Yeah, the non-defaulting bank gets to keep any collateral that has been posted.

Where does cash collateral fit into this? (Yes, not really to do with IRS, more CDS? Although perhaps with the owing bank downgraded cash cover could also be required for IRS?). Say bank A has a losing position of 200 mn to bank B and has put up cash to cover this, but there is some time to go before the contract matures. Bank A then goes bust. Does bank B get to collect its 200 mn and pass Go?

Would the guarantee only kick in if the bank was liquidated or forced into resolution?

That is my (cursory) reading of S.I. No. 411 of 2008.

If that is the case then the restriction on policy imposed by an over-inclusive guarantee can be alleviated to the extent that the guarantee is not extended in respect of certain debt.

Thus, if we can break through “the wall of cash” we should be able to improve our position somewhat.

A question arises as to whether the existing guarantee makes it more costly to break through the wall of cash.

On the one hand, the owners of debt maturing before the guarantee ends have a gun to our head in that if an act of default takes place on the covered institutions part then the other bonds which fall due outside the guarantee period may become payable.

On the other hand, the debt-holders would need to adopt a pretty unified position to create such a problem. Furthermore, whilst some debt-holders may wish to get out, there ay well be others willing to take their place under the ELG scheme.

In the meantime, it appears that we are adopting a staggered approach to escaping the guarantee. The first to be jettisoned will be the subbies and possibly others. It is not clear how covered bonds and longer term bonds are treated.

It would be interesting to have Colm McCarthy’s views on how we might best exit the Guarantee.

Close out netting just allows in-the-money swaps be offsetted against out- of-the-money swaps. Therefore if Anglo owe AIB €100m on swap contracts and AIB owe Anglo €50m, AIB has an exposure to Anglo of €50m in the event of liquidation. This is simply an unsecured claim and ranks pari passu with other claims from depositors and bondholders etc.
I suppose close-out netting could be seen as a preferential payment to certain creditors (as the €50m owed by AIB could be used to satisfy all claims instead of being just used to reduce AIB’s exposure) but this is permitted under Irish and English law and is usually covered under ISDA Agreements between the parties.

Kathleen Barrington published one of her Insider articles in the Sunday Business Post on June 13th, although I hadn’t a chance to read it properly until this morning. I quite liked the article, because it fits together a couple of more pieces of the jigsaw puzzle about property and banking in Ireland. A couple of more crucial pieces, which I believe had not been widely studied until I read Ms. Barrington’s piece from June 13th 2010, Cowen’s Act fuelled banks’ folly.

But the legislation also included a provision that allowed banks to issue certain bonds - known as ‘covered bonds’ - backed solely by commercial mortgages. Under the previous 2001 Act, the bonds could only be backed by residential mortgages or public sector debt.
The 2007 move was music to the ears of commercial mortgage lenders, particularly Anglo Irish Bank, as it meant they could raise new money by issuing securities backed by commercial mortgages.

http://kathleenbarrington.blogspot.com/2010/06/cowens-act-fuelled-banks-folly.html

I still don’t see how it is that much given the number of shares increased from 1.2 bn to 5.2bn. Not a 25 fold increase, but a less than 5 fold increase.

“The warrants were not possessed of majic powers. If there was a new share issue and the warrant owner did not participate he would have been diluted from a 25% ownership position prior to recap to a c. 5% ownership position when he exercised in five years time.”
But the warrants contain a “standard anti-dilution” clause. I understood this to mean full-ratchet anti-dilution ( http://papers.ssrn.com/sol3/papers.cfm?abstract_id=702581 ), whereby if the warrants were issued for 25% of stock pre-dilution, they would still be worth 25% of stock post-dilution.

“Form: On purchase of the New Preference Shares, the State will receive an option (the “Warrants”) to purchase 25% of the existing ordinary shares in each bank (calculated on a post-dilution basis). The State may exercise this option from the fifth to the tenth anniversary of the purchase of the New Preference Shares.

