Q&A

What you need to know about bondholders, bonds and burden-sharing

What does burden-sharing mean?

The Irish Government, with help from our European partners, is currently paying the bill for the reckless trading of our banks during the years of the property boom as a result of its decision in September 2008 to guarantee all money lent to the banks by depositors and bondholders.

It is now clear that the cost is unsustainable. The Government has already decided that subordinated bondholders in Anglo Irish should share some of the burden by taking a haircut, or discount, on their investment.

Now the IMF and the EU, which are having to bail us out, are toying with the idea of extending this concept to senior bondholders.

What is a senior bondholder and how do they differ from a subordinated bondholder?

Bondholders are people or, more likely, institutions which lend money to companies or states. They are referred to, respectively, as corporate or sovereign bondholders. They lend, generally, for a set period of time and receive a set rate of interest, or coupon, at regular intervals from the company.

The seniority of bondholders relates to the position they occupy in the event of a company in which they have invested running into trouble.

Top of the list come secured bondholders because their lending is secured against some assets of the company. Below these come senior unsecured bondholders – such as those currently in the spotlight in relation to the Irish banks.

Further down the priority chain come subordinated bondholders, sometimes referred to as junior bondholders. As the names suggest, holders of these bonds have rights that are subordinate to those of senior bondholders.

Why would someone lend as a subordinated bondholder rather than a senior bondholder?

The interest bondholders are paid reflects the level of risk they are taking. Bondholders of blue-chip or AAA-rated businesses get a lower rate of interest than lenders to new companies in high-risk areas like pharmaceuticals, for instance.

Similarly, subordinated bondholders are paid a premium to reflect the greater risk they bear in the event that the company in which they invest fails.