Promissory note news roundup

Which makes me believe that either our masters in the troika aren’t nearly as smart as I think they are — or they have something else in mind as a more permanent, nuanced, and elegant solution.

There is of course another explaination for the Troika’s actions

They’re just not that into you… they dont really care… its working well enough for the moment… no payment has been missed yet… and when push comes to shove, the local elite will do anything to keep their payments coming in.

I caught End Kenny’s enthusiastic assertions that Ireland was in recovery and steaming ahead, etc, on the web last night.

If I can track this down, Rehn andthe Troika misstep certainly can.

I ask the same uncofortable question I have asked several times about the PN repayment.

If everything is so marvellous, why do the current repayment arrangements need to be amended?

The government is speaking out of two sides of its mouth.

This is shaping up as the greatest non event since Y2K. What started out as a macho cry to tear up the PNs, write off the ELA, let the CBI go bust etc. etc. will finish up as a loan deferral.

This government since it came to office has been fairly careful to reverse the populist line it took in the election campaign (remember “Frankfurt’s way or Labour’s way”?) But they were lulled into a mistake on this one as they thought its espousal by a very high ranking economic academic made it plausible.

The name of the game is now to somehow give the appearance of some win for the government without any substantial concession. I wouldn’t be looking for nuances.

So, is there a growing feeling that the interest rate does matter?

Assumption A: Anglo relies on the the 8% or so currently.

Assumption B: Any reduction in this rate will leave Anglo needing additional cash from the State?

Seems to be the message from Indo’s LN:

http://www.independent.ie/opinion/letters/the-truth-about-anglo-and-the-30bn-black-hole-3061534.html

“The problem is, the interest rate payable on the pro note is completely irrelevant. It is paid from the state coffers to Anglo — another arm of the state.

TO

“IBRC has also factored in the regular interest (at 8.6pc) into its business plan. If the interest goes down, IBRC’s profits fall, or IBRC swings to a loss. IBRC is state-owned — its profits and losses are ours. If we cut the interest rate and IBRC loses money, that loss is borne by the taxpayer.”

In the same article.

@BWII

Sure, but there seems to be a growing feeling that the Anglo capital requirement isn’t actually just 30bn but is actually 30bn plus “some portion” of that 17bn interest – the removal of which would need to replaced by taxpayers’ funds.

Basically, the fear that some of this profit which you mentioned is actually being eaten into.

The primary ammunition I would have for this argument is the following:
Cite me one Government official who has mentioned the interest rate on the PNs does not matter? I find it highly suspicious that the Government wouldn’t be jumping at the chance to tell the nation that the 17bn in interest, referred to in the parliamentary’s questions all those months ago, would actually be coming back to the State.

@ Stephen, BWII, Rob

I think BWII’s analysis is correct: the interest on the promissory note does not really matter.

Indeed the interest that the IBRC pays to the Central bank doesn’t matter. The key question is the interest that the Central Bank “burns” the ELA. This has received hardly any attention.

My understanding from Karl Whelan’s paper to the Oireachtas is that the CB burns the ELA it receives from the IBRC. The CB reduces its accounting liabilities to the ECB and there is a charge of 1% imposed by the ECB on the CB. But the CB (a state institution) can keep the profit. This will be the 2.5% (according to Karl’s estimate) the CB charges the IBRC less the 1% imposed by the ECB.

The key interest rate is that imposed on the CB by the ECB under the terms of the ELA. This is the real finance cost to the State. There has been very little debate about this. It seems to be a closely guarded secret. As I said Karl Whelan thinks it is 1%. BWII thinks between 1 and 2%. I have heard other higher figures elsewhere. It would be good if there was some kind of consensus on what is the exact figure.

@ Rob

Missed your earlier post whilst writing that last one. You seem to have reached the same place.

@ John Martin

If the government injected 3.1bn cash into IBRC. IBRC would pay down its ELA and the CBI in turn would pay down its Target2 debit at the ECB. Target2 costs the ECB rate of 1%.

