Thursday October 28 2010
'WE are not negotiating.' With the kind of bluntness only the Dutch can summon up, Anglo Irish Bank's chief financial officer Maarten van Eden has shown subordinated bondholders in the nationalised bank what the future looks like.
It is a world of discounts, shared pain and creditors' meetings and, from the perspective of the bank and Finance Minister Brian Lenihan, it is all going swimmingly so far.
Anglo is offering to exchange €1.6bn of subordinated debt for new bonds at a rate of 20 cents in the euro as the nationalised lender seeks to generate capital and lighten the load on the citizenry, who are already on the hook for Anglo to the tune of €7,500 per person.
While Lenihan's critics think he should go well beyond just subordinated bondholders and grapple with creditors further up the line, that is a non-runner, especially when you are planning to borrow €20bn a year from these lenders to plug a chasm between spending and tax receipts.
But the move against subordinated bondholders in Anglo and Irish Nationwide is progressing well and there is little sign of elevated funding costs arising from the decision for Irish banks or the sovereign.
What is pushing Irish bond yields out wider this week is not concern over the legal rights of subordinated bondholders in just two non-clearing banks, but concern over the size of the budgetary adjustment required for 2011.
In fact, the move against subordinated bondholders may have provided something of a booster for the sovereign, indicating that the capital requirement for Anglo is going to be less, rather than more, as a result of the move.
The bondholders themselves have hired a legal firm and are wailing about the way creditors are being treated, while depositors are being protected.
Of course, not all creditors are being hit with such a savage exchange offer and debt holders in most of the entire Irish financial system are not in any way having their holdings eroded.
The public were curious to find out who was taking the losses on the subordinated bonds? Most observers expected to see the pages of the 'Financial Times' dripping with pathos as little old ladies from small German towns came forward to talk about their pensions being ruined because of the haircut being imposed on their investments.
But instead, in a publicity coup Lenihan's staff could never have conceived of themselves, Russian oligarch billionaire Roman Abramovich stepped forward to talk of his deep sense of loss at the plans to impose discounts.
His asset management company Millhouse has talked of reputational loss for Ireland from the move.
That may be the case, even though Irish Nationwide was until a year ago a private commercial company with not a cent of equity from the Irish government.
The financial world is full of investment punts of various hues.
But any rational person who bought a deeply subordinated bond in Irish Nationwide was taking what could mildly be described as an investment risk. A risk that should be insured for too, through a credit default swap.
Irish Nationwide has been massively loss-making since 2008 and even at that stage everyone knew its property exposures were truly terrifying (of its €10.4bn loan book in 2008, €8.1bn was accounted for by commercial property).
But apparently holders of subordinated bonds in the building society, like Millhouse, were expecting some new "strategy'' that would re-invigorate the property-laden company and protect all its creditors.
This was even though the society had become a national corporate governance joke, with its current management team claiming only two people used to manage its entire UK loan book.
So far, the jilted bondholders have filed no legal papers and produced no convincing argument why they should get back par value.
It has taken him a long time but Lenihan has finally picked a row with bondholders he has every chance of winning.
How do you convince $82 trillion (€60 trillion) worth of investors you are doing the right thing?
With great difficulty , the Government is finding out.
The depth and scale of the global bond market is such that it does not speak with one voice.
Attempts by the Government to "win over'' the bond market may be doomed to failure because the market is so atomised and consists of millions of different investor types, all with different financial world views.
There's no pleasing the markets
Some think the Irish Government should front-load its deficit reduction plan, some think tax rises are the best approach to closing the gap, others believe expenditure reductions are better.
The Government may have foolishly believed that winning over the bond market was all about showing your bona fides on spending cuts. But, in fact, 10-year government bond yields rose by 30 basis points last week when a total adjustment of €7bn was first mentioned.
"There is this central question of where does growth come from,'' one concerned bond trader said this week.
One must have a little sympathy for the Government on this.
If you give bond markets what they apparently demand -- drastic cuts in spending -- then those markets start to worry about the impact on growth.
If you delay and soft pedal on the cuts to protect growth, they then switch to worrying about the deficit.
It would drive one to drink.
