Noonan's Seismic SLO

posted 21 Apr 2011, 02:36 by Mark Taber   [ updated 26 Apr 2011, 15:11 ]
Last Thursday the Irish Finance Minister,  Michael Noonan, delivered a seismic shock to AIB junior bondholders in the form of a Subordinated Liabilities Order under the Irish Credit Institutions (Stabilisation) Bill 2010. While it was widely expected that the Minister would use the powers under the act to vary the terms of AIB junior bonds the extent to which he is attempting to do so is quite staggering. It is, therefore, remarkable how little financial media coverage there has been of events. So I feel compelled to try to generate some interest in what is going on.

The most striking thing about what is proposed by the SLO is the up-ending of capital hierarchies. Not only between different classes of junior bonds but also between equity and bonds. We saw the UK government use legislation to vary the terms of Bradford & Bingley dated subordinated bonds when the bank was nationalised. However, in that case the UK government was very careful to preserve the established hierarchy of creditors. The Irish government have taken no such care and have produced an Order which proposes that previous restrictions on the payment of dividends on ordinary shares while subordinated bonds are not paying are removed and that perpetual Tier 1 bonds remain cumulative whereas higher ranking mandatory dated Tier 2 bonds have been made discretionary and non-cumulative. Perhaps the most irksome part of the Order is that way in which it has left untouched the preference shares which were issued to the NPRF (Irish Pension Fund) as part of an AIB capital raising in March 2009 whereas two large issues of dated 12.5% 2019 bonds which were issued as part of the same capital raising exercise have effectively been moved below the preference shares in the capital hierarchy. The holders of those bonds accepted them in exchange for previous issues of AIB subordinated debt taking a haircut in the process. This preference of the NPRF held preference shares over holders (which will include other pension funds) of higher ranking bonds in the SLO will be seen by many as unfair, illegal and possibly fraudulant.

The strength of feeling on this issue can be seen in the eloquent posts by highly experienced investors on TMF Banking Sector forum. Rather than attempt to rephrase what has been said I have selected a number of quotes as follows:

"I wonder whether the politicians who drove the application for the court order really understand the magnitude of what they propose? Of course they will say that extreme measures are justified by the extreme situation but the whole point of established rankings of capital are to dictate what happens in extremis. In normal times it matters not a jot whether creditor A has a prior claim to assets than creditor B. The only reason that rankings are carefully enshrined in law and specified clearly in debt documentation is to predetermine the priority of creditors in case of insolvency.

An entire branch of the law and an entire branch of the accounting profession exists solely to ensure that creditor priority is handled fairly in case of financial distress. Seeking to flagrantly disregard creditor priorities or to selectively favour one creditor over another is a concept so central to the concerns of bankruptcy courts and insolvency practitioners that they have a term for it: fraud. You can go to prison for seeking to do this.

A country without a reliable system for creditor protection than can be depended up on in extremis is a country in which business cannot be conducted except for cash. So I am amazed that Ireland has taken this step and really do not believe that they understand the ramifications. And the weird thing is they didn't have to do it. They could have nationalised the bank or swapped equity for debt and the problem would have been solved. Why didn't they do that? Simple: to protect the NPRF from dilution. And that is fraudulent preference. Seismic indeed. Wow."


"The reason why I am flummoxed is that, reading the subordinated liabilities order in conjunction with the above, It appears to me to leave interest on the T1 7.5% notes as discretionary but cumulative, whilst making interest on the LT2 notes both discretionary and non cumulative. This cannot be right, as T1 notes are junior to LT2 notes. Yet I have now read through the documents three times and that is what the effect appears to be.

Further, the intention of the subordinated liabilities order appears to be to allow dividends to be declared on AIB ordinary shares whilst coupons are not being paid on higher ranking T1 and T2 debt.

Both of the above apparent effects of the order are in such clear breach of established capital hierarchy rules that it seems inevitable that this will lead to the mother and father of rows with institutional holders of these securities. Hence, I assume, the reference to "negotiations" with holders as to what terms they will accept for an offer for the securities.

It’s late, and I’ll try to go through the documents again tomorrow with a cold towel, but on first reading the order simply doesn’t seem to make sense to me – for example I can see no possible reason for leaving the 7.5% T1 cumulative whilst the LT2 are not. I have previously posted that I expected the coupons on AIB LT2 to be made discretionary, and that in itself is not necessarily a breach of capital hierarchies. But allowing ordinary dividends to be paid whilst interest on subordinated debt is suspended, and allowing T1 debt to remain cumulative whilst LT2 debt is made non cumulative simply makes no sense, and to me is an open invitation to law suits. It would certainly have a huge negative impact on any Irish bank's future access to external funding."


"I don’t think the Irish government will have appreciated quite what a hornet’s nest they are stirring up here. The fact is, if the established priority rankings of debt and equity can be unilaterally and retrospectively altered by government diktat at any EU bank, then no EU bank debt is investable. How, for instance, could any institutional investor possibly buy a bank COCO if the terms of that instrument can subsequently be altered at a government’s whim? And EU banks need to issue a lot of COCOs over the next few for Ireland, unless this is resolved, its banks will be unable to fund themselves in public debt markets for the foreseeable future.

I agree with what everyone else here has said that it seems lunatic for Ireland to cause this fuss when the whole purpose of their bank recapitalisations and restructuring is to allow them to return to public markets for restructuring.
They simply didn’t need to do this to achieve burden sharing. Had they simply extended the maturity dates of the dated sub debt and made the coupons discretionary but cumulative, with an ordinary dividend pusher, then there would have been a fuss but they would probably have got away with it because (as with B&B) in that scenario fundamental capital hierarchies would not have been breached. But it appears that they are indeed motivated by trying to protect and prefer the position of the NPRF as an ordinary shareholder, and as Sedieren said there is a word for such attempted preference : fraud. More importantly, it is contrary to fundamental European property rights law.

I think there will be a compromise of some kind, but unfortunately the die has now to an extent been cast with the publication of the SLO. The only way out for face saving on both sides is for agreement to be reached on a "coercive" type offer at an acceptable price which then results in the buy back of ALL AIB sub debt so that the issue of whether or not the coupons can be suspended whilst ordinary dividends are paid is never in fact tested. I’m sure there’s a price level at which such an agreement could be hammered out, but at the moment I suspect the two sides are some way apart. Quite apart from the direct implications on my relatively modest holding in these instruments, as a point of principle and precedent it will be fascinating to see how this turns out.

Finally, I’ve carefully read through the SLO and associated instrument terms again today. I agree with what’s been written here by other posters – the SLO has been very sloppily drafted and (for instance) inadvertently prefers the 7.5% T1 in liquidation over the LT2 which I’m sure was not the intention, and it also leaves extant contradictory coupon payment provisions in the terms of the LT2. The very sloppiness of this drafting tells me that the Irish authorities simply haven’t given this enough prior thought. The question now is how (or if) they can be helped to row back from the very dangerous position they’ve got themselves in."

The Irish Credit Institutions (Stabilisation) Bill 2010 allows a period of 5 working days for creditors to legally appeal against a subordinated liabilities order. Late yesterday it emerged that at least two hedge funds,  Aurelius Capital and Abadi & Co Securities Ltd, have filed appeals. Watch this space !

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