Ireland on the hook over debt, bondholders to be hit

Written by Bloomberg | Updated: Jan 29 2011, 06:38am hrs
Irish bondholders may have another 51 billion reasons to worry. Figures published by the central bank this month showed it lent as much as that sum in euros, equivalent to $70 billion, to commercial banks. Unlike the 132 billion euros the European Central Bank is using to prop up the countrys financial system, the government may be on the hook for it. Ireland has the fourth-highest debt level in Europe.

The increased liability of the state makes it more likely that senior bank bondholders will be forced to take a hit, said Juergen Michels, lead euro-region economist at Citigroup Inc. in London. While we dont currently see a restructuring of sovereign bonds, the risk increases the higher the aggregated general government debt level goes.

Investors are shunning Irish government and bank bonds because of concern that the bill for saving the financial system is still untallied. The extra yield investors demand to hold Irish 10-year bonds rather than German securities of similar maturity climbed 18 basis points to 593 points yesterday. Thats nine times the average of the past decade.

Citigroup said in a January 21 report that loans from central banks across Europe to their lenders are surrounded in secrecy. The program is called the exceptional, or emergency, liquidity assistance, or ELA.

Similar to other central banks, the Central Bank of Ireland can supply exceptional liquidity assistance to institutions that is judged necessary, Nicola Faulkner, a spokeswoman at the bank, said in an e-mailed statement. The bank does not, however, comment on these operations. The finance ministry and ECB also declined to comment.

The central banks other assets rose to 51.1 billion euros from 44.7 billion euros on November 26. Such assets include exceptional liquidity assistance lending for Irish banks, it said. Those loans make up the bulk of the money, according to a central bank official, who declined to be identified.

Commercial banks increasingly are resorting to borrowing from the authorities to fund their activities. The loans are designed to be short-term.

The assistance has the potential here to expose the Irish state to further losses from the banking system, said Brian Lucey, associate professor of finance at Trinity College Dublin. While all euro-member countries are responsible for any losses on funding from ECB lending operations, the Irish government is left with any losses from the central banks scheme. The cost of insuring Irish government debt against default has gone up 450 basis points to 632 points over the past year, according to CMA prices for credit-default swaps. The price of the swaps rose as the government stepped in to save the banks after a decade-long real estate boom collapsed in 2008.