New Projections of Interest Rates on EU Loans

The topic of the interest rate on Ireland’s EU loans has attracted a lot of attention. Unfortunately, however, hard information on the loans and comparisons with the loans being offered to Portugal is not always easy to come by. The purpose of this post is to provide the information that is publicly available on this issue and to present new calculations of the likely interest rates on Ireland’s loans.

The most common media reference point for the cost of Ireland’s loans is this information note released by the NTMA in November. That document projected the cost of Ireland’s loans from the European Financial Stability Mechanism (EFSM) at 5.7 percent and the cost of Ireland’s loans from the European Financial Stability Facility (EFSF) at 6.05 percent.

With €22.5 billion being provided to Ireland by the EFSM, €17.7 billion by the EFSF and €4.8 billion coming from bilateral loans, the NTMA note assumed the interest rate on the bilateral loans would be the same as the EFSF rate. Thus, the estimated average cost of the EU loans was 5.875 percent. (I am leaving aside in this note the question of the cost of funding from the IMF, which is determined according to standard, if somewhat complex, IMF procedures.)

In a briefing note for the Oireachtas Committee on European Affairs, I noted that market interest rates had risen since the November briefing and the pricing of the first EFSM bond had not gone as well as anticipated. Based on those considerations, I suggested that the cost of EFSM funding was likely to be 6.09 percent while the cost of EFSF loans would be 6.44 percent.

The period since that briefing note was written has seen a number of EFSF and EFSM bonds issued to Ireland and Portugal, so now seems like a good time to attempt to get a more accurate picture.

Here’s a link to a spreadsheet that describes each of the bonds issued by EFSF and EFSM as well as the conditions on which they were disbursed to Ireland and Portugal. I have made estimates of what the interest rates will be on funds that are not yet drawn down by assessing their likely average maturity (to match the planned 7.5 year average maturity for Ireland and Portugal), calculating current market interest rates for those maturities (based on the mid-swaps benchmark used by the EFSF and EFSM) and then adding in the estimated margins.

A quick summary:

1. The average interest rate on EFSM loans for Ireland is projected to be 6.13 percent.

2. For Portugal, the EFSM loans project to have an average interest rate of 5.34 percent. The lower rate than for Ireland is because the EFSM’s profit margin on Portuguese loans is 77 basis points lower than for Ireland.

3. The average cost of EFSF loans for Ireland is projected to be 6.29 percent. This is lower than I had estimated in January because I had used the assumption underlying the NTMA’s November document that the margin over funding cost that would determine the effective borrowing cost for Ireland would be 317 basis points. Based on the one EFSF bond issue for Ireland so far, I now estimate that this average margin will be 305 basis points.

4. The average cost of EFSF loans for Portugal is projected to be 5.76 percent.

5. Based on the assumption that Ireland’s bilateral loans (not yet drawn down) will carry the same average interest rate as the EFSF, the average interest rate on Ireland’s EU loans will be 6.21 percent, 33.5 basis points higher than estimated last November. The average interest rate on Portugal’s EU loans is projected to be 5.55 percent, 66 basis points lower than the projected rate for Ireland. 

6. The current terms on Greece’s EU-IMF loans have been widely reported to be 4.2 percent for a 7.5 year average maturity after Greece was granted a 100 basis point reduction at the March 11 meeting of the Heads of Government of the Euro Area member states.

For those interested, here’s a rough description of how the calculations were done.

1. EFSM raise funds in the bond market and pass those funds to borrowers by adding a margin. The announced margin for Ireland is 292.5 basis points. However, when the effective interest rates for Ireland were revealed in this June 15th Dail answer by Minister Noonan, there has been an additional charge of two to three basis points. This most likely reflects a small upfront service charge. I have added this extra three basis points to projections for future loans to both Ireland and Portugal. So, while the EU have announced the margin on Portugal’s EU loans as being 215 basis points, I have applied a margin of 218 basis points.

2. Noonan’s table shows that a small amount of funds were kept back from the EFSM loans and not disbursed to Ireland. I don’t have information on loan amounts versus disbursements for Portugal, so I have ignored this distinction in this case.