I think.

@ John Martin

I wasn’t aware that the ECB made an additional levy on the CBI for running an ELA. I join your request for someone who really, really knows what is going on to please clarify the matter.

@BWII

My summary of the situation is that we have a very good deal: a 1% interest on the ELA (that’s all that matters from the state’s view).

However, the EU wants us to gradually replace the cheap loan of 1% with a more expensive IMF/EU loan. This will be done over a period of 20 years.

The Govt wants to delay the replacement of the cheap ELA. But if the bond that they issue to postpone the promissory note payment is at roughly the same interest as the IMF/EU funding the benefit is purely cosmetic.

@ Rob

Agree the capital requirement of IBRC is not just 30bn and the 17bn in interest will make its way back to the public coffers. The PN makes up just 44% of IBRC’s assets, the remainder is made up of impaired loans. If those loans don’t perform then it seems inevitable that much of the 17bn in interest (a large proportion of which is supposed to circular) will have to be used to compensate for those non-performing loans…..that is why you don’t hear the government making the case that all this money is going to make its way back to the exchequer.

@BWII,

Our posts are crossing… regarding the “additional levy”.

The CB charges the IBRC about 2.5% (per Karl Whelan’s paper). In my view this doesn’t matter: the cost to the IBRC is profit to the CB. The key issue is the interest rate imposed on the CB by the ECB, which I think is indeed 1%.

I have been told by someone that Fortis had to be pay 5% plus Libor for ELA. However, from the Belgian point of view the relevant point is how much its Central Bank paid in interest for the ELA authorised by the ECB. I assume it was also 1%.

@Eoin, the NTMA spokesperson says the MoU itself “isn’t available”.

Shame, I would have enjoyed something with “WHEREAS, the Chinese being a great bunch of lads on the one part, and the Irish without a pot to pee in on the other part hereby etc etc”

Bringing forward my “lost” post from last night, but also adding the subsequent exchanges with BEB and BW II below.

Why not? (shoot this down)

@ John McHale, Karl Whelan, All

Not on the correct thread, but here are my simple “bubble up” thoughts re the PN restructuring…..My understanding is as follows:-

The Irish Central Bank (CB) wrote a loan (created a funded asset), representing CB printed funding euros on the liability side of its balance sheet, to the IBRC (Anglo and Irish Nationwide) on a back-to-back basis with the Govt PNs given to the IBRC (essentially unfunded IBRC loans to the Govt). The PNs were legally pledged by the IBRC as collateral for the CB loan to it. The Govt must now service principal and interest repayments on the PNs by paying Euro 3.1bn odd pa to the IBRC which in turn pays the CB.

Under EU rules, the CB cannot make loans without sufficient collateral, and there is a Q-mark over the PNs in this regard. So, the making of the loan by the CB to the IBRC is a bit of a problem in the first instance.

Question – Instead of receiving PN repayments from the Govt. via the IBRC (which causes liquidity strains and demands on the taxpayer), is there any reason why the CB couldn’t make a “capital contribution” of its loan asset (PV of principal and interest…circa Euro 31bn I believe) to the IBRC ? i.e. convert its loan asset into a capital holding in the IBRC? Such a “capital contribution” mechanism is not uncommon (debt-to-equity is quite topical nowadays!). The CB loan to the IBRC then becomes capital not debt for its accounting purposes….so the CB debt PN collateral issue falls away.

It then begs the question as to how the CB services its liability. At present, the annual Euro 3.1bn is apparently “burnt” i.e. there is simply a write-off versus that (notional) accounting liability (again, principal and interest). It seems to me that it should be possible to net the PN collateral against the CB liability, via a netting arrangement (it is afterall on the one consolidated balance sheet) e.g. in return for the capital contribution, the CB liability is assumed by the IBRC and extinguished against its Govt PN asset.

