Friday, September 17, 2010

Anglo Irish Bank = Creditanstalt?

I have been saying watch Europe watch Europe watch Europe. I still think that is where the next leg down in this whole mess will originate. Well news from Ireland just caused a major reversal in Europe and while U.S. futures are still positive, the luster has been taken off. Creditanstalt may be upon us.

From the Irish Independent

These are desperate economic times. So desperate that the subject of Ireland defaulting on its bank and sovereign debts is now routine conversation among academics, bankers and economists.

However, up until now, such an idea was rarely entertained by senior politicians, but in a surprising move yesterday the leader of the Labour Party, Eamon Gilmore, came very close to suggesting such a course of action when he talked about the Government "negotiating'' with bondholders in Anglo Irish Bank.

While Mr Gilmore trenchantly denied such an approach meant defaulting, he certainly came very close to that position.

If the market sees this as a gesture towards default, it's over. It is like the banks CEO being forced to come out and say everything is fine. When I got a call two days before suggesting I take money out of Bear Stearns money market funds as a precaution, I knew the game was up.

It continues...

Of course, Mr Gilmore (and his position got some support from Barclays last night) has some options. One is to simply press to reduce the total amount owed to the bondholders, allowing Anglo to book a gain from having to pay out less interest than originally agreed.

The second approach, one championed by the 'Financial Times', is to tell the bondholders you intend to swap their bonds for shares in Anglo.

This would effectively leave the bank, which is a heartbeat away from technical insolvency, in their hands. This is known as a debt-for-equity swap and is very common in downturns when companies run into problems. Technically it is also known as a distressed exchange offer. This approach could be taken, but again it comes with significant risks which need to be acknowledged by political commentators like Gilmore and others pressing for this course of action.

The problem with this idea is that there is no way Anglo Irish Bank is worth €16.5bn at the moment. So if the bondholders swapped all their bonds for Anglo shares they would be settling for less than par value. This is a selective default.

Of course, the big danger is not what would happen in Anglo if this course is taken, but what would happen at the other Irish banks. By how much would their fund-raising costs go up?

That is exactly right. Anglo Irish is big but not that big. The question is contagion. Is it Creditanstalt all over again? (the Austrian bank that declared bankruptcy in May 11, 1931 that really got the depression going).


The final danger is: would an Anglo technical default raise the funding costs for Ireland Inc itself? Again it is hard to say. There are two schools. One suggests that by cutting Anglo loose, Ireland becomes a better credit risk and funding costs could actually drop.

Others suggest once you welch on any debts, your funding costs elsewhere rise and you may even be locked out of the bond market entirely.

That is a danger and it may spill over to Portugal sovereign or Spain etc. but I think the bigger danger is other European banks. A) the funding costs could shoot up with an entire knew liquidity squeeze and B) all of a sudden you have precedence for sovereign nations not to take responsibilities of the banks. A for sure popular choice among the electorate. I mean if Ireland allows a default on one of its large banks why should Greek people suffer? Or Spaniards?

Something almost has to happen now in the next week. Irish - Bund Spreads are exploding.


Anonymous said...

Irish, Portuguese yields are rising. But Why TED spread and euribor-ois spreads are not widening if some liquidity crisis is coming. What do you say?

Market Seer said...

Because there isn't a liquidity issue, just a solvency issue. The ECB has stepped in making sure everything is well liquified in the banking system. The spreads are widening because of long term solvency issues. Not liquidity issues which is what drives euribor-ois and the TED spread.

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