RTE: Nation to Be Spared From Promissory Note Deal

RTE’s Nine O’Clock news are reporting Enda Kenny as explaining that promissory note negotiations are totally separate from the question of will the Irish people vote for the Fiscal Compact Treaty and that the Irish people will not bribed to vote for the Treaty.

RTE also noted that the latest Council meeting was “dominated by jobs and growth” which sounds like great news. And, best of all, reporter Tony Connelly helpfully explained that it was now felt that asking for a better deal on promissory notes was actually a bad idea because it would send a bad signal to financial markets that we were not able to cope with our debt burden and that there was no way this issue would be dealt with any time before the summer.

Ok, so be it. But I suspect that “the Irish people won’t be bribed” may prove to be the worst referendum slogan in history.

2012 TINA Award Winner: Laura Noonan

One of the most depressing aspects of the Irish banking crisis has been the consistent insistence of most of our financial journalists that any action that ran counter to government policy would result in disaster. There was simply no alternative.

I remember countless reports that nationalising any more banks after Anglo would result in torrents of frogs and locusts in the streets of Ireland. Today we have many economic problems but I doubt if the nationalised status of AIB and ILP would make the top ten.

I remember, time and again, journalistic reports that you couldn’t nationalise a bank because the ECB couldn’t lend to such a bank because of the monetary financing clause. Only this was blatantly false.

Even more common was the insistence that if any senior bank bond was defaulted on, the Irish people would be reduced begging in streets for scraps for a millennium. Of course, Brian Lenihan ended his period as Minister for Finance looking to get haircuts applied to senior bank bonds and Michael Noonan spent most of 2011 arguing that this was the right thing to do.

It’s early days yet, but the status of runaway favourite for the 2012 “TINA Award” must go to the Irish Independent’s Laura Noonan for her appearance on last night’s Vincent Browne show. Despite Michael Noonan’s consistent statement of his hope that the promissory note could be renegotiated, Laura insisted that There Simply Was No Alternative to making the €3.1 billion on March 31.

Among the reasons why we “Had to Make this Payment” were:

  • Eurostat have insisted on it (yes, Eurostat, who knew they were the real powers behind the throne, huh?)
  • Failing to make the €3.1 billion payment would, via some mysterious process, trigger the need to pay the full €28 billion that was outstanding on the notes.
  • Failing to make the €3.1 billion payment would also trigger the need to pay all of Anglo’s outstanding bonds.
  • And all of AIB’s guaranteed bonds.
  • And all of Bank of Ireland’s guaranteed bonds.
  • I think the frogs and locusts appeared again at some point.

Anyway, exciting stuff. All complete nonsense of course. There is nothing preventing the note being restructured in any number of ways, provided the ECB Governing Council are willing to go along with it. And none of Laura’s appalling vistas are remotely relevant.

I guess the more interesting question is whether Laura is passing along what she’s been told by DoF spinners or whether she came up with this exciting stuff all on her own.

Those interested in checking out this Olympic-level TINA performance can check it out here (in particular, after 26 minutes in.)

Update: Laura has written to me to say the following: “A few points of fact: I never said that the Government could not restructure the pro note, in fact I said repeatedly that efforts were under way to restructure the pro note, and that they were progressing well. I said that the pro note repayment for this March would have to be made, with the benefit of more airtime I’d have qualified that it will have to be made unless the pro note is restructured before then. I did not say that there was no alternative to make the pro note payment every year to maturity – the whole point of the restructuring is that the pro note payment schedule would be changed.”

So I’m happy to say that Laura was only saying that the March 31 payment had to be made and that failure to do so would trigger these consequences. I have edited the post to remove any implication that Laura said  the note couldn’t be renegotiated at some point in the future.

Briefing Paper for Oireachtas Finance Committee

I’m appearing at the Oireachtas Finance Committee this afternoon, along with Brian Lucey and Stephen Kinsella, to discuss ELA and promissory notes. Here‘s a copy of a briefing paper I have provided to the committee and here are my opening remarks.

I’m told that the meeting can be watched live online at this link by choosing Committee 4 and also on UPC channel 801.

Promissory Note Campaign: A Quiet Downgrading

From the Irish Times:

THE GOVERNMENT has quietly downgraded its campaign to persuade the European Central Bank to change the terms of the €30 billion of promissory notes it issued to bail out Anglo Irish Bank, according to an authoritative Government source.

The efforts by Minister for Finance Michael Noonan to seek a reduction from the ECB in the 8.2 per cent interest rates being charged on the notes or extend the term of the loan has not really worked, said the source.

I suspect most of us can think of other euphemisms for “quiet downgrading”.

Burning Ourselves?

