The public debate of the past number of days has focused on the question of whether Anglo Irish Bank should be wound up and whether that could save the government money. However most of the political discussion and, unfortunately, much of the discussion on this blog, has failed to shed much light on what are the real choices available to the government and what the relevant tradeoffs are.
Both the pro- and anti-windup supporters have produced unhelpful arguments. The government have a stronger case for their actions than most people think but they have undermined themselves by citing cost figures for a windup that are literally incredible. Meanwhile, pro-windup advocates have often given little consideration to the nature of Anglo’s liabilities.
This post is an attempt to describe the issues at hand in a reasonably comprehensive way without trying to fully endorse either government or opposition positions.
The starting point for any useful discussion about what to do with Anglo has to be its balance sheet, reported on page 38 of its report as the “consolidated statement of financial position”. However, the figures from the balance sheet have been mentioned only sporadically and selectively amid all the sturm und drang of the past few days.
So, what’s the balance sheet look like? After the injection of another €8.3 billion by the Irish government, Anglo’s balance sheet reported €85 billion in assets and €81 billion in liabilities. However, these figures value the NAMA-bound assets with a face value of €35.6 billion at €25.5 billion and it seems clear now that the discount will be more like 50%. Applying this, NAMA would be paying €17.8 billion for these assets.
This means that a more accurate picture of Anglo’s current balance sheet is €77.4 billion in assets and €81 billion in liabilities. One of the issues in calculating Anglo-related losses is what will be the ultimate value of the €17.8 billion in NAMA-bound assets but I’m going to leave that aside in the rest of this post and focus on the costs related to what’s left of the bank.
Now, let’s look at Anglo’s liabilities and assets.
Anglo has €81 billion in liabilities, so any talk of the bank costing €100 billion to close as Brian Cowen stated on Tuesday’s Nine O’Clock News, is incorrect. Even if all of Anglo’s assets were completely worthless, €81 billion is the maximum possible cost.
Of that €81 billion, €11.5 billion is money owed to the Irish Central Bank. If that is paid, it is one arm of the arm of the Irish state paying another, so one could consider the net liabilities the state owes from Anglo to be €70.5 billion.
What’s the composition of these liabilities? Let’s take them in order of size.
€27 billion are customer deposits (nearly €8 billion of which is payable on demand.)
€15 billion are debt securities. Most of this debt is due very soon. There’s €1.5 billion in shortish term commercial paper and CDs. Of the €13 billion in medium term notes, at least €7.4 billion is due before the guarantee runs out in September this year and €9.7 billion is due by December this year.
€12.2 billion is owed to the ECB (not the €24 billion figure mentioned by Brendan Keenan on Thursday.)
€9.3 billion is deposits from banks.
€2.3 billion in subordinated bonds, none of which are due before 2014.
And then there’s the usual odds and ends such as derivatives and other random stuff.
Looking at this list, I think there would be widespread agreement that depositors should get their money back and that we don’t want to trigger further instability by failing to pay back deposits from other banks. The ECB loans will be collateralised by a selection of the bank’s better assets, meaning they can grab the underlying assets if they’re not paid back, so no gain there from a wind-up.
The balance sheet also shows less room for cleaning out “professional investors” than you’d think is the case from some of the ongoing discussions. A relatively small amount of the €70 billion is owed in the form of senior debt. And the vast majority of this stuff is covered by the state guarantee.
From these figures, it appears that the only way to save significant amounts of money for the taxpayer would be to declare Anglo insolvent pretty much straight away and then renege on the guarantee. But this doesn’t at all seem like a good idea if we want international markets to continue trusting our other banks, which have significant amounts of debt maturing this year that will need to be rolled over. This point does get mentioned by ministers but tends to get lost amid claims about windup costs and other confusions about “Ireland welching” on debts, which mixes up bank and sovereign debt.
Better news is that Anglo’s subordinated debt does not fall due until at least 2014 with a little over half of it maturing in 2016 and 2017. So there is room for a future government to decide to declare what’s left of the bank at that time insolvent and fail to pay out on these debts. This would require, of course, avoiding a strategy of continually recapitalising the bank to make it a small business lender, in which case we would be putting our money in front of the subordinated bond holders.
In fact, this appears to provide the ideal timeline for an orderly wind-up of the bank. Run the bank as a going concern, not borrowing beyond 2014 and using funds from maturing assets to run down other liabilities. Then tell the subordinated debt holders that there’s no money left. Still, by 2014, if the economy is back on track, it might be considered that the potential reputational damage to the Irish government’s reputation is not worth the money saved from this.
