Pension reserve loses €457m in one month on its directed investments in AIB and Bank of Ireland

Well despite the summary budgetary information published by the government just as the markets closed yesterday which provide for a modest 1.75% increase in GDP in 2011 and an austerity budget which, it is claimed, will result in a deficit to GDP % of 9.25-9.5% in 2011, it seems like the bond market, which despite receiving buying support from the ECB in recent days is still negative on Irish debt. Ten-year bonds continue to trade at record levels of up to 7.71% with a further deterioration this morning.

The distinctly unsure-footed management of the crisis and a tendency for forecasts to be altered in drastic step-change fashion will not be helping. Nor will the increased political uncertainty for the government from the past few days caused by the loss of one supportive deputy who has resigned his seat (Jim McDaid) and an embarrassing loss by the government of a legal battle to prevent the holding of a bye-election in a seat that has been vacant for nearly 18 months. The lost legal battle has resulted in the bye-election now scheduled for just over a week before what is believed to be the most draconian budget in the State’s 90-year history (by reference to fiscal adjustment as a % of GDP) is voted on in the Dail. There is an overview of the political balance of power in the chart at the bottom but the upshot is that it is not in the bag that any budget will be passed with the intentions of some independents and Fianna Fail backbenchers not certain (some of the international audience might be surprised and amused at how blatant the pork-barreling can be to secure political support here)

The budgetary statement has received a mixed reception at home with a general acceptance that a downward adjustment to the 2010 deficit (of €19bn) of the order of €6bn is required in 2011 to enable the roadmap to a 3% budgetary deficit in 2014 to be adhered to. There is concern at the jiggery pokery with interest payable on the promissory notes used to pay for the bailout of the banks, and this is reflected in international reporting. The government issued a clarifying statement this morning that the interest on the promissory notes will be €13bn approx over 15 years with €1.8bn payable in 2013 after a “payment holiday” in 2013.  I think markets will see this accounting for what it is – an effort to defer a current commitment into the future when the crisis might have eased and the 3% deficit target for 2014 might be more malleable.

And this morning has seen shares fall by nearly 20% in the two main banks which are State guaranteed and recipients of €7bn of directed investment in 2009 from the State’s National Pension Reserve Fund (NPRF). The €7bn investment was reported by the NPRF to have been worth €6.615bn at the end of September 2010 and on the same basis is worth €6.158bn* this morning with AIB shares trading at €0.28 and BoI trading at €0.403 a share. A loss on paper of €457m in 36 days.

AIB of course has an immense mountain to climb in the next 60 days as it tries to reach a capital raising target of €10.4bn imposed on it by the Financial Regulator. The bank reported yesterday that it had completed the sale of its shareholding in M&T for which it will receive €1.5bn approximately, of which approximately €0.9bn will contribute to the €10.4bn target. There has not been any update on the sale of AIB’s 70.5% shareholding in Polish bank Bank Zachodni WBK, announced in September 2010 to Santander for €3.1bn (of which €2.5bn is reported to be recognised as a contribution to the €10.4bn target) – the sale must secure various approvals before it can be finalised. The AIB sale of its UK operation is being kept under review.  Credit-default swap pricing for AIB yesterday indicated there was a 64.5% chance of a default on subordinated bonds in the next five years.

As set out in the government’s “Big Bang” announcements on 30^th September, 2010, there is to be an equity raising exercise by AIB commencing in November 2010 to secure the remaining capital needed – €7bn it would now appear, up from €5.4bn at the end of September 2010 as a result of the UK sale being put on hold/under review. Observers are keeping a keen eye out for the issue of any prospectus for AIB. There is deep concern at the government’s commitment to underwrite the issue at €0.50 a share when the shares are worth €0.28 today which would see an immediate loss of €2.376bn on a €5.4bn issue or a €3.04bn loss on a €7bn issue whilst at the same time protecting shareholders and junior bondholders (who, in Anglo Irish Bank’s case are being offered 20c in the euro). This theme has been explored here in recent days (for example here and here and here)

* Bank of Ireland – 1.9bn shares at €0.403 plus €1.837bn in 10.25% preference shares, AIB – 198m shares at €0.28 plus €3.5bn in 8% preference shares. The NPRF valuation excludes accrued interest on the preference shares.

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