On tonight’s edition of The Frontline on RTE, Gavin Blessing, Head of Bond Research at Collins Stewart made some comments about repayments of ELA liabilities by the IBRC (i.e. Anglo-INBS) that I’d like to elaborate on. Gavin pointed out that IBRC’s major liabilities are to the Central Bank of Ireland. Indeed, I estimate that IBRC now owes about €42 billion in ELA to the Central Bank.

Gavin then followed this up by saying that we would be “burning ourselves” if we cancelled these payments to the Central Bank. This is a complicated business and I fully understand Gavin Blessing expressing the situation in this way. However, I would like to emphasise that it is my understanding that there is no offsetting financial gain to the Irish state from the IBRC’s repayment of Emergency Liquidity Assistance to the Central Bank.

The details are below but I can summarise this issue as follows: Channelling taxpayer funds towards repayment of ELA is equivalent to burning public money.

Let me start by describing the information communicated by a central bank balance sheet, such as this one for the Central Bank of Ireland. Central banks could create money by following Milton Friedman’s analogy and dropping it from a helicopter. However, helicopter drops are neither efficient nor fair. So the long-standing tradition has been for central banks to issue money by acquiring assets via open market operations.

Central bank balance sheets thus show you the assets that a central bank has accumulated via its money issuance. At some point in time, somebody decided it was a good idea to place the money that was issued to acquire these assets on the “liability” side of this balance sheet. I’m not sure this was such a great idea as central bank balance sheets can cause a lot of confusion. Suffice to say, however, these liabilities are somewhat theoretical. If someone brings a banknote to the Central Bank, the only thing they can exchange it for is other banknotes that the cost the Bank almost nothing to print.

That over with, the accounting treatment for Central Bank’s issuance of ELA can be described as follows.

1. The Central Bank provided ELA by crediting, for example, Anglo’s reserve account that it holds with the Central Bank. This was just the Central Bank creating electronic money out of nowhere and this new money was counted as a liability on the Bank’s balance sheet.  In particular, this shows up in “Other Liabilities” on the CBI’s balance sheet.

2. On the other side of the balance sheet, the money that Anglo then owed back to the CBI as a result of the ELA is counted as an interest-bearing asset for the CBI.

Now consider the repayment of part of the ELA by the IBRC. For example, consider repayments funded by IBRC’s annual receipt of €3.1 billion in promissory note payments. One could imagine two possibilities for what happens next.

One possibility is that the following happens. A €3.1 billion repayment gets taken in by the CBI who can then, for example, buy German bonds with it and ultimately use the interest payments on these to pay money back the government when they make profits.  In this case, the amount of money created from the original operation doesn’t change and the Central Bank’s ELA asset gradually turns over time into other, more tangible, financial assets. It is likely that this is what Gavin Blessing thinks is happening.

The alternative possibility is less attractive. The Central Bank takes in the €3.1 billion repayment and then deducts this from the value of its ELA asset. On the liability side it reduces “other liabilities”—the idea is that taking in this €3.1 billion is effectively siphoning off part of the money that was created in the original ELA operation.  In this case, no new securities are purchased by the Bank. The €3.1 billion is effectively being burned.

The available evidence indicates that the latter, less attractive, mechanism is what occurs.

Earlier this year, the Irish government deposited a large amount of money in the Irish banks; this money was later converted from a deposit liability into equity when the banks were recapitalised. When the banks obtained these funds, they reduced their ELA debts to the Central Bank of Ireland.

A quick look at the Central Bank’s balance sheet shows that “other assets”  (which we know is mainly ELA) are down by €17 billion since February. Other liabilities are also down by €19 billion. There is no sign of any jump in the Central Bank’s holdings of other securities as a result of the ELA repayments. There is no hidden positive story at the end of the ELA rainbow.

So why repay it at all? Well, if we don’t repay this money, the Central Bank’s ELA operation will have been equivalent to flying a helicopter over the IBRC, dropping €40 billion and not asking for it back. A jolly good wheeze for the bondholders and depositors who got paid back but possibly not a good precedent for the Euro area. If every Euro area country could do that with their troubled banks, there would be no banking problems but there would probably be a decent amount of inflation.

So our European partners would consider failure to repay ELA to be bad form. But that still seems to leave the pace of repayment, and the funding of this repayment, as very much an open question. In the meantime, let’s not kid ourselves about hidden benefits from these payments.

Anglo Bond Note from DoF

The talking point about repayment of Anglo bonds not costing the taxpayer any money had received a sufficiently wide rollout that it was clear that this was something government politicians were being told was a good thing to say. Via Constantin, here is a note from the Department of Finance apparently distributed to government TDs.

The note tells the politicians that “It is important to state that the redemption of the bond will be made by the IBRC. It will not be funded by the Exchequer.”

