FAQ Bondholders

Sunny

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I have written this to clarify a lot of the facts. Comments and corrections welcome.

What is a bondholder?

A bondholder can be simply thought of as a lender to the bank or company. A bond is very similar to a loan in that there is a contractual agreement to repay the money at a fixed date and make interest payments (coupons) during the life of the bond.

What is subordinated and senior debt?

This simply reflects where the bondholder stands in the capital structure. In the event of liquidation, senior bondholders along with other unsecured creditors like depositors will get paid before subordinated debt. Subordinated debt is usually only seen in Banks and Insurance companies because of the capital requirement regulations that these institutions operate under.
Bank capital is actually a very complicated subject to understand and try to explain. The most important difference between subordinated debt and senior debt is that sub debt is included in the banks regulatory capital while senior debt isn't. This is because sub debt contains contractual terms that mean the debt is dsigned to absorb losses if the bank gets into trouble before unsecured creditors such as depositors and senior bond holders get hit. Within sub debt, there are different categories such as Tier 1, Upper Tier 2, Lower Tier 2 securities. Tier 1 is considered the purest form of capital as it includes shareholders equity. So for debt securities to be included in this, they must display a lot of equity like features. Tier 2 securities display some loss absorbtion features such as coupon deferral clauses etc but are not equity like enough to be considered core capital. Here is a copy of BOI's capital disclosures. You will see the breakdown on page 6. This is what the bank has to absorb losses. You will notice that senior debt as well as normal customer and interbank deposits are not included.
http://www.bankofireland.com/includes/investor/pdfs/pillar_3_disclosures.pdf

This explains the different types of capital better than I ever could.

http://riskinstitute.ch/00007080.htm

How much does each institution have

I am not in work at the moment so not easy to see for every institution
but if we take the main two, the breakdown is as follows:

BOI: 45 billion of senior debt and 7.9 billion of Sub debt
AIB: 37.8 billion of senior debt and 4.5 billion of sub debt

What price are these trading at?

Again I don't have immediate access to the info but due to the Government Guarantee, all the short dated paper is trading at mid to high 90's to the best of my knowledge. I will have to check the longer dated paper.

It is important to remember that the most that bondholders will get back is par. The risk reward profile is completely different to shareholders.

Who holds this debt?

Mainly other financial institutions both Irish and Foreign. Also pension funds and insurance companies would also be big investors. I don't have a breakdown but people seem to think that the bonds might be mainly owned by rich individuals and that is who the Government is trying to protect. That is not the case.

Is it covered by the Irish government guarantee?

All senior debt and a small amount of dated sub debt is covered by the Guarantee.

What events trigger a default?

Obviously bankruptcy. But there are other events that would cause a default and lead to the credit ratings of the banks falling to junk. These include failure to pay e.g. not paying interest on senior debt or restructuring e.g. forcing bondholders to renegotiate the terms of the contracts.

If a bank is nationalised, is this debt automatically guaranteed?

Not 100% sure of this but I would imagine the bank's assets and liabilities become the State's so I would assume the State becomes liable for the debt.

What happens to bondholders if a bank defaults?

Assuming that there was no Government Guarantee in place, bondholders simply become unsecured creditors along with other people such as depositors (individuals, corporate and other banks), derivative counterparties. landlords etc etc etc. They would all rank pari passu in claims on the assets.

Not sure if there are any other questions that people have on the subject.
 

Shawady

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Re: Bondholders - FAQ

Useful post Sunny.
Just two questions.
(1) Do you know what happened or is going to happen to the different categories of bond holders and shareholders in Anglo?
(2) In layman's terms, what is the difference between buying a share and a bond in a bank regards the risk and return?
 

Brendan Burgess

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Re: Bondholders - FAQ

Sunny

That is very helpful. Thanks a lot. Factual posts like this will inform the analysis and debate.

I had not really thought about the difference between senior debt and subordinated debt.

The government guarantee expires in September 2010. The government could extend the guarantee to depositors only. Presumably the price of the Senior and the subordinated debt would plunge immediately.

Do we know how much of the AIB and Bank of Ireland debt matures within the guarantee period.

If the government extended the guarantee for depositors only, then the NTMA could buy the seniors and the subs for very little.

Brendan
 

Sunny

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Re: Bondholders - FAQ

Useful post Sunny.
Just two questions.
(1) Do you know what happened or is going to happen to the different categories of bond holders and shareholders in Anglo?
(2) In layman's terms, what is the difference between buying a share and a bond in a bank regards the risk and return?
1) Anglo senior debt holders continue to be paid as normal. Anglo, like other Irish banks bought back some of their subordinated debt that wasn't covered by the guarantee at big discounts to improve capital ratios (the profit from the deal went into retained earnings which is included in Core Tier 1 capital.) Anglo also deferred coupon payments on it's dated sub debt. The EU is likely to insist on this if State aid is provided. The UK banks like Bradford & Bingley and Northern Rock have done the same. Shareholders I would imagine have lost everything but I am not up to date on the valuation process etc that was supposed to be undertaken.

2) If I buy a senior bond, I am basically taking on a creditor relationship with the bank. As a shareholder, you own a piece of the company, and your rewards rise and fall in line with its profits. As a bondholder, you are a creditor of the company. You receive your interest and capital payments, but the amounts don't go up and down with company profits. (I am ignoring the trading side on the secondary market of both shares and bonds). It is important to remember that it wasn't bondholders who were pressuring the banks to go down the Anglo model of aggressive property deals. They have to share the blame along with regulators and rating agencies for not shouting stop but it wasn't bondholders that the banks were worried about pleasing. Bondholders don't generally care about return on equity and other such factors. At the end of the day all they care about is getting their money back. They are no different to the money markets. They just lend money for longer horizons.
 

