Give me a crash course in . . .

The Irish bondholders

What’s new?

This week it emerged more than half of the bondholders – whom it is often said should be burned by Ireland – may be located in Ireland.

What are senior and junior bondholders?

Senior bank bonds and second-class bonds are two forms of interest-bearing debts issued by a bank. Second-class bonds are also known as sub-ordinated bonds because the rights of the bondholder are sub-ordinate to those of the senior bondholder.

Sub-ordinated bonds pay a higher annual interest rate but are a riskier investment and owners must bear losses sooner than senior bondholders. Senior bonds pay a lower interest rate but are safer, as the legal protection against default is tighter.

Sub-ordinated bondholders in Anglo Irish Bank, Allied Irish Banks and Bank of Ireland have already borne losses. Senior bondholders have not. They have been supported at the expense of taxpayers.

Will they get a post-election ‘haircut’?

One way or another, each of the Opposition parties say that – if elected – they would compel senior bond investors to bear losses. This is controversial because Ireland’s European sponsors – the European Central Bank (ECB) especially – are trenchantly resistant to senior bond “haircuts”. The Government explored this before Ireland’s EU-IMF bailout last November but it was ruled out. It was dismissed again last Monday.

Why does Europe say no?

The ECB, which has provided more than €130 billion to Irish banks, fears that any move to default on money due to senior bondholders would trigger contagion in eurozone bank markets. Removing protection from the highest-ranked bond investors in one euro country would create a threat to investors in vulnerable banks elsewhere. This threat could lead to runs on deposits from weak banks in other euro countries, with a consequent threat to apparently secure banks, too.

So why advocate a default?

Because of the acute sense of injustice that surrounds Ireland’s bank rescue. To date, taxpayers have provided around €45 billion to Ireland’s banks. In essence, the argument is that the banks would need less new capital from the State if they were not obliged to repay senior bond investors in full.

Who are the bondholders?

There is no official register of bondholders. Banks, pension funds and other institutional investors frequently hold senior bonds as a secure, if unspectacular, investment.

However, European sources this week gave credence to an academic evaluation of Irish Central Bank data that shows a little above half of all Irish bank bonds are held not by shadowy international speculators but within Ireland.

University College Cork lecturer Seamus Coffey says investors elsewhere in the eurozone and in London have significantly reduced their holdings of Irish bank bonds. Many of these have been transferred to Ireland. Coffey estimates that Irish-domiciled investors were owed €33 billion at the end of 2010, investors elsewhere in the eurozone were owed €10 billion, and investors in the rest of world were owed €20.5 billion.

So “burning the bondholders” would be an act of national self-harm?

In the event of a default, a 25 per cent haircut for senior bondholders would be regarded as severe, triggering a financial loss for the holder. Though it is not known whether Irish banks hold each other’s senior bonds, if Irish banks suffered losses on each other’s bonds in this way, they might need yet more new capital.

For Ireland, any default must be measured against the risks. Ireland’s banks are dependent on ECB funding, as they are essentially shut out of the open market. Senior bond default would significantly increase funding costs, lessening prospects for any early return to the private inter-bank lending system. This is at odds with the ECB’s objective of weaning all banks off emergency financial aid.

It would also be likely to further tarnish the damaged credentials of the State. The aim of the bailout, after all, is to ensure Ireland regains the credibility required to borrow again from private investors.

In short?

Don’t expect any move soon in this direction. In Ireland these days, Europe calls the shots.