An €85 billion ($110 billion) rescue package for Ireland was announced over the weekend. The European Commission (EC) will provide €67.5 billion and the rest will come from Ireland.
An immediate €10 billion cash injection will be made into Irish banks and a further €25 billion will be provided on a contingency bases as a buffer against further bank write downs as needed.
The announcement of how the package will be structured has reduced the risk of haircuts on sovereign debt and senior bank debt. However, it was originally speculated that senior bondholders in Irish banks would share the burden of the bank rescues.
"The lack of any such provisions in the package announced this weekend suggests that decision makers have realized that bailing-in senior bank bondholders could have severe negative repercussions for access to funding in capital markets for other European banks and could precipitate the much-feared contagion the announced Irish rescue package was supposed to forestall," Barclays Capital analysts said.
While the risk of haircuts has decreased considerably for Irish bank senior debt, haircuts remain likely for junior debt. In a broadcast interview, Irish Finance Minister Brian Lenihan said that the government needs to impose “big haircuts” on banks’ junior noteholders, according to a Bloomberg report.
Haircuts imposed on junior bank paper will have a negative effect on ABS because it increases the chance of a non-calls in RMBS transactions. Barclays analysts explained that call risk in European RMBS arose, not exclusively but also, in connection with such similiarly structured bank bailouts.
"Specifically, the EC disallowed calls of bank capital securities issued by bailed out banks and routinely extended such a call prohibition to ABS transactions from bailed-out originators," Barclays analysts said. "Only once the originator proposes and the EC accepts a workout plan does it seem ABS calls are again be made on time."
If junior debt holders are forced to accept haircuts in the case of the Irish bailed-out banks, it is likely that these Irish RMBS bonds won't be called. This is at least until the bailed-out sponsors have submitted and the EC accepted a detailed work-out plan that sees the affected institutions eventually wean themselves off of government support.