Ireland’s bail-out: how it affects you

A European Union-funded bail-out of Ireland would provide reassurance for savers and potentially cause only small losses for bond funds – but will hit investors holding bank stocks in the long term, analysts claimed this week.

On Friday, Brian Cowen, the Irish prime minister, on confirmed for the first time that negotiations were under way with the European Union and the International Monetary Fund on a bail-out package to shore up the country’s economy and banking system. However, any package of financial assistance will have knock-on effects for UK investors.

Cash savings

Savings of up to €100,000 in Irish banks are protected by the Irish government’s Deposit Guarantee Scheme, and savings above this amount held with Allied Irish Banks, Anglo Irish Bank, Bank of Ireland, EBS Building Society, ICS Building Society, Irish Life and Permanent and Irish Nationwide Building Society are still covered by the Eligible Liabilities Guarantee, which has been extended to June 30, 2011.

But if the banks are offered additional capital, it is likely to increase confidence in the safety of these deposits. “In reality, it does not affect customers who have deposits with the ailing banks, but it should certainly give peace of mind,” said Tom Becket, chief investment officer of PSigma Investment Management.

Savings in the UK arms of Irish banks, including Post Office accounts operated by Bank of Ireland UK, are protected by the UK Financial Services Compensation Scheme, which covers the first £50,000 in any bank (rising to €100,000 in January).

Bond funds

European bond funds are expected to rally briefly – but their longer-term performance will depend on whether any bail-out involves a restructuring of Irish government bonds, or Irish banks’ corporate bonds. As concern over Irish debt grew, European bond funds gained from a rise in the price of safer German bunds, but saw the prices of Irish and other “peripheral” bonds fall, which pushed up the “spread” between bond yields. “If Ireland gets bailed out, this could stabilise Irish spreads,” said Willem Sels, UK head of investment strategy at HSBC Private Bank. Stuart Ratcliff, chief investment officer of the Matrix Credit Opportunities Fund, even predicted “a little bit from a relief rally but it will be modest”.

However, Sels warned: “Finance ministers stated last week that existing bondholders would not see their bonds restructured in case of a bail-out. This is an important pre-condition, without which bond markets could react more negatively.” If government bonds are restructured, fund managers have warned that investors will be made to accept only partial repayment of their holdings – known as a “haircut”.

Peter Geikie-Cobb, manager of the Thames River Global Bond Fund, said: “It’s clear that financial aid is unavoidable and the endgame will see bondholders forced to take a haircut.”

Funds that hold corporate bonds issued by Irish and European banks may also suffer price falls, according to Victoria Hasler, fixed income analyst at Brewin Dolphin. “Another worry is the cross holdings that many European banks have in other banks’ debt,” she said. “This could be an issue for some of the more index-focused European bond funds, but the more active funds have credit specialists . . . to limit the impact of such issues on their funds.”

Financial stocks

Bank shares are also forecast to enjoy a short relief rally, but analysts warn that prices will be held back by wider concerns. “With the latest bailout, another hurdle has been cleared for financials stocks,” noted Becket of PSigma. “However, given that the latest bailout measures merely stick another finger in an ever-creaking dam, one has to be concerned about the longer term outlook for the banks. They still have to de-lever their balance sheets and rid themselves of lingering bad debts.”

Chris Nicholls, managing partner at Investment-advice-online.com, expected UK bank shares to struggle. “Many of the UK’s major banks are heavily invested in Ireland. Therefore, the major British banks like Lloyds and Barclays will have more bad debts to cope with. We may therefore see this affecting UK investments like it did during the 2008 financial crisis.

He advises fund investors to look beyond Europe, and recommends First State Global Emerging Markets and Invesco Perpetual Hong Kong and China.