Bondholders are being offered as little as 10 cent in the euro on the face value of debts

ON WEDNESDAY in Court 3 of the Four Courts, a 74-year-old woman asked a judge to allow her to stay on in her home of 54 years after her daughter, who taken on the mortgage, fell ill and the bank got an order to repossess the house.

Eileen Tynan sought an injunction against Start Mortgages so she could remain in her home on the Old Callan Road in Kilkenny.

Two floors up, in Court 13, a very different case was going on.

New York hedge fund Aurelius Capital Management was on the second day of its trial against the Minister for Finance, attempting to stop a court order wiping out a high-risk investment worth millions of euro in AIB junior bonds.

The previous day, the senior counsel for the fund said his clients – whether disliked or not – were entitled to the same fair procedures and protections as others.

Attempts to demonise bondholders, irrespective of whether they were funds for “distressed gentlefolk”, orphans or hedge funds were inappropriate, he said.

At the core of the case taken by Aurelius is whether a subordinated bondholder – the lowest-ranking creditor in the capital structure of a company – should be wiped out when the bank is only in existence because of €13.3 billion that must be injected by the State on top of a €7.2 billion bailout.

Aurelius claims the Government has subverted the rules of the capital markets where shareholders should be wiped out first and then junior bondholders.

It says that the stakes held by shareholders, including the Government’s preference and ordinary shares, should bear losses first.

The fund is not against the concept of burden-sharing on bank losses, but argues that it should have been consulted first and offered a “market-based” solution before the Government used its far-reaching banking legislation to force them to accept the losses.

The Minister’s defence is that, without State support, Aurelius’s investment was likely to be irrecoverable.

Disputing Aurelius’s complaints about a lack of disclosure by the Minister, his counsel said the fund had from the start been “a litigant in search of a case”.

The order the Minister obtained last April changes the terms of the bonds to such a degree that it wipes them out in value, leaving bondholders with no option but to accept the current severe debt buyback deal with the bank.

The buyback is one of a series of deals being proposed by the banks where bondholders are being offered as little as 10 cent in the euro on the face value of the debt, and virtually zero if they decline to deal.

The Government is seeking to raise about €5 billion towards a bank capital bill that has risen to €70 billion by inflicting losses on subordinated bondholders at AIB, Bank of Ireland, Irish Life Permanent and EBS building society.

Only subordinated bondholders at Bank of Ireland are being offered shares – a point Aurelius has taken issue with, claiming that it doesn’t have the same opportunity to share in AIB’s recovery.

The whole area of burden-sharing with this class of bondholders was muddied by the last government’s decision to include dated subordinated bondholders in the September 2008 guarantee.

In its now famous advisory document of September 28th for the government, Merrill Lynch recommended a guarantee covering senior bonds and dated subordinated bonds because of the “crossover” between these two bonds.

The crossover presumably referred to the fact that there were the same type of investors in both.

The make-up of the investors in subordinated bonds has changed since then. In the Aurelius case, the court heard advice that JP Morgan gave to AIB, saying that the “real money funds” had exited Irish securities and that the only investors left in AIB junior bonds were “fast money funds”.

Aurelius began investing in the AIB bonds only last January, at the time of the bank’s debt buyback.

The fund has said it has lost about €12.5 million since then.

Another subordinated bondholder challenge is also looming. On Wednesday the London law firm White and Case said it had been hired by bondholders in Bank of Ireland holding about €700 million of the €2.6 billion.

They claim that the bank’s proposal to inflict losses on lenders through a debt-for-cash-or-equity deal is “fatally flawed” because it fails to respect the fundamental principle that creditors must be repaid ahead of shareholders.

Not all the losses inflicted by the State in the burden-sharing will be borne by “fast money” professional investors or hedge funds.

About 100 Irish credit unions face losses of €20 million on an Irish Life Permanent bond which it is proposing to buy back debt at about 20 cent in the euro.