Saturday 20 January 2018

Market pricing in 30pc haircut on Irish debts

Dan White

Dan White

Despite last weekend's announcement of an EU/IMF bailout, the pressure on Ireland shows no signs of easing with investors still convinced that we will have to default on our debts. Irish bond prices and the cost of insuring our bonds against the risk of default indicate that the markets are pricing in at least a 30 per cent "haircut" over the next three years.

On Friday, 10-year Irish government bonds paying a 4.5 per cent annual coupon (interest rate) were trading at 75 cent in the euro; while those paying a 5 per cent coupon were valued at 78 cent in the euro. By comparison, 10-year German bonds, which pay a coupon of just 2.5 per cent, were changing hands at over 97 cent in the euro.

You don't need to be a financial genius to see that the market is factoring in a hefty write-down on Irish government debt some time over the next few years. The Irish Government and the ECB can huff and puff all they like but an Irish debt default and/or rescheduling is a question of when rather than if.

So what sort of a write-down can holders of Irish government debt expect? The difference between the prices at which comparable Irish and German bonds are changing hands gives only a partial indication. The huge difference in the coupons being paid on Irish and German government bonds also needs to be taken into account.

If we assume that a default will occur in three years time, ie towards the end of the bailout period, then holders of 10-year Irish government bonds paying a 4.5 per cent coupon will receive an extra 6 per cent interest over that period compared to holders of similar German bonds; while those holding 5 per cent coupon Irish bonds will receive an extra 7.5 per cent. That indicates a likely haircut for bondholders of somewhere between 29.5 per cent and 31 per cent.

Prices for credit default swaps, where investors insure against the risk of debt default, paint a similar picture. On Wednesday the cost of insuring Irish government debt reached an all-time high of 618 basis points. Translated into plain English this means that insuring €10m of Irish government debt would cost you €618,000 a year. As credit default swap contracts run for five years this would entail a total outlay of €3.09m or just under 31 per cent. With the Irish national debt likely to reach at least €180bn as a result of the bailout, a 30 per cent write-down would knock €56bn off the figure, reducing the burden on the Irish taxpayer to "only" €126bn, which coincidentally is the forecast value of Ireland's economic output this year as measured by GNP. While a €180bn national debt is quite clearly unsustainable for any length of time, a national debt of only €126bn might be just about bearable.

Sunday Independent

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