3. The structure of EFSF’s operations is much more complicated. I described them in my Oireachtas briefing note. Also, here is my latest attempt to model the cash flows involved in an EFSF transaction, in this case the 5.5 year loan given to Ireland in January. (The discount rates used to calculate the net present value of the margin were provided to me by EFSF.) The EFSF’s FAQ states

Currently the margin for Ireland stands at 247 basis points, the margin for Portugal is 208 basis points following the conclusions of the March European Council for lower interest rates. Negotiations are ongoing to reduce the margin for Ireland.

Now you might think that this means that Portugal’s EFSF loans have interest rates that are 39 (=247-208) basis points lower than Ireland’s. However, that’s not the case. This is because the “margin” referred to here applies not just to the money that is disbursed to the borrowing country (what we usually think of as the loan amount) but to the full amount of funds earmarked for the country including the large upfront deduction of the net present value of the margin. In the spreadsheet example, the margin applies to the full 84 figure, not to the 71.8 figure for the disbursement.

If anyone’s still reading at this point, this means that the effective margin on EFSF loans is bigger than you’d think from reading various official statements that are made about EFSF’s “margin”. Somewhat mind-numbingly, the way the quoted margin translates into an effective margin appears to vary with the maturity of the loans, with longer loans having a slightly higher effective margin. I have attempted to model this in making assumptions about future margins for EFSF loans.

4. I assumed that the cost of funding for all future EFSF and EFSM operations will be 10 basis points above the mid-swaps figure for July 5th for the relevant maturity (obtained from the Financial Times). This is based on the average spread relative to mid-swaps so far for these operations being 10 basis points.

No doubt some aspects of the calculations can be improved upon and suggestions are welcome.

Finally, it’s worth noting that the EU Council announced that the Portuguese loans had

a margin of 215 basis points on top of the EU’s cost of funding. This will result in conditions similar to those of the IMF support.

Funnily enough, not that long ago, they also said

Ireland shall pay the actual cost of funding of the Union for each tranche plus a margin of 292,5 basis points, which results in conditions similar to those of the IMF support.

215, 292.5 — can both really be “similar to IMF support” given that they’re not so similar to each other?  I guess they both start with the number 2.

22 thoughts on “New Projections of Interest Rates on EU Loans”

  1. @KW

    Aside from the fact that these rates are abysmally high, considering the supposed purpose of the loans, do you have an estimate of how close Joe Higgins’ claim of a profit to ‘our partners’ of €9 billion based on these ‘loans’ is?

  2. @ DOD

    Well they won’t make any profit at all if we default on their loans. But if we pay them all back on time then we can calculate the profit off the margin of 300 basis points.

    €45bn time 0.03 = €1.35bn a year.

    Over 7.5 years, this gives a profit of €10.125bn.

  3. “Historians will look back on this period in amazement. Central bankers haven’t learned their lesson. They seem to be getting it as wrong today as they were during the boom.” per Jeremy Warner…
    Higher interest rates with indications of more to come..surely a receipe for disaster given current trends and debt crisis. JCT will have departed for pastures new.

  4. @Karl Whelan

    Thanks. These interest rates really are ‘sense-less’ – they tear the so-called principle of European Solidarity to shreds.

    … and increasing the risk of full blown sovereign default.

  5. @Mickey Hickey
    So the figures show 103 ECB, 55.7 ICB + 17.8 NTMA for a total of
    173.5 billion. At end of July the NTMA deposits will have to be replaced so the July figure is likely to be 173 billion rather than the numbers being quoted on another thread. I think they were out by about 20 billion.

  6. @ CP

    doesn’t the NTMA cash become permanent capital at the end of July, so it shouldn’t affect anything?

  7. @Karl,

    Thanks for bringing all of that together, that represents a lot of work.

    Separately, do we know the status of the loans with Sweden and Denmark, the terms of which were being debated in their parliaments a in Spring but which don’t appear yet to be signed.

    We have signed the €3.6bn deal with the UK in Dec 2010 which makes us pay 7.5 year sterling swap rate plus 2.29% margin. Plus exposes us to exchange risk because repayments must be in sterling – mind you, that might be OUR currency in 7.5 years anyway, though I see the canny Brits will want their money back if we leave the euro.

