Friday, September 17, 2010

Ireland in Extremis

Ireland Negotiating Default, Prepares To Call In IMF

By Tyler Durden | 17 September 2010

And the euro seemed so happy after its recent surge, that it completely forgot it is backed by an insolvent continent. Luckily, here's Ireland to remind us stuff is much, much worse than expected. According to the Irish Independent, the Labour Party's Eamon Gilmore, came very close to suggesting that Ireland is considering defaulting on its debts "when he talked about the Government 'negotiating' with the bondholders in the Anglo Irish Bank."

The same newspaper also reported that Ireland is on the verge of calling in the IMF for a 'bailout', citing "a report from Barclays, one of Europe's largest banks, [which] said Ireland may yet need financial help from the IMF or the EU if conditions got any worse". But a spokesman for Finance Minister Brian Lenihan said last night: "The Government's strategy for dealing with the economic and financial challenges has been commended by the EU Commission, the European Central Bank and many other international experts". In other words, domino #2 has at most a few more days. Net result of all this: Irish-Bund spread explodes and gold hits a new all time high of $1,282.

More from the Independent:

While there is almost unanimous agreement now that the subordinated bondholders should be either given nothing or very little by the Irish State, the more pressing issue is whether Ireland, which now owns Anglo, should welch on obligations to the senior debt holders, most of them German, British and French asset and pension funds.

Mr Gilmore said he was not recommending a default on these debts, but instead was suggesting negotiations begin with the holders. This suggestion has a populist ring to it, because as long as the bondholders don't absorb any losses, it means all of the Anglo losses are absorbed by the Irish taxpayer instead. But Mr Gilmore's problem and the deficiency in his argument is a lack of detail on how such an approach would work.

Presumably the negotiations would be aimed at forcing some of the losses on the bondholders, otherwise there would be no point in such conversations. The problem is that technically Anglo would be defaulting on its debts if it tried to get the bondholders to accept anything less than what they are owed. Mr Gilmore (and his position got some support from Barclays last night) has
some options. One is to simply press to reduce the total amount owed to the bondholders, allowing Anglo to book a gain from having to pay out less interest than originally agreed.

The second approach, one championed by the 'Financial Times', is to tell the bondholders you intend to swap their
bonds for shares in Anglo. This would effectively leave the bank— which is a heartbeat away from technical insolvency— in their hands. This debt-for-equity swap is very common in downturns when companies run into problems. Technically it is also known as a distressed exchange offer. This approach could be taken, but again it comes with significant risks which need to be acknowledged by political commentators like Gilmore and others pressing for this course of action.

The problem with this idea is that there is no way Anglo Irish Bank is worth
€16.5bn at the moment. So if the bondholders swapped all their bonds for Anglo shares they would be settling for less than par value. This is a 'selective default'.

Of course, the big danger is not what would happen in Anglo if this course is taken, but what would happen at the other Irish banks. By how much would their fund-raising costs go up? The answer, of course, is nobody knows, including all the commentators who give views on this subject regularly.

The punchline:

The final danger is: would an Anglo technical default raise the funding costs for Ireland Inc itself? Again it is hard to say. There are two schools. One suggests that by cutting Anglo loose, Ireland becomes a better credit risk and funding costs could actually drop.

Others suggest once you welch on any debts, your funding costs elsewhere rise and you may even be locked out of the bond market entirely
[[à la Greece: normxxx]].

While Mr Gilmore's contribution is welcome, it is only right that he spell out the huge unknowns embodied in the approach he has recommended.

Lehman déjà vu.



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