Ten Year Bond Spread at New High

A bad day in the sovereign bond market. Irish ten-year bond yields are up about 25 basis points, hovering at about six percent. Spreads over German equivalents are at about  370 basis points, well above the levels that prevailed in May prior to the announcement of the EU-IMF bailout fund.

Just reporting it, so don’t shoot the messanger. It seems worthy of discussion. Is this a temporary overreaction to relatively minimal news (WSJ story on the stress test deficiencies and some other stuff) or is this the markets catching up with the grim reality of the fiscal situation? The beginning of the end or a great buying opportunity for Irish sovereign debt?

Hot air over Poolbeg

As I expected, nothing happened yesterday. Times, Indo, and Examiner have the same story: Neither party walked away from the contract to build an incinerator in Poolbeg; and Minister Gormley continues in his role as leader of the opposition.

Meanwhile, of course, construction has halted — depriving a bunch of people from a job — and fines for breaching the landfill target accumulate.

The deeper issue was mentioned in the Times: ‘[Mr Tierney] said the managers of the four Dublin local authorities had been put in an “impossible position”. They had been given the responsibility by Government to ensure waste policy was implemented but “at the 11th hour complete and utter uncertainty has been created”.’

Long-term investment requires regulatory certainty.

Anglo’s Plan to Save Subordinated Debt Holders

It is now widely expected that the EU Commission will not approve Anglo’s Good Bank Bad Bank split and so there won’t be a good bank.

The media’s constant focus on whether the bank is being fully wound down or not has always been somewhat misplaced (I’ve been making this point for quite a while). Yes, the government would have to put extra money in to recapitalise the new bank but it wouldn’t be much (perhaps a billion or so) and, in theory, this investment could be earned back if the new bank was eventually sold off. In addition, the new bank would allow for the highest level of continuity for depositors and this could help restrict depositors leaving the bank which would complicate any adjustment to a new structure for Anglo.

In practice, there probably isn’t the basis there for a profitable new bank and there are other ways to deal with deposits, so I haven’t been a big fan of the split idea. However, this debate has been a distraction from the main issue affecting the cost of the bank to the Irish taxpayer, which is what the policy will be on the treatment of bondholders.

Now, however, a new reason has emerged to be against the new bank proposal. I had questioned here whether Anglo would have considered transferring subordinated debt liabilities to the New Bank. Now, Sunday Tribune journalist, Neil Callanan, informs us that Anglo’s management have informed him that their plan is to transfer some of the bank’s subordinated debt “to round out capital structure” (Thanks Neil.)

This is a bad idea on so many different levels. The idea about “rounding out the capital structure” sounds plausible but is, in fact, nonsense. International regulators have generally encouraged the issuance of subordinated debt because small numbers of professional bond investors may be better positioned to provide “market discipline” for the bank’s management than the shareholders, who tend to be poorly organized and easily deceived. The idea here is that the subdebt holders will lose all their money if the bank becomes insolvent, so they’ll pay close attention.

Now we have a bank which is insolvent and whose subdebt holders should get nothing. And the bank’s management wants to hive these bonds off into a new institution, fully capitalised at the expense of the Irish taxpayer, which would see the debt paid back in full.

One can only assume that Anglo’s management are aware that New Bank could “round out its capital structure” by issuing new subordinated debt, in return for which the state-owned bank would actually receive some money. But, for some reason, they would prefer to see the bank take on a legacy liability of Sean Fitzpatrick and co and pile it onto a new state-owned institution. The question is why they would want to do this.

The EU’s impending decision to prevent the new bank should stop all this. However, the planned subdebt transfer raises very serious questions about how exactly Mr. Aynsley and Mr. Dukes believe they are serving the Irish public with their plans for New Bank.

Renewable heat and the cost of capital

Today’s Independent reports that the government is preparing the ground for meeting the renewables target for home heating. Geothermal energy is to play a part in this. Treacy Hogan gets the numbers right, but does draw the obvious inference. Would anyone invest in a project with a payback period of 12-36 years? In a country that is desparately short of capital?

A friend of mine used to sell heat pumps. He had a brilliant marketing ploy: “The payback period is 40 years.” Most of his customers thought you need to maximise the payback period, so he sold loads.

As with most renewables, for geothermal energy, the fuel comes for free, but the capital does not. Compared to fossil fuels, the price risk is gone, but the interest rate risk is higher.

Exposures of Foreign Banks to Euro Periphery

The same BIS Quarterly Review also carries an analysis of the holdings of foreign banks (with a geographical breakdown) in the troubled periphery of the euro area and shows the allocation between claims on the public sector, banks and the non-bank private sector: you can read it here.

As has been pointed out repeatedly on this blog, the claims on Ireland have to be treated with some caution in view of the role played by IFSC-located entities. In its coverage of this new article, the New York Times highlights the probable role of Hypo Real Estate’s subsidiary in Dublin (the former Depfa bank) in contributing to the high claims of Germany on the Irish non-public sector.