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Archive for January 19th, 2012

I wonder how many of you can remember a time when the word “bondholder” was not in your vocabulary. Well it seems that the term “promissory notes” is about to acquire the same familiarity. In March 2012 and every March until nearly 2030 Ireland will need to find about €3bn per annum to pay the so-called promissory notes. There have been a couple of blogposts on here previously – here and here – which discussed aspects of the Anglo promissory notes but the aim here is to explain in simple terms what they are, what the Government position is with respect to them and what the IMF said a couple of hours ago in Dublin which seemingly contradicted claims made by Minister for Finance, Michael Noonan and others.

What is a promissory note? It’s a sheet of paper on which the former Minister for Finance, the late Brian Lenihan wrote an IOU. He gave a few of these sheets of paper to Anglo Irish Bank and Irish Nationwide Building Society, totalling €29bn-odd (€24bn for Anglo and €5bn for INBS). Not only did the sheets of paper provide an IOU but they provided for Brian Lenihan to pay Anglo and INBS interest on the value of the IOU.

Why on earth would Ireland pay interest on these IOUs, wasn’t the giving of the IOU in the first place enough? The ECB insisted that the IOUs have an interest rate, otherwise the ECB wasn’t going to allow lending to Anglo/INBS of cash against the collateral of the IOUs.

So that’s all there was to it, Brian Lenihan writing IOUs? No, in addition the late Brian Lenihan wrote so-called “letters of comfort” to the Central Bank of Ireland saying the Irish state would stand behind the promissory notes. These letters of comfort enabled the Central Bank to lend cash to Anglo/INBS using the promissory notes as collateral.

What is the interest rate on the promissory notes? This doesn’t appear to be in the public domain but it seems it is between 6-8.2% per annum.

Who pays the interest on the promissory notes? We do, or rather the Department of Finance does, it pays the interest to Anglo and INBS.

But we own Anglo and INBS 100% so aren’t we paying ourselves? CORRECT! And this is why the interest rate on the promissory notes is a red herring. By the way, Anglo borrows cash from the Central Bank ofIreland using the promissory notes as collateral but this interest which is paid to the Central Bank is also ours as we retain 100% of the profits of our own Central Bank.

Why did we create promissory notes in the first place? Anglo and INBS became insolvent – that is their assets were worth less than their liabilities – after making big losses on their property loans when the property bubble burst. The Government gave guarantees to Irish banks in September 2008 and was consequently compelled to inject funds into Anglo and INBS to make them solvent again. The Government did use cash at the start and gave Anglo €4bn and INBS €0.1bn but thereafter started writing these promissory notes with the approval of the ECB.

So we have this giant noose around our necks with these promissory notes, can we renege on them? Pass. I don’t know if the promissory notes and the letters of comfort together make for a binding obligation. On one hand, the notes were issued pursuant to a banking guarantee in September 2008 which was approved in our Oireachtas. On the other hand, the specific costs have not been agreed by the Oireachtas as provided for under our Constitution and there is an international concept of “odious debt” which argues that debt not properly incurred by a nation is not sovereign debt.

What can we do to reduce the cost of the promissory notes? Well one thing that won’t reduce the cost is getting agreement from the ECB or anyone else to lower the interest rate on the promissory notes, because as shown above, it is a red herring as we own Anglo and INBS 100%.  Present projections are for the annual €3bn is to sourced from the sovereign bond market from 2014. And that bond market is presently charging 7.5% for 10-year money. We are paying just over 3.5% for bailout money, so if a second bailout was arranged at a low cost then that would probably deliver savings. Or the ECB could agree for the promissory notes to be paid over a longer period, 30 years perhaps.

What’s the difference between Anglo promissory notes and Anglo bondholders? Bondholders lent money to Anglo before 2008 for fixed periods of time, five years for example, and these bonds are coming due all the time with a particularly big one next week when €1,250m is repaid. Promissory notes are our IOU debts to Anglo.

Now you may have gotten the impression in recent months that Minister Noonan and the Department of Finance were frantically burning the midnight oil in negotiating the financing of the promissory notes. Minister Noonan was practically tapping his nose with his finger in a knowing way, as if to say it was all under control and talks were taking place behind the scenes which would imminently deliver results. Just before Christmas, the Department of Finance began downplaying the prospects on the supposed negotiations. But the Government continues to assert that it is involved in such negotiations, and those assertions have been repeated as little as four hours ago when Ministers Noonan and Howlin gave a press conference. However when the Troika was asked at its press conference about the “negotiations”, the response from the IMF Mission Chief to Ireland, Craig Beaumont was merely thatIreland had “requested” technical discussions. These seem to be two very different interpretations of what is going on, and I can’t help but remark that the IMF has less reason to obfuscate the truth than our own embattled politicians who next week will face the fury which will accompany the payment of €1,250m to senior unsecured, unguaranteed – that is, not covered by the September 2008 guarantee which has now expired in relation to pre-2008 bonds – bondholders at what was formerly Anglo.

