EXPECTATIONS grew today that bondholders in Irish banks may be offered the chance to swap billions of euros of debt for new bonds, sharing the pain as they realise a loss - but avoiding a potentially worse outcome.
Such tenders have been used successfully by Irish and other European banks during the financial crisis. to allow institutions to buy back bonds at a premium to their market price but at a discount to nominal value.
The deal saves the banks' money but forces bond investors to take a so-called "haircut".
Standard & Poor's on Wednesday cut Irish banks long-term credit ratings, saying "the stand-alone creditworthiness of the four domestically owned Irish banks has weakened".
And expectations increased that senior bondholders in Bank of Ireland, Allied Irish Banks and nationalised Anglo Irish Bank would have to bear some of the distress after The Irish Times said the IMF and European Union have been examining ways of spreading the bailout costs.
Investor nervousness grew after the report, with prices of Irish and European bank bonds falling sharply.
There were no bids for Allied Irish or Bank of Ireland senior debt, with liquidity in the market drying up.
A tender would be among the least painful options for Irish bank bondholders.
Another scheme being considered involves swapping bank debt into equity.
Investors could also be given the choice of injecting fresh capital or face a cut in their investment, The Irish Times said.
Whether senior bondholders are forced to take a hit is a hot topic after several European politicians said they should share the cost of the bailout.
"Clearly things are coming to a head in Europe and there's a debate, particularly in regard to the Irish banks, that bondholders may need to be subject to burden sharing," said Mark Dowding, senior portfolio manager at Bluebay Asset Management in London.
"In the first instance it may be offered as a debt swap. But if there's not sufficient take up there may be more of an enforced effort," Dowding said.
However, such a dramatic move could further undermine confidence in banks in Portugal and Spain, by showing all investors are vulnerable.
And it could make it tougher for Irish banks to fill a future funding gap estimated at about €160bn (£135bn).
German Chancellor Angela Merkel has repeatedly said bondholders should share the pain when a country hits trouble, but only for bonds issued from as early as 2011.
An €85bn rescue package is expected to be unveiled, possibly over the weekend, to cover Ireland's funding costs and the cost of "overcapitalising" the banks.
Ireland's government has consistently said it will honour its obligations to senior bank bondholders, despite forcing a haircut on holders of subordinated debt in Anglo Irish and Irish Nationwide.
But the main opposition party Fine Gael, which will likely lead a new government next year, has said all bondholders should share the burden of bailing out the banks.
Bank of Ireland, which has boosted capital by €1.7bn from bond offers in the last two years, had about €31bn of senior debt and asset-backed securities at the end of June.
AIB had €20bn of senior debt and Anglo has about €6.5bn of senior debt after maturities in September.
City A.M. Reporter