Is it really important to state that? Why? So someone sitting at home might think that we’ve stumbled upon some money that eases the burden of paying the bonds, even though the US assets were being sold at a loss? So they might forget that the alternative to using the money to pay off the bonds is to return it to the exchequer?

Anglo has lost all of its equity capital multiple times over and has been continually recapitalised by the state. Money is fungible. All resources being used to pay off the bonds are state resources.

This talking point doesn’t work. Time to give it a rest. Please.

Anglo Bonds No Cost to Taxpayer Talking Point Gets Full Rollout

In advance of next week’s $1 billion Anglo bond repayment (congrats to all our international hedgie readers), the government talking point that repayment of this bond doesn’t cost the taxpayer a cent is now getting a full rollout, with Michael Noonan on RTE Radio’s News at One today and Leo Varadkar on Tonight with Vincent Browne both at it.

Both ministers were insistent that because the IBRC (i.e. the new Anglo-INBS institution) has sold loans worth €2.5 billion for a loss of €500 million, thus realising €2 billion, that paying the remaining €3.7 billion in unguaranteed senior bonds won’t cost the Irish taxpayer any money.

Let’s make this as simple as possible: Even if you wanted to view this repayment as costless because Anglo has its “own funds” to repay the bond, ask yourself who would be the beneficiary of these “own funds” if they weren’t used to repay unguaranteed bondholders. Every cent going to these bondholders is coming from Irish taxpayers.

Slightly less simplistically, Leo acknowledges that we are putting large amounts of money in the form of the promissory note payments (“the only money we’re putting in is the promissory note” — ah yes, “Other than that Mrs. Lincoln ….”). How did they arrive at the figure for the promissory note? The figure was arrived at by figuring how much money was required to keep Anglo solvent, i.e. paying back all its bonds debts. If we didn’t pay back the unguaranteed bondholders, then we could revise the promissory note payments down.

I know that the remaining unguaranteed bond debts are dwarfed by the approximately €40 billion Anglo owes in ELA but this talking point is irritating all the same. Honestly guys, please stop.

How Would a Greek-Style Haircut Affect Ireland?

Someone asked me today how a Greek-style haircut for private bondholders would impact on the Irish debt situation if applied here. Without any claim that this is a prediction for what could happen to Ireland, or a policy recommendation, here are the calculations.

While the figure grabbing the headlines is the 50%-60% haircut for private holders of Greek sovereign bonds, it appears that the bonds bought by the ECB will not be written down, nor will the IMF loans. FT Alphaville discuss a UBS report that calculates that a 50% haircut for private bondholders actually implies a 22% reduction in total debt.

In Ireland’s case, the latest EU Commission report estimates (page eight) that our year-end general government debt will be €172.5 billion or about 110 percent of GDP. The report also estimates that by the end of this year, we will owe €38.2 billion to the EU and IMF.  (Table 4 on page 23).

We don’t know how much Irish sovereign debt the ECB own but it’s believed to be a large amount. I do remember a report from Barclay’s claiming they owned €18 billion by June 2010. Let’s say ECB owns €22 billion of Irish debt (that’s just a guess, I really don’t know). Combine that with €38 billion from EU-IMF and you have €60 billion in debt that wouldn’t be getting a haircut. Better guesses of ECB holdings of Irish sovereign debt are welcome.

Now apply a 50% haircut to the remaining €92.5 billion of our debt and you reduce the debt by €46.25 billion, or 29 percent of GDP, getting the debt ratio down to 81 percent. (Of course, we’d still be running large deficits, so it would start increasing again.)

So that’s the answer. Perhaps worth noting, however, is that an alternative method of writing down Ireland’s debt by close to 30 percent of GDP without haircutting private bondholders at all would be to have Anglo’s ELA debt to the Central Bank of Ireland written off.

According to its interim report Anglo owed €28.1 billion in ELA at the end of 2010 but this had risen to €38.1 billion by the end of June. This is because Anglo transferred €12.2 billion in NAMA senior bonds to AIB in February to back the deposits that were being moved out of the bank.

On July 1, Anglo was merged with Irish Nationwide Building Society (INBS) to form what is now called the Irish Bank Resolution Corporation (IBRC). As of the end of 2010, INBS had €7.3 billion in loans from the ECB. However, €3.7 billion of this was backed by NAMA bonds and other assets that were transferred to Irish Life and Permanent. INBS has been in receipt of ELA since February to replace this lost funding. While this has been admitted by a Department of Finance official (see this story) the exact figure has not been released. I assume it is about €4 billion.

So my estimate is that the IBRC now owes about €42 billion in Emergency Liquidity Assistance to the Central Bank of Ireland. If the European authorities ever decide they like the idea of haircuts for Irish debt, it would be fair to ask which of a fifty percent haircut or a write-off of ELA would be more likely to damage Ireland’s reputation or cause financial market contagion.

