Download Minister adopts the `Big Stick` approach

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Credit Analyst
Stephen Lyons
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Head of Fixed Income
Barry Nangle
April 15, 2011
Research Report: Sector update
Irish Banks
Minister adopts the 'Big Stick'
approach
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High Court issues a subordinated liabilities order (SLO) for
AIB
• Payment of coupons on dated subordinated debt is to
be made discretionary and the maturity dates are now
extended to 2035.
• Distribution & capital stopper provisions are removed
from undated subordinated debt, as are any
requirements to pay arrears of interest or coupons
following a dividend by the bank.
Pressure to participate in Liability Management exercises
• According to the Minister for Finance, AIB is to launch
a liability management (LM) exercise in the 'coming
weeks' to ensure that subordinated bondholders share
the burden of the capital position of AIB and reduce
taxpayer support.
• A high take up is likely given the change in the terms of
the bonds. The European Commission currently
prevents discretionary coupon payments by AIB and
the Minister also threatens further action if the LM
exercise is unsuccessful.
• Bondholders will be offered cash. Losses could be c.
80%, at levels similar to Anglo/INBS offers.
Negative read-across for all Irish bank subordinated debts
• The issue of a SLO for a systemic bank and the
statement that work is underway to ensure appropriate
burden-sharing in BOI and IL&P is negative for all
subordinated debt as evidenced by market reaction.
Subordinated bonds fell by 5 points in the aftermath,
before finishing down 3.
• We remain of the opinion that a viable debt-to-equity
story remains for BOI, however, and the Minister has
acknowledged as much.
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Research Report: Minister adopts the 'Big Stick' approach
April 15, 2011
Minister adopts the 'Big Stick' approach
 The Minister previously indicated
that the bank recapitalisation
requirements arising out of the
stress tests would be reduced by
€5bn through a combination of
liability management and asset
sales
Background
On the 31st of March the Minister outlined that arising out of the
PLAR/PCAR stress-testing that the four systemic Irish banks would
require a gross recapitalisation of €24bn. In addition it is the Minister's
intention that this gross figure is reduced by €5bn to €19bn through a
combination of liability management (LM) of subordinated debt and
asset sales. Internal resources of €17.5bn (NPRF assets and cash
balances) broadly match this net recapitalisation requirement and limit
further borrowings to no more than €2bn, or 1.5% of GDP (see recent
note: Significant development in sorting out Irish banks and funding
environment for Irish sovereign).
The market has come to expect that liability management would
contribute €4.4bn towards the recapitalisation. This was arrived at
through deducting a possible €600m benefit from the sale of Irish Life
from the €5bn contribution. From the outset however gains from
liability management have not been an exact science and the Minister's
comments on national news that subordinated bondholder losses will be
between €5-€6bn confirms this.
 AIB is currently 92.8% owned by
state and requires an additional
€13.3bn of capital following arising
out of the recent stress test results.
AIB is currently 92.8% owned by state and has received €7.2bn of
taxpayer support. Furthermore, if the government's €3.5bn of preference
shares convert as indicated back at the bank's capital update in
December, state ownership would rise to 96%. Furthermore the bank
requires an additional €13.3bn of capital (€11.9bn in the form of
equity) to achieve prescribed capital targets under the recent stress tests.
The quantum of current and likely future state support has always left
the bank vulnerable to a subordinated liabilities order under the Credit
Institutions Stabilisation Act 2010 (see later section for overview).
High Court issues a subordinated liabilities order (SLO) for AIB
Payment of coupons on the bank's €1,992m of dated subordinated debt
is to be made discretionary and the maturity dates are now extended to
2035. This is significant as the LT2 bonds trade with accrued and
currently pay coupons as high as 12.5%, resulting in a yield of nearly
50%.
 The non-payment of the now
optional coupons on the
subordinated bonds does not
constitute an event of default by
the issuer
The €757m of undated instruments outstanding do not currently pay
coupons, but the SLO removes distribution & capital stopper provisions
from several of the instruments which acted as an obstacle to future LM
exercises (see note: Coercive action on undated junior sub-debt may be
unavoidable). The order also removes any requirement to pay arrears of
interest on certain undated instruments or make coupon payments
following the payment of a dividend by AIB, any payments are now
entirely at the option of AIB.
Significantly the non-payment of the now optional coupons for the
subordinated bonds does not constitute an event of default by the issuer
(but more than likely a CDS event). No noteholder shall have any claim
in respect of any amount not paid by the Issuer by way of interest on an
optional interest payment date. Any such amount will not cumulate for
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Davy Research
Research Report: Minister adopts the 'Big Stick' approach
April 15, 2011
the benefit of Noteholders or entitle Noteholders to any claim
whatsoever in respect thereof against the Issuer.
Pressure to participate in Liability Management exercises
According to the Minister for Finance, AIB is to launch a liability
management (LM) exercise in the 'coming weeks' to buy back its
outstanding liabilities. Bondholders are expected to make an appropriate
contribution to the cost to the State of providing additional capital to
AIB while providing them with an additional opportunity to voluntarily
exit their investment in a way that will generate material capital for AIB.
