Government move on AIB notes unlikely

The Government is unlikely to offload its €1.6bn contingent convertible (CoCo) capital notes in AIB before the results of the ECB’s comprehensive assessment of the banking system is completed later this year, according to market sources.

It is also likely that the Government will convert its preference shares in AIB into ordinary shares.

There has been a ramp-up in demand among investors for high yielding assets, which has prompted speculation the Government might look to offload its CoCo notes in AIB, which carry a yield of 10% and mature in 2016.

However, one market source who asked not to be named, said it was much more likely the Government would keep the CoCo notes as a potential buffer against any potential adverse outcome for AIB arising from the comprehensive assessment of the banking system.

CoCo notes are a tier two capital instrument that converts to ordinary shares in the event that AIB’s core tier one capital falls below 8.25%.

However, the Government already owns 99.8% of ordinary shares. Consequently, if the Government sold the CoCo notes, which then had to be converted to ordinary shares following the results of the ECB’s stress tests later this year, investors would be left nursing heavy losses.

This would weigh on the Government’s attempts to return AIB to the private fold over the next few years.

Moreover, the Government will be keen to have a buffer in place if AIB is forced to raise new capital following the stress tests.

As part of new rules under the EU’s Banking Union, existing shareholders will be bailed-in to plug capital holes.

Therefore, it would be much more politically feasible for the Government to convert the CoCo notes into ordinary shares rather than write a cheque, says the source.

The Central Bank completed its Balance Sheet Assessment of the three Irish banks last year with the results announced at the end of November. It found that AIB had enough capital to meet regulatory requirements, although loan loss provisions would have to be increased.

The ECB’s comprehensive assessment of the banking system will take place over most of this year.

The Central Bank’s balance sheet assessment will feed into the asset quality review (AQR). This combined with the results of the stress tests will determine whether banks will have to raise new capital.

If AIB does not redeem the €3.5bn Government-owned preference shares by May, then a 25% step clause will see the value of these increase by €875m. However, these preference shares carry a yield of 8%. If they were sold on to private investors, they would act as a huge drag on AIB’s profitability over the next few years.

It was much more likely the Government would at some stage convert the preference shares into ordinary shares, said the source.

Both the Government and AIB declined to comment.