Valuation of Anglo Irish Golden Circle Deal

There has been some discussion on this blog site about the value of the secret deal provided by Anglo Irish management to a circle of ten wealthy Anglo clients.  The deal was done last summer, in order to prop up the Anglo Irish share price.  Each of the clients was lent Euro 45,100,000 by Anglo Irish with the requirement that all the loaned funds be spent on Anglo shares. Clients were only responsible for repaying one-quarter of the loaned amount (Euro 11,275,000) in cash; they were permitted to repay the remainder of the loan by returning the shares.

At the time of the deal, the Anglo share price was approximately Euro 6.01 per share.  The share price has since collapsed to zero.  Each of the wealthy clients in the secret circle has lost Euro 11,275,000 (unless they now avoid repaying through bankruptcy or restructuring).  Meanwhile, the “shareholders” of Anglo have lost the remainder of the loaned cash (Euro 33,825,000 for each of the ten circle members).  Everyone has lost on this deal ex post.  It is particularly vexing since the Irish taxpayer now serves as the Anglo Irish “shareholder” and suffers a loss of Euro 338,250,00 on this secret deal. 

It is worthwhile to analyse, under reasonable assumptions, the ex ante value of the deal, both to the clients and to the Anglo management acting on behalf of shareholders (as if).  An accurate valuation is not possible with the information available to me, but a reasonable approximation can be made, and also a reasonable analytical framework provided for anyone who wishes to substitute other parameter values.

Last July Anglo had total shares outstanding of 749,585,405 and a share price in the range 4 – 7 Euros (quite volatile during the month), see the data here.  If we use a share price of Euro 6.01 then this gives a total cost of Euro 451,000,000 to purchase 10% of shares outstanding, which corresponds to the stated amount in later government reports.  Hence I assume that this is the share price at the time of the deal.  The one-year LIBOR interest rate last July was 3.2796% so I use a slighly higher interest rate of 3.75% as the two-year borrowing/lending rate.

Suppose that the clients have no insider information telling them that Anglo Irish shares are over-valued.  Also suppose that they are not liquidity-constrained.  In this simple case, the loan-plus-share-purchase is window-dressing designed to hide the real value of the deal. The client takes a loan of Euro 45,100,000 from the bank, and puts the proceeds in an interest-bearing account which exactly pays off the loan.  The client also purchases Euro 45,100,00 worth of Anglo Irish shares with true value of Euro 45,100,000.  Neither of these transactions adds or subtracts any value for the client.  The real value of the deal comes in the free put option which Anglo management has provided to the client.  If the client’s Anglo shares fall in value, the client can pay Anglo only ¼ of initial loan value, plus hand over the shares, in full restitution of the loan.  This put option constitutes the only source of value in the deal (admittedly under these strict assumptions).

The put option can be valued reasonably well using the Black-Scholes option pricing model; see here for details.  These estimates of value are conservative since empirically the Black-Scholes model tends to undervalue out-of-the-money put options.  I assume that the loan is for a two-year period and that the Anglo Irish shares have annualised volatility of 60% per annum.   The put option has an exercise price of (1-.25)(Euro 6.01) = Euro 4.512.  Using normdist and exp in excel it is easy to compute that the value of the put option for each client was Euro 6,757,469.  The put option is given to the client for free, in exchange for acting as a go-between to allow Anglo Irish management to secretly use bank-deposited funds to purchase their own shares.

The client is earning excess return of Euro 6757469 on risk capital of Euro 11,275,000 which is 59.93% or 29.97% abnormal return per year.   So even allowing for some liquidity-constraints or client nervousness about Anglo Irish share values, it seems a good deal.  Admittedly, it turned out disastrously for the clients, but this was due to a worldwide bank share meltdown plus the emerging scandals (notably this one) at Anglo Irish.

Perhaps Anglo Irish management raised the borrowing rate on the loans to account for the free put option.  This seems unlikely.  Again using the case of 2 years and 60% volatility, in order to recoup an option value of Euro 6757469.675 on a loan with principle value of Euro 45,100,000 they would need to add roughly (1/2)( 6757469.675/45,100,000) = 7.49% to their  base interest rate.  So if the base rate is 3.75% they would need to use a loan rate of 11.24%.

Bob Dylan has a song “The Lonesome Death of Hattie Carrol” about a shameful incident in the early twentieth century when a wealthy, well-connected young man bludgeoned to death a poor, African-American female servant, and escaped with virtually no punishment.  In his lyrics, Dylan makes the point that the truly horrifying aspect of this event was not the murder (there will always be violent individuals) but the reaction of the judicial establishment in ignoring it.  Analogously, in the Anglo Irish scandal, it is not the presence of greedy, underhanded individuals in Irish financial services (such people exist around the world in all countries and all industries) but the horrifying approach of the Financial Regulator, condoning and even encouraging such behaviour.  To quote from Dylan’s song:

In the courtroom of honor, the judge pounded his gavel

To show that all’s equal and that the courts are on the level

And that the strings in the books ain’t pulled and persuaded

And that even the nobles get properly handled

Once the cops have chased after and caught ‘em

And that the ladder of justice has no top and no bottom,

Stared at the person who killed for no reason

Who just happened to be feelin’ that way without warnin’

And he spoke through his cloak, most deep and distinguished

And handed out strongly, for penalty and repentance

William Zanzinger, with a six-month sentence.

