BANK OF Ireland (BoI) has begun an exchange programme for holders of five of its lower tier 2 securities with a nominal value of €2.9 billion in a bid to strengthen its capital base.

The offer relates to five classes of bonds – three denominated in euro and one each in sterling and dollars – which the bank says are currently trading “at significant discounts to their original issue prices”.

Bond holders who accept the offer will receive 10-year fixed rate bonds.

Banks have been using the current fragile state of the market to refinance debt at more favourable rates to improve their capital position.

The news came as Royal Bank of Canada’s European capital markets division published research saying that the lower tier 2 debt of Bank of Ireland and AIB would outperform the market.

BoI said it expects to announce results of the exchange offer on February 11th when the exact improvement to its capital position will be known. It is understood that each 10 per cent of bonds that take up the offer will increase capital reserves by about €70 million.

Last summer, BoI improved its capital base by €1 billion through a buy-back of junior debt, while AIB added a similar amount to its capital reserves through a bond swap.

RBC now believes that, while the weakness of the Irish banking sector is priced in for AIB and BoI’s senior debt, potential recapitalisation is not factored into the price of their lower tier 2 bonds, which it has upgraded to outperform.

“Valuations of lower tier 2 debt of AIB and BKIR [Bank of Ireland] appear attractive relative to other European banks that have received large levels of government aid and when placed in the context of eventual recapitalisation of these banks,” wrote RBC analyst Hank Calenti in a note to clients.

Mr Calenti advised debt investors to buy the Irish banks’ bonds before they are recapitalised.

RBC projects that AIB will require an additional €1.9 billion in capital after it transfers its development loans to the National Asset Management Agency, while BoI will have a capital shortfall of €1.7 billion.

RBC’s analysis suggests that BoI can absorb a 57 per cent discount on Nama transfers before depleting its capital. Because of a larger Nama-bound loan book and its lower capitalisation, AIB can only absorb a 47 per cent “haircut”.

It estimates that, post-Nama, AIB could have the lowest tier 1 capital level of any internationally active bank, at 5.9 per cent.