Can we make the bondholders pay?

Bank Bond Holders

I can understand the rationale behind the Irish Govt. guaranteeing funds on deposit with Irish Banks.
But the Irish Banks borrowed some 90 Billion from International Bond Holders and I see from the letter from 46 Economists in todays Irish Times that
".... most of the bonds are in great part covered by the 2008 State guarantee ."
Why should the Irish tax payer guarantee the investment from these international investors , when they were aware of the risks wen they made their high yielding investment ?

darag said:

And yes I agree that one of the most important issues is whether the bondholders can be made take some of the hit. But we haven't even gotten to ordinary bondholders yet. The current NAMA plan allows the shareholders and the unsubordinated bond holders to keep all their money.

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I have raised this issue in other threads but it has tended to get choked off by other aspects. We need a clear honest answer to this. Many academics have publicly called on the bondholders to take the hit and Fine Gael has latched on to this. The official line seems to be that this would be disaster though it has not really been explained why. My take is as follows:

Shareholders are fair game, have already taken a major hit, and in my view no one could argue if through temporary nationalisation they lost everything.

But bondholders have a completely different legal status. If a company defaults on its bonds that company is bankrupt. That means liquidation/receivership, forced sale of assets etc. The deposit guarantee would be fully triggerred.

In non bank cases (e.g General Motors) this threat of, or actual, receivership can be used to negotiate bondholders to accept the best of a bad lot by doing some equity swap deal.

But in the case of the banks the bondholders hold all the cards, they know that the threat of liquidation is not on.

A lot is made of the fact that these bondholders knew the risks they were taken and so should now suffer. But these bonds carried almost Irish sovereign credit rating. They (the market) knew that at least for the big two defaulting on bank bonds was equivalent to sovereign default i.e. the final meltdown.

Or maybe I have this all wrong, after all Brian Lucey is much more learned than me. Maybe we can simply nationalise the banks, tell the bondholders to sod off and then start all over again.

Duke, I fully agree with your points re bondholders in the banks. One of the most important issues in the whole nationalisation/NAMA debate and one which is very frequently overlooked is liquidity and funding. As a nation we rely on huge amounts of foreign investors to fund our country's banks and government debt. This will continue to be the case in our post recovery phase. Nama will provide a huge one off liquidity inflow to the Irish banking system. Our focus and that of the press, politicians etc sjould be to encourage/demand that that is lent out to support businesses and jobs. The banks should be given new lending targets related to their NAMA liquidity inflow. (not let them just drop deposit rates)

Next to the bondholders and the banks.
1) If the banks were nationalised it would take a very long time for international investors to trust and invest in Ireland again.
2) The cost of government borrowing would increase
3) The government would struggle to meet its borrowing requirements as a) there would be no Irish banks buying and b) international investors wouldnt invest on the scale required
4) So far the NTMA has raised approx €22bn out of a full year target of €25 bn
5) We need access to that funding to buy time until the business model that is Ireland inc is back on its feet.
6) We also need access to international capital and therefore we need to be careful not to take rash actions against these stakeholders

On a final point re NAMA , in my opinion the taxpayers will be taking the risk either way i.e through NAMA cost (yet to be determined) or through sustained levels of high unemployment. Taking a practical perspective we need to get the Irish banks lending in Ireland ( there will be no foreign competition) , for that the banks need to rebuild their profitability and the Govt should use its stake and position to push lending targets. The quicker this happens the better the prospect of reducing the final NAMA costs.

Both very good posts. I am sick of tired of peope saying the banks should be allowed fail or that bondholders should be made pay. As pointed out above, we need international investors alot more than they need us. They will survive writing off their Irish Investments but it will be a long time before we see them in this Country again and we can't survive without them.

Right now the priority is fixing the problem. I don't necessarily like NAMA but I have yet to see a more attractive alternative despite the political rubbish being spouted by Labour and FG. NAMA can be improved but the concept is the correct one.

Duke of Marmalade said:

But bondholders have a completely different legal status. If a company defaults on its bonds that company is bankrupt. That means liquidation/receivership, forced sale of assets etc. The deposit guarantee would be fully triggerred.

In non bank cases (e.g General Motors) this threat of, or actual, receivership can be used to negotiate bondholders to accept the best of a bad lot by doing some equity swap deal.

But in the case of the banks the bondholders hold all the cards, they know that the threat of liquidation is not on.