Oh, but you who philosophize disgrace and criticize all fears,

Bury the rag deep in your face

For now’s the time for your tears.


19 thoughts on “Valuation of Anglo Irish Golden Circle Deal”

  1. If anyone dislikes my parameter assumptions here is excel code that can be adjusted as one wishes. The titles go in column A and the formulas in column B and the code must be started in Row 1.
    1.share price +6.0166
    2.strike price +.75*B1
    3.time +2
    4.volatility +0.6
    5. interest rate +.0375
    6. shares outstanding +749585405
    7. % total purchased +0.01
    8. number of shares +b6*b7
    9. d1 +(LN(B1/B2)+(B5+(B4^2)/2)*B3)/(B4*(B3^.5))
    10. d2 +B9-B4*(B3^.5)
    11. put price +B2*EXP(-B5*B3)*NORMDIST(-B10,0,1,1)-B1*NORMDIST(-B9,0,1,1)
    12. total value +B11*B8

  2. strictly, the taxpayer did not lose on this deal. There was no cash to lose. The whole deal was notional and just served to make the balance sheet look good.

    If the deal hadnt been done the only difference would have been the bank collapsing faster as the inadequacy of the capital would have been obvious.

    Now don’t all take this the wrong way but trying to put a value on that transaction using that formula is just academism gone mad. You are hopelessly assuming that this was a commercial deal. It might have had the form of one but it is extremely unlikely that it was one. It is much more likely it was a dressing exercise, and was carried out by parties who were already so far out of the money that they had nothing to lose.

    I am rather curious at the exact amount of the loan, an uneven amount. Is there any possibility the spare 100k was a sweetener or commission for somebody?

  3. I can’t agree with Antoin that the taxpayer didn’t lose. Instead of lending the Golden Circle the money to buy the shares (from you know whom) Anglo could have placed it on deposit at the ECB where it could still be sitting today.

    On the transaction itself, I am still puzzled by why the loans were not made non-recourse, especially if the bank management was, as one supposes, mainly trying to keep the share price high. Even for these presumably wealthy persons, losing €11 million hurts. I wonder are there more transactions still hidden behind the scenes that would make the whole story more coherent.

  4. The taxpayer certainly did lose on this transaction. Since the taxpayer was the ultimate residual claimant for Anglo this transaction resulted in a wealth transfer from the taxpayer to whoever was selling the shares to this group of 10.

  5. Is there not an additional taxation issue for the individuals concerned. I understand that anything in the nature of a free loan would have to constitute a gift and thus be subject to a gift tax. This would seem to apply in this case. Maybe someone could cast light on this aspect of the transaction?

  6. Since “the taxpayer” only became the owner *after* these loans became clearly bad, and did so with knowledge of that fact, how can it be said that the taxpayer is at any loss from them ?

  7. @ Aidan

    You might be right about the “gift” issue. If the loan was 100% non-recourse then its a gift from the company to the 10. Then they they may run into gift tax issues. Also, there might be restrictions in Irish corporate law with respect to companies making gifts (like, is there a requirement to disclose material gifts?).

    Since this deal would have been run past lawyers this 25% is not an accident. Seems to be just enough to make sure the 10 face a material risk. Most likely this is to circumvent some tax law, corporate law or disclosure constraint.

  8. @Fergus O’Rourke: In a normal takeover the acquirer pays the target shareholders an appropriate positive valuation. However Anglo Irish has negative value since it has poor prospects for any positive future earnings — the State took it over at value zero when in fact it has a negative value (there are likely to be cash injections which account for the negative value). This takeover was done for public policy purposes not to maximize investment value. I will not pass judgement whether the takeover was a good decision by the government, but it certainly was not done as a profit-making investment.

    So the 338 million passed to Sean Quinn in the Golden Circle deal from Anglo corporate funds (he was the seller to the Anglo Golden Circle according to news reports) means that the negative value of the government takeover was that much larger in magnitude. So the taxpayer has effectively lost 338 million retrospectively on the Golden Circle deal.

  9. An interesting theoretical calculation but it proceeds from the same false assumption as the political discourse i.e. that a “golden circle” were given an opportunity for profit with minimal risk.

    We don’t know the full picture but even now it is clear that the “Maple Ten” were put under pressure by Anglo management to buy the Anglo shares. The five share purchasers who have been named thus far were all major borrowers from Anglo and, as such, had a vested interest in preventing a collapse in Anglo’s share price which might lead to a change in management thereby exposing these borrowers to a different and probably a more stringent new management.