So, classic debt-into-equity restructuring (for a banker). Any thoughts? Do you know whether the Govt has thought about alternatives other than the present attempt at debt-to-debt restructuring (with all its interest-matching, risk transfer, etc. limitations)?

If this or some similar version is workable, all steps are within Irish control. Importantly, the cash issued to the IBRC remains in place (no external refinancing of that aspect required).

What am I missing?

BEB @ Paul W
the equity the CB has is worth how much, exactly? Zero? Any chance this exercise would make the CBI insolvent?

Paul W @BEB Credit enhancement for the IBRC can always be considered e.g. unfunded Govt guarantee. The idea is that not much changes except the E 3.1bn annual cashflow, and the fact that the CB loan is now capital.

BW II @ Paul W
You have been watching too many Karl Whelan movies. That 3.1bn would not be “burnt”. It would be used to pay down Target2 liabilities to the ECB. These are real liabilities of the CBI not entries in an internal ledger to be written down or bits of paper to be burnt.

Paul W @ BW II: The set off /netting of the PNs against the CB liability would do the same.

@ BEB Don’t agree. It is not a bond, it is an equity investment in a Govt backed entity.

@ BEB As you know, not an exact science (still). Also, I am not an accountant so will not attempt to give you a definitive answer…Agreed this is a complex area. However, there is flexibility. It also depends on how the equity investment is organised e.g. debt-to-equity can be different to a capital contribution to reserves. So, there is some structural flexibility also, particularly given that the IBRC is not a publicly listed entity. The point is however that the risk nature of the existing debt is not unlike the risk nature of the “capital” (albeit capital is subordinated).

I haven’t looked at how the Govt equity investments in AIB, etc. are dealt with. Perhaps you can clarify?

@ Paul

“I haven’t looked at how the Govt equity investments in AIB, etc. are dealt with. Perhaps you can clarify?”

eh, AIB may actually be worth something in 5yrs time?

@ BEB Without far more factual detail, it is not possible to give you a definitive answer. Neither can you answer definitively. However, again, in principle, under the scenario I set out above the risk valuation of the capital doesn’t look hugely different to that of the existing loan i.e. without more, I think that one cannot assume a huge disparity of result under IFRS (bar I do accept that the lack of capital dividend expectation could be a wrinkle in that statement).

With a Govt unfunded guarantee support, the value of the IBRC in 5 years time is not relevant…..Fair value looks at the likely 3rd party market valuation now. Speculation re AIB’s valuation in 5 years time is in any event just that: speculation…even a pure guess.

@ BEB I should add that, even in relation to the (lack of) dividend expectation, one cannot look at that in isolation from the reduction of interest cost on the CB’s liability side as I suggest (by way of the set off /netting). Listenening to Patrick Honohan live, there is still it appears secrecy surrounding the CB liability side, albeit we know that the existing external funding rate is far lower that the PN coupon rate.

Still, I just wonder whether the focus of the Govt parties on clearing out the trackers from the banks has distracted them from looking at alternatives to the present debt-to-debt restructuring approach on the funding end.

@ Paul

the existing CB loans pays 1-2% annually, are senior liabilities, and are being paid down every year….you are suggesting replacing them with long term equity, which is the ultimate risk capital, with no dividend, and no reasonable chance of profit (ie any profit above the 3.1bn in capitalisation you’re putting in). My point is simple – if you put in 3.1bn, get no interest, and then are more or less guaranteed to get back no more than 3.1bn back at a later date, your equity is worth less than 3.1bn today. This isnt an accounting issue – its finance 101.

Honohan says ‘deal likely’ over Anglo promissory notes

‘Mr Honohan said that the settlement of the €3.1 billion payment on March 31st with a long-term Government bond instead of cash, expected within days, was a “very considerable step forward” and “a very definite gain” on the ability of the State to repay its debts.

