Irish Economy
EU banks forced to consider losses on bonds in stress tests; BoI cuts State's maximum stake to 69%
By Finfacts Team
Jun 24, 2011 - 7:05 AM

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Bank of Ireland was founded in 1783 and the former premises of the defunct Irish Parliament at College Green, Dublin, were purchased for £40,000 in 1803.

The European Banking Authority has updated its bank stress tests to include the risk of losses on banks’ holdings of sovereign debt from crisis- hit European Union countries, The Wall Street Journal reports. Meanwhile, Bank of Ireland (BoI) cut the maximum stake the Government might take in the bank to 69% after almost three quarters of subordinated bondholders took up shares in a debt-for-equity-or-cash offer.

The EBA has revised its guidelines on banks’ exposure to sovereign risk to reflect recent market movements in the debt of countries such as Greece and Ireland, the Journal said.

A spokeswoman for the European Banking Authority said the agency's ongoing stress tests of 91 banks across the European Union will now require lenders to take stiffer 'haircuts' on their holdings of certain countries' sovereign debt. The EBA spokeswoman said this was "in line with recent market movements for those countries most adversely affected."

The newspaper says the those haircuts will apply to securities banks hold in their so-called "trading books," which means they are classified as available for sale and that their values have to be adjusted regularly to account for market fluctuations.

But most banks' holdings of potentially risky sovereign debt are parked in their "banking books," a designation that means banks do not need to account for their changing values as frequently. The Journal says those banking book holdings are a source of angst among investors who worry that banks are sitting on big piles of debt issued by financially shaky European governments.

However, banks will be forced to provide details of their sovereign debt holdings, which will enable analysts to assess the exposure of individual banks.

Andrea Enria, chairman of the European Banking Authority earlier this week called for a "backstop" plan for financial institutions to be supported by the private sector or public sector if necessary, following the current stress tests.

He noted that stress tests were not yet finalized and were currently in the "quality assurance peer-review process." He said there are some issues with regard to the quality of the data and inconsistencies, and that he expected resubmissions from the banks in the coming days.

"We will then see what the results are," Enria said. "In any case, in the case of failures, we want there to be appropriate backstops to deal with them."

Bank of Ireland on Thursday announced the early participation results of its LME (liability management exercise) - -  in effect an offer of 'haircuts' or big discounts to holders of junior debt.

BoI said to date, 72.4% of eligible holders have elected to accept the offer to exchange their bonds for cash or new ordinary stock. 95.4% of accepting bondholders elected to receive new ordinary stock and 4.6% of accepting bondholders elected to receive cash. As a consequence of this, the LME is expected to generate at least €1.98bn of equity capital for Bank of Ireland. The final closing date for the LME (other than the Canadian Dollar 2015 Notes) is 7 July 2011.

BoI offered bondholders as little as 10% of the original value of the debt in cash, but 20% or 40% if they took shares in the bank.

AIB must raise €13.3bn by the end of the month while Bank of Ireland requires €5.2bn, including €1bn in contingent capital.

The State currently has a 36% stake in BoI, which is seeking to raise more than €2.1bn from bondholders and up to €2.2bn in a rights issue to raise the capital requirement set by the Central Bank after stress tests last March.

Also on Thursday, Allied Irish Banks (AIB) announced that discussions are continuing with the Government in respect of the terms and structure of a capital raising in order to satisfy AIB's revised regulatory capital requirements following on from previously indicated capital support for AIB as one of the two Pillar Banks.

AIB said while discussions remain ongoing it is evident to AIB that any subscription for shares by the State would likely be at a very low price, being a very significant discount relative to the current share price. If this is the case, it is likely that the State's shareholding in AIB would increase substantially beyond its current c. 93% ordinary shareholding, resulting in potentially significant additional dilution for existing ordinary shareholders other than the State.

"It is expected that discussions with the Government will finalise within the next week, at which point AIB expects to be in a position to announce the final terms and structure of any capital raising transaction with the State. AIB expects to remain as a listed company which will allow shareholders continue to trade their shares," the bank said.

Meanwhile, Minister for Finance Michael Noonan said the Government expects to spend €9bn less than originally forecast in recapitalising Ireland’s banks.

The Government had said in March that €24bn would required for recapitalisations.

On Thursday, Noonan said funds from burning subordinate bondholders, bank asset sales and private investment would cut that amount by €6bn. In addition, the Government does not expect to spend a €3bn contingency fund.

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