Guarantee end to throw up options on Anglo debt
Saturday September 25 2010
Markets like order, and they like information. At the moment we are providing neither and it's costing us dearly.
The end of the State's guarantee of €2.4bn of Anglo's subordinated bonds at the end of the month creates an opportunity to address both issues. This week, holders of the bonds were ringing around London advisers for any steer on where a possible removal of the guarantee leaves them and what could be coming down the line.
The expiration of the guarantee raises the possibility of an Anglo default. A default on unguaranteed Anglo bonds must not be confused with a national default.
But because we still have no legislation in place to manage a bank in default, an unexpected default today could prompt Anglo depositors to remove funds faster than the bank can cover them (a run).
It would also sharply increase the cost of borrowing for the other Irish banks -- just as their debt falls due to be refinanced and could easily spiral into a financial crisis on top of the current economic one.
The taxpayer would have to step in, and start the whole sorry process again.
But there are some smart alternatives. The Government has already indicated it plans a "liability management exercise" for Anglo debt. That is market chatter for cutting debt without going through a default.
Paper exchange
It could try to convince holders of subordinated (junior) bonds to exchange their paper for a smaller number of more senior bonds. Senior lenders might be uncomfortable with that, because it increases the amount of paper at their level. Junior bondholders might go for it, but it's hardly compelling and doesn't really reduce debt.
The easiest way to cut debt is to buy Anglo subordinated (junior) bonds close to the current trading price of 20c in the euro.
A buyback involving a willing buyer and a willing seller would reduce debt without the lender being actually seen to default.
The €2.4bn of subordinated bonds could be bought and cancelled for less than €500m.
Describing the difference as a profit would go too far, but it does limit the downside.
Subordinated (junior) bondholders would welcome it, they benefit because they get cash for bonds on a limited if any market. In a buyback they can probably expect a price somewhere above where the bonds trade today, though not far above, and in the overwhelming number of cases bondholders "book" a profit by selling even if they sell at a loss. That's because they "mark to market", raising and decreasing the book value of their bonds daily or weekly. Everybody wins?
Not quite. Senior bondholders would be unhappy. With €16.5bn of guaranteed senior debt outstanding they fear they too are ultimately at risk. They'd rather not see today's cash leak down the capital structure for fear it won't be around tomorrow. The simple answer is to extend the buybacks into the senior debt, offering market prices to willing sellers of any Anglo bond.
But taxpayers should also have concerns. A buyback that is not part of a coherent plan easily becomes good money after bad, and with a gaping hole in the national finances- €500m is real money.
Buybacks
Buybacks have been done for the banks before. Legally they are uncontroversial, but a really credible buyback requires a stick as well as a carrot. The end of the guarantee provides that, but only if the Government moves to introduce bank resolution legislation quickly.
Legislation setting out clearly how to transfer a bank to lenders without undermining the financial system would reassure markets that the bank system had a solid base while reminding investors that the guarantee was not open-ended. Without new banking legislation, as long as the State is solvent it remains the sucker of last resort, and everybody knows.
A debt-cutting buyback combined with a real plan to restore credibility to the banks, backed up with legislation, would show the wider markets that we are moving out of crisis mode. That could restore some semblance of normality to both the bank system and the national risk profile, and save us the bones of €2bn while we're at it.
Donal O'Donovan was the former debt-restructuring specialist at Thomson Reuters before recently joining the Irish Independent business desk
- Donal O'Donovan
