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Is repaying bondholders still an issue?

Yesterday’s Troika press conference has attracted more attention than usual because of an exchange between journalist and broadcaster, Vincent Browne and Klaus Masuch, head of EU Countries Division at the European Central Bank.   The exchange can be seen here.

Although not named we can only assume that Browne was referring to Anglo Irish Bank.  Anglo’s 2008 Annual Report provides details for the year ended 30th September 2008.  This is also the date of the guarantee so it gives us a good indication of the liabilities that were guaranteed on the same night.

By the end of September 2008, the Anglo balance sheet had ballooned to a massive €100 billion.   On the asset side Anglo had forwarded loans of around €72 billion.  We now know that Anglo made losses of around 50% on this loan book.  We have filled that €30 billion+ gap.

Then comes the issue of where Anglo got the money to make these loans.  The Anglo balance sheets reports €100 billion of liabilities of which over €70 billion were just deposits (€52 billion from ‘customers’, €20 billion from banks).  It also shows that there was about €17 billion of 'Debt Securities' (i.e. bonds) in issue at that time.

A note to the accounts gives a breakdown of this total at the 30th September 2008:

Medium term note programme: €10,622 million
Other debt securities in issue: €6,658 million

The category of 'other debt securities' includes commercial paper and certificates of deposit which are almost analogous to deposits.  There were also some €4 billion of subordinated liabilities but those are not of concern here as most of those were not repaid. [Junior debt holders in the covered banks incurred €15.5 billion of losses across the covered banks.]

Anyway at the end of September 2008 Anglo had €10.6 billion of bonds outstanding.  A breakdown showing the amounts of these that were secured and unsecured is not provided.  These bonds (along with all other liabilities) were guaranteed on September 30 and over the past three and half years many of these have been repaid.  After Monday's payment of €1.25 billion there will be around €3 billion of Anglo bonds left to be repaid.

The issue raised by Browne is the repayment of unsecured bondholders in Anglo after the expiry of the original two-year guarantee in September 2010.  Unfortunately for 2010, Anglo changed its year end to 31st December so we cannot get the exact balance sheet position at the expiry of the original guarantee from the 2010 Annual Report.

By the 31st December 2010 the balance sheet of Anglo had shrunk to €72 billion and the total amount of debt securities outstanding had fallen to €6.9 billion.  All the deposit-like 'other securities' had been redeemed so the €6.9 billion was all bonds.  At this stage the bank was again mainly funded by deposits but these were now almost 80% central bank deposits.

Of the €6.9 billion of bonds we are told that "€3.0bn of medium term notes, all of which are Government guaranteed with maturities of up to five years, were issued during the year."  That means there could only be a maximum of €3.9 billion of bonds which were outside the guarantee.

This was confirmed in March 2011 with this release from the Central Bank.  This showed that on the 31st March 2011 there was €3,147 million of senior unsecured unguaranteed bonds in Anglo on the 18th of February 2011 from a total of €6,255 million of bonds (the other €3 billion being the guaranteed bonds).

It is the re-payment of these €3.1 billion of unsecured bonds that was the subject of yesterday's exchange.  It is hard to know how much could be saved if these bonds weren't repaid but given the 60%-80% haircuts applied to subordinated debt it is likely that a haircut of 40% to 60% would be applied to senior debt.  If we take the mid-point and assume that a 50% haircut could be applied then the State will lose around €1.5 billion by repaying these bonds.

Of course, we don’t have the money to repay these bondholders.  We have borrowed it (or rather we will borrow it) through the Promissory Notes.  Repaying the bonds will not cost us €1.5 billion.  The price is €1.5 billion but the cost will be the annual interest payments made on the borrowing to pay the bonds.  At an interest rate of 5% it would cost €75 million per year to service €1.5 billion of debt.  The true savings of not repaying these bonds is this €75 million per year.

Here is the question and the answer and some subsequent comments from this transcript.

Vincent Browne: “Klaus Masuch, did your taxi driver tell you how the Irish people are bewildered that we are required to pay unguaranteed bondholders billions of euros for debts that the Irish people have no relation to or no bearing with, primarily to bail out or to ensure the solvency of European banks? And if the taxi driver had asked you that question,hat would have been your response? That’s my first question.”