Brendan Burgess

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Anglo, like other Irish banks bought back some of their subordinated debt that wasn't covered by the guarantee at big discounts to improve capital ratios (the profit from the deal went into retained earnings which is included in Core Tier 1 capital.)
Hi Sunny

What did they buy back the subordinated debt with? Other debt similar to the AIB 12.5% stock? Or with cash?
 

Sunny

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Hi Sunny

What did they buy back the subordinated debt with? Other debt similar to the AIB 12.5% stock? Or with cash?
As far as I know they paid cash but am open to correction. My understanding is that Anglo is still able to obtain capital market funding so they probably just financed the buy back through internal liquidity.
 

Duke of Marmalade

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A key point is that Senior Bondholders rank pari passu with Depositors. Everybody, even Brian Lucey and David McWilliams, seems to agree that Depositors should be protected. So if Bondholders are to pay for the losses in the banks the depositors must pay equally and the losses of the latter would have to be made up by the taxpayer. In other words there is no question whatsoever, even for the hawks, of all the losses being borne by the shareholders and bondholders after the banks have repaid depositors in full.
 

Bronte

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Sorry if I'm being stupid but I find all this very difficult to understand. Could we have maybe a pyrimid table

1. Bondholders = (what percentage of a bank) and is made up of financial institutions = pension funds
2. Subordinated debt
3. Unsubordinated debt
4. sharehholders = (%) ordinary people = financial instituations
The above own the bank?
5. Depositors (%) = ordinary people
6. Borrowers (%) = ordinary people
The last funds the bank, makes the profits? No 5 costs the bank?

And then how do the Tiers link to this? I realise my question doesn't seem to make sense and I apologise for it.
 

Brendan Burgess

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Bronte. This is how I understand it.

Risk capital
1) Shareholders have pure risk capital. Share capital is permanent and never repaid. Regulators require banks to have a certain amount of Shareholders Funds which is known as the Tier 1 ratio.

2) Subordinated Debt is next. Unlike share capital, they are not permanent sources of capital. They must have at least 5 years to go to maturity. They get paid a higher coupon than depositors but can have their coupon reduced or deferred without triggering a collapse. €10 billion in AIB and Bank of Ireland). Regulators require banks to have a certain amount of Tier 2 capital.

Non Risk capital
3) Depositors and Senior Bondholders (€80 billion in AIB and Bank of Ireland). Any renegotiation of their terms triggers a default.

Borrowers
These are not providers of capital. They absorb capital.
 

Brendan Burgess

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Here are the main figures for Bank of Ireland as at March 2009

Tier 1
Shareholders funds: €6.5 billion
Government's preference shares: €3.5 billion
Other Hybrid debt: €2 billion

Tier 2
Dated loans: €4 billion

Total Tier 1 and Tier 2: €16 billion

If the bank has losses of €1 billion in the year to the end of March 2010, it would reduce its Shareholder funds to €5.5 billion.
 

nialdel

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Was it never possible to do a deal with the bondholders ? Could the Govt./ Banks not have insisted that they bore some responsibility and that they should share in the pain by having their debt converted into equity as was done in US by General Motors ?
 

Vega

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Excellent information Sunny. I would just add that, in Ireland it's not just banks and insurance companies but also many investment firms, asset managers etc. use subordinated debt because it qualifies for Tier 2 capital.
 

Lobby

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Can anyone exlain in practical (layman) terms exactly what happens when the state re-caps a bank. In particular, the Gov gave Anglo 4.5bn in extra capital requirements, what actually happens in this scenario?

Does:

The Gov transfer €4,500,000,000 from a bank account into an Anglo account
Anglo then uses that money to repay bond obligations as they arise

I.e. where does this money actually go to? Or does any "real" money actually change hands?
 

Brendan Burgess

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Hi Lobby

Yes,the government will actually transfer real money from their bank account into Anglo's bank account.

The primary use for the money will be to repay the deposits of ordinary consumers. Bondholders will be comparatively less.

With the EBS, it's different. The Government is issuing a promissory note agreeing to pay in the cash in the future if it's needed. TheEBS is solvent, so it is unlikely to need it.

Brendan
 

leesider29

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If I have got this right, instead of Anglo being nationalised it could have been let go to the wall and default on its debt (not taking into account the guarantee)?

So the decision was that that could not happen as Anglo was of systemic importance. This is the part that has never been explained.....were they pushed by other govs whose banks are bondholders? Were they afraid the sovereign bonds would be hard to sell like Greece?? Was it a coverup to get away with any scandals that might have emerged?

Anyone out there have the answer?
 

Sunny

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Thanks - could you be more specific? What law/Act?
Sorry, wasn't a great response. Senior bondholders invest money on the basis that they are unsecured creditors of the bank. Just like anyone else that the bank owns money to. The relationship is then set out in usual insolvency law. Will try and find something more specific for you but don't think there is any specific mention of bondholders in any law.
 

Complainer

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Sorry, wasn't a great response. Senior bondholders invest money on the basis that they are unsecured creditors of the bank. Just like anyone else that the bank owns money to. The relationship is then set out in usual insolvency law. Will try and find something more specific for you but don't think there is any specific mention of bondholders in any law.
Thanks for this. I'm trying to get my head around the impacts of defaulting. To understand those impacts, I have to understand the basis and the law around their agreement.

So my real question is 'who says that senior bondholders rank with depositors'? Is this a matter of law, or a matter of the agreement between the bank and the bondholder?
 
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