Anglo Bonds: Not Coming From the Taxpayer

Via NAMA Wine Lake, I came across this very important statement from An Taoiseach on September 28 about repayment of Anglo bonds

If the Anglo bondholders are paid, they will be paid from their own resources. This will not come from the taxpayer. The Minister for Finance has been dealing with this situation at the ECOFIN meetings.

This is really good news. I had been under the impression for some time that all of the funds used to pay Anglo bondholders came from the taxpayer. But apparently that’s not the case. Phew, that’s a relief. Hats off to the Minister for his excellent work at those ECOFIN meetings.

Update: In case anyone thinks Enda’s on his own here with this idea of Anglo bondholder payouts not coming from the taxpayer, listen to Leo Varadkar on RTE’s This Week today (32 minutes and 25 seconds in). When asked about the looming payout to bondholders, Leo says

Well that’s not quite the case. What’s happening in relation to the Anglo bondholders is they’ll be paid from Anglo’s own resources, from the sale of its own property assets, for example. The only money that is being put into Anglo Irish by this government is the promissory notes, the €3 billion a year that we are required to give to Anglo, or what is now the IBRC, as a result of the deal made by Fianna Fail and the Greens, and we are trying to have that changed. That is our major objective at the moment.

I recommend strongly that the government retire this particular piece of spin immediately. Every cent that is given to bondholders is an additional cent that will have to be poured into Anglo by the Irish tax payer, whether as promissory note payments or some rejiggered version of these notes.

Dan O’Brien on Burning Bondholders

Dan argues the ECB case for not burning Anglo bondholders in today’s Irish Times. I’ll quote the main argument at length

Apart from Ireland, nobody else in the euro zone has sought to make seniors take their losses so there are no cases to which one can point as evidence. But an immediate neighbour’s experience has been watched very closely. Denmark last year introduced the toughest bank resolution laws in Europe. These laws, which govern the winding-down of bust banks, are more similar to those in the United States than those across the rest of Europe. In the US, senior bank bondholders have traditionally got their just desserts if the institutions they invest in fail.

When two Danish banks failed earlier this year, their seniors were burned. This raised funding costs for the entire Danish banking system.

From the euro zone perspective, the ECB is obliged to consider that if a default precedent were to be set in the senior bond market, then at the very least funding costs for all banks in the zone would rise. The savings for Ireland of a few billion euro would be offset many times over by the generalised increase in funding costs for the already-teetering euro zone banking system.

That there is good reason – in the collective European interest – not to burn seniors does not lessen the injustice of having Irish citizens pay for European bankers’ losses (although the hugely subsidised bailout loan is a partial de facto spreading of the burden).

The point that burning senior bondholders may raise the cost of funding for banks is a fair one. But the relatively lower cost of bank funding obtained from a policy of supporting all senior bondholders is hardly a free lunch. The additional risk that the market would perceive as being attached to bank bondholders would have been transferred away from sovereigns.

Now one could argue that some sovereigns in the Euro area are in a position to take on this kind of risk in order to protect their banking systems. But others clearly are not.

My position on this is that there is no need for the question of burning senior bondholders to be a simple black or white proposition. As I discussed in this paper, the EU could adopt a policy that sees senior bondholders only incur haircuts if equity and subordinated bonds have been wiped out, the bank has been nationalised, and the state has incurred costs of x% of GDP to bring the bank back to solvency.

What x is could be a matter for policy discussions, and could evolve over time. But a policy that set x=5% would mean that the EU is only ruling out bailouts that would place enormous burdens on the state. Indeed, given the state of Euro area public finances, there simply isn’t room for another round of expensive bank bailouts so an approach of this sort may help to reduce the perceived riskiness of much of Europe’s sovereign debt.

This policy could see the remaining Anglo senior bondholders receive severe haircuts without implying a contagion effect for other institutions apart from those the market suspect to be severely insolvent and to which states should probably be reluctant to offer blanket liability guarantees.

But, of course, such a policy would tradeoff state and private sector interests in a balanced way and, as I argue in this paper, M. Trichet’s approach to the question of debt defaults has consistently been characterised by dogma rather than balance.

Anglo Bondholders to be Repaid in Full

Today’s Sunday Independent appears to provide the answer to the question I posed on Tuesday about the government’s position on Anglo bondholders. Despite Brian Hayes stating firmly on April 2 (go here and click on the April 2nd edition of Saturday View, about 56 minutes in) that the government’s position was that haircuts should apply to Anglo senior bonds, the Independent reports that the Department of Finance has confirmed that Anglo’s senior bondholders will be repaid in full.

