Irish Bond Haircuts: Too Little, Too Late

The justification for Lenihan’s ruinous guarantee of both bank deposits and senior bondholders was partly a legal one. Irish law, like UK law, makes it hard to favour depositors ahead of bondholders; so FDIC-style resolutions aren’t an option. One might object that laws can be changed by sovereign governments, but the other justification was political: big haircuts would have transferred losses to the UK and Eurozone financial systems.

The political objections to a haircut have diminished, or rather, the futility of trying to avoid one has become evident, as the monstrous scale of the resulting problem for the Irish sovereign has become more and more obvious to all over the past year or so. Now the outgoing Irish government has cobbled together a mechanism by which some bondholders could be haircut:

Stockbrokers are this weekend warning senior bondholders in Anglo Irish and Irish Nationwide to brace themselves for writedowns after the government moved to sell off the banks’ €14bn deposit book last week.

Fine Gael’s Michael Noonan, the man most likely to be the next finance minister, gave a strong indication yesterday that once the deposits are removed, reductions of some sort are likely, but only with agreement from Ireland’s EU partners.

“Deposits and senior debt rank equal in creditor status, so you can’t haircut senior debt without haircutting depositors,” said Donal O’Mahony, global strategist for Davy.

“However, if a bank’s balance sheet is restructured so that depositors and senior debt holders are separated, such as through a deposit book disposal, then senior debt is left on its own at the top of the balance sheet — and is vulnerable to politicians’ errant ways.”

Well, errant ways or belated realism, take your pick. One wonders how much of the EUR14Bn were Anglo liabilities – you’d think those depositors would have long since panicked and fled.

Over in mainland Europe, they can see which way the wind is blowing: the Irish corporation tax rate, (reluctantly) assented to by Europe back in December once the ‘no haircut’ commitment had been reaffirmed by the Irish Government, is now being bickered over again. It’s pretty obvious that a haircut is coming. According to the Irish broking firm, Goodbody, via FT Alphaville, there’s about EUR21Bn of unsecured debt that could be haircut. Yet it’s hard to see how even (a highly improbable) total wipeout of EUR21Bn would help all that much. As well as the EUR150Bn of toxic debt they’ve gradually been owning up to, Irish domestic banks had suffered about EUR19Bn of deposit run by the end of the year:

Because we don’t have a breakdown between deposits at the six State-guaranteed institutions and the other 14 institutions serving the local economy, we probably can’t get at the information most people want. But I would suggest that the next best indicator is the private sector deposits held at the 20 domestic institutions which fell by €19bn in 2010 and €3bn in December to leave a year end balance of €157bn.

By the way, Ambrose’s scary EUR110Bn of deposit flight during 2010 is for all financial institutions in Ireland, most of which (foreign subs) are not part of the Irish Government’s funding problem, though the scale and acceleration of the flight certainly illustrates the loss of confidence. More and more convoluted means are being employed to paper over the domestic cracks: lots (EUR130Bn?) of ECB support of course, but also some very dodgy looking self-issuance:

Alas, it seems that alternative funding has in fact increased by €14bn with banks “self-issuing” debt to themselves and converting it to liquidity at the ECB.

The numbers just keep getting bigger, in a way that makes you wonder just how much determination is going to be required of the ECB. Namawinelake again (he manages to keep track of both the murky finagling and the bigger picture, somehow: a star):

There is only a finite amount of funding in Irish banks that will need continuing ECB and CBI support for replacement should it “flee”, but at €429bn in the 20 domestic banks, are the ECB/CBI’s pockets deep enough?

As for the total sovereign liability that is brewing up behind all this, Namawinelake also has some handy rough workings, in a comment to one of his own posts:

The real question is what will happen with ECB operations that see €100bn in our banks at present, how long can this emergency funding continue (it started in Sept 2008 in earnest) and will part of that end up on the national debt? So general govt debt of €148bn in 2010 + €43bn deficit 2011-2014 + additional capital for banks (€35bn earmarked of which €25bn is described as a contingency) + debt redemption nil (rollover) + NAMA €45bn (€40bn bonds including pyt for sub-€20m exposures and €5bn development debt) + swapping of ECB/CBI ELA for national debt x,

So €271bn + x for ECB/CBI ELA swap for general government debt
Obviously NAMA will have some value as will ELA and we start off with some funds in the NTMA/NPRF so the net will be less than that , but I would have said €220bn as a rough ballpark.

That’s a 50% increase in the Irish debt by 2014; comfortably the wrong side of the event horizon. Goodbody, via FT Alphaville, has this to say about that drop-in-the-ocean EUR21Bn that might be haircut:

As a rule of thumb, every 10% haircut on the unguaranteed, unsecured bank debt is equivalant to 1.3% of GDP. We would note that the longer the process goes on, the less incentive there is to burden share with senior, unsecured, unguaranteed bank debt holders. Time is of the essence.

Well, the Irish government had a couple of years to sort out something better. It’s far too late now, and the bailout is going to be retraded, with the usual Eurotheatrics, soon.

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  1. Richard

    One area that has not been looked at, but might prove very interesting is the gradual movement of the ECB’s exposure to the Central Bank of Ireland.

    The Central Bank of Ireland’s exposure grew dramatically at year end and has expanded since then. The reason cited for this growth is that the quality of the assets funded by the CBI did not allow these assets to be pledged to the ECB.

    What happens if CBI were to fund 100% of the “bad” assets?

    Is there a need for a bailout?