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This morning Ireland’s Central Statistics Office (CSO) has released its inflation figures for December 2011. The headline Consumer Price Index (CPI) was down 0.3% compared to November 2011, but up 2.5% year-on-year (down from 2.9% in Novembe 2011). The biggest driver of inflation in the past 12 months continues to be the CSO category of housing-related costs, and within that, the most significant component is mortgage interest* which has risen a hefty 14.1% in the past 12 months as domestic bank-driven interest rate rises take effect. It should be said that in the month of December 2011, inflation on mortgage interest fell by 3.2% as ECB interest rate reductions and domestic regulatory and political pressure bore fruit.

Mortgage interest comprises nearly 7% of the CPI “basket” so the effect is significant.

Elsewhere private rents fell by 0.9% in the month of December 2011, the biggest monthly fall in over a year, but over the past year, rents are up by 3.0%. It seems that in our financial crisis, the big correction in rent took place in 2009 with a 19% maximum decline, compared to a decline of just 1.4% for all of 2010. Since the start of 2011 there has been a 3.0% increase (mostly recorded in February and October 2011). At the start of January 2012, the Department of Social Protection reduced its rent assistance payments by up to 29% (an average of 13%) and the Department claims that some 40% of the rented market in the State is affected by rent assistance payments. Private rents have tended to fall in line with rent allowance even though many landlords will not accept rent allowance tenants. The betting on here is that private rents will come under pressure in the short term but it might take a couple of months for the changes to feed through.

*The CSO notes the following in respect of mortgage interest “In line with normal practice for a fixed base price index, the current approach to measuring mortgage interest in the CPI reflects the situation in the base reference period December 2006 when the standard variable rate was dominant. Subsequently, tracker mortgages have become more popular. This did not give rise to any difficulties while the standard variable and tracker mortgage interest rates moved broadly in line with one another, which would be the normal expectation. However, the decoupling that has taken place since August 2009 has resulted in dramatically different trends emerging. For example, between September 2009 and September 2010 the standard variable rate increased from 2.93% to 3.66% whereas the tracker rate did not change. The Mortgage Interest component of the CPI, which is largely determined by the trend in the standard variable rate, increased by 25.1% as a result and contributed +1.25% to the overall change in the All Items index. It is crudely estimated that the latter impact would have been reduced by between 0.2% and 0.5% had the Mortgage Interest component been calculated on a current weighting basis. Users should take this “weighting effect” into account in interpreting the mortgage interest related movements in the index”

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NAMA is connected to the sale of two retail properties – one in Derry and one in Dublin. This entry examines the pricing differences.

Jack Fagan in the Irish Times  reports that NAMA is offering a 20,000 sq ft retail property in Sandyford in south westDublin for €8m. The property is leased to German discount retailer Aldi for €603,375 per annum. The start date of the lease is October 2011, is for 25 years, has a break clause for 2029 and rent is reviewed every five years in line with the Consumer Price Index subject to a maximum of 4% per annum.. The implied yield is 7.5% and price per square foot is €400 and annual rent per square foot is €30. The property was part of John Fleming’s group – John recently emerged from bankruptcy in the UK which saw his former €1bn+ property empire repossessed by his creditors.

Meanwhile Margaret Canning in the Belfast Telegrah reports that just across the Border in Derry, another retail property is now on the market, again with NAMA in the background. The 33,000 sq ft property at 150 Strand Road in Derry is said to be on the market at GBP 19.4m (€23.2m) and it generates annual rent of GBP 1.1m (€1.32m). The property is supposedly on the market through Lisney’s but a search of its 34 commercial properties on offer in Northern Ireland this morning doesn’t throw up any match. The implied yield is 5.7% and price per square foot is GBP 588 (€704) and annual rent per square foot is GBP 33 (€40). The Belfast Telegraph reports that the sale includes a 0.65 acre development site which will distort comparisons to a degree.  The property is being sold by the McGinnis Group whose registered name is Monnaboy Limited. Last month, the BBC reported that NAMA had taken over loans connected to the group.

Why is Northern Ireland’s retail property sector so much more attractive than the Republic’s, in the sense that yields are lower and capital values/rents are higher. In the office sector, the reverse is apparently true with prime rents in Belfast almost half those of Dublin. As with any property, there will be unique details – leases for example – but on the face of it, the difference between the two cities is striking.

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