This is a good time to point people in the direction of NAMAWineLake’s very useful post from Friday detailing all the outstanding bonds of the Irish banks by maturity. November 2nd promises to be a great day for those international hedge fund investors who chose to buy some of the $1 billion senior unsecured Anglo bond first issued in November 2006.

Anglo-INBS Loan Loss Assessments

The Central Bank of Ireland has released an addendum to its Financial Measures Programme report covering loan losses at Anglo and INBS.  It concludes the loan losses estimates that were produced last September are still satisfactory.

What does this mean for the remaining Anglo bondholders (€200 million paid out on last Friday)? The government’s policy on this issue is a little unclear to me at this point. The Irish Times reported in April

the head of financial regulation Matthew Elderfield said losses may be imposed on senior bondholders at Anglo Irish Bank and Irish Nationwide Building Society if the cost of the two failed institutions rises above the current €34 billion bill.

This wording also suggests the converse—that without evidence of higher losses than €34 billion, senior bondholders would be repaid in full. However, I doubt if policy on this issue is being set by Mr. Elderfield. In the week after the stress test announcements, government politicians continued to maintain that they wanted to see burden sharing with Anglo and INBS bondholders. For instance, listen to junior minister Brian Hayes discussing the issue here on the April 2nd edition of Saturday View (56 minutes in).

There isn’t really any need to base such a decision on whether the Central Bank announces combined losses of more than €34 billion. An amended version of the Credit Institutions bill could be introduced that allows the Minister to apply haircuts to all bonds issued by banks that required enormous support from the state, and perhaps this is what government politicians have in mind when they say they are still pushing for burden sharing.

Anyway, there has been no official response to this release from the Department of Finance, who have instead preferred to issue press releases on the subdebt buybacks proposed by BoI, EBS and ILP. My guess is that the government is hoping this issue will just fade away but, if asked, they will still claim that Anglo senior debt shouldn’t be paid out on but that they’re still “discussing the issue with their European partners”.

As a purely political matter, I’d guess that if and when Ireland gets a lower rate on its EU loans, that may prove to be the moment that they admit they had to give up on haircuts for Anglo bonds. Investors who bought these bonds at steep discounts over the past year (because so many people assumed the government would not pay out on them) will have obtained a fantastic rate of return.

Moving Deposits

I am trying to get my head around the Anglo/Irish Nationwide “deposit sales”.   The collective wisdom of this blog might help set things straight.   (Useful reporting by Simon Carswell and Mary Carolan here and here.)

A few initial comments/questions:

First, I think term deposit sale (or selling the deposit book) creates a lot of confusion.   I think it is better to think of what is happening as asset sales, but where part of the price is taking on existing liabilities to depositors.   From the purchaser point of view, another perspective is that it is a purchase of assets that comes with a certain amount of pre-arranged funding (i.e. the deposits). 

Second, there seems to be a view that it is a good thing to retain the deposits in the Irish banking system.  But then there is also a view that Ireland needs to deleverage – essentially sell assets to reduce outstanding liabilities.   The ECB wants this to happen because it is afraid it will be further called on as lender of last resort if those deposits later flee.   What are your thoughts on selling the assets to (and retaining the deposits with) other Irish banks? 

Third, in terms of the total being exchanged for the deposits (mainly NAMA bonds and cash), what is the inference about how the bonds are being valued?   I’m sure someone has done these calculations.    Are the implied valuations related to the fact that the asset sales have been made to other Irish banks — one 92.8 percent State owned, the other privately owned?  

Anglo Trading Update & Orders on Deposits

A busy day for our grossly insolvent banks. Anglo has issued a trading update. In addition, the Minister for Finance has obtained direction orders from the High Court for Anglo and INBS to allow for deposits to be transferred and to enable other aspects of the restructuring plans. Nearly identical statements from Department of Finance and NTMA (with an FAQ here.)

Anglo’s January 31st Bond

There have been some comments on this blog this morning on the popular subject of bank bonds.

Let me point out some facts and then some questions for debate.

The facts:  On Monday, January 31st, Anglo Irish Bank are going to pay out on a maturing bond worth €750 million. (For reference, the total cut in this year’s welfare budget will be €873 million.) The investors who purchased this bond invested their money with Anglo on the 17th of January 2006. The bond is senior unsecured debt and is not covered by a state guarantee.

The questions: Should the government have passed legislation this month to allow the Minister for Finance to intervene so that the bank did not pay this bond back? And if so, should the next government pass such a bill in relation to the remaining €4 billion or so in outstanding unguaranteed bonds owed by Anglo and INBS?

