What happened yesterday?
We learned that the Government had achieved its long-stated goal of reducing the cost of a portion of the State’s debt. This debt, which related to the former Anglo Irish Bank and Irish Nationwide Building
Society, was created in 2010 whenthe State issued promissory notes.
Why did we have promissory notes in the first place?
The government of the time was under pressure to support Anglo and Irish Nationwide (now together known as IBRC) with an injection of billions of euros that it simply did not have.
The usual route to raising the funds on the bond markets was closed to the Republic at the time and other sources of cash, such as the National Pension Reserve Fund, had already been exhausted, so the idea of promissory notes came to the fore.
The notes are like IOUs, the beauty of which (at the time) was that the State did not have to produce the ¤30-plus billion needed by the two banks upfront. Instead, it could promise to pay it in the future,
along with interest. The ECB, which held all the cards at the time, said this was OK.
How did the promissory notes work in practice?
The government gave IBRC an IOU for €31 billion, which the banks then used as security, or collateral, to borrow from the the Irish Central Bank via its short-term Exceptional Liquidity Assistance facility –
the very last resort for commercial banks.
This was expensive, involving an annual repayment of €3.1 billion until 2023, followed by lesser payments until 2031. The total cost of this would have been €48 billion.
Why was it so important to achieve a deal?
Apart from the cost savings that will be realised under the newarrangement, the Government had hung its hat on the negotiations and thus needed the political victory that should ensue.
Crucially, it is expected that the deal will ease the path to exiting the EU-IMF bailout programmeat the end of this year by making it easier for the State to borrow on the bond markets.
A good gauge of this will be the reaction of ratings agencies to the new deal – an enthusiastic thumbs-up should make life for the State on the bond markets much more straightforward.
How will the new deal work?
IBRCwas liquidated early yesterday morning, which means it will be quickly run downand disappear from the banking system.
As part of this, the Central Bank will take ownership of the promissory notes that were being used as collateral for the funds the Central Bank itself was providing to IBRC via the last-resort lending
structure known as ELA. Nama will also be involved, “buying” some of the IBRC collateral held by the Central Bank by issuing Nama bonds and thus taking control of IBRC assets. Nama will, later this year, try to sell these assets.
So does this mean the debt disappears?
No, far from it. It will become cheaper, though, and won’t need to be repaid as quickly as the promissory notes. This is being achieved by the State issuing a batch of long-term bonds with a life of up to 40 years to replace the promissory notes.
These bonds will have an average interest rate of 3 per cent, whereas the headline interest rate on the promissory notes was 8.2 per cent. It should be remembered, however, that the real interest rate on the notes was considerably lower because both IBRC and the Central Bank benefited from the way the Statemade its repayments.
But does this not just mean that the debt is hanging over our heads for longer?
Yes, we now won’t see the back of it for four decades, with the last payment due in 2053. Wherethe Government steals its victory, however, is in agreeing that no repayment of the principal (the actual amount borrowed) needs to be made until 2038.
This eases pressure on the State’s finances over the next few years. The Taoiseach likes to use the example of replacing an expensive short-term overdraft with a cheap long-term mortgage.
But surely long-term loans are ultimately more expensive?
Here,we get some help from inflation, the process by which prices rise in most economies. By the time we come to repay the bonds, inflation should have significantly eaten into their value, thus making them cheaper. The complicated structure of this deal has also been designed to minimise the overall cost.
Where does the IBRC liquidation fit into all of this?
Many would wish Anglo and Irish Nationwide had been liquidated, or wound up, at the very start of the financial crisis, saving us all a lot of stress and money.
Instead, both banks were originally allowed to limp on because the then government was persuaded that letting them go would destabilise the whole financial system too much. In the event, State bankruptcy ensued anyway.
So what’s the logic of liquidation now?
It could be argued that IBRC’s liquidation was not strictly necessary for a deal to be done on the promissory notes, but that it came as a convenient consequence, albeit not for the staff and customers involved.
For the State, expunging what Enda Kenny describes as “stains on our international reputation” provides closure on a sorry legacy from the previous administration. The idea of standing over the permanent removal of the bank from the landscape is thus appealing.
For the ECB, meanwhile, no more IBRC means no more ELA, its least-favoured form of finance. ECB governor Mario Draghi was reluctant to discuss the agreement at yesterday’s monthly press conference in Frankfurt, but the end of ELA was something he was prepared to emphasise.
It is also worth considering IBRC’s annual running costs of €320 million or so – it is hard to argue that these could be justified in the wake of this deal, particularly with Nama available to take on a similar role. Nama’s annual running costs are in the order of €130 million.
Why did it have to happen yesterday?
News of the liquidation had reached the media, which immediately made IBRC vulnerable. This led the Government, as shareholder, to act quickly to protect the bank’s €12 billion in assets.
What does liquidation mean for IBRC’s depositors?
Most deposits at IBRC were transferred to AIB last year, while those that remain (mostly corporate loans worth about €1 billion) should be covered by two State guarantee schemes.
What about IBRC staff?
The bank’s 1,031 employees are being made redundant but the liquidators will be able to rehire them for as long as the liquidation takes. It is expected that most staff will be retained on this basis, with some then transferring to Nama.
What is the benefit for the domestic economy in the deal?
Kenny said it would mean the State’s overall funding shortfall, or deficit, would ease by about €1 billion over coming years. The knock-on effect of this should be that the Government will need to impose €1 billion less in spending cuts and tax increases, or €1 billion less austerity.
It should also remove a lot of pressure from the NTMA, the body charged with managing the State’s funding requirements.
Over the coming decades, the agency should need to borrow €20 billion less than it had expected, making the overall debt burden more sustainable.
