Singeing the bondholders

Malachy Browne reports on the banks and investors keeping the loan pyres burning. 

In a post-bailout interview with Miriam O'Callaghan in late-2010, Brian Lenihan said that one of the contributory factors to our collective economic collapse was that "we all partied". We partied, it was our choice and collectively, the country is now broke.

Well, some of us are more broke than others. News has reached CrisisJam of one party animal stuck in the frenzied revelry of mid-noughties market speculation. Last May, this fellow was approached by Davy Stockbrokers about an opportunity to 'invest' in the one-third nationalised Bank of Ireland. He was offered the purchase of tier two bonds (the infamous subordinated bonds) at a minimum purchase of €50,000. Subordinated debt was risky, but the Bank offered a healthy coupon (or interest) of around 10% annually on the bonds when they matured in ten years. Undeterred, our friend bought €140,000.

He was not alone. Many other like-funded people – "sophisticated high net worth individuals" as described by one banking source – also bought in. The bonds were sold through one of two schemes. The first – with a minimum €50,000 punt - was run by the New Ireland branch of Bank of Ireland. The second, run by Bank of Ireland Private Banking, was open only to existing bank clients and required a minimum investment of €250,000.

In total, over €40 million of tier two bonds was purchased by private money. Not by institutions or pension funds, but wealthy people (though another €1.4 billion was bought by pension and insurance funds).

Things moved swimmingly through June and into July and the bonds retained their value. But as fears emerged that Ireland would default on debt, the interest rate on state borrowing began to rise. It reached an unprecedented 6.5 per cent in September before soaring to the "psychological" landmark of 9 per cent in October.

This took its toll on subordinated debt and by December, Bank of Ireland tier two bonds on secondary markets were trading at around 45 cent (the initial investment being 100 cent per bond).

Davy Stockbrokers picked up the phone once again under orders from the Bank. Our friend was informed on a Thursday in December that the Bank was willing to swap his €140,000 in junior bonds for €70,000 in senior Government-guaranteed bonds to mature in early-2012 with interest of around 7 per cent. The Bank would pocket the €70,000 difference and post it as capital on the balance sheet (conveniently before year-end). He had until the following Monday to decide. He already had his mind made up and after quickly checking with a banking insider (friends in high places) if the offer tallied with market rates, he agreed to the trade in.

A number of events had converged in the preceding weeks to cause disquiet to our erstwhile merrymaker. On 30 September, Brian Lenihan said that "subordinated bondholders would be expected to share in the cost of bailing out INBS and Anglo Irish Bank". Then in December, once the EU/IMF bailout was agreed, Brian Lenihan reported that "big haircuts" would be sought from junior bondholders. The Credit Institutions (Stability) Bill 2010 saw to this. It enabled the Minister for Finance to dispose of any assets or liabilities of a state-owned banking institution that was in the public interest. This included the power to "issue orders, under particular conditions, meaning subordinated bondholders taking a haircut on sums owed. Senior bondholders [would] remain untouched." A manager appointed to a banking institution by Government also had these powers to coerce bondholders into selling.

And then there was Bank of Ireland's motive for the buyback – to meet a requirement to raise new capital of €2.2 billion by the end of February 2011. Against this figure, pocketing a potential €20 million from private investments is a pittance. But the Bank also swapped the €1.4 billion in bonds held by institutional investors, raising €700 million in fresh capital. On 14 January, AIB followed suit, offering to buy back €4.1 billion at 30 per cent of the initial investment. The ratings agency Fitch said that if bondholders don't subscribe, they will be coerced. AIB must raise €6.1 billion in new capital by 28 February.

The banks refer to negotiations on such debt swaps as "amicable discussions". The transaction itself is termed "burden-sharing". The ratings agency Standard and Poor's called it a "distressed exchange". The ratings agency Moody's was more forthright: They termed Bank of Ireland's deal a "default". Brian Lenihan refers to it as a "haircut". Popular economists refer to it as "burning" the bondholders.

As shareholders in Bank of Ireland, the Irish public would be led to believe that we should be happy with this chicanery. Though arguably, "burning" the bondholders is a mite fanatical. "Singeing" the bondholders is probably more accurate.

Brian Lenihan honoured his September promise on burden-sharing. In the event, tier two bondholders in Anglo were forced to sell their bonds at 20 per cent of the initial purchase. But why gamblers should net any return at all is questionable.

Also questionable, in the case of Bank of Ireland, is the hurried trade-in of risky subordinated bonds for Government-guaranteed bonds immediately after the Credit Institutions Bill. Who sanctioned this chicanery and should Government-guaranteed bonds be used in this manner? And why were such favourable conditions offered to the bondholders? 

Moreover, doesn't the very sale of junior bonds say something about Bank of Ireland? That it continued through the crisis not to curtail the sale of risky bonds, but to sell more – this time to individuals, including its own customers? Indeed, do questions of market manipulation arise if Bank of Ireland misrepresented the health of its loan books, as is alleged by Nama?

And isn't it instructive about the degree of wealth in Ireland that people invested €250,000 or more of their own money in this scheme – a gamble on the very banks that created this economic and social mess? It is estimated that the wealthiest 5 percent of households in Ireland hold €122,000 million in assets and wealth. The United Left Alliance suggests that €6 billion could be raised in public finance by imposing a 5 per cent wealth tax on such individuals. Putting money into schools and mental health services instead of risky investments.

But that would be socialism.