Masuch: “I can understand that this is a difficult decision to be made by the government and there’s no doubt about it but there are different aspects of the problem to be, to be balanced against each other and I can understand that the government came to, came to the view that, all in all, the costs for the, for Irish people, for the, for the stability of the banking system, for the confidence in the banking system of taking a certain action in this respect which you are mentioning could likely have been much bigger than the benefits for the taxpayer which of course would have been there. So the financial sector would have been affected; the confidence of the financial sector would have been negatively affected, and I can understand that there were, that there was a difficult decision but that the decision was taken in this direction.”

Browne: “That, that… Well, that doesn’t address the issue. We are required to pay, in respect of a defunct bank – that has no bearing on the welfare of the Irish people at all – we are required to pay in respect of this defunct bank, billions on unguaranteed bonds in order to ensure the health of European banks. Now how would you explain that situation to the taxi driver that you talked about earlier?”

Masuch: “I think I have addressed the question.”

Browne: “No you haven’t addressed the question because you referred to the viability of the Irish financial institutions. This financial institution I’m talking about is defunct. It’s over. It’s finished. Now, why are the Irish people required, under threat from the ECB, why are the Irish people required to pay billions to unguaranteed bondholders under threat from the ECB?”

In his answer Mausch basically said that it was the government’s view (he never actually have his view) that the benefits of repaying these bonds were greater than the savings that could be made by not repaying them.  We know that the saving could be around €1.5 billion.

It would have been useful if Mausch was pressed further on what he felt these benefits were.  It is still not clear what benefits, if any, did accrue from undertaking to repay these bonds; it certainly wasn’t “stability of the (Irish) financial system”.  There may have been benefits from repaying these bonds and this has been couched in references to veiled threats from the ECB.  Would the ECB “pull the plug” if these €3 billion of bonds aren’t repaid?  Unlikely, but in the greater scheme of things the €1.5 billion in question here is not the key issued.

The key issue is the €25 billion of Promissory Notes given to Anglo (along with €6 billion to Irish Nationwide) to cover the loan losses referred to above.  Most of the money that these Notes allowed Anglo to get from the Central Bank went to repay depositors rather than bondholders. 

This issue is how (or whether) we repay the €28.5 billion of these Notes that are still outstanding.  This money is owed to the Central Bank of Ireland but when the Central Bank gets it, it will just “burn” it.  There is no one waiting for this money to be repaid so the question is why do we have to repay it now.  Prof Karl Whelan is once again excellent on this point in this article in Business and Finance.

This issue was raised at both the Noonan/Howling and Troika press conferences.  You can listen to the responses in this extract.  It seems we can expect some kind of ‘position paper’ to be released before the end of February.  This issue is far more significant than some pre-ordained grandstanding about bond payments.  The bondholders are gone.  The debate must move on.  Maybe the next haranguing of the ECB will press them on this.

Interest on the Promissory Notes

A restructuring of the €31 billion of Promissory Notes given to Anglo Irish Bank and Irish Nationwide (now merged in the Irish Bank Resolution Corporation) has been getting a good deal of attention recently.  Much of the focus has been on reducing the interest rate coupon on the Notes but as we have said a number of times it is not clear that this would actually save the State money.

Here is a table of the issued Promissory Notes from a previous post.

When we account for the “interest holiday” taken in 2011 and 2012 the equivalent annual coupon for Tranche 4 is 8.6%.  This means that the average annual coupon rate across the €31 billion was about 5.8%.

The interest rate on each tranche was based on the yield Irish government bonds of the same maturity on the day the tranche was provided to Anglo/INBS.   This increased from 4.17% to 8.60% as the tranches were issued beginning on the 31st March 2010, though the second and third tranches on the 31st of May and 28th of June 2010, and finishing with the final tranche on the 31st December 2010.

For the first six months of 2011, Anglo reported it had Interest Income of €644 million on the €25.3 billion of Promissory Notes that it had received.  The amount of the Promissory Note outstanding was reduced to €23.8 billion when the first annual payment was made on the 31st of March.

The “bank” also paid €519 million of interest to the Central Bank of Ireland for use of Emergency Liquidity Assistance (ELA).  The total amount of ELA the bank was drawing down stood at €45.0 billion on the 31st December 2010 and had reduced to €40.8 billion by June 30th 2011.  With an haircut of around 20% applied to the use of the Promissory Note as collateral it is clear that the Promissory Notes were supporting about half of the ELA that Anglo was drawing down.

