## EU Interest Rate Calculations

Well thanks Silvio! If it weren’t for the comical actions of Signor Berlusconi, I doubt if we would have obtained yesterday’s long-hoped-for interest rate cut on our EU loans. Certainly, the cut isn’t in any way related to the negotiating skills of the government – who were last seen essentially waving a white flag on this issue.

On the substance of the deal, like Namawinelake, I’m frustrated at the lack of useful detail about the new interest rate and potential changes in loan maturities.

An annual saving of €800 million is being widely cited but I have my doubts if the correct amount has actually been calculated. My guess is that the final savings could be a bit larger, perhaps as much as €1.2 billion annually.

The first open question relates to which funds the cut is being applied to and the second relates to the size of the cut in the interest rate itself. The statement merely says

The EFSF lending rates and maturities we agreed upon for Greece will be applied also for Portugal and Ireland.

However, Ireland is only borrowing €17.7 billion from EFSF and no reasonable multiple of this number delivers annual savings of about €800 million. It seems most likely that the reasonable assumption is being made that the interest rate will also be cut on Ireland’s €22.5 billion of loans from the EFSM, though as this is an EU vehicle, last night’s meeting could not announce such a cut.

If we applied a cut of “about two percent” to the “about €40 billion” of EFSF and EFSM loans, then my fuzzy math calculations come up with “about €800 million”. So that’s the likely source of the figure.

However, it seems likely to me that the terms of Ireland’s €4.8 billion in promised bilateral loans from the UK, Denmark and Sweden will be renegotiated, so a more accurate fuzzy math would apply “about two percent” to exactly €45 billion to arrive at “about €900 million”.

Then there’s the question of the size of the interest rate cut. The Irish media have clung firmly to the notion that the average interest rate on our loans was about 5.8 percent, despite plenty of evidence that the cost of the EU component was going to be higher than had been projected last November.

As I reported here a few weeks ago, by my calculations (spreadsheet here), the average interest rate on Ireland’s EU loan was going to be 6.21 percent. The Eurozone statement promises an interest rate

equivalent to those of the Balance of Payments facility (currently approx. 3.5%), close to, without going below, the EFSF funding cost.

That could imply a cut of 2.7 percent, which if applied to the full €45 billion would give “about €1.2 billion”. That may be right or wrong since we don’t have much information yet. But I suspect that once things are worked out, the savings will be greater than the €800 million being quoted.

Update: Sean O’Rourke just put my calculations to Michael Noon on the RTE News at One. The Minister conceded that it was likely that the interest rate cuts would be extended to the bilateral loans and that this would get the savings up to €900 million.

When a higher figure of €1.2 billion was put to him, the Minister noted that this might have included the likely reduction in future IMF rates (something I’ve written about before but wasn’t including here.)  The difference here comes from my comparison of the “about 3.5 percent” with my calculated current average EU rate of 6.2%.

With the average margin over cost of funds currently running at about 300 basis points, it still seems to me that a reduction of this margin to get the interest rate “close to” the funding cost sounds like a reduction closer to three percent than two percent. But I could be wrong.

## 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.