‘”It puts off for a long number of years the actual need to refinance those payments,” he said, but relative to the bigger amount due on the €31 billion promissory notes was “a considerable improvement”.

‘The cost would be at “quite a low valuation” to other sources of funding available and lower than the interest paid on the bailout loans advanced by the troika, he said.

‘Mr Honohan said that there would be “no net cash outlay” to the State under the terms of the deal being worked for the March 31st payment to settle the €3.06 billion instalment by issuing a Government bond instead of paying in cash.

‘The Government planned to issue debt to IBRC on an existing bond rather than issuing a new Government bond to cover the next instalment due this Saturday.
‘

http://www.irishtimes.com/newspaper/breaking/2012/0327/breaking34.html

@ Gavin/Paul

i was listening to it, and i though he said “net cost” (ie as the “profit” is retained by Anglo)

Do we yet know what the proposed deal is with the €3.1bn prom note payment.

(1) Govt pays Anglo €3.1bn
(2) Anglo buys Govt bond – is this a new issue or does Anglo go to the market and buy extant 2025 bonds? There’s 8bn of them so a €3.1bn purchase would be market moving no? Or does the Govt issue additional debt and if so, how is it priced. As a single buyer and given we own Anglo, presumably we dictate the price
(3) What happens to the €30bn of ELA with the Central Bank. Doesn’t that get redeemed now? And if so, how does Anglo get the cash? Does it exchange the newly issued Govt bond with the ECB and pay 1% per annum on that lending?
I saw the 60 mins of presentation and questioning at the Committee but I still didn’t understand what was intended, even though Governor Honohan has raised my expectations that a deal will be done by this weekend.

@Eoin

As always thanks!

It does make a difference what happens with the ELA does it not? If Anglo borrows €3.1bn from the ECB at 1% then that is €31m per annum (or 1/5th of a household charge!) that goes out of the country, no?

@ Jaqdip Singh

If IBRC borrows from ECB at 1% and then pays off its ELA, the CBI will then pay down its Target2 debit account with the ECB thus saving itself 1% interest. So Ireland Inc. is neutral on this transaction and it is no different from IBRC simply replacing the PNs with the bond as collateral for ELA.

@ Jaqdip

Re “Would that be a fair characterisation?”

Only if you accept you are liable for that debt in the first place, otherwise you get screwed with a liability you don’t owe at 78% which is 28% less than a higher liability at 100% that makes you foolishly think you are onto a bargain 🙂

@REFERENDUM

May 31 is a foolish date ….. it ignores developments in other parts of the EZ

The Debate in the Bundestag is ongoing – and no way will the Bundestag have voted on this by May 31 …

See: Anglela’ Korset, The SPD/GP forced compromise, the debate on the Korset including measure for growth etc …. & [Hi Olly!] the superior Wisdom of Festina Lente in this case:

Der Spiegel International Today ….

Separately, the main opposition parties on Tuesday rejected plans by Merkel’s government to push a European pact on budget discipline, the so-called fiscal pact, through parliament by June, saying more time was needed to complement it with measures to boost growth.

http://www.spiegel.de/international/europe/0,1518,824104,00.html

@ Jagdip

Not sure about the inflation angle. But netting everything out it seems that what is happening is that Ireland Inc. is replacing long term ESF funding with short term ELA/ECB funding. In terms of interest rates that currently looks like a win but over 13 years what will ECB funding rates average out at? Possibly not much different from current long term ESF rates.

Another gain, it seems to me, is that we have in effect extended the bail out fund. Originally the bail out fund was calculated so as to make these PN repayments. Now we are allowed to meet the PN repayments with other non-ESF loans, thus increasing the bail out facility by the back door.

@ David O Donnell

Why can’t these dates be on a Sunday?

From yor link:

“”I’m pleased that the coalition now supports the SPD’s proposals on strengthening the rights of parliament concerning the euro bailout fund,” said SPD parliamentary manager Thomas Oppermann. He welcomed that “as a rule the whole Bundestag will decide on providing billions for the rescue of the euro.” The measures would become “more transparent and easier to understand for people,” he said.””