Therefore we could allot around €260 million of interest expense to the ELA backed by the Promissory Notes.  In the first six months of 2011 Anglo made an interest profit of around €380 million on its Promissory Notes transactions.  As Anglo is 100% state-owned this profit is not lost.  Any reduction of the interest rate on the Promissory Notes will simply reduce this profit and no money will be saved.

What about the €519 million of interest Anglo paid to the Central Bank of which around €260 million is due to the Promisory Notes-backed ELA?  We don’t have the 2011 Annual Report for the Central Bank of Ireland yet but we we can track the flow of the interest that was paid to the Central Bank over the past few years. This is given under the heading 'Other' in the Income Received total in the Central Bank Annual Reports

2008: n/a
2009: €240.5 million
2010: €510.2 million

Given the level of ELA that was issued during these years it is possible that the interest rate charged was around 2.5%.   In 2010, Anglo paid €435 million in interest to the CBoI for ELA so it is clear that the bulk of the ELA was issued to Anglo.

The full extent of the ELA (up to €50 billion) only arose in late 2010 so it will be interesting to track the 'Other' Income Received when the Central Bank publishes the 2011 Annual Report later in the year.

It is hard to see if this interest is paid on to anyone else by the Central Bank, with anyone else of course being the ECB.  Earlier this week John McManus in a very good piece on the Promissory Notes in the Irish Times said:

"The Central Bank is in turn getting the money it lends to Anglo from the ECB at a much lower and not disclosed rate which is reported to be 2 per cent or less. It keeps the difference. The real cost to the State is the rate at which the ECB provides cash and it is far from penal."

In a piece from last February on the ELA, Laura Noonan of the Irish Independent wrote:

“While money that comes directly from the ECB is issued for terms ranging from seven days to 90 days, the money given out through ELA is typically granted for seven days.”

I’m not so sure the Central Bank needs to get the money.  This might be the case but it is also possible that the Central Bank of Ireland just created the money as only central banks can do.

 This little note on the ELA mentions nothing about a payment to the ECB and, says:

The little known ELA facility allows national central banks (NCB) to provide funds to domestic financial institutions in financial difficulty over and above the liquidity provided by the ECB's regular refinancing operations. These operations are separate from the Eurosystem, but the ECB's Governing Council can with a ⅔ majority oppose the granting of further ELA, if, for instance, it considers the emergency assistance provided constitutes monetary financing.

The assistance provided is supposed to be temporary and to an illiquid but solvent financial institution. The lending is not subject to ECB collateral requirements. Thus a bank can present its NCB collateral which would not be acceptable by the ECB (but which would be acceptable by the NCB).

If you really want to get into ELA you can read this five-page note from Citigroup’s Willem Buiter.   On the first page it states:

Any profits or losses made from the collateralised lending of NCBs under their ELA facilities are for the account of the NCB alone and are not shared/pooled with the rest of the Eurosystem.

There is lots of technical sounding stuff here but it really throws little light on the subject.  To try and track these profits we can look at the Central Bank surplus that is payable to the Exchequer each year.  Here it is for the past six years.

2005: €109.2 million
2006: €98.5 million
2007: €183.4 million
2008: €290.1 million
2009: €745.9 million
2010: €671.0 million

There could be other reasons for this but the Central Bank surplus has increased in the period in which the ELA has been provided.  The interest received from the ELA doubled to €500 million in 2010 but the Central Bank surplus fell.  Again it will be the 2011 Annual Report that will give a more telling indication of the impact of the ELA in the surplus that is transferred to the Exchequer.

We know for definite that the interest profit that Anglo makes on the Promissory Notes is not initially lost as Anglo is 100% state-owned.  It remains to be seen what Anglo will do with these profits.  It appears that the chunk of the interest that the Central Bank takes for providing the ELA also stays within the State.

Getting back to markets

Just a few days after John Corrigan of the NTMA said this:

“Our plan would be to try and return to the Treasury Bill market, which is for debt instruments with less than three month maturity, to try and return to that market by mid-year which would represent the first signs of normalisation, and as regards the longer-term market towards the end of 2012 early 2013 but again it is subject to external conditions improving.”

It might be worth considering this:

Meanwhile, Greece saw its borrowing rates ease marginally in a bill auction on Tuesday.

