My thoughts on Enda Kenny’s Time magazine cover are here.
I haven’t been as euphoric as some commentators about Ireland’s prospects of getting a “seismic” “game-changing” deal on bank-related debt. Still, even my relatively mild hopes have been dashed a bit by this evening’s statement by the German, Dutch and Finnish finance ministers. Thoughts here.
An updated version of my promissory note paper is now available. Details here.
The byzantine complexities of the IBRC’s promissory note-emergency liquidity assistance arrangements are such that it is inevitable that even the smartest of people will get confused. Unfortunately, Irish Times reporter Arthur Beesley (who does excellent work covering Brussels) came a cropper in this morning’s article on the negotations over restructuring Ireland’s bank-related debt.
Arthur’s article discusses the issues as follows:
On the table is the provision of about €30 billion in bonds from a European bailout fund to the former Anglo Irish Bank to replace expensive State-funded promissory notes …
The release of European bonds to the former Anglo would be in addition to the €40.2 billion Ireland is receiving from European sources under the original bailout agreement.
This is one element of the package which would certainly necessitate parliamentary votes in a number of countries.
The key issue in this part of the negotiation is the rate of interest which would be charged on any bonds from the temporary European Financial Stability Facility or its successor, the ESM.
The basic idea is that the Government would remain on the hook for EFSF or ESM bonds given to the former Anglo but that the annual interest rate charged would be far lower than the 8.2 per cent which applies now.
Precisely what rate would be charged remains subject to negotiation, the official said.
Under present arrangements the State would pay €16.8 billion in interest by 2031, bringing the total cost of the Anglo note scheme to €47.4 billion.
This description misses the key issues at stake here in a number of ways.
The problem with the promissory note arrangement is not that it causes the state to incur high interest costs. In fact, the opposite is the case. The 8.2 percent interest rate quoted here relates to interest payments that the state is making to IBRC, a state-owned institution. This is one arm of the state paying another so the interest rate has no impact on the state’s underlying debt situation.
In the same way, the IBRC uses its promissory note payments to repay its ELA debts to the Central Bank of Ireland (another arm of the state) and the (lower) interest rate it pays on ELA also has no relevance. The Central Bank returns the profits it makes on these ELA loans to the state (see its 2011 annual report).
What is the interest cost to the state of the current arrangement? As I described in detail in this paper, the Central Bank takes in the principal payments on ELA and then retires the money that it created when granting the ELA in the first place. This reduces the balance sheet item “Intra-Eurosystem Liabilities” which the Bank currently pays 0.75% percent on.
So the effective interest rate to the state of the promissory note arrangement is 0.75%, not 8.2%. The problem with the current arrangement is not the interest rate but rather the schedule for repayment of the principal, which will see a punishing 2 percent of GDP paid over each year over the next ten years.
The article mentions a figure for the total cost of the promissory notes of €47.4 billion. However, because most of the interest cost is returned to the state, the true net cost is far lower. Effectively, the total cost will be the €31 billion in principal on the notes that were issued plus the cumulated interest costs calculated at the ECB refinancing rate. This will be far less than €47.4 billion.
In relation to substance, the article suggests the negotiations are focused on replacing the promissory notes with bonds from the EFSF and or ESM, which could then be repo’d with the ECB allowing most of the ELA borrowings to be paid off. The state would then provide EFSF\ESM with the funds to cover the annual interest on the bonds with funds.
One version of this arrangement could see the bonds pay out €30 billion in 2042, with the Irish state providing the principal to EFSF\ESM and IBRC finally repaying the ECB. A more likely scenario would see a gradual repayment of the principal via repayment of ECB and retirement of the EFSF bonds.
If these bonds are placed directly rather than borrowed from the market, then one could argue that they should carry an interest rate of close to zero, since the EFSF is no longer adding a profit margin to its cost of funds (and the cost in this case is zero).
An arrangement of this type could mimic the low interest cost to the state of the current arrangements while adding a long-term schedule for repayment of principal. However, it carries with it some serious political complications. As the Times article notes, this arrangement would require political approval throughout Europe and that may be difficult obtain. In addition, this debt would have to be repaid even if Ireland left the euro because of its official status, while a post-euro Central Bank of Ireland would have the option of agreeing to a unilateral restructuring of the promissory notes.
