Why Irish burden-sharing is talking out its backside | FT Alphaville

Why Irish burden-sharing is talking out its backside

First, it was Allied Irish Banks, and a capital structure which had egregiously flipped to favour equity over credit.

Now, as of Tuesday, it’s spread to Bank of Ireland:

The Bank intends shortly to launch a liability management exercise in respect of approximately €2.6 billion of its subordinated liabilities. The terms of the liability management exercise will reflect the Minister for Finance’s objective of ensuring subordinated bondholders contribute a significant element of the Bank’s Core Tier 1 capital requirement of €4.2 billion. The Bank’s current expectation is that the cash prices under the exercise will be 10 per cent of nominal for Tier 1 securities and 20 per cent of nominal for Tier 2 securities, with no payment in respect of accrued interest. The liability management exercise will incorporate proposals to amend the terms of the relevant subordinated liabilities to grant a call option, allowing the Bank to acquire the securities for a cash amount which would be materially less than the cash tender terms listed above. The Bank may also offer an equity alternative to subordinated bondholders incorporating both a premium to the cash alternative and a payment in respect of interest accrued.

To the extent that subordinated liabilities are not acquired or exchanged pursuant to the proposed liability management exercise or acquired pursuant to the exercise of the call options under the amended terms of the eligible subordinated liabilities, the Bank understands that the Government will take whatever steps it considers necessary to maximise burden sharing…

And also to Irish Life & Permanent:

IL&P intends to launch a liability management exercise in respect of up to €840 million of its subordinated liabilities. This exercise is expected to be in the form of a cash tender offer. IL&P’s current expectation is that the cash prices under the exercise will be 20 per cent of nominal for the relevant subordinated liabilities, save in the case of one series of zero coupon subordinated liabilities where the cash price is expected to be 8.6355 per cent of the nominal amount. No payment in respect of accrued interest will be made on any of the subordinated liabilities. The exercise will also involve noteholders’ meetings to approve certain amendments giving IL&P the right to redeem the subordinated liabilities not purchased pursuant to the cash tender offer.

To the extent that eligible subordinated liabilities are not acquired pursuant to the liability management exercise or redeemed pursuant to the exercise of the call options under the amended terms of the subordinated liabilities, IL&P understands that the Government will take whatever steps it considers necessary to maximise burden sharing.

And the capital-flipping is getting ever riskier.

(What a coincidence for Bank of Ireland and Irish Life to finish with exactly the same line – as if they’d both been fed the same script or something…)

Sorry for quoting both statements at length. But we really want you to catch the details about non-payments of accrued interest on the sub bonds (as highlighted) first of all.

Seems technical enough — and look, whatever happens, the sub debt has to be bailed-in if Irish banks are to recapitalise — but the accrual issue reveals a nasty truth about the way Ireland had dealt with the banks in the “lost” years before the collapse of 2010.

As we noted with AIB, the non-accrual of interest on debt is a legal gambit by the Irish government to allow dividends to be paid on its holdings of preference shares in banks. These shares were issued as part of previous and inadequate cash calls by the banks, back when both they and the government were in denial about the true losses facing the system and the need to burn bondholders. And for which shareholdings, the National Pension Reserve Fund acted as a giant dustbin:

There are no government preference shares in Irish Life, but we’d note that it retains the capacity to issue preference shares as of its latest AGM.

Anyway, so that’s why the Bank of Ireland exercise is structured like this. Indeed the exercise actually contains an even bigger kick in the teeth to the principle of creditor priority than the original AIB order quite possibly, in that BoI will specifically offer sub holders an equity “alternative” that includes payment of accrued interest.

There are other large “keep out” signs to investors in both the sub exchanges here, notably the threat/bluff of other means to bail-in holders, in addition to all this talk of voting on call options/”certain amendments”. If the AIB offer is any guide, it’ll be impossible for holders to vote for the offer without voting on these amendments, which will ensure holdouts are burned.

You could say that’s simply part and parcel of a sub debt exchange, and the government must be as severe as required. But the bid to rescue the preference shares is entirely different — a monument to previous failures to write down and rebuild Irish banks. This simply isn’t new — it’s been obvious that equity would be protected since a law was passed on sub debt exchanges last year — but the more the government does it, and adds “equity alternatives” to coerce the deal, the more set in stone it gets.

Mark Taber, of Fixed Income Investments, put the consequences best a few weeks ago regarding the Allied Irish exchange:

It is quite likely that if the accrued interest had been thrown into the offer holders would have reluctantly accepted but, instead, to try to save the cost of a couple of decent premiership strikers Noonan has come out blazing on all fronts. Of course the extra risk premium investors will demand for years to come before touching Irish bank debt as a result of this approach will massively outweigh any savings acheived by it but that sort of thing never did get in the way of politicians trying to save face!

And just think — if the government does eventually burn holders of senior debt in addition to the sub (as it should have a long time ago), what will it look like if the equity stays protected there too? Back to front… with a vengeance.

Related links:
Flipping the capital structure – FT Alphaville (2010)
Give me priority – Deus Ex Macchiato
Allied Irish and a pension fund fail – FT Alphaville
Fraudulent conveyance – Wikipedia