Early redemption: If the bank redeems up to €1.5bn in New Preference Shares from privately sourced Core Tier 1 capital prior to 31 December 2009, then the Warrants will be reduced pro rata to that redemption to an amount representing not less than 15% (the “Core Tranche”) of the existing ordinary shares of the bank.

Strike Price: The strike price of the Core Tranche of the Warrants shall be €0.975 for Allied Irish Banks and €0.52 for Bank of Ireland. The strike price of the balance of the Warrants granted to the State shall be €0.375 for Allied Irish Banks and €0.20 for Bank of Ireland.

Anti-dilution: Market standard anti-dilution protection will apply. ”
http://www.finance.gov.ie/viewdoc.asp?DocID=5669&UserLang=GA&StartDate=1+January+2010

“we need a small govt surplus and we need it now”. How do we achieve that?

The warrants gave you the right to buy a certain number of shares which represented 25 % of the bank at the time of issue. At the time of their issue there were around 1bn shares in issue. The complicating factor is that the warrant owned did not actually own the shares now. It was a right to buy at a strike price 5 years hence. How he could actually participate in a rights issue to recap without actually owning the shares now is above my paygrade.
The warrants were not possessed of majic powers. If there was a new share issue and the warrant owner did not participate he would have been diluted from a 25% ownership position prior to recap to a c. 5% ownership position when he exercised in five years time.

The bottom line is that the state switched 1.7bn of 8% prefs to an equivalent of ords plus it got the 185m shares in lieu of dividend. The total consideration was about 1.9bn. These are now worth about 1.5bn at current market prices. In addition the state received 490m cash for cancelling the warrants. State ownership went from 38% or so of an undercapitalised entity to 36% or so of a properly recapped entity (according to the FR). I just cannot make out where 95% dilution comes from.

PEOPLE NO LONGER WANT DEBT!

The banks are now expensive forms of workfare for the unemployed. They will slim down when the government ceases to borrow to pay for the jobs.

The banks are ZOMBIES! They feed off the living. Only those who read this are alive. The banks are not.

We hear the banks will have to pay for regulation. The state will have to pay. You and I will pay through our taxes! The banks are nationalized. They now belong to the state. We do not need the employees nor the offices. We only need 10% or so of the branches.

My brain is of a simple taxpayer wondering how an increase in shares outstanding of 400% (from circa 1.2 bn to circa 5.2 bn) could result in a 96% dilution - surely that is less than 80% dilutive?

How 25% of a bank ‘worth’ 2 bn was worth 491 mn pre-dilution, but the same figure now would be 25% of a bank ‘worth’ 4.4bn? I don’t see that the sale of the warrants was anything other than the sale of the century.

Am I missing something about how warrants work? They permit you to buy a fixed proportion of the bank at a set price. They cannot be diluted. You have to wait until a certain date to exercise them.

How many “jobs” are now fully funded by state borrowing? What happens when the state no longer borrows?

The true economy cannot support such low taxes! We need a small government surplus and we need it now!

“IT DOESN’T MATTER A WIT THAT WE DIDN’T EXCLUDE SUBBIES AND EXISTING BONDS.”
Now that is a more interesting argument.

I don’t think we could have let an uncontrolled collapse of the banks take place.
I don’t think we could have excluded any bank from the guarantee.
However, we could now be in a position of talking to the Anglo and INBS bondholders and doing debt for equity swaps with them, taking a plain haircut etc.

About the only thing an abrupt collapse would have given us would have been a death to the derivatives monster, as derivative payouts are senior to everything else. But who is on the other side of the IRS swaps?

remind me of “apart from that, Mrs Lincoln, how was the play?”

The state owned 184m shares from the coupon and had warrants to buy another 230m shares (roughly) so it had close on 40% of the pre recap share issue.

Now lets assume that the state did not particiapte in the rights issue and somebody else too up the shares. the share count rises from 1.2bn shares roughly to 5.2bn shares approx. In which casre the state’s share holding drops from close on 40% to around 4% ex warrants or 8% including the warrants which of course were not exercisble for a number of years.