An alternative arrangement that avoids these political risks is to simply alter the current arrangements to have the promissory note schedule be far more back-loaded than at present. This requires only the agreement of the ECB. As I wrote here a few weeks ago, there is a strong argument that it is time the ECB could Ireland some slack.
I have written a new briefing paper for the European Parliament’s Economic and Monetary Affairs committee. The paper discusses the ECB’s role in Ireland’s financial assistance programme. Here’s the abstract:
This paper reviews the role the ECB has played in financial assistances programmes in the Euro area, focusing in particular on Ireland. The ECB’s involvement in Ireland—in particular its policy in relation to senior bank debt—has raised questions about whether it has over-stretched to act beyond its mandate. The ECB is not providing official assistance to the Irish government and its involvement in monitoring the programme has confused the public about the nature of the programme’s conditionality and contributed to undermining its legitimacy. I recommend that future financial assistance programmes should not feature the ECB as a member of a Troika tasked with monitoring the programme. The ECB’s relationships with other crisis countries are reviewed. I conclude that Europe needs to clarify its policies on bank resolution and systemic risk—and the role of the ECB in relation to these policies—before it is too late.
The other briefing papers (some more on the ECB’s role in financial adjustment programmes and others on the response of central banks around the world to the crisis) can be found here. Click on 09.07.2012.
In this article on Forbes.com, I discuss the possibility of a deal with the ECB on Ireland’s promissory notes in light of last week’s summit statement.
One of the great myths about the Irish economy that has circulated in recent years is the idea that the National Asset Management Agency (NAMA) has borrowed money from the European Central Bank. I tried on various occasions in the past to observe that this is not the case without having any impact. However, I had hoped that the people running Ireland understood how NAMA works. Apparently this was too much to hope for.
The money which we accessed for bridging finance from NAMA was money which is due to be repaid to the ECB for the loans it gave to NAMA to acquire the impaired assets in the bank. Again, it is ECB money that is providing the bridge. What will happen is that when the circle is completed and the shareholders give their consent, which is my expectation, the NAMA funds will be restored and NAMA will do what it intended to do last month, namely, it will repay another portion of what it owes to the ECB.
Just for the record (and I know now for sure I’m wasting my time) NAMA has issued bonds to the Irish banks in return for property assets. It can redeem those bonds as it acquires cash for the property assets. The bonds can be used by these banks as ECB-eligible collateral. However, NAMA is not a bank. NAMA is not ECB-eligible counterparty. NAMA has never borrowed, and will never borrow, from the ECB.
During my appearance on the Vincent Browne show a few weeks ago, government TD Damien English told me that the Irish banks were meeting their lending targets to SMEs. It’s hard to follow all the news that comes out on the Irish economy so I wasn’t sure what Damien was talking about but I did express skepticism about this claim based on figures from this IMF report (page 13) showing the banks deleveraging core assets faster than had been planned in the PCAR\PLAR document.
Anyway, I did some work today to check what’s going on. You may recall that in 2010, AIB and Bank of Ireland both committed themselves to €3 billion in …. well in what? That’s a good place to start. Bank of Ireland’s document was fairly vague. The only mention of the €3 billion figure in the announcement was this
Bank of Ireland is committed to providing a minimum of €3bn in lending to viable SMEs each year for 2010 and 2011.
Now banking is a sufficiently complicated business that this could mean anything. It could stretch from an addition €3 billion of loans on the balance sheet, to issuing €3 billion in new loans while some old loans are repaid, or perhaps something else. AIB’s announcement, however, was clearer. It committed itself to
Make available €3bn in new or additional credit to SMEs, including specific working capital support, in both 2010 and 2011.
Since we can presume that both banks had to agree to the same type of commitments, this statement told us that the banks were agreeing to make new loans to customers (featuring “additional credit”).
One thing that the €3 billion commitment clearly did not refer to was restructuring existing loans, as this counts as neither new credit nor additional credit. Indeed, elsewhere in AIB’s document setting out its commitment, the bank makes it clear that they do not think restructuring loans counts as new lending:
AIB is already providing considerable lending support to SMEs in both new lending and in the re-scheduling and restructuring of their existing borrowings
Note “new lending” and “re-scheduling and restructuring” — if the bank thought restructuring was new lending they would not have added the second half of this sentence.
Ok, that’s what the commitment was. Let’s find out how much new lending there has been. Since June 2011, the Central Bank has been publishing figures for SME credit in Ireland, including data on Gross New Lending defined as follows.
