Archive for January 13th, 2013

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.

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It is interesting in this crisis how public perception has been shaped towards the banks. Sean Fitzpatrick, former chairman at Anglo (recipient of €29bn bailout) is cast as a pantomime villain whilst Eugene Sheehy, the former CEO of AIB (recipient of €20bn bailout) has escaped relatively scot-free. Similarly Michael Fingleton at Irish Nationwide (recipient of €5bn bailout) is constantly prodded in the media but you never hear a dickey bird about Denis Casey at Irish Life and Permanent (recipient of €4bn bailout). In fact, these were the 12 CEOs and chairpersons at the six state-guaranteed banks in September 2008 – Eugene Sheehy, David Drumm, Brian Goggins, Fergus Murphy, Michael Fingleton, Denis Casey, Dermot Gleeson, Sean Fitzpatrick, Richard Burrows, Mark Moran, Michael Walsh and Gillian Bowler. How many would you recognize? You can check your answers below!

Permanent TSB has received a €4bn bailout from us, and although that bank rejects the suggestion it will need additional funds from us, it is also a fact that it is pushing out the date by which it expects to be profitable again – in August 2011, it told the European Commission it would be returning to profit in 2014, a year later in August 2012, it was reported to have said it would return to profit “at the end of 2014 or start of 2015” and last week, it said it would return to profit in 2016; the pattern of ever-deepening bad news from PTSB is clear. We may get some of that money back because as part of the bailout, we have taken full control of Irish Life and that might be worth over €1bn if we ever sell it.

Tomorrow though, PTSB is repaying €1.3bn to bondholders. Unlike Anglo which is a designated zombie, it seems that PTSB has become a designated “pillar bank”, though it was not announced as such in March 2011 when the other two pillar banks, AIB and Bank of Ireland, were announced. And the bond being repaid tomorrow is one that was guaranteed by the Government when it was issued in January 2010, unlike many of the unguaranteed bonds repaid so far. However, this bond is NOT sovereign debt and is being paid from a bank that is 99.2% owned by us, which has an uncertain future and which has to date cost us €4bn.

The bond payment tomorrow should not go unnoticed.

When: Tomorrow, 14th January, 2013
What: Government guaranteed bond at Permanent TSB originally issued on 14th January 2010
Where: A bit of a vague answer but a payment will be made by PTSB to bond clearing companies who will then divvy the payment out to the bondholders. PTSB’s headquarters are at 56-59 St Stephen’s Green, Dublin.
How much: USD 1.75bn, that’s €1.311bn at the current exchange rate of EUR 1=USD1.3343
Why: Because the previous government guaranteed the bonds when they were issued in January 2010. But even if they had not been guaranteed, it is the policy of this government to repay senior bonds 100% unless the ECB changes its position and allows partial or full default, something that appears unlikely.

You will find details of all bonds payable in Irish banks at the Bondwatch website which is operated by Diarmuid O’Flynn who is active with the Ballyhea and Charleville bank bailout protests.

And as for recognizing the chairpersons and CEOs of the banks in September 2008, how did you do. This is the gallery.


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The Japanese have a tendency to produce fictional radiation-inspired monsters; the Germans have, what we might view as, an irrational fear of inflation, the Poles ban police raids in the middle of the night because of their echoes of communism and totalitarianism – amusing to see them before a “bust” peering at their watches to make sure they don’t break the door down before 6am! If you’ve ever been involved in a serious car crash, you might know it can take some time before you’re comfortable back behind the wheel.

Individuals, groups of individuals and nations suffer trauma during national catastrophes and it takes some time for normality to return.

In Ireland, in September 2008, our politicians, whom we trust to manage the country, bankrupted the country over the course of a few hours, a few flicks of a pen with minimal direct oversight by our elected representatives.

Since then, people who had nothing to do with property and banking found themselves the victims of the consequences, with their living standards threatened so as to bail out banks, which to most people are no more than a utility – they keep your cash safe and pay you interest and allow you to make payments from your own cash, and they might give you a loan, a utility.

But, people who knew nothing of bondholders, haircuts, debt sustainability, deficits, the IMF have became passing experts in subjects that they assumed the politicians were keeping on top of.

Just five years later, a politician – and an arch-politician at that – complains about the general denigration of politics. I wonder when the Japanese will stop creating Godzillas or when the Germans will loosen the purse-strings and permit 2%-plus inflation – it’s been about a century since the original catastrophes unfolded.

Why should Pat Rabbitte think the intense and robust analysis of politics and politicians, and challenge to political decisions, will end any time soon?

And when the Government does anything sudden and significant, like selling €1bn of its investment in Bank of Ireland this week, it should expect the most robust questioning. From some of the commentary this week, you might think that the €1bn sale of the so-called “Contingent Capital Notes” in Bank of Ireland was a complete gift horse and that any challenge or questioning of the manner in which the sale took place – the engagement of the “professionals”, their fees, the price achieved and whether it might have been a little better – then somehow, to even ask these questions, is to undermine trust in the Minister for Finance, the Department of Finance, the NTMA, or the group of companies that facilitated the disposal of €1bn of our national wealth.

The Dail resumes this coming Wednesday, and it is to be hoped that our 166 TDs scrutinize the €1bn transaction. It may have been a good or even great deal, there are usually lessons to be learned from large transactions, it is conceivable there might have been failings in the execution of the deal. Regardless, we owe it to ourselves to scrutinize the deal in fine detail.

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