan said in parliament on Nov. 2 as the government sought to cut the cost of the banking bailout.

Expensive Rescue

Noonan hasn’t touched the senior bonds of the Irish banks. The state has injected about 62 billion euros into the financial companies, or about 40 percent of gross domestic product. That may be among the most expensive banking rescues in history, according to estimates from Alan Ahearne, an economics professor at Galway University who acted as adviser to Noonan’s predecessor, Brian Lenihan.

In addition, Irish banks, like their European counterparts, now have access to three-year loans from the ECB at 1 percent. Europe’s banks tapped the Frankfurt-based central bank for 489 billion euros of three-year money in December, with another tender scheduled for February, according to the ECB.

Anglo Irish Bank Corp., the nationalized Irish lender whose lending came to epitomize the country’s banking crisis, paid a 1 billion-euro bond in November. Chairman Alan Dukes said in a Newstalk radio interview on Dec. 29 that he expects the company to make a 1.25 billion-euro bond payment on Jan. 25.

“It’s a misconception that the guarantee enshrined in law can be reneged upon,” said O’Leary at Glas Securities. “That would amount to a cross default of the sovereign.”

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