The public debt agency said it raised €1.625 billion ($2.06 billion) in a sale of 13-week treasury bills, an interest rate of 4.64 per cent, compared with 4.68 per cent in the last such auction in December.

Demand for the bills was 2.90 times the amount on offer, roughly the same as last month.

Unable to issue long-term debt due to untenably high borrowing costs, it maintains a market presence through regular treasury bill auctions.

A country whose ten-year yield is nearly 35%, whose two-year yield is 164% and is forecast to default in exactly nine weeks was out in the markets today and raised over €1.5 billion of three-month funds at an interest rate of 5%, with demand of close to €5 billion.

While getting back to short-term markets is undoubtedly an important first step, it is a small step and is one that a country with a nine-year yield of 7.5% and a two-year yield of 5.7% should have little problem in achieving.    Irish has an outstanding bond maturing in seven weeks that is yielding 2.12%.

Today saw a steepish decline in the nine-year yield on Irish government bonds as calculated by Bloomberg.

At 7.47% this is the lowest the reported yield has been since the 4th of November 2010.

S&P keeps Ireland at BBB+

For the second time since August, S&P has reaffirmed its BBB+ rating for Irish government bonds.  BBB+ is two grades above junk status and is defined as “adequate capacity to meet financial commitments, but more subject to adverse economic conditions”.  In August, though, the outlook was Stable, now it is Negative.  That implies there is a one-in-three chance of a downgrade over the next two years.

Italy, Portugal and Spain all had two-notch downgrades.  Italy has been moved to BBB+ and now stands alongside Ireland.  Portugal, which previously had a BBB- lowest investment grade rating, now has a junk status grade of BB.  Spain began at AA- and is now at A.  As with Ireland the outlook on all of these is Negative.  The last of the PIIGS, Greece, did not form part of the current review and remains at the low-junk CC grade and a disorderly default is a growing possibility.

A lot of the current S&P statement explaining the decision on Ireland deals with the general eurozone environment but there are some interesting country-specific elements.   Two of these are:

1.  All other things being equal, we view the government's fiscal consolidation plan as sufficient to achieve a general government deficit of around 3% of GDP in 2015.

2.  We expect the general government net debt burden to fall to about 103% of GDP in 2015, having peaked at 109% in 2013. Our net debt estimates include the impact of the government's €64 billion (40% of GDP) in banking sector recapitalizations during 2008-2011 and €29 billion (18% of GDP) in debt issued by the National Asset Management Agency (NAMA) as of end-2011.

In August they were forecasting that their measure of net debt would peak at 110% of GDP in 2013.  That has now being reduced to 109% of GDP (possibly as a result of the double-counting error in the Department of Finance.)  The 103% net debt/GDP for 2015 is unchanged.  On the general eurozone response to the crisis they state:

1. In our opinion, the political agreement [the fiscal compact of December 9th] does not supply sufficient additional resources or operational flexibility to bolster European rescue operations, or extend enough support for those eurozone sovereigns subjected to heightened market pressures.

2. [.] we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers' rising concerns about job security and disposable incomes, eroding national tax revenues.

The full text of the S&P statement is below the fold.

LONDON (Standard & Poor's) Jan. 13, 2012--Standard & Poor's Ratings Services today affirmed the 'BBB+' long-term and 'A-2' short-term ratings on the Republic of Ireland. At the same time, we removed the long-term rating from CreditWatch with negative implications, where it was placed on Dec. 5, 2011. The outlook on the long-term ratings is negative.

Our transfer and convertibility (T&C) assessment for Ireland, as for all European Economic and Monetary Union (eurozone) members, is 'AAA', reflecting our view that the likelihood of the European Central Bank restricting nonsovereign access to foreign currency needed for debt service is extremely low. This reflects the full and open access to foreign currency that holders of euro currently enjoy and which we expect to remain the case in the foreseeable future.

The outcomes from the EU summit on Dec. 9, 2011, and subsequent statements from policymakers lead us to believe that the agreement reached has not produced a breakthrough of sufficient size and scope to fully address the eurozone's financial problems. In our opinion, the political agreement does not supply sufficient additional resources or operational flexibility to bolster European rescue operations, or extend enough support for those eurozone sovereigns subjected to heightened market pressures. 