    Against this, Anglo shares were a pure property play and the property market was already under severe strain last summer. Despite their links to Anglo’s management, the Maple 10 were probably looking to retrench and reduce their financial exposure to the Irish property market. The “non-recourse” nature of the loans was probably designed to sweeten an otherwise unpalatable deal.

    More importantly, the shenanigans last summer were simply a consequence of Sean Quinn’s 25% shareholding through CFDs. The real scandal is how he managed to acquire a controlling interest in a bank of ” systemic importance”. Once Quinn acquired this stake through a highly leveraged scheme like CFDs, there was a clear risk to Anglo.

    When did the Financial Regulator/ Central Bank become aware of this stakeholding? They admit putting pressure on Anglo to unwind this position while denying knowledge of the details of the share-purchase loans.

    It is disappointing that the Opposition parties have focussed on the “Maple 10” and their possible links to Fianna Fail. As the full story emerges, the spotlight will shift to Sean Quinn and the Financial Regulator. Eamon Walsh does himself no credit by ignoring the real issues.

  10. @patrick: if the bank had loaned the money to another party, the bank would have run out of capital just as it eventually did. The only difference is that it would have happened a bit sooner. The state would have had to pick up the pieces, just the same. The management were just trying to buy some time.

    I am not for a minute making a case for the people involved. I am just trying to be realistic about what actually happened. What went wrong here is a lot bigger than this ridiculous transaction. It is just a distraction.

    I should say that I feel I am constrained at this stage by the rules of libel (and possibly also good taste) from saying what I really think about the whole thing.

  11. It is worth remembering that Sean Quinn might not have known who was buying his shares, and it is very likely that he did not know whose money they were being bought with.

    There is nothing wrong with buying shares using CFD’s. It turns up the metaphorical heat for the people managing the situation but it doesn’t change anything. There is nothing particularly wrong about owning a significant share of an ‘important’ bank. The bank failed because it had a load of duff loans, not because of the ownership structure.

  12. The original article and other commentators have focussed on valuing the benefits received under the loan using a put option. I think it is instructive to look at the value of a non-recourse loan to buy shares and then consider the effect of adding (partial) recourse provisions.

    A non-recourse loan on a share can be looked at as a call option, i.e., if the share price increases, the holder pays off the loan and takes the profit. If the share price falls, the holder never “exercises” their option but instead hands over the shares. Like any call option, they have a levered position that benefits from increases in the share price.

    The addition of recourse provisions exposes them to downside risks. This means that they have essentially written (i.e., are short) a put option that means they lose money if the share price falls. Partial resourse, as here, means that their downside risk is limited once the limits of their recourse are reached. This essentially means the investor is short a put option with a strike equal to the loan amount and long a second put option with a strike equal to the loan amount less the resourse amount.

    On this basis, there are three options, i.e., the investor is essentially long a call option and short a put option with exercise prices equal to the amount of the loan and long a put option with an exercise price equal to the amount of the loan less the recourse limits.

    This clarifies that the investors wanted/expected the share price to increase, which is consistent with being long a call. The partial recourse provision meant there to limit their downside risk.

    Some of the difficulties in valuing this arrangement include the term of the award, which depends on when the loan is called and an exercise price that is increasing at the interest rate, in addition to volatility, etc.

  13. @ANOther: It is possible to re-express the deal using a call option based on put-call parity: put + share = riskfree account + call. So instead of owning the share and a free put option the client owns a riskfree cash account plus a call option which is “in the money” with exercise price equal to .75 of the current market price of the share. It does not change anything basic but it might be preferable for certain types of analysis along the lines you suggest. Yes I agree with you that these difficulties in accurate valuation are considerable such as when the loan is called, what is the true volatility, and other issues.

    Along the same lines, Lefournier makes a good point about the sharp decline in the Irish and UK property markets by last summer, and the possible desire of the Golden Circle clients to reduce not increase their exposure to this market. This is perhaps why they were given such a big sweetener. I accept this point.

  14. Does the 75% of the loans that were written off become income taxable as it is forgiven debt? I know that in the U.S., forgiven debt is treated as income.

  15. It is not taxable if this is a limited recourse deal and was part of the original transaction docucmentation – I would say. If the debt is simply written-off (which I understand is not the case here) then that would be taxable under CAT.

    Also worth noting that non-recourse or limited recourse lending is very common globally (especially in the States) accross many different asset classes. Property is the most typical, but also in media, energy, infrastructure and even in share acquisition. The difference with Anglo is that it appears they were lending secretly buy shares in their our OWN bank – that’s quite unusual in my experience!

  16. guys many if the maple 10 do not pay tax in Ireland, I know one of them personnally , their kids go to school in Ireland but they are not resident here for tax purposes

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