The lesser-spotted variegated burdensharing for senior bondholders

Posted by Tracy Alloway on Jun 16 11:02.

So Ireland has been busy threatening to throw senior bank debt investors under a bus. Again.

Earlier this week, Irish finance minister Michael Noonan announced plans to force “substantial” burdensharing for investors in the senior debt of Anglo Irish Bank and Irish Nationwide . As a reminder, senior debt investors have traditionally ranked above sub-debt and pari passu (the same) with depositors in a bankruptcy. Forcing losses on them has therefore been a very rare event.

However, times are also changing. Faced with the crushing weight of a failed financial system, Ireland has made plenty of noise about ‘burdensharing’ for senior bank bondholders — or the idea of the investors sharing in the losses of failed-out banks. Denmark actually went through with it when it imposed losses on the bankrupt, Amagerbanken, forcing a 41 per cent loss on senior unsecured debt.

Anyway, there are still massive hurdles to overcome before any such burdensharing in Ireland.

For a start, as far as we know the European Central Bank still opposes the idea — though Noonan mentioned that the IMF and US Treasury secretary Tim Geithner are now on his side. BNP Paribas analysts reckon any ‘relaxing’ of the ECB’s policy stance “would be a very negative signal for the markets indeed and could have repercussions far beyond Ireland (e.g. market appetite for caja IPOs could be significantly reduced).” They figure Noonan is posturing for a reduction in the interest rate of its bailout package, or setting the stage for a deeply discounted — but voluntary — tender offer.

The amount of senior debt we’re talking about here is rather paltry too. At the end of February, Anglo Irish had about €3.1bn worth of senior unsecured debt outstanding, and Irish Nationwide just €600m — or under two per cent of Ireland’s annual GDP according to Barclays Capital. But burning bondholders could have a greater effect in terms of gathering popular support to push through much-needed austerity. No one likes to think of bank bondholders being ‘saved’ at the expense of Irish taxpayers (even, we imagine, if the bondholders claim to be pensioners about to lose their life savings).

And again, times are changing. Here’s Barclays’ Antonio Garcia Pascual:

So far the official position taken by the [Irish] government (at least until recently) indicates that the costs of restructuring outweigh the fiscal-saving benefits. Also, the ECB, at least at the time of the bail-out package for Ireland, has not favoured the restructuring of unsecured senior debt, even in nonviable institutions. In our view, the ECB’s position was justified on financial stability concerns for Ireland, as well as on grounds of potential contagion for other European banking systems. Ongoing concerns on financial stability, especially in European periphery financial institutions, could make contagion remain a relevant issue for ECB’s stance on this issue.

An additional consideration by the Irish authorities may be related to the bond holders of unsecured senior debt of nonviable banks, as we expect regulators and policy makers to view these investors as highly speculative. In this context, debt holders of failed and nonviable institutions are poised to bear the burden in a resolution of the nonviable banks. The possibility for burden sharing of unsecured senior debt holders in nonviable institutions also appear to be consistent with the 7 January 2011 proposed new framework (for discussion) on bank restructuring and resolution.

In our opinion: 1) a distinction is likely to be made by the government between the treatment of viable and nonviable banks, likely affecting the latter more and the former less; 2) it could affect unsecured senior debt but not the secured debt (ie, probably not affect secured covered bond holders); and 3) this issue is likely to be re-opened by the new government as the political costs of a broad and protracted fiscal adjustment are not to be underestimated. In fact, an important argument favouring a restructuring solution is that the fiscal position of the sovereign would otherwise suffer, as the fiscal consolidation plans could be less likely to succeed, potentially leading to a higher public-debt-to-GDP ratio.

The idea is that forcing losses on ‘non-viable’ (read: doomed) banks could be one way of isolating the contagion effect — leaving viable banks to continue pretty much as as normal. Though, we have to say, that seems difficult given recent market reaction to Noonan’s musings.

(P.S. Did you notice the wee mention of covered bond burdensharing by BarCap? Things are really getting interesting)

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