Irish Banks Downgraded Over Bondholder Rumors

Ireland's banks suffered a string of credit downgrades Friday—one reduced to junk-bond status —as speculation mounted that an EU-IMF bailout of Ireland could require senior bondholders to share the massive bill.

dublin commuters the earl
Peter Muhly | AFP | Getty Images
dublin commuters the earl

Prime Minister Brian Cowen saw his own hold on power slip another notch, as his ruling Fianna Fail party lost a special election for a long-empty seat in parliament. The winner vowed to force Cowen from office before he can pass an emergency 2011 budget being demanded as part of the international rescue.

The New York-based Standard & Poor's credit ratings agency said it was lowering Anglo Irish Bank six notches to a junk-bond B grade. It also cut the ratings on Bank of Ireland one notch to BBB+, and downgraded both Allied Irish Banks and Irish Life & Permanent one notch to BBB.

The agency said bonds issued by Anglo are particularly at risk of being discounted as part of an €85 billion, or $113 billion, loan to Ireland by the European Union and the International Monetary Fund. It says Ireland "may be forced to reconsider its current supportive stance toward Anglo's unguaranteed debt."

Junior bondholders at Anglo are already being forced to accept losses of 80 percent to 95 percent on their loans. Anglo gambled most recklessly on runaway property markets in Ireland, Britain and United States using money borrowed from overseas, and was the one that triggered Ireland's plunge toward bankruptcy in 2008. It was nationalized last year and represents a bill to the taxpayer of at least €29 billion.

"People are already joking on Twitter that Anglo's move (to a B grade) is really an upgrade," said Constantin Gurdgiev, finance lecturer at Trinity College Dublin, reflecting widespread surprise that S&P's ratings on Irish banks had been so benign until now. "There really is a serious question as to whether Anglo Irish Bank should even have a banking license."

Gurdgiev said it was inevitable that the emerging EU-IMF bailout would require even senior bondholders to take "a haircut"—lose part of their stake—on the money they could claim back on their loans to Ireland's debt-crippled banks.

"It's becoming clearer by the day there is really no other solution," he said.

Later a second ratings agency, Fitch in London, said each Irish bank soon "could face negative rating action" depending on whether Ireland's deal with EU and IMF negotiators seeks to inflict sacrifices on senior bondholders.

And Fitch trimmed its ratings on the lowest-level securities issued by Bank of Ireland and Allied Irish Banks to various grades of junk. Fitch said it "believes that the prospects of enforced burden sharing for (subordinated) debt holders is much more likely, although still not certain."

In the northwest county of Donegal, an Irish nationalist who has vowed to vote against Ireland's austerity plans won a seat in parliament, cutting Cowen's majority to just two seats.

Sinn Fein candidate Pearse Doherty said his dominant win, taking nearly 40 percent of votes in a six-candidate field, showed that people want to elect a new government that will force foreign banks, not Irish taxpayers, to bear the cost of Ireland's financial crisis.

Doherty earlier this month successfully sued the government over its 17-month refusal to permit an election in Donegal, a delay reflecting Cowen's fear his party would lose.

Voters "are telling Brian Cowen to get out of office. It's not clear that this budget will pass. It is completely unfair and unjust to attack the weakest and most vulnerable in this society," Doherty said. "The government should suspend the budget, call a general election, and let the people have their say."

Emergency Budget to Come

Cowen is unveiling an emergency budget Dec. 7 that he and European officials say must be passed to clear the way for the EU-IMF loan. The Irish Times reported that a loan announcement was expected Sunday, but Irish and other officials called that report premature.

irish policeman eu bailout protestors
Peter Muhly | AFP | Getty Images
irish policeman eu bailout protestors

Cowen has already offered to hold an early national election sometime in February or March— but only once all budget measures have been approved in parliament.

The 2011 budget seeks to slash €4.5 billion, or $6 billion, from spending and add €1.5 billion ($2 billion) in new taxes as part of a four-year plan to reduce Ireland's annual deficits to 3 percent of gross domestic product in 2014.

Ireland's2010 deficit is running at 32 percent of GDP, the highest in Europe since World War II. Two-thirds of the deficit comes from Ireland's €45 billion bailout of its banks under terms of a state guarantee to bondholders that the government can no longer finance.

Doubts about Ireland's ability to keep paying its bills are reflected daily in the bond market. Ireland's treasury withdrew from bond auctions in September once interest rates being demanded by investors grew too high.

Those yields have kept rising in line with an investor sell-off of Dublin's debt securities. The yield on a bond goes up as its face value declines.

The yield on Ireland's 10-year bonds reached a new euro-era high of 9.24 percent Friday and closed in Dublin at 9.15 percent. The yield on 3-year bonds remained flat at 7.3 percent.

By contrast, analysts expect the EU-IMF fund to charge 5 percent interest or less for a three-year loan. Ireland hopes to use the fund as a credit line for covering government deficits through 2013 and reinforcing the capital base of its banks.

While forcing losses on foreign banks would be the much-preferred option for the Irish public, some analysts warn it would generate unintended shock waves that would make it more expensive and difficult for banks and governments worldwide to refinance their debts.

Monument Securities in London said any effort to force-feed part of the Irish bailout bill to bondholders would spur lenders to "demand yield premiums on bank debt to compensate for the risks of future 'haircuts,' or withdraw altogether from bank debt.'

"Talk of 'haircuts' on bank bonds opens a fresh channel of contagion in the debt crisis," it said in a research paper.

Until now, Ireland has stressed that its financial laws give 100 percent protection to senior bondholders, just like depositors. That guarantee underpinned the banks' credit ratings despite their mounting property-based losses.

But hard financial evidence suggests that investors in Irish banks long ago stopped believing that guarantee.

Since the summer tens of billions in deposits has left Dublin for safer shores, and €130 billion in short-term loans from the European Central Bank and Irish Central Bank have been required to help plug the hole. ECB officials, in particular, pressed Ireland to accept a bailout because the Frankfurt bank was seeing its own exposure to Ireland grow too large.