Oct. 6 (Bloomberg) -- Banks and hedge funds may have to pay out on Anglo Irish Bank Corp. debt insurance after the government insisted holders of its riskiest bonds share the pain of a $47 billion bailout.
The cost of credit-default swaps protecting Anglo Irish’s subordinated notes has more than doubled since Sept. 1 on speculation of a payout. Irish Finance Minister Brian Lenihan said last week that holders of the bank’s 2.45 billion euros ($3.4 billion) of junior notes must take on some of the “burden” of the rescue, raising the prospect of the swaps being triggered.
Ireland is pledging more cash for Anglo Irish after nationalizing the lender in January 2009 as its bad loans mounted following the collapse of a decade-long real-estate bubble. The bill represents as much as 21 percent of Ireland’s economic output, the most for a euro-region bank rescue since the start of the credit crisis three years ago.
“It’s almost guaranteed that there will be an event of default” that will cause the swaps to pay out, said Michael Hampden-Turner, a credit strategist at Citigroup Inc. in London. “It’s almost inevitable that the junior bondholders won’t get paid.”
Net $390 Million
There are 674 credit-default swap contracts insuring a net $390 million of Anglo Irish’s senior and subordinated debt, according to Depository Trust & Clearing Corp. data. It now costs 5.2 million euros in advance and 500,000 euros annually to insure 10 million euros of the bank’s junior bonds for five years, implying a more than 82 percent probability of default, according to data provider CMA.
Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent when a borrower fails to adhere to its debt agreements.
The Irish government pledged as much as 11.4 billion euros to support Anglo Irish on Sept. 30, on top of the 22.9 billion euros it has already pumped in since seizing the lender in January 2009. Lenihan said that, while senior bondholders will be paid in full under the bailout, legislation is being prepared to “address the issue” of junior bondholders taking a loss on their investments.
Ireland will retain the option of asking investors to sell their holdings back at a “very deeply discounted” price, according to Michael Torpey, head of banking at the National Treasury Management Agency, established in 1990 to manage assets and liabilities for the government.
Possible Downgrade
The cost of bailing out Ireland’s banking system has also weighed on the nation’s credit quality.
Moody’s Investors Service placed the nation’s rating on review for possible downgrade yesterday after the government in Dublin pledged as much as 50 billion euros to save the country’s banks. Any downgrade to Ireland’s Aa2 rating will “most likely” be by a single level, Moody’s said in a statement.
Credit-default swaps tied to Irish debt have risen 115 percent since the beginning of August, climbing to 427 basis points, according to CMA. The extra yield investors demand to hold 10-year Irish government bonds instead of benchmark German securities rose to a record 4.54 percentage points on Sept. 29, and was at 4.12 percentage points today, Bloomberg data show.
The Anglo Irish rescue package will cost every man, woman and child in Ireland as much as 7,500 euros. The bailout of Germany’s Hypo Real Estate Holding AG, in absolute terms Europe’s most expensive bank collapse, cost less than 5 percent of the nation’s GDP of 3.4 trillion euros in guarantees and cash injections, according to data compiled by Bloomberg.
‘Lessons of Crisis’
“Anglo Irish is one of the lessons from the crisis,” said Simon Adamson, a banking analyst at CreditSights Inc. in London. “A bank may not be obviously systemically important, yet because it’s a bank that makes it too big to fail.”
The price of Anglo Irish’s junior debt has fallen in past months on speculation holders would lose money in a rescue. The bank’s Tier 2 floating-rate bonds due 2016 have dropped to about 23 cents on the euro, from as high as 42.75 cents in May, according to composite prices compiled by Bloomberg. Tier 2 notes rank above so-called Tier 1 debt in a default.
If the Irish government fails to repay Anglo Irish’s junior notes, investors would then need to ask the New York-based International Swaps and Derivatives Association, which administers the credit-swap market, to declare an event of default that would cause the insurance contracts to pay out.
Game Changer
After the U.K. government nationalized Bradford & Bingley Plc in 2008, it changed the rules to allow the troubled lender to defer interest on its subordinated debt without that legally constituting a default. Its failure to pay still triggered credit-swaps protecting all the Bingley, England-based bank’s bonds in July.
“If the terms of the debt are changed to the detriment of the holder, then that usually constitutes a restructuring event” and triggers credit-default swaps, said Arup Ghosh, a strategist at Barclays Capital in London. “If buyers of default swap protection are subsequently not made whole on their investment, it could damage the credibility of the market.”
--With assistance from Joe Brennan in Dublin and Paul Dobson in London. Editors: Michael Shanahan, Paul Armstrong
http://www.businessweek.com/news/2010-10-06/anglo-irish-debt-swaps-may-pay-out-on-burden-sharing.html