Bank of Ireland: Following the Citibank Script?

| About: The Governor (IRE)

“Ireland was a fiscal union by the back door. The real thing will take a long time but it is kind of there already.”

--Anonymous Senior Investment Banker, London.

A sucker is born every minute.

The easy mark. The sucker. The hardscrabble Irish gamblers and grifters of the mid-19th century virtually invented the streetwise “scam,” designed to separate the gullible from their money. With the famine schemers plying their trade in London and America’s seaboard cities, conjuring up their “poker” rooms and “phony” rings, Gaelic was the language of vice and the sporting life. Even the term “sucker” actually comes from the Irish term “Sách úr,” meaning “a fat cat” or “plump, naïve person.”

But times have changed and the Gaels grew rich. This time it was Ireland starring as the mark, willing to take the hit to maintain its membership as a proper “lace-curtain” European. As the liabilities of its banking sector have been folded into Ireland’s public responsibility, the EU’s big money center banks seem to have evaded their poor risk management-induced liabilities and left the “Paddys” holding the bag.

At first glance, the “bailout” is more of a “saddling” -- a transfer of private / bondholder liability to the future taxpayer, with pundits quick to correlate the act to Weimar reparations. It appears to have laced the Irish into an austerity straightjacket and tipped them into utter, bone-gnashing, debt-deflationary ruin.

At least that was according to last week’s news cycle.

Of course, things swing fast these days. Shares of Bank of Ireland rose 11% on Friday, all in the last hour of trading. The once-proud heir to its 18th century namesake, Bank of Ireland (NYSE:IRE) traded at near $100 a few years back. This year it has been obliterated, hovering at a support around $1.71 for most of last week.

I read Friday’s last hour 11% rise as a hint that a few traders are betting that this week’s news may be unexpectedly bright. There is massive short interest in IRE, and any good developments out of Ireland will cause a major short covering gap, as shorts flee their now complacent positions. Again, a new sucker is born every minute.

Events in Ireland certainly can’t get any darker and the following three events may add to the upside volatility.

Finance Minister Brian Lenihan’s budget speech on Tuesday may calm the markets, as it will interject a focus and new assembly of facts into what has now become an agonizing debate on nationhood.

Thursday’s vote on the bailout in the Dáil Éireann (the lower house) may force the more polemic parties to face up to the fact that the ECB offer is the best available, as its 5.8% is still better than an immediate bank run, and Ireland facing the bond market alone. Theatrics may be set aside for the January election.

As mentioned in the Finance Times, Brussels will be meeting on Monday with a real focus on Ireland and combating the crisis. The bailout itself may also see kinder terms to sweeten the Dáil vote.

More broadly, new tools might emerge from that meeting to combat the crisis. These include:

  • Giving the eurozone’s crisis management mechanisms the powers to buy government bonds.
  • Increasing the bailout rescue fund ahead of 2013, as suggested Saturday by Didier Reynders, the Belgian finance minister.[1] .
  • Jean-Claude Juncker’s idea of E-bonds –eurozone members issuing a common bond –something which Germany shied away from earlier but which might actually be the kind of instrument of “fiscal union” that can stave off the crisis.

Don’t discount the arsenal that the EU can eventually bring to the issue. And once things have stabilized via the above mentioned options, a later “soft default” of Ireland may occur. This would include rescheduling debt at much longer maturities and a lower interest rate, rather like an IMF adjustment program. As Uri Dadush stated convincingly in his recent essay “The Choice for Europe”: “This could be done quite elegantly: private creditors could accept the change in terms in return for a full or partial guarantee from an expanded EFSF.”[2]

Remember: a structured re-capitalization of the Bank of Ireland via a debt-for-equity swap could be implemented. Back in May, the Bank of Ireland carried an €852m conversion of subordinated debt for equity, netting a capital gain of €233m in the process. So anyone crying that a debt-for-equity swap would immediately tank the entire Irish system is incorrect.

Ultimately, evenly mildly positive news out of this week’s events would mean that Bank of Ireland could proceed with its plans to inject capital. It gives the Bank of Ireland time to raise 2.2 billion –and thus avoid the bailout money that enforces a government-mandated downsizing. It also en-heartens any prospective investor consortium that might be intrigued at buying a dominant franchise. Whether that be a HSBC (HBC) or Santander (SAN) led effort, or even an East Asian initiative is still not clear, but brisk introductions are being made. With 30% of its revenue from outside Ireland, IRE’s portfolio might find some appeal.

From a stock perspective, this would leave last week’s lows as the permanent floor for IRE’s stock in 2010. Several trading firms have suggested parallels to another behemoth –Citibank (NYSE:C) -- which saw its shares plunge to $1 in the darkest days of February 2009, only to quadruple since, but I’m more fascinated by the thought of an imminent short squeeze.


[2] Carnegie Endowment

Disclosure: I am long IRE.