On Thursday, Anglo Irish — Ireland’s euro-guzzling bailed-out bank — unveiled a dramatic exchange offer for investors in its subordinated, or junior, debt.
The bank is offering holders of some of its outstanding sub-debt to swap their notes for new Irish government guaranteed bonds that will be due in 2011 with a coupon of three-month Euribor plus 3.75 per cent. Holders of the €1.57bn worth of three Lower Tier 2 (LT2) bonds will receive just 20 cents on the euro. Investors in about €377m of perpetual junior debt will get even less — 5 cents on the euro.
Even if this is the end of a long-trailed (but often confusing) “burden-sharing” process for bondholders in the troubled bank, it comes with an added motivational twist.
The LT2 bonds had been trading in the mid 20s before the announcement. (The perpetuals don’t really trade any more). The ‘stick’ in this equation, however, is that the Irish government is also looking to alter the terms of outstanding bonds via an extraordinary resolution.
If adopted, the change would enable the bank to redeem the debt of bondholders that haven’t opted for the exchange offer for practically nothing — €0.01 for every €1,000. Double ouch.
Bondholders have to vote on the resolution — at a series of special meetings in November — by submitting their exchange instruction.
To paraphrase the FT’s Anousha Sakoui, the meeting requires about two-thirds of creditors to attend and of those attending, three-quarters to vote in favour. Assuming enough bondholders approve the resolution then — the option for most sub-debt investors seems to be accept 20 cents on the euro, or face being wiped out altogether. Vito Corleone springs to mind.
In the beginning there was B&B…
The Irish government itself has been rather vocal in its support for “burden-sharing” for bondholders — that is, forcing creditors to share in the losses of troubled banks. To date, Lower Tier 2 debt can’t really absorb bank losses unless the company is liquidated, and many banks are often too big to go bust.
Anglo Irish itself, for instance, may have been bailed-out but it hasn’t quite gone bankrupt. Nevertheless — with a bail-out price tag of as much as €34bn — you can see why Ireland’s finance minister expects “subordinated debt holders to make a significant contribution towards meeting the costs of Anglo.”
How then to go about it?
There’s some European precedent here — but Bradford & Bingley is of particular interest. In 2009, the nationalised British bank enforced burden-sharing on both LT2 debt and perpetuals — offering 45 pence for every pound of LT2, and 25 pence on perpetuals. That was a premium of about 10 to 12 points at the time.
B&B burden-sharing, however, also came with a ‘special resolution regime.’ The UK government went ahead and changed the terms of outstanding Bradford & Bingley subordinated bonds — allowing the bank to defer coupon and principal payments.
The problem, however, with that particular stick was that the market didn’t very much appreciate it. The senior LT2 differential on UK banking debt rose to 150 basis points after the special resolution was passed — suggesting the riskiness of UK bank capital was, at the time, writ large.
The contagion to other UK banks was significant too. RBS and HBOS subordinated CDS widened 66bps and 32bps on the day the UK released its amendments to the terms of Bradford & Bingley’s nationalisation. In fact, the fall-out made its way through the European debt market, and even to the US.
A bondholder balancing act
These kind of burden-sharing exercises provide plenty of fodder for regulators still considering the prospect of so-called bank bail-ins.
Witness that Bradford & Bingley reaction, and consider that so much of the traditional bank investor base has already been eroded in the recent financial crisis. We hear 30 per cent in some estimates — and investors are reluctant to return to capital markets unless they get an expensive 87bps pick-up in bank paper, because of this risky regulatory bail-in stuff.
Anglo Irish — and Ireland — would have had to keep investors in mind here too.
For instance, the country has been keen to stress that burdensharing won’t fall on senior debt investors, for fear it could roil Anglo’s funding costs. Thursday’s burden-sharing announcement is generally thought to be a positive for the senior debt. It’s also generally thought the exchange qualifies as a restructuring event, which will trigger technical CDS pay-outs on both the senior and subordinate paper. It has, however, been structured in a way to avoid a more serious event of default.
As for Ireland itself, now the biggest stakeholder in Anglo, we hear there was some concern the exchange could lead to an ‘incorrect’ read-across to the emerald island. Instead, the reaction in Irish five-year CDS was pretty muted on the day — up 0.27bps to 417.9bps — though on Friday it’s up 19.4bps at 435bps (Markit prices).
The future is already here
So in one sense the Anglo Irish exchange is very different from previous “liability management exercises” — it forces a discount on bondholders rather than a premium. It also smartly ‘persuades’ bondholders to share in losses without going down that Bradford-like regime scheme. Instead, bondholders are asked to vote on changing the terms — thus avoiding unilateral legislative change à la B&B.
While much gnashing of teeth amongst Anglo Irish sub-debt investors — hedge funds and the like — might be expected, we suggest they get used to it. What Anglo Irish are doing here could well provide a future template for those bank bail-ins.
The future is here, and it bites for bondholders.
Related links:
Anglo Irish bondholders asked to share pain - FT
Abramovich vs Ireland - FT Alphaville
Flipping the capital structure – FT Alphaville