 According to the Minister,
bondholders will be given a cash
offer and that although the offer is
up for negotiation, the losses
would be 'something like 80%
The Minister indicated on the National News that bondholders will be
given a cash offer and that although the offer is up for negotiation, the
losses would be 'something like 80%'. This seems at similar levels to the
Anglo/INBS offers, which we note also paid accrued interest. Full
conversion of AIB's subordinated bonds at 20% of par would generate
€2.2bn of core capital/investor losses. However, a reoffer of the LT2s at
the previous 30c price offered by the bank in January and an offer of 10c
for the undated instruments would generate similar amounts of core
capital.
A high take up is likely given the change in the terms of the bonds. The
European Commission currently prevents discretionary coupon
payments by AIB as the bank's restructuring plan has not been agreed.
But more importantly the Minister threatens further action to ensure
appropriate burden-sharing if the LM exercise is unsuccessful.
Negative read-across for all Irish bank subordinated debts
The issue of a SLO for a systemic bank and the statement that work is
underway to ensure appropriate burden-sharing in BOI and IL&P is
negative for the prospects of all subordinated bank debt (we still view the
Irish Life bonds as separate) as evidenced by the immediate market
reaction. The more liquid LT2 bonds of AIB and BOI (AIB 12.5/19,
BOI 10/20) fell by up to 5 points in the immediate aftermath, before
recovering to finish 3 points down in the day.
The Minister reaffirmed Government's policy not to pursue burdensharing in the senior debt of AIB, BOI, IL&P and EBS, and their
unsecured debt was relatively unchanged but better offered. The
unguaranteed unsecured bonds of Anglo and INBS however fell by 2
points in the day.
Further liability management was always expected across the other banks
and because a SLO has been issued for AIB does not necessarily mean
that we will see similar orders for the other banks. This is because the
negative contagion across all banks subordinated debts arising out of the
AIB SLO may make the issuance of equivalent SLOs for the other banks
unnecessary. Weaker subordinated bond prices after the AIB SLO and
now expected higher take-ups from future LM offers will generate the
additional capital that a SLO would be looking to accomplish.
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Davy Research
Research Report: Minister adopts the 'Big Stick' approach
 The Minister acknowledged on the
National News that holders of BOI's
€2.7bn subordinated debt may be
offered a debt-for-equity swap
April 15, 2011
Debt-to-equity story remains for BOI
We remain of the opinion that a viable debt-to-equity story remains for
BOI, however. The Minister acknowledged as such in his statement on
the National News that holders of BOI's €2.7bn subordinated debt may
be offered a debt-for-equity swap.
Conversion of the majority of the bank's outstanding €2.7bn of
subordinated debt is the most effective source of core capital creation,
yielding core capital equivalent to 100% of the nominal value of the
bonds outstanding. The bonds also carry an annual interest burden of c.
€250m (ex-swaps, €200m contractual), and their equitisation would
significantly enhance the earnings recovery story.
Equitisation of the subordinated debt could yield over half of the bank's
outstanding €4.2bn equity raise requirement and contribute to the
objective of limiting state ownership below the 50% threshold. Limiting
state ownership via bond-holder equitisation would also enhance the
bank's prospects of sourcing new outside equity in our view.
BOI's subordinated bondholders are aware that equity conversion is the
most likely outcome. Yet despite this, the bonds have remained well bid
as bondholders view equity conversion as an attractive way to play a
recovery story through a final bank recapitalisation. Furthermore we
believe that bondholders are more engaged with the recovery story at
present as the equity audience interest slowly re-engages post the
credibility of the stress tests.
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Davy Research
Research Report: Minister adopts the 'Big Stick' approach
April 15, 2011
Detail of AIB Subordinated Liability
Order
The detail below provided by AIB summarises the details of the
subordinated liabilities order in respect of the bank's €2.7bn of
instruments outstanding (€757m undated, €1,992m dated). The order
amends the terms of the instruments as follows:
1. The terms of the subordinated liabilities listed at 1 to 11 (inclusive)
in the table below have been amended such that any interest that
may fall due on such liabilities will only be payable at the option of
AIB (in its sole discretion).
2. The terms of the subordinated liabilities listed at 1 to 11 (inclusive)
in the table below have been further amended such that the maturity
date of each such liability has been extended to 2035, on the relevant
interest payment date specified in the Order.
3. The terms of the subordinated liabilities listed at 14 to 17 (inclusive)
in the table below have been amended such that any restriction on
(i) payment of any distribution or dividend on any other specified
junior or parity securities of AIB, or (ii) any repurchase or
redemption of such junior or parity securities, has been removed.
4. The terms of the subordinated liabilities listed at 12, 13 and 18 in
the table below have been amended such that (i) the requirement to
pay any arrears of interest on such liabilities upon the payment of
any dividends by AIB has been removed, and (ii) the payment of any
coupon on such liabilities following the payment of a dividend by
AIB is now entirely at the option of AIB.
Table 1: AIB subordinated liabilities outstanding
Subordinated Liabilities
Issuer
ISIN
1
€419,070,000 10.75 per cent. Subordinated Notes due 2017
Allied Irish Banks, p.l.c.