In answering the question, it’s worth noting that the logic of the section of the recent Credit Institutions (Stabilisation) Bill relating to subordinated debt suggests that a government can change the terms and conditions of bonds to apply haircuts if the bank owes its continued existence to significant amounts of public money being injected.

It is unclear whether this power can simply be extended to senior bonds but it seems to me that it can. Another issue is whether such changes in terms and conditions can legally work to allow a bank to distinguish between different types of unsecured creditors that start out with equal claims, by haircutting bond holders but not deposits. Mechanically, of course, one could achieve the same outcome by haircutting both senior bonds and depositors and then compensating depositors via a separate piece of legislation, but this would be more complicated.

The other issue is the implications of a default on a senior bond for the Irish and European banking sectors. My belief is that how this plays depends on what investors believe is the precedent being set. If the precedent is that investors can lose out if they place their money with banks with flawed business models, who engaged in shady business practices and then become grossly insolvent—then surely this is a precedent that must form part of new proposals for dealing with failed institutions?

On the other hand, one could argue that at such a sensitive time for the Irish banking sector, defaults of this type would send the wrong message and worsen an already extremely serious liquidity problem. This is the argument put forward by our new best friend, Mr. Bini-Smaghi.

I’m open to considering all sides of this argument. On balance, however, I’m inclined to the position that it is in the interests of both Irish citizens and those in the wider EU to set a precedent with the Anglo and INBS bonds that there need to be limits on how much support European taxpayers will provide to insolvent banks.

Anglo SubDebt Buyback Offer Announced

Anglo Irish Bank have announced buyback offers for their subordinated bonds. The holders of the €1.5 billion in dated subordinated notes have been offered 20c on the euro, so this will cost the bank €300 million. The holders of the undated perpetual preferred securities (about €700 million outstanding according to page 56 of Anglo’s interim report) are being offered 5c on the euro, at a cost of about €35 million.

It appears that those signing up for the offers also have to vote to give the bank “the right to redeem all, but not some only, of the Existing Notes of each Series at an amount equal to €0.01 per €1,000.” In other words, if a majority of the bondholders acccept the deals on offer, then those who don’t accept will get essentially nothing.

It is disappointing that there has been no statement explaining this decision on the Department of Finance website. With €335 million of taxpayer funds being offered, the public should get a full explanation of why this is money well spent.

Anglo Subdebt, Again

It is now pretty clear that the government and Anglo management are shaping up to do a buyback deal on Anglo’s outstanding €2.5 billion in subordinated debt after the original CIFS guarantee expires at the end of the month.

Here’s my question. Given that

(a) The terms of these securities allow for the possibility of them not being paid back if the bank is insolvent (this is why banks get to count these securities as part of their regulatory capital).

(b) None of this debt matures until 2014 at the earliest (see page 56 of Anglo’s interim report).

(c) These bonds will no longer be covered by a state guarantee.

why would we do this? Why not let the bonds sit as an obligation of the Asset Recovery Bank, let it go about its business of recovering value from assets, and then let the next government make a decision in 2014 as to whether we want to put in taxpayer funds to pay off these bonds?

Those of you who want to comment that you think a bond buyback is a good idea might help clarify things a bit by explaining what type of deal you would offer (i.e. how much of our money you’d give the hedge funds and other distressed debt outfits that now own these bonds.)

The Mechanics of Buybacks

The Sunday Business Post reports the government intends to launch a buyback from Anglo bondholders (available here). 

The government is expected to launch a bond buyback for Anglo Irish Bank in the coming weeks, as part of a restructuring plan agreed with the EU Commission. 

The buyback, which will reduce the bill for taxpayers, will offer some bondholders in the new Anglo asset recovery vehicle the option of a bond, or a term deposit, in the new funding bank at a significant discount.

In the discussion of buybacks, or negotiating with bondholders”, it sometimes seems to be forgotten that the only way these negotiations succeed is that there is a credible threat that losses will be directly imposed on bondholders.   One particularly strange example was when the Minister for Finance took credit for the earlier round of Anglo subordinated debt buybacks, even though these buybacks only took place because of the lack of credibility of the governments policy of protecting bondholders.   The main reason the bondholders were willing to accept the buyback must have been the risk of a change of government.  

A good cop, bad cop routine may be going on at the moment, with the opposition parties being quite explicit about their intentions.   The Post reports,

Last week, Fine Gael leader Enda Kenny wrote to the EU competition commission saying there was, in his partys view, no sound legal or economic case for the Irish taxpayer to repay bond investors in Anglo Irish Bank following the expiry of the guarantee.

The letter made it clear that he was referring to those bondholders who invested before the September 2008 guarantee, both subordinated and senior debt holders. 

In considering what the threat point in buyback negotiations should be, I have also been surprised by the lack of curiosity about the details of the proposed Anglo split.   Most commentators have been content to repeat the mantra about the need for certainty on the cost and timing of resolving Anglo.   

