Just 77 days to go before 31st March 2012 when the next €3.06bn payment on the Anglo Irish Bank and Irish Nationwide Building Society, or IBRC as the merged entity is known, promissory notes falls due – actually 31st is a Sunday, so it might be 29th though last year it was apparently paid on 3rd April. But in any event it’s about 11 weeks from today. As we kick off the New Year, politicians are keen to commit to a deal being struck with the European Central Bank by 31st March. But if Mario Draghi, in revenge for all the pesky questions he gets at the monthly ECB press conference, were to give Governor of the Central Bank of Ireland, Patrick Honohan a €10 note at the start of March 2012 and tell him to give that to the Government, would that constitute a “deal”? After all, it would allow the Government to claim that it has in fact negotiated a writedown of the outstanding debt in respect of the promissory notes – sure it’s only €10 on the €27bn of notes still remaining and the circa €16m of interest we have to pay, but it’s still technically a write-down.
This reduction ad absurdum is used to here to illustrate the point, that the expectation is of a substantial write-down in the liabilities we have shouldered in respect of the promissory notes.
But what is “substantial” and what exactly is a “write-down”?
If, as seems likely, we are given 30 or 40 years to repay the Anglo promissory note, would that be “substantial” or a “write-down”. On the latter point, there seems to be widespread skepticism because the debt is being merely spread over a longer timescale, and there is no apparently write-down on the sum owing.
So, because there is confusion over what a deal is or isn’t, let me offer the following to start the ball rolling:
“A deal is done when the present value of the net external cash outflow from this State to pay off the promissory notes is reduced by at least 25%”
Examining the components of this deal
“net external cash outflow from this State” – this is the complicated bit, because as presently constructed, there is a lot of transfers between ourselves; the state pays IBRC which pays some of it to the Central Bank and the Central Bank burns part of the cash but returns the rest to the state, and of course we own IBRC so any profit made by IBRC on the deal also comes back to us. This is what the payments by the State to IBRC look like for the next 20 years under the existing arrangement:
In broad terms, we know what happens next, but Minister for Finance Michael Noonan refuses to provide the detail. IBRC makes a payment to the Central Bank of Ireland, but we are not sure how much and what interest rate applies to the loan from the Central Bank to IBRC secured on the promissory notes. We don’t exactly know when IBRC will be giving us back any profit it makes on the promissory note arrangement – remember IBRC is being paid a rate of interest of about 8% and although we don’t know how much it is paying to the Central Bank, it is believed to be around 3%. IBRC says it will have wound up by 2020, but it might be kept open after that purely to repay lending received from the Central Bank secured on the infernal promissory notes.
The Central Bank burns most of the money received from IBRC but it passes some to the ECB and some back to the Government. We know that last year, the Central Bank passed a total of €958m back to the Government but there is no analysis of this total which shows us how much is directly attributable to IBRC paying down its loans from the Central Bank secured on the promissory notes. The Central Bank gives some of the money to the ECB but apparently, the Central Bank itself benefits from any profit made at the ECB, but we have no way of measuring that.
So what are the “net external outflows from the State”? We don’t exactly know by year because we don’t know what profit will be made by IBRC on the arrangement and when it will be returned to the State, nor do we know the profits made by the Central Bank of Ireland. We could insist on an annual dividend from IBRC specifically to deal with the profit it has made on the current arrangement. It is unclear why we can’t insist on the Central Bank also disclosing its profit on the arrangement.
But, based on what we presently know, I think we could approximate the “net external outflows from the State” to be the cashflows shown above less 8% as an approximation of the interest which mostly gets recycled and repaid to the Government from the Central Bank and IBRC.
However we will need adjust the above to reflect the source of funds to pay the promissory notes. At present, the State is running up a deficit on its normal day to day operations, so we will need borrow the funds to pay off the Anglo promissory notes. Our long term borrowing costs are just over 4% per annum from the traditional bond markets and that is also approximately the consolidated cost of borrowing registered by the NTMA. So if the payment of the promissory note each year is funded by 10 year borrowing at 4%, the overall outflow looks like this.
“present value” – will be familiar to some if not most of you, but to be clear, in this context, it is the value of the payments in today’s money, which means taking the future payments and discounting them by an appropriate rate to represent inflation. For example, if you are going to receive €100 this year, €102 in 2014 and €104 in 2015 but there is annual inflation of 2% then the present value of the three payments is €300, because you in 2014, you will need get €102 to be worth the same as €100 today, and in 2015 you will need €104 to be worth the same as €100 today. The 2% in this case is the “discount factor”, and for a simple consumer transaction, inflation might be all you need take into account.
For example, let’s say that in order to repay the promissory note payment that falls due imminently, we borrow €3.06bn in March 2013 from the bond markets by issuing a 10 year 4% bond and our annual inflation is 2%, then in today’s money those borrowings will cost us €3.7bn being €3.06*(1.04^10/1.02^10). There are actually two levels of discounting – take the €3.06bn payment that is due in 2023 for example, the €3.06bn is borrowed in 2023 at 4% and repaid in 2033 so the cost in 2023 money is €3.7bn but in 2013 money, we need further discount it for 10 years worth of inflation to bring it back to 2013 cash terms.
So, applying all of the above, the present value of the cost of the promissory notes works out at €45.43bn.
How do we get a better deal?
(1) Reduce the principal, the amount of promissory notes
(2) Reduce the interest rate on the external cost of borrowing. If we reduced the cost of borrowing from 4% to 0%, then the present value of the net outflows would reduce from €45bn to €31bn. More realistically, if someone would lend us money at 1.5% long term, in line with what they charge Germany, then the present value would drop to €36bn. A reduction from 4% to 3% would see us paying €41bn in present value terms.
What DOESN’T constitute a better deal?
(1) Reducing the interest rate charged by IBRC to the Government for the promissory notes – at present they charge about 8%, but as we have seen above, practically all of this interest gets recycled and returned to the State.
(2) Reducing the interest rate charged by the Central Bank of Ireland to IBRC for the loans it is providing to IBRC, secured on the promissory notes as collateral. Again, as we have seen above, practically all of this interest gets recycled and returned to the State.
(2) Extending the term to pay the promissory notes from 2031 to 2041. In fact, if the interest rate applicable to our long term borrowing remains at 4% and our inflation at 2%, then this will INCREASE the present value cost of the arrangement.