I know it’s only €34m and in the context of the billions that have gone before, it is small beer. But INBS, that zombie building society now stripped of its deposit book and NAMA loans, is still proposing to pay subordinated bondholders, who control €170m of subordinated bonds at face value, 20c in the euro for their bonds which are otherwise due to mature between 2016-2018. INBS is the 100% state-owned financial institution which, to date, has swallowed up €5,400m of state funds. These €170m of subordinated bonds represent all but €5m of the bonds identified by the Central Bank of Ireland in their statement two weeks ago.
We need be clear that the bonds in question are (1) subordinated and cannot rely on any parity with depositors or senior bondholders to claim full repayment and (2) the subordinated bondholders are not due to be repaid until 2016-2018 by which time the residual INBS lending will have been transferred elsewhere (NAMA 3 or some such) and INBS will presumably be well and truly buried and (3) not subject to a guarantee
So why is INBS paying anything whatsoever to these subordinated bondholders? Again it is small bear but in case you hadn’t noticed it, there is a cloud gathering over the Irish economy and in the near future a few million here and there will be significant to the State’s coffers. Our benefactors in the ECB/IMF have insisted that we deleverage our domestic banking system so that it is more appropriate to the nation’s economy and doesn’t have liabilities over three times the size of our GDP. Once the banking mess is dealt with, we will very quickly get used to national decisions being in terms of millions again and not billions.
So what is INBS playing at, with our money?
UPDATE: 24th March, 2011. It seems that INBS has had 99% acceptance of its offer which now appears to relate to €146,770,000 of subordinated bonds at par value and the 20c in the euro buy-back offer will see the State (which 100% owns INBS) pay out €29,354,000 for unguaranteed subordinated bonds which were only due for redemption in 2016 and 2018). “Settlement” according to INBS will take place tomorrow. Is it not scandalous that the State is now spending €29,354,000 on redeeming bonds in a zombie financial institution that benefits from some €5,400,000,000 of State-funding, on bonds that would only be redeemable in 5-7 years time.
UPDATE: 26th May, 2011. Anglo will tomorrow redeem some €200m of senior unsecured bonds at par. According to the Irish Independent these bonds were trading at 87c in the euro last December 2010 so some investors may see 30% annualised returns (13c / 87c for 6 months = 30% for one year). Apparently Minister Noonan is powerless to stop the redemption because (1) the stress tests for Anglo and INBS have not been completed and (2) IMF and EU approval would be required which would take some time.
NAMA Wine Lake 
What indeed?
In my opinion, this whole process where banks are paying off their bondholders is misguided and a lost opportunity. The NAMA banks should be writing down their commercial property loans to the level of the bonds and allowing the borrowers to pay back the loans through the purchase and set-off of the bonds.
In essence there would be a consensual settlement between the borrower and the Bank whereby:
The bank and borrower agree the value of the outstanding loan and the borrower delivers senior bonds to the bank for an equivalent amount in satisfaction of the borrower’s repayment obligations. The bank in turn would release the secured assets to the borrower, who would finance these at the newly reduced level from a fresh lender (or even the old one).
The bank would receive regulatory capital relief on the provisioned asset and it would potentially mitigate the NAMA haircut in terms of commercial loans.
By way of explanation, regulatory capital relief arises because the bank would be replacing a commercial real estate asset held on its balance sheet with its own debt.
Commercial real estate loans attract a 100% risk weighting which means that they are capital intensive. Banks must maintain 8% of capital against exposure and the risk weighting typically increases to 150% where the loan is impaired.
If the bank holds its own debt, the usual capital treatment is that this is zero risk-weighted (i.e. there is no obligation to hold any capital against the position)
In consequence, by writing down the debt and accepting the bonds in exchange for the loans, the bank downsizes and improves its balance sheet simultaneously.
I’m not a banker, nor am I directing policy, but I would like someone to explain to me why the strategy sketched above cannot be utilised both for commercial and, with a bit of ingenuity, residential property loans.