It will take some time before these uncertainties can be resolved.  But surely we should be told now exactly how the mechanics of the split will work.   What will be the value of the claim that the funding bank will hold on the recovery bank?   Will this bond be guaranteed?   How will capital be divided between the two entities? 

On the last question, a number of reports make the point that the funding bank will only need light capitalisation given that it wont be making new loans.   This strikes me as a strange claim.  The main purpose of capital is to protect depositors from losses.   Surely a key objective of the split is to protect depositors so that they are willing to keep their funds in the funding bank, potentially weakening the need for guarantees of deposits or the bond issued by the recovery bank.   On the other hand, if the goal is to encourage the bondholders to accept buybacks, shouldnt the recovery bank be capitalised as lightly as possible?  Some harder questioning about the mechanics of the split seems warranted. 

Government Paid PWC €4.95 Million for Advice on Banks

The Irish state paid Price Waterhouse Coopers €4.95 million for advice and professional services in relation to the banking crisis.

PWC were commissioned after the state guarantee was put in place to assess the balance sheets of the covered banks. As I have noted here before, PWC finished their fieldwork in December 2008 and concluded in relation to Anglo:

Under the PwC highest stress scenario, Anglo’s core equity and tier 1 ratios are projected to exceed regulatory minima (Tier 1 – 4%) at 30 September 2010 after taking account of operating profits and stressed impairments … We used an independent firm of property valuers (Jones Lang LaSalle) to value a sample of 160 properties held as security in relation to the top 20 land & development exposures on Anglo’s books as identified in our Phase II review and report. The results of this work indicated that impairment charges over the period FY09 to FY11 would fall in a range between the two PwC impairment scenarios but closer PwC’s lower impairment scenario.

Can we ask for our €5 million back?

FT: No Irish Lazarus

The FT has a new editorial on Irish banking policy and it is perhaps surprisingly harsh. Text below:

Just shy of the second anniversary of the Lehman collapse, the Irish government last week issued its latest plan for Anglo Irish Bank. It reveals how little Dublin – and most other governments – have learnt from the crisis.

Back then, there were good reasons to offer taxpayer crutches to toppling banks. Contagion could bring the system to its knees. Panic made market valuation useless: even solid banks looked wobbly on a mark-to-market basis. It made sense to tide them over until the insolvent institutions could be distinguished from the illiquid.

Uncertainty is now receding. Unhappily, what is emerging in Ireland is how staggering bank losses are. It is time to let them fall where they should: on unsecured creditors once shareholders are wiped out. But Irish leaders are prolonging the uncertainty in the hope that zombie banks will, Lazarus-like, come back to life.

Dublin has poured €23bn into Anglo. The new plan – to split deposits from a “recovery” bank with loans not yet transferred to the government – looks like another round of three-card monty. It does not clarify the final size of the hole to be filled (S&P thinks it can reach €35bn), and continues to make citizens protect bondholders from their own folly.

Dublin fears that cutting loose Anglo’s bondholders will kill demand for Irish sovereign debt. The opposite is true, as record-high sovereign spreads show. Its huge fiscal deficits are manageable – just. It is the open-ended exposure to private liabilities across the banking system that drives up sovereign yields. Dublin must get its priorities right.

Irish depositors must be protected, but they fund less than half of the €776bn domestic banking balance sheet. Bondholders are owed €98bn, some of it guaranteed. Explicit state guarantees must be honoured. But the extension of a scheme to guarantee new debt issues to maturity forces taxpayers chained to a sinking ship to build lifeboats for exiting creditors.

The guarantee scheme should be cancelled for new issues, and sweeping resolution authority put in place immediately. It should apply to any bank that cannot refinance itself privately, and ensure that viable business continues while assets secure the claims of depositors and already-guaranteed creditors. Any shortfall thus crystallised should be put on the public balance sheet once and for all.

This will be painful. But investors who know the bleeding has stopped will soon prove that there is life after death.

Reading this, it strikes me as interesting how quickly we’ve gone from a situation where the government’s defenders were complaining about domestic malcontents and pointing to increasingly receptive audiences overseas to one where the exact same people are blaming the international press for our problems on the grounds that they don’t understand the situation as well as those who are living here.

Anglo Announcement: A Multiple Systems Failure

Anglo Irish Bank’s failure has become the single most costly fiscal problem in the history of the Irish Republic. The citizens of this state should at least expect to see evidence that the problem is now being managed in a competent manner and to be clearly informed about what is going on. Today’s announcement is a failure on so many levels that I can honestly say that, even by the low standards that have been set up to now by this government in its handling of the banking crisis, I fear we may have reached a new nadir.

