The 65 Billion Euro Question

In an Irish Times article that must have much of the country talking, Morgan Kelly calls for a Special Resolution authority to force bank creditors to swap 65 billion of debt for equity (link in Greg’s post below).     The number is €50 billion less than called for in his V0X article earlier in the week, and critically calls for the losses to be imposed after the original guarantee expires in September.   He is thus, as far as I understand, not calling for default on the “quasi-sovereign” guarantee. 

I am sympathetic to the idea of forcing the funders of Ireland’s banking binge to bear a fair share of the resulting losses (some thoughts here).   But if Morgan’s policy suggestion is not to be dismissed, we need more specificity on the source of the €65 billion.   The Anglo accounts revealed that roughly €7 billion of bonds will mature post September.   He must have the big two in his sights. 

Even with Special Resolution authority in place, the proposed debt-equity swap could only be triggered if capital adequacy falls below some critical threshold.   But the two “technocrats” Morgan lauds appear to believe that Bank of Ireland and AIB are on course to reach the new capital adequacy requirements.   Patrick Honohan had this to say in a recent speech:

Over the previous few months, we at the Central Bank have been making a careful assessment of the likely bank loan-losses that are in prospect over the next few years. This is over and above the valuation work being carried out by NAMA, and which gives us a good fix on the likely recoverable value of the larger property loans.  We have been working on the non-NAMA loans and figuring out their likely performance as they suffer from the impact of the overall economic downturn – part of it of course attributable to the global crisis, and not just to the bursting of our own bubble.  This exercise involved working with the banks, but challenging their estimates of loan-loss based on our own more realistic – some may say pessimistic – credit analysis. (I am over-simplifying the exercise, as it also looked at other elements of the profit and loss account over the coming years).  The conclusions of this exercise are worth emphasizing. 

To my relief, and slight surprise, it turns out that most of the banks started the boom with such a comfortable cushion of shareholders’ funds that they would be able to repay their debts on the basis of their own resources.  This includes the two big banks.  It is because of this fact – that their shareholders’ funds will remain positive through the cycle – that one of them, Bank of Ireland, has already been able to tap the private market for an additional equity injection.  Of course they do need additional capital to move forward, but, as has happened in the US and elsewhere, the Government’s capital injections of last year into these two institutions looks like being well-remunerated.

The €65 billion number needs more explanation. 

Update (Sunday, May 23)

In correspondence, Karl Whelan has provided maturity information for the outstanding bonds of the major banks.   The information is drawn from the 2009 accounts, and is based on bonds that mature more than one year after December 31, 2009.   Thus, it does not include bonds that mature in the last quarter of this year.   (It is not clear what fraction of the bonds were issued based on the extended guarantee.)

The numbers are as follows (billions of euro):

BOI:       Senior, 18.5;  Subordinated, 5.3;    Total, 23.8

AIB:       Senior, 8.5;    Subordinated, 4.6;    Total, 13.1

Anglo:    Senior, 4.1;    Subordinated, 2.7;    Total, 6.8

INBS:     Senior, 1.2;    Subordinated, 0.2;    Total, 1.4

ILP:       Senior, 5.1;    Subordinated, 1.6;    Total, 6.7

Totals:   Senior, 37.4;  Subordinated, 14.4;   Total, 51.8

These numbers suggest that Morgan’s €65 billion is in the right ballpark.   But they also highlight the extent to which the money relates to the big two, and especially Bank of Ireland.   The most natural sequence for implementing the loss imposition strategy that Morgan proposes would be: (1) legislate a resolution regime; (2) apply comprehensive stress tests to determine capital adequacy; and (3) trigger resolution tools as required.  Based on the stress tests that have been done so far, which we are told have been quite comprehensive and conservative, the big two would not be put into resolution.   Of course, it is evident that Morgan does not believe these tests were comprehensive or conservative enough, with AIB probably being more suspect than BOI.   Even so, I think it is important not to expect too much in the way of loss imposition on creditors from a resolution regime.  Yet it is still worthwhile to pursue a regime even if the savings to the taxpayer are just a fraction of the €65 billion.