I’m afraid I must disagree with my distinguished colleague Eamonn Walsh’s arguments in today’s Irish Times about the Anglo 10 loans. Walsh argues that “to state in the Dáil or elsewhere that the Anglo 10 “were given” €450 million is patently incorrect” and that “The most likely outcome is a wealth transfer that was somewhat less than €40 million.”
Let’s recall the details here. In July 2008, the ten investors borrowed €451 million from Anglo and used it to buy shares in the bank. The Anglo reports describes the terms of loans as “As well as the shares being held as security for the loans, there is additional recourse to the individuals’ personal assets equivalent to 25% of their borrowings.”
Walsh argues that this was equivalent to Anglo selling a standard “put option” to these investors. He argues that such options “can be easily valued” and puts the estimate of the value of such an option at a maximum of €40 million. In fact, valuing put options is a tricky business unless one makes pretty strong assumptions about the time series process underlying the value of the share. The “easy valuation” method that Walsh refers to is most likely the Black-Scholes formula, which relies on the assumption that the share price follows a geometric Brownian motion, i.e. that it is just as likely to go up as it is to go down. Walsh indeed explicitly characterizes the Anglo “put option” as such:
Consider an investment opportunity. I offer you the chance to invest €50 in a financial product that tracks share prices. If the share price falls by 25 per cent, you lose €50. If the shares appreciate by 25 per cent, you gain €50. Would you invest? Would you describe this investment opportunity as “heads I win, tails you lose”? I would imagine that many readers would be unwilling to engage in risky financial bets of this nature. In essence, this was the nature of the deal that was offered to the Anglo 10.
Walsh then argues that if the interest rate on this loan was higher than interbank rates, then “Anglo Irish Bank may have effectively earned a profit from the sale of its insurance policy.” However, I think the key word here is “may” since I don’t believe there is any evidence that Anglo did indeed charge its investors for this insurance.
So, why do I disagree with Walsh’s assessment?
Anglo’s shares in July 2008 could not fairly be characterized as being an each-way bet to go either up or down. Indeed, while it has hard to know for sure, there is a strong suggestion that the purpose of the deal was to support a share that was threatening to go into freefall.
Ex post, with Anglo’s shares having collapsed (an outcome that can hardly have been too surprising to these investors) this “put option” has now been cashed in. Anglo’s report tells us “The total amount loaned to ten longstanding clients of the Bank to buy shares from the CFD providers was €451 million of which €83 million has been repaid. As well as the shares being held as security for the loans, there is additional recourse to the individuals’ personal assets equivalent to 25% of their borrowings … The Bank will seek repayment under the borrowers’ recourse obligations as necessary.” In other words, with the shares worthless, the government-owned bank is willing to go as far as to attempt to recover another €50 million from the Anglo 10, at which point €113 million (or quarter of the original loans) will have been recovered, leaving the taxpayer with the bill for the remaining €338 million. So perhaps Walsh is partially right. The Anglo 10 stand to lose up to €113 million and their deal was only responsible for costing the state €338 million, not €451 million. Heroes indeed!
Finally, I have some sympathy with Walsh’s suggestion that the campaign to name the 10 individuals is a witch hunt. There are no good grounds for any bank to publicly release information on who it has lent to. However, Colm Keena’s arguments that the equity holdings of the Anglo 10 should have been reported to the Stock Exchange seem pretty convincing to me.