Irish bondholders

6th December 2010

According to the Daily Telegraph , holders of debt issued by Allied Irish Banks (AIB) are up in arms about looming ‘haircuts' – or forced reductions in the face value of their bonds.  Fixed-income pension and insurance funds are threatening court action if the government goes ahead with the one sided deal.

Like other Irish banks, AIB needs to clear down its debts.  One way to do so is to swap its outstanding IOUs for government ones as part of the bank's nationalisation.  In theory, such deals give bond holders a greater chance of getting their money back. 

Yet there is no such thing as a free lunch.  Bondholders must pay a hefty price.  Other AIB deals have invoked haircuts up to 50% as junky bank debt is swapped for not so junky government paper.   European leaders and the IMF see such ‘burden sharing' as a fair price for bailing out the country.

As Jamie Stuttard, Head of European and UK Fixed Income at Schroders points out: "The Irish government bond market has been undone by its banking, consumer and housing sectors, and their combined effect on the real economy, fiscal position and debt capital markets funding."

The gross financial exposure of the Irish banking system is 1400% of GDP.  There simply is not enough cash to payback bonds at face value.

Another set of AIB bondholders must now vote on a new deal.  A ‘sweeper clause' may scare them into agreeing.  Those that refuse could receive just one cent per €1,000 worth of bonds held.

The deal is hardly being conducted on fair terms, say the pension and life funds.  John Pattullo, head of retail fixed income at Henderson, points out that governments can simply change the rules – as the UK did over Bradford & Bingley.  He adds: "You also get moral hazard.  If all bondholders are 100% guaranteed by the government, then they should only get sovereign yields."

The other issue is that these bonds are subordinated or junior debt.  Holders only get paid their regular coupons after senior bondholders are paid first.  Senior payments must stop if the bank wants to revise subordinated debt terms and conditions, say the group of investors.

Senior debt holders certainly do not like that idea, nor does the Irish government or the EU.  If senior holders are affected, Europe's fragile bank bond market will freeze over.  Spanish, Portuguese, Italian and even British banks could face a huge liquidity squeeze.

If the worst happens and banks and countries default, investors might then think that one cent per €1,000 was not such a bad deal after all.

One Telegraph reader thinks bondholders are being greedy and that they should accept the terms on offer.

"These large insolvent financial institutions need to go bankrupt and the senior debt not take a haircut but a blood bath. Wipe the slate clean and get it over with – get the bankers out of public debt once and for all!" (M_P_Jones)

What do you think?

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