# Bruton claims that €30b in bonds is not guaranteed past next year?



## Brendan Burgess (15 May 2009)

Richard Bruton claimed in the Dail yesterday that €30b in bonds is covered only up to 30 Sept next year. 

If this is true it is hugely significant and would be a big reason for not nationailising the banks. 

I raised this before on Askaboutmoney and was told that Irish banks' bonds were trading at par, so it was assumed that they were guaranteed.

Does anyone know if it is true?


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## jpd (15 May 2009)

The Government guaranteed all deposits and bonds in Irish Banks for two years (see here http://www.rte.ie/news/2008/0930/economy.html )

If they hadn't it looks like Anglo, AIB and BOI would have folded.

Of course, that begs the question - what will happen on 30th September 2010 ?


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## room305 (16 May 2009)

jpd said:


> Of course, that begs the question - what will happen on 30th September 2010 ?



They will extend the guarantee.


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## z109 (16 May 2009)

Um, I'm not sure if he is telling the full story. The banks have issued about a fair amount in bonds that will fall due in August/September next year (i.e. before the guarantee runs out). Those bonds have defacto AA/AAA status (depending on which rating agency you look at) status as being backed by the Irish government. So they will indeed be trading at decent levels (similar levels to Irish government debt of the same vintage). The rest of the bonds that the banks have outstanding are also guaranteed up to this point, but expire after that date and are trading at somewhat less then par, I believe, but I haven't seen any prices lately. I can't remember how much this is, though.

AIB have (or had at 31 December 2008):
9.6 bn in senior debt
21 bn in certificates of deposit and commercial paper
7.2 bn in asset covered securities
All of which, I believe, are covered under the guarantee (in addition to 25.6 bn in deposits from other banks and 92.6 bn in customer accounts).
(Taken from the 2008 final results).

The figure of 30 bn issued under the guarantee looks a little high if that is what it he means? (i.e. issued after the guarantee came into effect and due for repayment before the end of the guarantee). But maybe not if you take commercial paper into account aswell. 

Whatever, there is going to be a funding crunch if the guarantee is not extended in some form or another. The former chairman of INBS has already said that they (INBS) would be bust if the guarantee is not extended. I suspect the other banks are in the same position...


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## OPTIMUM (16 May 2009)

We will know for sure by August this year, when banks have bond maturities and have to issue new ones for at least one year in term....if we get a soverign downgrade by then you can expect margins on loans and mortgages to widen out to pass on the pain.


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## Brendan Burgess (16 May 2009)

Yog

All of the debt is covered by the guarantee...but only until September 2010.

Can you tell from the AIB accounts how much of it will have the guarantee expiring? 

Is this then the best argument for not nationalising the banks? It gives the government the option of not extending the guarantee.

Could the government not extend the guarantee selectively? 

Where can you monitor the prices of these bonds? 

If they fall significantly below par, couldn't the government buy them? 

Brendan


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## z109 (17 May 2009)

Brendan said:


> Can you tell from the AIB accounts how much of it will have the guarantee expiring?


All of the commercial paper, most of the deposits and all of the repos will expire before the guarantee. My guess is that it will be refinanced, but at increasingly shorter durations to coincide with the expiry of the guarantee. (So a six month commercial paper sale that expired in May 2010 will be refinanced as a four month one). 

From p.216 there's 4.5 bn in subordinate liabilities and other capital instruments which either does not expire or is dated for five years or more (from end 2008).

I recall that AIB issued bonds under the auspices of the guarantee that were dated to September 2010, but can't find them in the annual report, so they may have been this year? (This is a problem for all of us in keeping track of the current situation in the banks, much of the activity is outside the reporting periods. We'll have to wait for trading updates?).

This is assuming that there is no announcement on a new guarantee.



> Is this then the best argument for not nationalising the banks? It gives the government the option of not extending the guarantee.


I don't know that it's the best argument, but it's certainly a good one. To me the best argument is that the banks will be able to fund the deficit as private institutions where they might not be as state ones. But it certainly gives the state the option to put a 'better' guarantee in place - 
- more limited liability - 'new' issues only, limited issue types
- better value for money for the state - reflecting the increase in cost of state funding and the loss of the AAA rating

With the current state of the proprty market (in particular the commercial property market) in the countries that the banks have lent in, the unemployment situation in those countries, and the 'shortage' of cheap capital, I can't see the banks being able to survive without the guarantee never mind prospering the way that many want them to.



> Could the government not extend the guarantee selectively?


Yes. I think this the only sensible thing to do. What will be interesting is what they do with the deposit guarantee in particular. At the moment, deposits are still flighty, so any dilution could have stability consequences. Not guaranteeing existing, but guarantee new bond issuance is a bit of a no-brainer, really and is what they should have done in the first place (like the Germans did) and guaranteeing for a range of maturities to avoid a refinancing crunch (like the Germans did).



> Where can you monitor the prices of these bonds?


I believe they're quoted on the ISEQ, but you need to know the code to reference them. They are, I believe, quite thinly traded so there is only the odd reference sale. If they had to be sold in bulk, the price would likely be quite different to that of the reference sales. But I'm not a trader and don't have a Bloomberg terminal to see...



> If they fall significantly below par, couldn't the government buy them?


