Bank of Ireland and AIB's riskiest bonds jumped to record highs on Friday on heightened speculation that they will be bought back at the first opportunity, after the lenders unveiled plans for how they plan to structure themselves in the event of a future crisis.
Both banks outlined that they will set up holding companies at the top of their corporate structures to comply with new European rules that would allow for bondholders to face losses without impacting depositors should a bank run into trouble in future.
The holding companies would issue senior and junior debt in future the could be “bailed in” if needed and minimise taxpayer bailouts. Deposits, however, would be held in the existing operating banks, where they would enjoy greater protection.
Irish banks imposed about €15 billion of losses on junior bondholders during the crisis as they shared the cost of soaring loan defaults with taxpayers. But they were unable to "burn" senior bondholders because of opposition from the European Central Bank and the fact that there was no framework in place to do so without also hitting depositors.
Demand
"Essentially, taxpayers' money will be used as a last resort to bail out troubled banks in future," said Ryan McGrath, an analyst with Cantor Fitzgerald in Dublin.
The banks succeeded in selling further risky bonds after the crisis, including so-called additional Tier 1 (AT1) capital debt, which stand first in line to be hit in the event that either lender’s capital levels fall below what regulators demand.
These bonds are known as perpetual bonds, meaning they may never be redeemed. However, the risks attached were reflected in the interest rates set – at about 7.4 per cent – when the bonds were sold, in 2015.
Meanwhile, Davy analyst Stephen Lyons said his firm had a "strong expectation" that, as both banks sell "bail in-able" debt through holding companies over the next few years, they will use the first opportunity, between 2019 and 2020, to buy back existing subordinated debt issued by the operating banks.
Fresh highs
The price of Bank of Ireland’s €750 million of AT1 bonds jumped 1.8 per cent to a record €104.9, sending the market interest rate, or yield, on the notes down to 5.8 per cent. AIB’s €500 million of similar notes gained 1.6 per cent to €103.8, with the yield declining to 6.2 per cent.
The price of €1.5 billion of Tier 2 bonds sold by the banks in recent years also hit fresh highs.
Sources familiar with AIB’s situation have said that setting up a holding company will be less of an immediate priority if the Government proceeds with a sale of a 25 per cent stake in the group in the first half of this year.
If the State decides to hold off on an initial public offering, complex planning around setting up a holding company may be accelerated.