    1. Richard Smith

      As an official, semi permanent policy, that would go down unbelievably badly with the Germans, I suspect. In fact I’m surprised they aren’t making more of a fuss about the CBI’s emergency liquidity support already. Both the ECB and the CBI have already ended up doing things that stretch their mandates, that’s for sure. I’d read the exposure migration as a sign that the ECB had swallowed all it could, and that the next step was barrel-scraping to get the CBI going on this new funding scheme.

      You have to wonder how long either CB can stay so far off the reserve, as it were. Something else for the politicians to wrangle over.

      First I’d seen of your blog BTW. Have now added you to my RSS feeds!

  2. sean

    The two parties (Fine Gael and Labour ) most likely to coalesce in the new government following the 25th February election colluded with the current disastrous Fianna Fail government in rejecting the outcomes of two most recent EU referenda and holding new referenda until the people gave the right answer.
    The first of these referenda ,the Nice Treaty 2004,has had a massive but little reported effect on Irelands economic crash.Following the 2nd Nice referendum result which reversed the previous one (and on foot of solemn promises from politicians of all the parties above that massive uncontrolled immigration from eastern Europe wont happen.)

    As Michael Lewis has reported in the current edition of Vanity Fair the resulting immigration from Eastern Europe into Ireland following the Nice treaty was the equivalent of awarding 18 million Mexicans Green cards to the US.

    Within weeks government ministers in Ireland were stating that the massive inflow of immigrants was an economic fundamental and this ramped up the construction of housing at an alarming rate.(No economist I know will state that immigration is, in technical terms, an economic fundamental).
    Huge capital flows from German banks,etc., swamped Ireland on the basis of this new ‘economic fundamental’.

    This in some way explains the reticence of the three main parties to go negative on the EU as they are so married to it and because they are all guilty of rejecting the people’s mandates on Europe.
    It is an incontrovertible fact that had the first Nice treaty referendum result been accepted by the Irish political establishment then massive immigration followed by the firehosing of Ireland with German and French money would not have occurred and any economic fallout in Ireland would have been easily manageable.

    The haircuts being talked about are political electioneering and can only affect 21 billion euros of bonds.The liquidity provided by ECB and by the Central Bank of Ireland is where the action really is and I cannot see any new Irish government defaulting on the ECB.
    Its also worth pointing out that the 51 billion euros of liquidity provided by the Irish Central bank is not backstopped by any issuance of bonds .It is printing money out of fresh air.

    Unfortunately it is becoming more apparent that this will carry on for a couple of more years with some tinkering with bonds and interest rate here and there but essentially changing little.
    Eventually default will just happen anyway but what is worrying is it will be a disorderly default (like Russia 1998) rather thasn a managed one which should be done now.

    1. Philip Pilkington

      “Within weeks government ministers in Ireland were stating that the massive inflow of immigrants was an economic fundamental and this ramped up the construction of housing at an alarming rate.(No economist I know will state that immigration is, in technical terms, an economic fundamental).”

      Yeah, I often wonder if this is catching on or not…

      Every day I wake up thankful that most people who consider themselves nationalists in Ireland are lefties…

    1. Richard Smith

      Hah, dunno. He posted a similar cheery piece about the *Irish* export boom a few months back; he seems to like export booms.

      Still, even the gloomier current estimates of Spanish banking losses (EUR20Bn-120Bn, nice big range) seem an order of magnitude too small to hibernify Spain.

      And in the short term that is the crux of it for Spain (and the Euro) I hope – you’d think that Greece, Ireland and Portugal would be manageable, though the discussions to come will be noisy and messy; and the chronic North/South structural problems will still be there.

      Pending surprises that would all be broadly in line with the analysis of a certain broomstick-wielding olive farmer.

      1. Charles Butler

        Do you still read these things a day later?

        Totally correct about the recap magnitudes, Richard. The uproar is just another instance of any proof being acceptable when the outcome is already known. But the cajas (and the country and its press) do themselves no favours on the public relations front. They really haven’t figured out, mostly because none of the actors has ever been outside his own home town, that a circle the wagons reaction doesn’t cut it with international capital markets.

        Meanwhile, I’d love to see the opportunities they’re missing with the current international roadshows.

        Broomstick riding. Please.

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  5. Pat Donnelly

    The ECB can and will print as much as is needed to keep the German banks afloat. The debts owed to UK banks, though, are a different matter!

    Will this mean that at their much devalued rate, it is now right for the UK to join the EZ?

    Hang separately or hang together?

    1. formais

      The real question is whether the German Finance ministry is making contingency plans for a Euro failure. Perhaps the ECB is trying to distribute its risk amongst member nation central banks, so that in the event of a total failure of the EU, what’s left of the risk at the ECB can automatically revert back to the Bundesbank. Somehow even the crazy Germans cannot be too keen on carrying the complete burden.

  6. moving_forward

    Sorry but the key question is exactly what is noted and is transpiring.
    It became apparent that ‘too big to fail’ was not the issue.
    The issue was ‘too big to default’. The banks knew this and so did the analysts.
    The other research notes of the time (same f’ing date!) of Philip Ingrams note clearly show this.
    (I.e. MLs ‘Eschatological. Time to go long’ see Why Iceland? By Ásgeir Jónsson or his website)
    The governments played into their hands and still do.
    The seniority of bond holders and depositors is the key issue.
    Until this is addressed banks will be able to continue as they have done.
    Of course there is a link between failure and default but here timescales are key:
    the lack of risk of default can be used to delay the likelihood of failure.
    i.e. if a bank is too big to default this can and was used to justify giving them yet another ‘second’ chance.
    Of course nothing changed within the management and never was likely to.
    And of course nothing changed with respect to the effect of the credit crunch on the economy
    and hence on the property market and hence on the credit-worthiness of the banks.

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