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Good thread.

Any liquidation/receivership would have to be timed to occur after the expiry of the guarantee. Otherwise the government picks up the entire tab and so it would achieve nothing.

This will mean the government will probably need to continue to inject capital to carry the bank or banks over the finish line. It would be important to ensure that this capital be in the form which has priority at least with existing bondholders.

I think it is worth separating the bond classes in this discussion. Subordinated bond holders should not be treated in the same fashion as the rest; they have been receiving excess coupons in exchange for relinquishing their priority in the event of collapse. I feel that they should be first in line to lose their stake. It is likely they would be completely wiped out. I don't think the sums are huge though.

I believe that all depositors should be paid fully but not completely at the expense of the ordinary bond holders. I actually believe that the government should cover the depositors and then join the rest of the bond holders to share the pain of the inevitable haircut.

It is important to point out that we are not talking about wiping out regular bond holders - we are talking about a haircut. I can't imagine the hair cut would be greater than 25% but I haven't done the sums. This would not be catastrophic - most of these bond holders would be long-term earning relatively high coupons - so maybe they lose 3 or 4 years worth of coupons. Not the end of the world, surely.

I very much doubt that any bond holder would have any interest in maintaining any of the smaller banks as going concerns. The costs are too high and the economic/business prospects are not too enticing. I estimate that keeping Anglo running for example costs at least a quarter of a billion maybe even half a billion a year.

I notice after I opened this thread that today's IT is in fact somewhat dominated by this very point.

Brian Lenihan has written a very helpful open letter to his pal Enda Kenny which nearly answers my question. As darag says, there are bondholders and bondholders. If the T&C of the subs allow waiver of interest or even repayment then BL says that will happen and crucially will not constitute a default.

If the bonds rank with deposits, then even to suspend interest payments constitutes a default. According to BL, and he is supported by an opinion piece in the same paper, any default would be a catastrophe. It seems we just have to keep faith with international bondholders or else the costs of funding Ireland Inc will completely balloon or not be available at all.

It is the case that a decision has been made, as part of the State Aid submission made to the EU, not to make interest payments on certain subordinated debt of Anglo Irish Bank, but this is a very different situation.


First, the market does distinguish somewhat between senior and subordinated debt, and secondly subordinated debt of its nature carries with it different sets of terms and conditions, such that interest payments can in appropriate circumstances be deferred or left unpaid.


This is not the same as a default and certainly does not impact on any debt currently guaranteed by the Government.


This subordinated debt is different from senior debt which includes other types of bonds, such as certificates of deposits and commercial paper. Senior bonds are not part of the banks’ risk capital – they are part of the banks’ normal funding in the same way deposits are. Generally, they rank equally with ordinary deposits in a wind up situation, and they are issued at interest rates that reflect their much lower expected risk profile compared to subordinated debt.

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How much of these bonds are out there?
Are they trading at a discount?

If a bond paying 5% on nominal, is trading at 50% of par, then presumably the state, through the Pension Reserve Fund, should buy these bonds.

The government should not do anything to increase the value of these bonds e.g. by an early announcement of an extension of the government guarantee.

As I write this, I think we might have had this discussion before on Askaboutmoney.

Brendan

Re: Bank Bond Holders

Further thoughts on Bond Holders
1 ) Irish Banks not lending
Irish Govt, invests capital into banks
Banks then use this money to buy back the loans from Bond Holders ( yes at a discount ) .
Time for the men with white coats ?
2 )Do Bond Holders not bear a share of responsibility for property bubble with their irresponsible funding of Irish banks ?
3) How about equity for debt with bond holders ?
4) Can we trust the bank linked economists when they tell us of doomsday consequences if we force Bond Holders to compromise seriously ?
5) These Bond Holders lent their funds to commercial banks not to the Irish State.

North Star said:

1) If the banks were nationalised it would take a very long time for international investors to trust and invest in Ireland again.

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Sunny said:

They will survive writing off their Irish Investments but it will be a long time before we see them in this Country again and we can't survive without them.

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Is there any evidence or precedents to support this contention that they won't invest in Ireland again? How do you know?

I take a lot of these warnings with a very large pinch of salt. These investments aren't driven by emotion. Most of the investment decisions are being driven by software. If the return is going to be there, then the investment will come.