We also believe that the agreement is predicated on only a partial recognition of the source of the crisis: that the current financial turmoil stems primarily from fiscal profligacy at the periphery of the eurozone. In our view, however, the financial problems facing the eurozone are as much a consequence of rising external imbalances and divergences in competitiveness between the eurozone's core and the so-called "periphery." As such, we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers' rising concerns about job security and disposable incomes, eroding national tax revenues. 

However, we have not adjusted the political score of the Republic of Ireland down. This is a reflection of our view that the Irish government's response to the significant deterioration in its public finances and the recent crisis in the Irish financial sector has been proactive and substantive. This offsets our view that the effectiveness, stability, and predictability of European policymaking and political institutions (with which Ireland is closely integrated) have not been strengthened so as to match the severity of the broadening and deepening financial crisis in the eurozone.

Excluding government-funded banking sector recapitalization payments, the authorities have adjusted the budget by almost €21 billion (13% of estimated 2012 GDP) since 2008 and plan additional fiscal savings of some €12.4 billion (7.8% of GDP) for 2012-2015. All other things being equal, we view the government's fiscal consolidation plan as sufficient to achieve a general government deficit of around 3% of GDP in 2015. In our view, there is currently a strong political consensus behind the fiscal consolidation program and policy implementation so far has been extremely strong. In the face of a weaker-than-expected outlook for economic growth, additional measures (€0.2 billion, 0.1% of GDP) have been introduced to meet the government's targets.

We expect the general government net debt burden to fall to about 103% of GDP in 2015, having peaked at 109% in 2013. Our net debt estimates include the impact of the government's €64 billion (40% of GDP) in banking sector recapitalizations during 2008-2011 and €29 billion (18% of GDP) in debt issued by the National Asset Management Agency (NAMA) as of end-2011. NAMA's purpose is to acquire, hold, and dispose of land and property; it has acquired and is now working out eligible assets from participating financial institutions. Should NAMA asset disposals progress more rapidly than our current assumption (10% of GDP over 2013-2015), the government's net debt burden could improve at a faster pace.

In our view, Ireland has a flexible and very open economy. This is illustrated by the 25% depreciation in the trade-weighted exchange rate between May 2008 and October 2011 (latest data) and by goods and services exports estimated at about 113% of GDP in 2012. Partly as a result of these factors, as well as the noncyclical nature of a substantial part of Irish exports, net export growth has contributed positively to the muted Irish economic recovery in 2011. However, in our view this also leaves the Irish economy and, ultimately, the Irish government's fiscal consolidation program, susceptible to worsening external economic conditions. This is reflected in our downside hypothetical scenario, which contemplates real GDP per capita economic growth, general government deficits, and general government net debt averaging 0.9%, 6.6%, and 114% of GDP, respectively, over the 2012-2015 period, compared with our base-case scenario of 1.7%, 6.1%, and 107%.

We have lowered our assessment of Ireland's external score. On Dec. 5, 2011, we said that this score was unlikely to change as our concerns raised with regard to a sudden stop in interbank funding had already been realized in Ireland. However, the Irish government and Irish financial institutions have not had access to the capital markets for unsecured long-term funding since early 2010. Our assessment of the sovereign's external risks has been updated to reflect this.

Yields under 8 percent as yield curve looks ‘normal’

The downward slide of Irish government bond yields continued today and the nine-year yield as calculated by Bloomberg finished at 7.91%.  Apart from a two-week period at the start of October this is the only time that this has been below 8.0% in the past year.  This time last year the yield was at 8.4%.

Here is the one-chart for the nine-year yield.

What is perhaps of even greater interest is the Daily Outstanding Bonds Report published by the NTMA.

We can see that no Irish government bond is yielding more than 8%.  Michael Noonan has spent the day proclaiming that “Ireland is fully funded until 2013” (or two-thirteen in Noonan-speak).  This is true.  What happens in 2014?

The €11.9 billion bond due to mature on the 15th January 2014 is now yielding 6.85%.  It now costs €94.84 to buy a unit of this bond.  Last July this bond could was trading at less than €70 giving a yield of close to 20% (if you could find someone willing to sell).  The perceived risk of this bond has dropped considerably in the past six months.

Finally, it is interesting to see the reasonably normal shape of the yield curve for Irish government bonds.

It would be more than reasonably normal if we could knock a few more percentage points off the yields but lets take it one step at a time.  It’s a good deal better than this yield curve from just five months ago.