Strife of Brian

Last Updated: Fri, Nov 26, 2010 19:20 hrs

Irish banks: Ireland’s finance minister may be about to pull off a huge U-turn. Brian Lenihan has spent the last few weeks assuring senior creditors in Irish banks that they will not be forced to take losses in the country’s expected bailout. Now, reports suggest exactly that kind of thing is being considered. The bond market has recoiled.

Lenihan’s sudden application of the handbrake could be because he is no longer the only one at the wheel. Ahead of an 80 billion euro to 90 billion euro rescue, the International Monetary Fund and the European Union are debating how to finance it. It is they who think senior creditors should bear some of the pain, the Irish Times reports.

Morally, they are right. Creditors in bust institutions should not expect to be made whole. The three biggest lenders — Anglo Irish Bank, Allied Irish Banks and Bank of Ireland — hold 54 billion euros of senior debt, of which 15 billion euros is unsecured and unguaranteed by the state. A 15 per cent haircut on the unsecured piece, to roughly where the bonds were trading before today, would magic up 2.3 billion euros of equity. But forcing this would involve legal hassle, and could fan contagion.

A debt-for-equity swap might work better. Offering BoI and AIB holders the chance to tender 15 per cent of their senior debt for equity would give them the market value of their debt plus some equity upside. If the intention was to raise substantial equity this way, the guaranteed bondholders could also be targeted — for example, by renewing the guarantee on a portion of the debt only. And a swap might be achievable without coercion. Senior holders might play ball because doing so provides some chance of getting all their money back.

From Ireland’s point of view, it’s hard to argue with the idea, which would share pain all round. But what works for Ireland could wreak havoc elsewhere. Even if the swap — or a tender to buy back debt — is presented as a choice, holders would only play ball if they thought a more penal haircut lay in wait. Merely the suggestion of this could undermine confidence and keep wholesale markets shut for periphery EU states. AIB and BoI senior debt fell sharply on the report, so creditors might now accept a deal when offered. But the bailout mission may have opened Pandora’s Box.

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