You are correct, international investers will/should base their investment judgments on logic. By the same logic if the risk of investing in Ireland were to rise either via a perceived failure of the banking system (nationalisation) or by forcing bondholders accept a debt/equity swap; bond holders will either need an increased premium which translates into higher costs for all of us or they can simply choose to invest elsewhere.

Complainer said:

I take a lot of these warnings with a very large pinch of salt. These investments aren't driven by emotion. Most of the investment decisions are being driven by software. If the return is going to be there, then the investment will come.

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Precisely; I have no idea where this doomsday idea that investors would never put money into Irish enterprises ever again if the holders of the banks' bonds had to take a haircut.

Does anyone have any international precedent to support this view? Because I don't know of a single case.

I would demand proper evidence rather than a feel before feeling comfortable compensating these investors with 10s of billions of tax-payers' money.

I know that investors have quite short memories even in the case of the government bond default in Russia. Even the serial offenders in the South America seem to attract investors after a year or two. And in fact these are extreme cases which involve default on government bonds. Bondholders take haircuts all the time without anyone seriously arguing that the government step in to compensate them in order to "encourage future investment".

Price can be taken as empirical evidence. The price of Irish Gvt credit default swaps has narrowed from 262 bps in March to 169 bps currently. ( Source Bank Credit Analyst- an independent internatnal research house) How much of this we attribute to increased confidence in our national and bank solvency as a direct result of NAMA and how much we attribute to general credit market recovery we can debate about forever. For arguments sake lets assume NAMA has accounted for 25% of that recovery i.e 23bps. For a full year borrowing requirement of €25bn that saves the Govt €57mio. If we assume a stable €25bn Govt borrowing requirement for the next 5 years total savings would be €687 mio. This figure is a loose calculation assuming all debt issued remains in issue.

There is an even greater CDS price contraction for AIB and BOI approx 300bps narrower than in March, however the banks have not been able to issue significant levels of long term debt to take advantage of this yet.

According to Davys foreign banks provide over 33% of credit in Ireland. Many want to withdraw from the Irish market. Over time the remaining Irish banks will need to lend to replace this 33%, otherwise the economy will be starved of credit with dire consequences.
I agree that many of the negative comments about banks and bond holders are factually accurrate and the principals behind the sentiment are correct in theory. However theory doesnt help in the real world we live in. Ask any employer/small business what they need to survive and grow; the answer will be credit availability and revived consumer spending. Both depend on the banks being able to lend, not only at their normal levels but also to take up the slack from overseas banks withdrawing. I wish more of the debate in public and even on AAM was focused on solving the problem of how to to get credit flowing and the banks lending (for all of our benefit) rather than looking to punish them and other stakeholders for past mistakes and at the same time hugely damaging our economy.
There is evidence of the damage not having a domestic banking franchise. Ask Mike Soden ex BOI boss what happened when the Kiwi banks were bought by the Aussies.
The New Zealand economy was severly hit as the banks contracted credit in NZ at a far higher rate than in their own market. And that wasnt at a time when the global economy had gone through such a severe concerted downturn.

If you want to punish the banks fine but make sure the punishment doesnt kill the economy. Why not introduce lending volume targets related to the NAMA liquidity inflow that the banks will benefit from?

I dont think anyone can provide firm evidence but I think it is reasonable to assume that large foreign banks wont be attracted to Ireland as a key market for retail/sme lending due to our specific challenges and the fact that our economy is too small to deliver economies of scale. We are going to have to help ourselves to get the economy back on track. Lets have more of a practical solution based debate as how best move forward, not a backward looking critique.

darag said:

I know that investors have quite short memories even in the case of the government bond default in Russia. Even the serial offenders in the South America seem to attract investors after a year or two. And in fact these are extreme cases which involve default on government bonds. Bondholders take haircuts all the time without anyone seriously arguing that the government step in to compensate them in order to "encourage future investment".

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What bank bondholders have taken a haircut? Even if for some strange reason they decide to take a haircut, this probably constitutes a restructuring event in the CDS market so it would be a default and the ratings of the Irish banks would plummet below investment grade. This will cut off access to capital markets or as Northstar says would lead to the banks paying a massive risk premium to get funding. This will delay the recovery of the banking system and the economy because the banks will struggle to access funds or be able to provide money into the economy or if they do, at a reasonable cost.