The NPRF took up its rights and therefore was not diluted. Is still do not understand your logic. Clearly my brain is not as big as yours.

You are being so incredibly stubborn here that I am going to agree with you so as to get my point across.

The guarantee is a disaster, we are all doomed.

BUT IT DOESN’T MATTER A WIT THAT WE DIDN’T EXCLUDE SUBBIES AND EXISTING BONDS.

Really.

Let me put it another way. According to the prospectus - if the state had kept the warrants and exercised them post recap, the state would have ended up with 34.3% of the bank (assuming it paid to avoid dilution on the dividend stake).

Instead, the state received overall a 36% stake and 491 mn in cash at the cost of 1,036 in preference shares and the warrants.

So the state has increased its stake by 1.7% points for 545 mn euro cash equivalent (the preference shares). This would value BoI at 32 bn euro… At current price it is worth 4.4 bn…

You don’t see anything bad, wrong, illogical, inefficient about that?

Honohan’s point that subbies and existing bonds should have been excluded is of course technically correct and I think he is delighted to be seen to have at least one point which is anti the official line.

But let us not overegg it, which I think Karl does in his IT piece.

We would be in no different place today if we had excluded these and Lenny will exclude them next time round.

I’m of the opinion that Honohan’s comment on guaranteeing existing means that he can’t agree with the guarantee as implemented. Aside from increasing the losses to the taxpayer, it also pushed up the cost of Irish sovereign debt. It makes absolute sense not to cover bonds that couldn’t move. The only scenario I can think of where covering existing debt makes sense is where Irish banks were holding each other’s bonds. In such an event, not guaranteeing existing bonds would cause ratings downgrades and balance sheet markdowns across the board.

I suspect the “97% agrees with” is the percentage guaranteed that wasn’t subordinate debt. This was the impression I got from an interview with Michael Martin on Vincent Browne last week. The unfortunate Mr Martin doesn’t appear to understand tiering risk.

I’d like to draw out Governor Honohan’s comments that the cost of fixing the banks was “manageable”. Is it a nuanced “in isolation” the cost is manageable?

In addition the state received just under 500m in cash for cancelling the warrants.
Prior to the recap, the NPRF had 15% of the equity and warrants exercisable in five (?) years to buy another 25%. It now has about 35% of the ordinary shares. Where does 95% dilution appear out of all that number crunching.

…. ’some mechanism will be developed at the EU/IMF level to keep AIB/BoI afloat. As to Anglo and the rest of the dross, I think there is broad agreement that the state - and, ultimately, all citizens - will have to take these continuing hits on the chin without a possibility of respite only in the very long term’

Everything suggests that a little state has stood, perhaps patriotically, or at least politically, over a number of ‘its’ insolvent banks, whose balance sheets are of the same order as the finances of that same state.

You can use a VW Golf to tow a big trailer, but you will be sniffing asbestos on the uphills. Any EU/IMF mechanism which is planned for purposes of bank rescue will also come in handy when there are no funds to pay public sector salaries. But the EU side will be far too polite to mention that.

The CEO and the CFO of Anglo both say that 22 bn that has been paid into it will never be returned. That not cost enough for you?

Mr Dukes said in March that the wind-down cost would be 20 bn. http://www.rte.ie/news/2010/0312/anglo.html

It has since ballooned to 49 bn. All based on makey-uppy double-secret figures. It is a steaming pile of nonsense to suggest these figures without given some detail on how this can be the case and how supposedly smart people can be 150% out on their figures in just three months. How much less then zero can Anglo really cost?

The warrants were sold at above the pre dilution market price. But as they could not be diluted, this matters little - the pre-dilution (capital raise) value of the bank was much lower than the post-dilution value. Do you really think that the current share price of BoI represents anything other than a distressed level? So the future value of the warrants would be greater given the inevitable recovery.

That is what I mean by a song - either the value of the shares is going to increase as a result of the recapitalisation being successful (in which case the warrants are valuable) or it is not (in which case the preference shares are more valuation with 8% dividends).