Why not disband the Dáil and allow the German parliament to dictate to us the terms of rescue, the full financial oversight required and the detail required to give it effect?

Re Honahan

http://www.irishtimes.com/newspaper/breaking/2012/0327/breaking34.html

As discussed earlier, “no net cash outlay” The disingenuousness of it all.

Suddenly the bond appears hours before a court injunction on the PN’s, does the injunction also cover the bond as well ?

Court to decide tomorrow morning

http://www.rte.ie/news/2012/0326/anglo-business.html

Would FF/FG/LB all troop back into the Dáil to vote in favour of the PN’s?

@ Jagdip,

Re, “If we want to issue €67.5bn in bonds tomorrow…”

http://www.forexpromos.com/what-is-ltro-financing-ecb-ltro-explained

I agree. The way Spain and the other peripherals are doing this is the banks take the LTRO at 1% and use sovereign bonds as collateral.

Why not issue a sovereign bond for €67.5bn and get the LTRO for same amount at 1%?

@ Blucher

More a case of it being wound up early, thus saving on future PN payments. Not as big as 17bn because the interest costs of ELA need to be met but yes if current valuations are correct there will be a substantial saving in terms of foregone PN payments. Put another way, if current valuations are accurate, no way do we need 48bn to wind down IBRC.

@ Brian Woods II

“if current valuations are accurate, no way do we need 48bn to wind down IBRC.”

Current valuations of property?

I’m all in favour of winding up IBRC now.

Can’t see why we are paying for all the running costs.

If the plan is that ECB roll over 3.1bn of ELA/repo – when will they finally get their money back, and on what terms. Is it

(a) 3.1bn in 2012 – i.e. this is an interim deal until all the PNs are redeemed later in the year with a loan from the EFSF. At that time all the ELA will be paid off, including this newly rolled over tranche, and replaced with a loan from the EFSF. ECB are out of the picture.

(b) 3.1bn in 2025. The March 31, 2012 tranche remains separate from whatever deal is done with the rest of the PNs. This arrangement would be equivalent to VVLTRO at the ECB repo rate. Not bad. However doesn’t square with Honohan’s “Funding such flows is not something that a central bank will normally do for any longer than is necessary” comment, or the “beyond criticism of Articles 123 and 124” one.

(c) 4.0bn approx in 2025. ECB get the same amount of money in 2025 as 3.1bn today invested in German Bunds, or an inflation-indexed bond. Since sovereign bonds owned by or pledged to the ECB are de facto super-senior to any other sovereign bonds, no country-specific risk premium is considered. Could well be argued as “fair value”.

(d) 7.3bn approx in 2025. ECB get the same amount of money in 2025 as 3.1bn today invested in Irish bonds at the current market rate, or those of a country with similar risk profile to Ireland.

(e) none of the above

@ BWII

I would therefore argue that we benefit from this situation: 7yr IRS vs 1mth (ie as close as you’re gonna get to an “ECB rate projection”, although somewhat messed up in short term due to LTRO effect) is 1.61% at the moment.

13yr swap vs 1mth is around 2.35%, fwiw (ie vs the 2025 bond redemption)

A high profile editorial from Bloomberg:

http://www.bloomberg.com/news/2012-03-27/ireland-deserves-breathing-room-on-debt-to-revive-economy.html

@Jagdip

I think I recall you drawing attention to the irony of us not being able to access LTRO because our banks have already been recapitalised. Access to 3yr LTRO 1% also highlighted here:

http://www.forexpros.com/analysis/some-irish-banks-unable-to-qualify-for-ltro-are-tapping-bank-of-ireland's-ela-118447

@Brian Woods 11

Look forward to analysis of NPV swap components of the giveaway they decide this weekend.

The Irish zombie economy looks doomed from whichever vantage point you pick.