Simon Carswell reports on legal challenges by subordinated bondholders of AIB and Bank of Ireland. The main contention seems to be the up-ending of usual ranking of equity and junior debt.
At the core of the case taken by Aurelius is whether a subordinated bondholder – the lowest-ranking creditor in the capital structure of a company – should be wiped out when the bank is only in existence because of €13.3 billion that must be injected by the State on top of a €7.2 billion bailout.
Aurelius claims the Government has subverted the rules of the capital markets where shareholders should be wiped out first and then junior bondholders.
It says that the stakes held by shareholders, including the Government’s preference and ordinary shares, should bear losses first.
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Another subordinated bondholder challenge is also looming. On Wednesday the London law firm White and Case said it had been hired by bondholders in Bank of Ireland holding about €700 million of the €2.6 billion.
They claim that the bank’s proposal to inflict losses on lenders through a debt-for-cash-or-equity deal is “fatally flawed” because it fails to respect the fundamental principle that creditors must be repaid ahead of shareholders.
Although I am open to correction by the experts out there, my understanding is that for junior bondholders in place before the State’s capital injections, solvency is being judged based on pre-State capital injection capital levels. On this basis, the reversal of the usual ranking should not affect the ability to raise bond financing in the future. Moreover, Eoin Bond, our expert commenter on these issues, has argued on a few occasions that the subordinated bond is dead as a financing instrument for Irish banks, so we shouldn’t be overly concerned about its treatment.
Even so, I worry that uncertainty about the future creditor regime – and not just for subordinated bondholders – is making the restoration of the creditworthiness of the new pillar banks more challenging. There is not much point in pumping large amounts of supposedly loss-absorbing capital into a bank if there are fears that the capital will later be disregarded. Regime uncertainty is being much debated in regards to sovereign debt, but it applies in the case of bank debt as well. The temporary and rather draconian nature of the Credit Institutions (Stabilisation) Act has not helped in this regard; and the proposed permanent special resolution regime is not set to be enacted until the end of 2012.
I would be delighted to hear from commenters that these concerns are misplaced, and that potential creditors draw a sharp line between the treatment of legacy junior debt and any new debt issued by the banks. But I do think it would help for the government to provide as much clarity as possible as to the nature of the future creditor regime.