XS0498532117
2
£1,096,645,000 11.50 per cent. Subordinated Notes due 2022
Allied Irish Banks, p.l.c.
XS0498531069
3
U.S.$177,096,000 10.75 per cent. Subordinated Notes due 2017
Allied Irish Banks, p.l.c.
XS0498530178
4
£368,253,000 12.5 per cent. Subordinated Notes due 25 June 2019
Allied Irish Banks, p.l.c.
XS0435957682
5
€868,518,000 12.5 per cent. Subordinated Notes due 25 June 2019
Allied Irish Banks, p.l.c.
XS0435953186
6
£700,000,000 Callable Dated Subordinated Fixed to Floating Rate Notes due July 2023
Allied Irish Banks, p.l.c.
XS0368068937
7
€500,000,000 Callable Subordinated Step-Up Floating Rate Notes due 2017
Allied Irish Banks, p.l.c.
XS0232498393
8
£500,000,000 Subordinated Callable Fixed/Floating Rate Notes due 2025
Allied Irish Banks, p.l.c.
XS0214107053
9
€400,000,000 Subordinated Callable Step-Up Floating Rate Notes due 2015
Allied Irish Banks, p.l.c.
XS0208845924
10
U.S.$400,000,000 Dated Callable Step-Up Subordinated Notes due 2015
Allied Irish Banks, p.l.c.
XS0197993875
11
£350,000,000 Subordinated Callable Fixed/Floating Rate Notes due 2030
Allied Irish Banks, p.l.c.
XS0180778507
12
€200,000,000 Perpetual Subordinated Callable Step-Up Notes
Allied Irish Banks, p.l.c.
XS0100325983
13
£400,000,000 Perpetual Callable Step-Up Subordinated Notes
Allied Irish Banks, p.l.c.
XS0227409629
14
€500,000,000 7.50 per cent. Step-Up Callable Perpetual Reserve Capital Instruments
Allied Irish Banks, p.l.c.
XS0120950158
15
€1,000,000,000 Fixed Rate/Floating Rate Guaranteed Non-voting Non-cumulative Perpetual Preferred
Securities
AIB UK I LP
XS0208105055
16
€500,000,000 Fixed Rate/Floating Rate Guaranteed Non-voting Non-cumulative Perpetual Preferred
Securities
AIB UK 2 LP
XS0257734037
17
£350,000,000 Fixed Rate/Floating Rate Guaranteed Non-voting Non-cumulative Perpetual Preferred
Securities
AIB UK 3 LP
XS0257571066
18
U.S.$100,000,000 Subordinated Primary Capital Perpetual Floating Rate Notes
Allied Irish Banks, p.l.c.
IE0000189625
Source: AIB
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Davy Research
Research Report: Minister adopts the 'Big Stick' approach
April 15, 2011
Credit Institutions Stabilisation Act
2010
The Credit Institutions (Stabilisation) Act 2010 grants exceptional
powers to the Minister for Finance and was approved based on a number
of justifications, which include:
• where there are serious economic disturbances
• where measures are necessary to address a unique unprecedented
economic crisis
• where there is a continuing serious threat to the stability of certain
credit institutions in state and to the financial system generally
• the common good requires permanent or temporary interference
with the rights, including property rights, of persons who may be
affected by the performance of those functions
SLO contains broad powers and removes default event
According to the Act, the Minster may apply to the court for a
Subordinated Liabilities Order to enable burden-sharing. This may
result in the granting of a shareholding in the relevant institution to the
subordinated creditors affected by the order.
It may also result in a postponement, termination, suspension or other
modification of specific rights, liabilities, terms and obligations
associated with all or any of such subordinated liabilities, including any
or all of the following rights, terms and obligations:
• the payment of interest
• the repayment of principal
• what constitutes an event of default
• collective action provisions
• the timing of obligations
• the due date
• the applicable law
• the right to declare, specify or determine an event of default
• any right to enforce payment, whether by winding-up or otherwise
Quantum of state support is the primary consideration
In determining whether to make a proposed subordinate liabilities order,
the Minister shall have regard to a range of considerations. The court
when hearing an application for an order will check whether the opinion
of the Minister was reasonable in this regard. The considerations are
outlined as follows:
• the amount of the indebtedness of that institution to its
subordinated creditors relative to its assets
• the extent and nature of financial support provided or to be provided
to that institution by the Minister under the Act of 2008 or
otherwise
• the extent to which the state has, in particular, provided financial
support by way of equity investment (or equivalent) in that
institution
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Davy Research
Research Report: Minister adopts the 'Big Stick' approach
•
•
•
•
•
7
April 15, 2011
the quantum of the financial support relative to that institution’s
balance sheet
the viability of that institution in the absence of that financial
support
the present and likely future ability of that institution to raise equity
capital from market sources
the likely extent to which the subordinated creditors would be repaid
amounts owing to them in a winding up of that institution in the
absence of such support
the effectiveness or likely effectiveness of liability management
exercises undertaken by that institution in respect of its subordinated
liabilities.
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