The figures for enormous costs for winding down Anglo cited by the government have relied on the idea that the bank’s assets would practically disappear to zero if the bank was wound down. For instance, Brendan Keenan describes the Minister for Finance’s position as follows:
But closing Anglo without defaulting would cost €70bn, he says — that figure being the difference between the cost of paying back Mr Trichet, other depositors and secured creditors, and the pitiful amounts the bank could raise by selling its loans and assets.
Since Anglo’s liabilities are €81 billion, this would mean that Anglo’s assets would only be worth €11 billion if the bank were closed and assets sold off quickly. Well, let’s look at those assets.
After the NAMA transfers, Anglo will hold €17.8 billion in Irish government-backed NAMA bonds, the €8.3 billion promissory note from the government, €6.2 billion in other government bonds and €1.7 billion in other financial securities. Anglo also has €7.4 billion in loans to banks. Winding the bank down over the next few years would allow time for these loans to be paid back and not rolled over.
These financial assets might sell at a discount if they were sold off very quickly but given their current value of €41.4 billion, there is no way they would fetch as little as €11 billion. So the idea that Anglo’s financial assets would be worth a “pitiful” €11 billion doesn’t stand up to any kind of scrutiny and I think the government are undermining their own strategy by persisting with these claims.
The government have also objected to the idea of winding the bank down over a number of years. However, if, as suggested above, the bank was wound down over four years up to 2014 and the securities were sold gradually and loans allowed to mature, it’s hard to see the bank recouping too much less than their par value of €41.4 billion.
Most of the rest of the bank’s assets are accounted for by its non-NAMA loan book. This doesn’t look so great. €35.6 billion in original value loans are being held on the balance sheet, which is currently held on the balance sheet at €30.8 billion due to bad loss provisions. €9.5 billion of these loans are impaired and €4.7 billion are past due but not impaired (€1.9 billion over 90 days.) I would guess (not necessarily very accurately) that this loan book won’t end up bringing in more than €20 billion in the end.
In relation to a fast wind up involving all creditors being paid back by the Irish government, the uncertainties surrounding the quality of Anglo’s lending would certainly mean that this loan book would yield even less than €20 billion if it had to be sold off very quickly this year. However, most of these loans are likely due to be paid back over the next few years, so the vast majority of whatever is going to come in from these loans is likely to come in prior to a potential wind up in four or five years time.
To summarise, if wound down over the next few years, there’s probably about €67 billion in assets in Anglo to pay off liabilities of €81 billion, €11.5 of which is owed to the Irish Central Bank. However, the vast majority of these losses will stem from the non-NAMA loan book and the fact that the NAMA assets are worth less than currently listed. So these losses will be incurred regardless of whether the bank is kept open or wound down. From my reading, there’s not much evidence that there would be huge losses on gradual sales of the bank’s financial assets over the next few years.
The Bottom Line
Ultimately, the government are now between a rock and a hard place with Anglo. The bank has enormous liabilities but the government is going to have to pay most of them back unless we want depositors to lose out or to renege on the government guarantee, which could lead to serious financial instability. Keeping the bank going over the next few years is likely to generate further losses and I can see why Minister Lenihan has flagged the need for another €10 billion to be injected. It may require more.
I’m sympathetic to the government’s position that Anglo needs to be kept open for now. However, Anglo’s balance sheet does not suggest that there would be substantial losses stemming from winding the bank down over the next few years. Certainly, the huge figures mentioned by the Taoiseach and the Minister for Finance in relation to the cost of winding down the bank cannot be justified.
One way of minimising the cost to the Exchequer stemming from the bank would be to wind it down gradually up to 2014, using maturing assets to pay off maturing liabilities. At some point, once the bank has shrunk in size, the government could decide to stop injecting capital and leave the bank to default on its €2.3 billion in subordinated debt.
Certainly, I hope that future strategy focuses single-mindedly on keeping costs down for the taxpayer. This strategy is probably not consistent with laudable aspirations to rebrand the bank as a small business lender or some other such niche business because this approach would require continuous recapitalisation and rule out any savings from not having to pay subordinated bond holders.
To be honest, I suspect and hope that a wind up over the next few years may actually be the government’s plan but that they have decided to suggest the opposite to prevent bad publicity for the bank that could trigger a disorderly exit of depositors over the next few months.
So that’s my take on it. It’s not pretty but I think the set of good options is more limited than many realise. My hope is that the debate about Anglo will become a bit more reality-based over the coming weeks and months.