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.
NAMA Wine Lake 
Again I doff my hat to your impressive analysis, but as a layman with limited understanding I can’t help feeling that our country has been signed over to Milo Minderbender.
“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 99%”. No compromise – the country is bankrupt and has been robbed blind by bankers, borrowers, politicians and bondholders.
@NWL, I thought we had established that “substantial” was €50?
When you do a PV you shouldn’t forget about compounding.
@VH, agreed, and that is done above – in fact twice.
If we need borrow 3bn in 2020 for example, then in 2020 the PV of that borrowing *in 2020* is 3bn * (1.04^10)/(1.02^10).
But then we need represent that sum in 2013 money so we divide the result of the PV *in 2020* by 1.02^8 to represent it in today’s money.
Sorry, my comment wasn’t a criticism. More a general statement. It is truly shocking the number of people that should know better don’t factor it into their thoughts.
It’s a bit like when we hear €xx billion in Bonds has been sold. What isn’t being made clear is how much the NTMA is getting into their hands today. And people are getting confused between the Bond and a Loan. RTE and other media outlets mix up the two to such an extent you’d wonder. But since I subscribe to idiots before conspiracy… .
If I had a criticism at all it is that you and other ‘in the know’ commentators have moved over the last few years from explaining for the general public, or at least in a way such that the general public could understand, and moved to a far more internal and knowing position. This is of course wholly understandable since you cannot keep going step by step. But when you were doing just that it was showing up just how idiotic was the thought process and how outlandish the decisions. There is a strong whiff of baffle with bullshit and confuse with crud emanating from government&cs circles.
Oh, I find this a great yoke http://www.libreoffice.org/download you just plug in the numbers. None of those pesky longhand calculations.
@VH, didn’t take it as a criticism, and it is good to clarify!
Yesterday’s blogpost required detail and it does get very convoluted and the suggestion for evaluating a “deal” is very rough and is in the spirit of kicking off a conversation.
We will look like a bunch of clowns if someone, I guess Minister Noonan or An Taoiseach announces a “deal” and we’re all scratching our heads wondering is the new arrangement better than the old arrangement.
@DreadedEstate, the analysis yesterday is quite rough and ready, and you can argue about elements of it. There is an assumption here that all the money used to repay the promissory notes is borrowed. That may not be correct, but given the immediate outlook of deficits and existing repayment obligations, it looks fair enough for the next 5-10 years at least.
As regards the discount factor, yes, economic growth might be a substitute for inflation, but we know the ECB target for inflation – “below but close to 2%” – what will economic growth be? Rocketing 2000s 5-10%, current ambitions of 3% or a lost decade of 0-2%?
@Brian Flanagan
Yes, any engagement on a negotiation implicitly concedes the validity of the promissory notes in the first place.
Good work NWL, the PV is the only way to measure any ‘deal’ on the PN.
But I disagree with some of the factors you are using.
The external interest rate on the PN rate is really the rate the ICB pays the ECB, which is probably about 2%. I don’t think or actual borrowing rates come into it.
And as with most national debt metrics I think the correct measure is the size of the economy so the discount rate should be the growth in that metric. So either long term nominal GDP or GNP growth.
That probably reduces the current PV of the PN.
@NWL here is the Minister on the costs of the PN.
“When the final capital contribution was made on 31 December 2011 an interest holiday was inserted into each of the Promissory Notes which meant that between 1 January 2011 and 31 December 2012 no interest was payable. Absent the interest holiday the weighted average interest rate on these Promissory Notes would have been 5.8%. However, as a result of the insertion of the interest holiday the weighted average interest rate from 1 January 2013 is c.8%.”
Click to access unrevised2.pdf
This may also aid in the above its the interest and principal detailed,never understood why its so front loaded,perhaps in table one above.
” In light of the recently agreed reduction in interest rates on funding available under the Joint EU/IMF Programme of Financial Support however, the estimated interest cost on such borrowing reduces to approximately €115 million per annum.”
http://www.kildarestreet.com/wrans/?id=2011-09-27.896.0
Good analysis.
Just as relevant as “How” is “When”;
From a negotiating point of view, if you think of the 77 days as height you jump from a plane, then if getting a deal is equivalent to getting a working parachute, the closer you are to the ground, the less negotiating time you have before impact. In fact you will do anything for any sort of parachute in final few feet/days.
In other words, each day without a deal announced, lessens the chance of a substantive deal. Perhaps this is why Enda et al are politely upping the ante now.
If our negotiating team are getting a slow-no (and based on Messers Noonan /Kenny business background – I am not sure if they would recognize it) then they need to show that there will be serious impact (BTW higher bond rates for Ireland is not really a concern for Germany or ECB) in return.
@Jerome, it was intended as a start, but it has now been pointed out that Karl Whelan did something similar in November 2012 and wrote about it in Forbes
http://www.forbes.com/sites/karlwhelan/2012/11/21/why-ireland-would-benefit-replacing-the-promissory-notes-with-a-long-term-bond/
And he even attached a spreadsheet to back up his calculations
http://www.karlwhelan.com/IrishEconomy/LongBond.xlsx
As regards the “serious impact in return” have you any ideas? I suppose Messrs Kenny and Gilmore could announce that they will hold a new election if there is failure to secure a deal, and the political uncertainty might rattle some in Europe but (1) the opinion polls point to 30% for FG and 15% for Labour and (2) would the Europeans be all that concerned. Frankly the prospect of Berlusconi returning to power in Italy is probably far more frightening.
But what other “serious impact” might there be? The immediate reaction to last year’s fudge announcement of the NAMA/Bank of Ireland temporary funding of the promissory note payment, was a debate about sheep worrying in the Cooley Peninsula!
At least, if we can talk more about the shape of the deal, and the means to judge if it is better than the old arrangement, should mean the politicians need hold out for something substantial.
Regarding ‘reductio ad absurdum’, when I try to type that my iPad corrects it to ‘reduction’.
I don’t think there will be any reduction in the NPV. I think the best we can hope for is that the interest payments are postponed for a few more years which will make it easier in the short term to hit the 3% deficit target. Would the ECB not consider a reduction in the NPV of the PNs to be monetary financing?
Karl Whelan has a spreadsheet which examines the impact of replacing the PNs by long term bonds. It show that a 40-year bond produces a reduction in the Net Present Value of the payments of 43%. Perhaps more important is the greatly reduced net financing needs over the next decade — €6 billion instead of €33 billion.
Details at http://www.forbes.com/sites/karlwhelan/2012/11/21/why-ireland-would-benefit-replacing-the-promissory-notes-with-a-long-term-bond/