Bondholders challenge Government attempt to share pain

 

ANALYSIS:TWO INVESTMENT funds holding subordinated debt at AIB last week stepped into the High Court to challenge the Government’s first plan to burn bondholders and raise about €2 billion.

New York based funds Abadi & Co Securities and Aurelius Capital Management, which are not connected, have sought to stop a Government order aimed at forcing losses on their debt investment.

The previous week Minister for Finance Michael Noonan had secured a Subordinated Liability Order under the powerful bank restructuring law, the Credit Institutions Stabilisation Act, introduced late last year. It was the first such order obtained under the legislation. Under the order, bondholders had just five days to file objections.

Some investors had thought that the Government would only use this part of the law as a stick to force bondholders to sign up to voluntary deals they were offered.

The court order earlier this month handed the Government the power to impose changes to €2.6 billion worth of subordinated bonds at AIB that will devalue them, forcing investors to take any cash offered by the Government. This is the so-called burden-sharing in practice, where bondholders will be forced to meet some of AIB’s €13.3 billion capital bill, reducing the burden on the taxpayer.

The Minister is seeking to extend maturities on dated subordinated bonds to 2035 from 2017. This will wipe significant value off them as few investors would want to hold the investment that long. The order also aims to make any interest payments discretionary.

Losses have been imposed on subordinated bondholders previously at the main banks and more recently at Anglo Irish Bank and Irish Nationwide Building Society. But this exercise at AIB is different. The previous liability management exercises have taken place on a voluntary basis where investors were given a choice. While in the case of Anglo and Irish Nationwide the offers were coercive and tantamount to a default – as investors would get virtually nothing if they did not accept 80 per cent discounts on their bonds – the debt buybacks were still regarded as voluntary.

In this case, the Government is in effect seeking to tear up the existing contract with the bank’s subordinated bondholders.

The other big difference is that the Government is seeking this action against investors in a bank that is not in wind-down but which still has a small amount of shares trading on the market and which will be the second “pillar” bank.

Carlos Abadi, director of Abadi & Co Securities, was quoted as saying last week that the company felt that it had “a compelling argument and [had] Irish and European law on our side”. He said the court order violates “fundamental property rights” and does not allow for bondholders to recoup losses if the bank returns to profitability and eventually repays State aid.

This is what complicates this action. By retaining a “free float” of shares on the market, the Government is giving shareholders, who rank below subordinated bondholders, the opportunity to retain some upside in the bank, but not the subordinated bondholders.

While any logical person would accept that AIB’s subordinated bondholders must share losses in a bank whose capital bill has soared to €20.5 billion, the bondholders have taken issue with the coercive, non-negotiable manner adopted. They will argue that the Government has signalled it is prepared to invoke draconian legislation to rewrite contracts to its liking.

This, investors claim, will undermine efforts by the State’s other “pillar” bank, Bank of Ireland, to swap subordinated debt into equity as part of its drive to raise its own equity bill of €4.2 billion.

Bondholders would argue that the Government will require such investors, who target high-yielding investments, when it starts to try to borrow again in the debt markets and that this action will not help. But then the losses are so great at AIB that the Government has to enforce pain on bondholders.

The arguments will be debated when the case is heard on May 9th.