  8. Could the NTMA disbursements to the 4 private banks be considered loans (at low interest) in perpetuity which are part of the reserve funds in each bank. Or do they become Gov’t owned equity in each bank presumably paying a dividend at some point. Who pays the piper, in this case the ECB.

    When it comes to the Irish Gov’t and Irish banks I must admit I am sceptical.

  9. @Eoin Bond

    It was figures posted by Seamus Coffey on another thread that I was referring to…
    “(currently €53bn ELA + €71bn ECB = €124bn)”

    The NYT figures =103 ECB, 55.7 ICB
    so the difference is 34.7 billion.

    So what are the correct numbers. I agree the NTMA cash moving from deposit to permanent capital won’t make any difference.

  10. @ceterisparibus & Eoin
    “I agree the NTMA cash moving from deposit to permanent capital won’t make any difference.”
    Um, if they use the capital to make up a deposit short-fall, then it will no longer be capital. It will be an admission that it has been eaten by losses. No?

    Which would leave us with no longer “the best capitalised banks in the world”.

    It also depends on the synchronicity of the deposits – is it mostly in AIB or PTSB? Actually, scratch that. They’re all the same aren’t they? We own all the bank…[sic]

  11. The Reuters figures are likely to have come from an interpretation by the chief economist of the KCB Belgian bank who is looking from the perspective of his banks exposure at the time (July) the Irish Gov’t transfers 24 billion to the 4 private banks as per agreement with IMF. The rest of the discrepancy could involve the 17.8 billion.

    Chief economists do not engage in idle chatter with reporters they get their message across. The other side of the coin is the position of the Irish Gov’t and its agencies who are spinning as positively as they can. Belgium and its banks are considered to be fifth riskiest after Spain and Italy hence the interest in how Ireland is faring.

  12. @ CP

    NYT figures are wrong, they, predictably, include foreign banks operating here. Real figs are 71 + 53 + 18 = 142

    @ Hoggie

    Capital injections should increase capital, obviously, as well as liquidity/funding? Imagine a brand new bank tomorrow, 10bn of seed capital. What can it lend initially?

  13. @eoin
    The figures came from Reuters, the reporter Conor Humphries is Irish. Humphries appears to be a generalist who relied on the KCB chief economist. Reuters is owned by Canadians the Thomson family to be precise.

  14. @Eoin
    “Capital injections should increase capital, obviously, as well as liquidity/funding? Imagine a brand new bank tomorrow, 10bn of seed capital. What can it lend initially?”
    Granted for a new bank. For an existing bank, though, the money is already loaned. The assets are created. The deposits have been sought and indeed paid back.

  15. @ Jagdip

    Currency fluctuations I assume? IMF loan is in SDR’s, not Euros.

  16. @Eoin,

    Maybe, so we haven’t hedged the IMF bailout? Let’s hope we never get EZ QE.

    Interestingly the EFSF bailout is up €42.5m in the month which again seems like a very small amount, and exchange issues wouldn’t arise.

  17. @ Jagdip

    i’d assume the IMF loan is hedged, but the derivatives required for that probably appear somewhere else. NTMA report or something i’d imagine. The exchequer statement just refers to the actual loan itself, not the gain/loss that would come from the hedging.

  18. @ EB

    My understanding from communication I have had with NTMA on this issue is that the IMF loan is not currency hedged nor has any floating-to-fixed swap been done. The quote from the November document is about a hypothetical transaction.

  19. Thank you Karl, this is a lovely example of how useful blogs can be when real work is put into them.

    It seems to suggest that Ireland was indeed made an example of, and that the urge to punish the peripherals for failing European financial capitalism is diminishing as the systemic nature of the banking crisis has become more difficult to paper over.

    The FT is now suggesting that Monday’s meeting of EU finance managers might signal the end of the coddling of investors, at least with regards to Greek debt.

    EU stance shifts on Greece default

    For us this change of attitude comes years too late but it is a promising sign that European involvement with, and contribution to, the global financial crisis is finally being acknowledged.

    Not at all coincidentally by the time our beloved LBS exits the ECB to preside over Italy’s central banking triage operation for their Berlusconi enabled economic apocalypse he may not have to contend with the idiocy he helped promote.

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