Business World

Friday 17 November 2017

Eight things you need to know about the senior bond debate

Donal O'Donovan

Donal O'Donovan

1. What is a bond?

Bonds are a form of debt used by banks, countries and companies to raise finance on the money markets.

In layman terms, a bond is just another type of loan.

Bonds -- especially bank bonds -- tend to be most appealing to conservative investors.

As a lender rather than a shareholder, the first thing a bond "holder" looks for in an investment is getting their money back, plus interest.

It means the amount to be made on a bond is limited from the get-go, but the investment is designed to keep cash safe while generating a steady income, not to make spectacular gains on the markets.

In the case of Ireland's banks, typical bondholders historically tended to be the likes of pension funds, insurers and credit unions.

2. And a senior bond?

Senior bonds are simply those first in line to be repaid when things go wrong at the borrower. In Ireland, they rank alongside customer deposits, at least under current rules. Senior bondholders tend to be the most conservative, even among risk-averse investors, at least in normal circumstances.

3 Has a senior bondholder ever suffered a loss?

Yes, in the US all classes of lenders to Lehman Brothers shared the losses when that bank collapsed in 2008.

Last year, Denmark allowed senior bondholders in two of its banks to suffer losses when those banks failed. Iceland allowed some losses to fall on bondholders. Until now, however, no senior lender to a eurozone bank, and no depositors in the eurozone, has ever been hit with a loss. Ireland wanted to force losses on senior bondholders in Anglo Irish Bank last year but the plan was blocked.

4 Why?

The ECB thought the wider financial situation was so delicate that any such losses would spook the market -- driving up the cost of borrowing for all banks and hurting the flow of credit. Ireland relies on the ECB to keep money flowing through the bank system, so the Government was unwilling to defy it on the issue.

5. So what has changed?

Under ECB policy someone other than the senior bondholders had to pick up the tab. In the case of Ireland, that was the exchequer, which ultimately damaged the credibility of the national finances.

That lesson appears to have been learnt, so the ECB has become more open-minded on where the losses should fall and has backed calls to break the financial link between states and banks. Europe is now developing a system for shutting down banks when they fail, which it's hoped will mean losses are less of a shock to the system if they do occur.

6. Will Spain impose losses on senior bondholders in its banks?

Spain has been given the green light to force losses on senior bondholders, but doesn't want to use it.

In Spain, many ordinary people use bond investments as a form of saving -- we do, too, through the post office, but on a smaller scale.

It means any losses for senior bondholders in Spain would be the political equivalent of forcing losses on ordinary deposit account holders here. Even Iceland balked at that scenario.

7. Would Ireland have escaped if bondholders had been burnt?

No. Bailing out the banks was a significant factor in Ireland needing a rescue bailout in 2010, and the cost of rescuing banks was much bigger than just the bondholder issue. Anglo Irish Bank, for example, had about €50bn of deposits when it was bailed out, compared with €20bn of bond debt.

8. How much could Ireland have saved by burning senior bondholders?

Taking the policy outlined by the ECB last week as the model, Ireland might have shaved between €4bn and €10bn off the total cost of the bailout.

Irish Independent

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