All bonds trade above or below par depending on the coupon, the time to maturity and sentiment. Par is only a useful concept if you are holding to maturity. Otherwise, price/yield is the thing to look at. So if the face value of a 2% coupon bond is 100 euro, and the bond is sold for 90 euro initially and the duration is ten years, the yield is 3something% ((100-90/10)+2%). There's a formula for working it out, but I can't either find it or get my head fully around it (despite having kind posters here and elsewhere point it out to me! Apologies if I have it wrong again!).

But you get the idea - the current yield is based on how much the bond pays you plus what you pay for the bond. And that price, more or less, is dependent on demand. So if the government started to buy bank bonds, the price would go up (even if no-one knew it was the government buying).

It's one reason I intensely dislike the ability of companies to make an accounting gain based on how much it would cost them to buy back their debt vs. how much that debt is worth at hold to maturity. If a company started to buy back debt, the price would increase, so the accounting gain is a fiction. Further, if the company can afford to buy back its own distressed debt, then it is not in such dire straits after all, so there is less reason for the debt to be distressed.

(Sorry about the ramble!)


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## Brendan Burgess (17 May 2009)

Hi Yog

That is a very useful ramble and makes sense.

I am not sure I  agree with the last bit though:



> Further, if the company can afford to buy back its own distressed debt, then it is not in such dire straits after all, so there is less reason for the debt to be distressed.



If the markets decided that the debt of, say CRH, is stressed and priced it at a very high yield, then CRH would be wise to take advantage of this by buying back the debt. They are going to have to repay the debt anyway, so if they can buy it cheaply, they should do so.

Buying it would presumably reduce the yield to normal levels which would make CRH more attractive if they wanted to raise debt again. 

Likewise, if the debt of AIB and Bank of Ireland is yielding higher than the government can currently borrow at, then the government should look at buying it. Especially if the government intends to guarantee it anyway.

There might be a bit of "insider trading" here though. If the government announces that it is not guaranteeing this debt and it falls in price, then the government could be accused of rigging the market. 



Brendan


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## Brendan Burgess (17 May 2009)

Karl Whelan says the following on irisheconomy.ie 



> In our current circumstances, the almost-blanket guarantee on liabilities agreed on September 30 ...



Clearly, he does not believe that there is €30billion of bonds not covered by the guarantee.

brendan


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## Brendan Burgess (17 May 2009)

Brian Lucey says later in the same article:



> 1)
> As of now, from Reuters, AIB have 17b total debt instruments outstanding. Of these teh subordinated notes (4b) are trading at 30-60c on teh euro. The 8b of Senior Debt is trading better but that is mostly coming from the guarantee as they are mostly within the guarantee and are mostly for liquidity purposes as I noted


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## Sunny (18 May 2009)

I have heard the the guarantee will be extended to allow banks raise longer term finance in the next few months. I have heard 2014/15 being mentioned. I can't post links but thats the rumour out there. 

As for buying back debt. There are also rumours that AIB and probably BOI are looking at buying back their sub debt or more than likely do an exchange as is the norm across Europe now. The main reason for this though is that it would generate capital for the banks. There is no real reason for the banks to buy back their senior debt even if it is trading at distressed prices. Mainly because investors are unlikely to sell senior debt at those prices especially while a guarantee is in place.

I have bloomberg here. I will have a look when I get a chance and post some prices for benchmark issues in the two main banks.


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## Sunny (19 May 2009)

Bank of Ireland announced a Tier 1 debt buyback. 

[broken link removed]

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Price really sucks!!!! AIB will have to follow.


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## North Star (19 May 2009)

The non core Tier 1  buyback / tender makes sense as the improvement in profit more than offsets the redemption of the Capital. Net net BOI and other banks who can do this succesfully will have an improved Capital position, which can/may be used to support current/new lending.
Additionally the current capital investors will now have reduced exposure to BOI and they may purchase new debt or capital at current prices.
The fact that this can be done highlights the lack of liquidity and stressed conditions in Capital Markets worldwide


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## Brendan Burgess (19 May 2009)

Could the NTMA have done this instead, given that the taxpayer is sort of guaranteeing those bonds anyway?


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## Sunny (19 May 2009)

Brendan said:


> Could the NTMA have done this instead, given that the taxpayer is sort of guaranteeing those bonds anyway?


 
They were Tier 1 securities Brendan. They weren't covered under the guarantee which is why investors will probably sell to get out of or reduce BOI exposure as NorthStar says. The whole point of the exercise is that the Banks can realise the profit from the buy back and add it to core tier 1 capital.


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## z109 (21 May 2009)

Just by way of explanation, Tier 1 debt is, to my understanding, 'pseudo-equity', that is, it is early in line for losses. As such, it is normally expensive. I believe BoI issued some of this tier 1 a couple of years ago with a coupon of 9.25% (but that could be my memory playing up!). I believe it is excluded from the guarantee under the "equity-like instruments" clause. Apologies if some of this is incorrect, clarifications welcome.

I don't understand how this can improve BoIs position with regard to taking losses - they are effectively swapping 3 bn of equity for 1.6 bn? They can also realise an accounting gain, I suppose?

WRT Mr. Bruton, I believe he is saying there is 30 bn in debt that will be due on or near the end of the guarantee and so will need to be refinanced or paid down. In the absence of a guarantee extension, that refinancing looks unlikely?


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