Three issues are worth pointing out:

Communications Meltdown: The Department of Finance released a minimalist statement this afternoon on its website. However, much of the media discussion of today’s announcement has revolved around an FAQ document which, as of now (almost 11PM) the Department has not seen fit to release to the Irish public. On this site, we have been able to read the FAQ because anonymous commenter Eoin received it and posted it here (Thanks Eoin, much appreciated). I don’t think I’m giving away any secrets in saying that Eoin received this document because he works for a financial institution. Think for a moment about this as a communications strategy: Guys who work for banks get to read the answers to key questions but the taxpayers who have bankrolled this disaster don’t. For sheer tin ear, the Department officials deserve to be sent for three months compulsory service at the Terry Prone School for fake sincerity.

Mixed Messages to Depositors: The only, and really I mean this, the only advantage of the Good Bank\Bad Bank split was that it could reassure depositors that their deposits were going to be attached to a fully capitalised, fully functioning bank. Preventing a deposit flight from the bank is in everyone’s interest. That their deposits would not be attached to a fully functioning bank was clear from the DoF’s statement, which established that New Bank would not be making loans. However, the statement tried to reassure that “Depositors with the Funding Bank will be completely insulated from the future performance of the rest of the current Anglo Irish Bank loan book.” However, the FAQ (thanks again Eoin) informed us that

It is anticipated that the Asset Recovery bank will be funded by the Funding bank. Funding will be provided by the Funding Bank from normal sources. As the Recovery Bank reduces in size its funding requirements will also reduce.

In other words, if you have a deposit with Funding Bank, that bank’s assets are loans to the Asset Recovery bank, which (word has it) is insolvent. A statement that the deposits were being transferred to, for instance, Irish Life and Permanent (backed by NAMA bonds or other Anglo financial assets) might have been reassuring to depositers. Today’s messages to depositors were mixed and not reassuring.

Drawing a Line Under It/Message to Sovereign Bond Market: The sovereign bond market is crying out for some sign that we’ve got a final credible figure for the cost of Anglo Irish Bank. What did we get today? Assurances that more technical work would be done to figure out how much capital would be needed. Almost two years after Brian Lenihan talked about “going deep into the banks”, a year and a half since we were told that NAMA would provide clarity about losses and help us move on, over a year since new supposedly highly qualified management were put in place to preside over the bank, we’re being told that we need more time to look at the books? Give us a break.

Note that I haven’t even discussed any of our old bugbear issues of risk-sharing with bond holders (Lenihan indicated today that unguaranteed senior bond holder would be looked after.) The point is that even when judged against what the government wants to achieve, today’s announcement can only be judged as a complete failure.

Anglo Split Announcement

The statement from the Department of Finance is here.

A quick reaction. That the new bank isn’t making lending is a good thing. The bank didn’t have the capacity to transform itself into a small business lender or the other proposals that the management were floating. It will presumably need less money to be capitalised as a pure deposit-funding bank.  However, nothing in this statement about the bad bank gives us any reason to think that Anglo will cost the taxpayer less than the projections that have been floating around. That it is still going to be “a licensed regulated bank” (unlike, I believe, the Northern Rock equivalent) could be interpreted as a sign that all bondholders will get their money back, though that may be over-reading this (pretty minimal) statement.

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.

20 Billion euro extra to wind down Anglo?

Simon Carswell reports on an interview with Anglo’s Mike Aynsley  and Maarten van Eden in this morning’s Irish Times.  The number that jumps out is the extra €20 billion Mr. Aynsley claims it would cost to wind down the bank.  

Winding down the whole bank would cost €20 billion – on top of the cost of the split, which stands at about €25 billion – he said.

Maarten van Eden, Anglo’s chief financial officer, added that the split option would also retain €47 billion of the bank’s funding, which would otherwise have to be provided by the Government.

This comprises €23 billion of customer deposits, €16.5 billion of wholesale funding and €7 billion provided by other banks, he said.

A few observations: First, the €47 billion does not include funding from the ECB and Irish central bank, which I presume would be available (subject to liquidity programmes in place) in the wind-down scenario.  Second, surely Anglo’s “deposit franchise” is dependent on the government’s liability guarantees, and again it is not obvious that these it would not be available in a wind down – after all, the bank is presently not engaging in any new business either.  Finally, even in the worse case scenario where the deposit funding disappears, would it really be that much more costly if the government had to borrow to pay off the funders directly?   As it is, the markets are well able to see through the consolidated balance sheet of the government and the nationalised (and semi-nationalised) banking system.  And even with the guarantee, Anglo must offer premium rates (e.g. 3.5 percent on one-year deposits).

It would be good to get commenters’ views on the €20 billion premium cost estimate.