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.