I will open myself to dogs abuse and admit I work for a foreign financial institution managing a fixed income portfolio that includes Irish Government and Bank paper. I accept all the negative comments about bondholders and I don't expect to be bailed out by the taxpayer but I do expect to be treated the same way as other unsecured creditors. People need to remember that bondholders simply provide banks with funding for their day to day operations. We don't invest hoping to double our investment as the most we will ever get back is par so I don't see why bondholders are being held up for such criticism by people like Enda Kenny.

Punishing everyone might feel better for a few days but we are the ones that will pay the price in the long term.

North Star said:

Price can be taken as empirical evidence. The price of Irish Gvt credit default swaps has narrowed from 262 bps in March to 169 bps currently. ( Source Bank Credit Analyst- an independent internatnal research house) How much of this we attribute to increased confidence in our national and bank solvency as a direct result of NAMA and how much we attribute to general credit market recovery we can debate about forever. For arguments sake lets assume NAMA has accounted for 25% of that recovery i.e 23bps. For a full year borrowing requirement of €25bn that saves the Govt €57mio. If we assume a stable €25bn Govt borrowing requirement for the next 5 years total savings would be €687 mio. This figure is a loose calculation assuming all debt issued remains in issue.

There is an even greater CDS price contraction for AIB and BOI approx 300bps narrower than in March, however the banks have not been able to issue significant levels of long term debt to take advantage of this yet.

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This only tells one side of the story. It tells you that market prefers NAMA to the vacuum that went before, but it doesn't tell you anything about how the market might view the alternatives, such as making the bondholders pay along with either FG's 'good bank' or Labour's temporary nationalisation.

Complainer said:

This only tells one side of the story. It tells you that market prefers NAMA to the vacuum that went before, but it doesn't tell you anything about how the market might view the alternatives, such as making the bondholders pay along with either FG's 'good bank' or Labour's temporary nationalisation.

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Seriously how do you think the market react if they announced that senior bondholders will be forced to pay even though there is no legal obligation on them to.

Sunny, surely when investors put their money into shares or bonds, they accept there is a risk. There seems to be some suggestion in the media that if these investors are wiped out, in the future people would not invest in our banks even after they were cleaned up and therefore all the risk to dispose of these bad assets should lie with the taxpayer.
I am not into bashing share/bondholders but I do not think it is fair that the burden is placed on the taxpayer.

On a side note: the government is going to have to make some pretty tough decisions in the next couple of budgets and if NAMA is put through in it's current format, I think it will be virtually impossible to get people to accept whats coming down in relation to social welfare cuts, property tax etc

Sunny said:

Seriously how do you think the market react if they announced that senior bondholders will be forced to pay even though there is no legal obligation on them to.

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How do you think the taxpayers will react if they are forced to pay, even though there is no legal obligation on them to do so.

There are no easy solutions here, and the bondholders have to take their pain.

Shawady said:

Sunny, surely when investors put their money into bonds, they accept there is a risk.

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But what is that risk? They made a judgement that at least with the Big Two they could not be allowed to go into liquidation. So the risk was that they would be nationalised and that the Government, as is its right, would legislate to selectively screw the bondholders. That was the risk they took and they still take that risk no more than holders of Post Office Savings Certificates take a risk that they might be defaulted.

The Government (as indeeed the private individual) always has a choice - to default and hope it will soon be forgotten - or to defend the national credit rating. That choice should be taken on purely financial grounds. Russia, Argentina, Iceland have decided that default was the lesser of two evils. Has Ireland reached that stage? FG thinks yes. FF thinks no. It is a judgement call, and I think and hope that FF are right.

Complainer said:

How do you think the taxpayers will react if they are forced to pay, even though there is no legal obligation on them to do so.

There are no easy solutions here, and the bondholders have to take their pain.

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No-one is suggesting there are easy solutions but people need to get their head around that we need to have a functioning banking system with access to capital markets if we are to ever hope for economic recovery. For the Irish Government to unilaterally rewrite creditor agreements with senior bondholders would cause untold damage. I don't expect you to believe me but I can assure you that it would. No Government has done it with senior debt holders. Even if you look in the UK and at someone like Northern Rock and Bradford & Bingley which were nationalised they have hit the subordinated bondholders somewhat but the Government has cleary stated its intention to support senior creditors.

Sunny said:

No Government has done it with senior debt holders.

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So how do we know what damage it might or might not cause?