This component details the amount of new credit facilities drawn-down during the quarter by SME counterparties, i.e. where this credit facility was not part of the outstanding amount of credit advanced at the end of the previous quarter. Gross new lending is defined in such a way as to exclude renegotiations or restructuring of existing loans.
The latest figures are available here.
Over 2010, total gross new lending to SMEs from all banks in Ireland, not just AIB and Bank of Ireland, was €3.1 billion. For 2011, the figure was €4.3 billion. Total new lending to SMEs excluding lending to financial intermediaries (which I’m guessing is closer to what the commitments actually referred to) was €3.0 billion in 2010 and €3.1 billion in 2011. Whatever way you look at, without knowing how much the non-pillar banks loaned out over the past few years, it is clear that AIB and Bank of Ireland have not met their commitments to together make €6 billion in new loans to SMEs.
Given these figures from the Central Bank, why would Damien English think that the banks have met their target? The answer is likely to be that John Trethowen of the Credit Review Office has declared that the banks met their targets in 2011. Here‘s his latest report from February 2012
I am pleased to advise that AIB and BoI have both achieved their €3bn on loan sanctions.
And here‘s the Irish Times reporting this happy outcome.
Now how can Trethowen think that the targets for new lending have been met when the statistics show that they haven’t? The answer is that, contrary to the original commitments, Trethowen is counting loans that have been restructured:
The €3bn targets achieved in 2011 has a majority of restructured sanctions
It’s interesting to see the evolution over time in Mr. Trethowen’s discussion of these targets. Here‘s his first report, from June 2010. The only mention of targets is a mention of his role in
ensuring the two banks have plans in place to achieve the €3bn p.a. new lending targets over the next two years.
Here‘s his second Report from November 2010. This report mentions that the €3 billion targets being achieved wouldn’t necessarily see balance sheet expansion of the same amount because of a number of factors such as loan repayments. One factor that is mentioned is
‘Old new Lending’ being the restructuring of overdraft lending already on the balance sheets.
The inverted commas are Mr. Trethowen’s, not mine. It looks as though at this point, he doesn’t view restructuring as genuine “new lending”.
By his third report in February 2011, Mr. Trethowen has begun to state that restructuring loans counts towards meeting the targets:
The Minster’s target for new sanctioned lending of €3bn by each of the banks is in line to be achieved by April 2011. This may appear contradictory to the comments elsewhere in this report on balance sheet contractions. The explanation is that much of this sanctioning activity is in debt restructuring to assist many businesses to survive. I have asked both banks to report the amount of ‘New’ money being sanctioned, and they are presently both amending their systems to provide this information.
The target has apparently now shifted from the fairly clear “new or additional credit” to “new sanctioned lending … including debt restructuring”.
By his fifth report in August 2011, Mr. Trethowen had taken an Orwellian turn and started chastising people for actually expecting the banks to keep their promise in relation to new credit:
Until the demand for credit is fully understood there is little point in some commentators being fixated on the amount of New Credit as opposed to restructuring sanctions. It is obviously impossible to grow New Credit in an economy where such credit is not being demanded.
This may have been a rhetorical over-reach for Mr. Trethowen as in his next report in November 2011, he seems to have re-discovered (perhaps via a clip around the ear from someone in government) that new lending is sort of the point of the whole loan commitment thing:
Whilst I have not subscribed to the disparaging of the restructured financing element of how these targets have been achieved to date, I do however accept that a focus should now be brought onto the ‘New Money’ element to reflect and support the prospects for a continuing economic recovery in 2012.
And in his latest report he notes
There is growing interest in the level of new money: restructured money in these sanction figures. I fully accept that restructuring, while important, will not drive growth and the Government would like to see a sharper focus on the element of ‘new’ money sanctioned and drawn in the quarters ahead, and this is reinforced in our meetings with the Pillar Banks.
So there’s a growing interest in finding out how many new loans the banks are actually making given that they had both promised to make €3 billion a year in new loans? Funny that.
Since the Central Bank now collect and publish statistics on new lending to SMEs, one hopes that Mr. Trethowen won’t find it too difficult to obtain this “sharper focus” on new lending. One would also hope that members of the media might remind the government and Mr. Trethowen that spinning about targets met isn’t really the same thing as meeting the targets that were actually set.
I was interviewed on Morning Ireland earlier today about the prospect of a deal with the EU on Ireland’s promissory notes. A recording is available here.