Hedge Funds and Institutional Longs Increasingly Negative on Irish Govt. Debt

The solvency of Ireland is a question that is not going away. Yesterday’s news of a government bond sell off caused by increased margin demands in the repo market has captured headlines and raised the anticipated likelihood of a Greek style bailout. As ever, we like to look behind the headlines for hard evidence of sentiment. We will look at how investors are positioning themselves in Irish sovereign debt while also looking at the situation in Ireland’s banks and then contrasting this with their Portuguese counterparts. Stocks include various Irish Government Bonds plus: Allied Irish Bank’s US listing (NYSE: AIB) and Banco Comercial Portugues (ELI:BCP).

One way of gauging investor sentiment towards the solvency of Ireland is to observe how much Irish sovereign debt is in the hands of large, long term investors and whether this is changing. We are able to view a proxy for such daily institutional ownership by looking at the holdings of funds who lend their shares. If they think Ireland is in clear and present danger of defaulting on its sovereign debt we would expect to see them reducing their holdings.

At present, such asset managers own €6.9 billion of Irish Government bonds. This is more than they own of Portuguese debt, by comparison, but is less than the amount of Finnish debt held by the long only fund management community according to our data. It is also only slightly ahead of Greece which sees €6.1 billion in the hands of funds who lend. Germany is the number 1 with €200 billion.

The Irish government was early to take deficit reducing action and the combination of this along with “quantitative easing” meant that 2009 saw a big increase in the institutional ownership of their debt from €3 billion to 10 billion between January 09 and April this year. This tailed off slightly in Q2 of this year during the Greek bailout period, stood steady at around €9 billion over the summer. It has just fallen to today’s level of €6.9 billion. This must reflect investor nervousness about the future value of Irish Government debt.

On the other side of the coin, there is also strongly rising demand to borrow this pool of bonds. The balance on loan for Ireland’s Government bonds is just off a 3 year high after doubling since late July to EUR 2 billion. Interestingly, there was a similar increase earlier this year ahead of the Greek bailout. People lend and borrow bonds to raise cash but it is far more likely that they would use German or UK bonds for this purpose.

We see above average lending fees for Irish sovereign debt which further supports the conclusion that these could be directional trades. These 4 individual bonds have more than €200m on loan: 4% 15 Jan 2014 (IE00B3KWYS29), 3.9% 5 Mar 2012 (IE00B5S94L21), 5% 18 Apr 2013 (IE0031256328) and 4.5% 18 Apr 2020 (IE0034074488). It could be that people who have sold Credit Default Swaps against these instruments are borrowing to hedge themselves should they have to pay out if a default occurs.

If we look at Ireland’s banks from a short interest perspective we do not see any recent major movements in the demand to borrow their Irish listings. However, we do see a very interesting spike in short selling in Allied Irish Bank’s US listing (NYSE: AIB). The quantity on loan has trebled since September to 3.7m shares. This is noteworthy because we have already detected a trend whereby US investors are more suspicious about the solvency of certain European nations and banks than their closer and more emotionally connected counterparts in Europe.

Lastly, a very in demand European bank to short at present is Banco Comercial Portugues (ELI:BCP) which has just hit a new 52 week high with over 6% of its shares on loan, which represents a very high proportion of supply.

We have just released our Securities Lending Review for Q3 2010.  For more information, please visit www.dataexplorers.com/Q3-2010

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