Ireland will get a deal on bank debt. There is nothing that has happened over the past few weeks that has made this more likely or less likely. The debt burden assumed by the government in bailing out the banks will be changed but it will fall short of the "seismic", "game-changer" description which greeted the June 29 EU summit.
There have been two ways suggested in which changes to Ireland’s bank debt may be possible. Discussions on a restructuring of the Promissory Notes used to prop up Anglo Irish Bank and Irish Nationwide have been ongoing for more than a year now and is the most likely area where a deal will be struck.
After the June EU summit, which promised to break the link between bank debt and sovereign debt, the possibility of Ireland transferring the equity stake in the viable banks to the ESM was mooted. However, there has never been official confirmation at Irish or European level that this can actually happen.
On September 15, the finance Ministers of Finland, Germany and The Netherlands issued a statement and the main focus was on the part that said “legacy assets should be under the responsibility of national authorities”. In Ireland, the legacy assets of our banking collapse are in the National Asset Management Agency (NAMA) and the Irish Bank Resolution Corporation (IBRC).
NAMA has taken over the hugely delinquent property and development loans from the covered banks while the IBRC is the wind-down vehicle for the now-defunct institutions of Anglo and Irish Nationwide. There was never a suggestion after the June 29 summit that the responsibility for these could be shared through some EU-wide mechanism.”
What is in question is the structure of the Promissory Notes provided to Anglo and Irish Nationwide. In 2010, these bust banks transferred around €43 billion of loans they has issued to land buyers and property developers to NAMA. These loans were so toxic that NAMA was only willing to pay €16 billion to acquire them.
This immediately crystallised massive losses on the balance sheets of both institutions and Brian Lenihan as Minster for Finance issued them with Promissory Notes which committed the Exchequer to providing them with €31 billion plus interest over the following 20 years. In 2009, €4 billion of cash was injected directly into Anglo, bringing the total cost for these failed banks to €35 billion.
After last week’s EU summit, Angela Merkel held a press conference and in response to a question about the recapitalisation of Spanish banks she said that “there will not be any back-dated direct recapitalisation”. In Ireland, the covered banks which the State has assumed responsibility for are already capitalised and are unlikely to need further capital over the next few years.
What Ireland may be looking for is not the recapitalisation of bust banks by the ESM but the sale of heavily capitalised banks to the ESM. In the absence of these injections the banks would be bust but they now have core capital ratios of around 20pc. This capital will be eroded when the banks face up to losses on their loan books but, thus far, there is little suggestion that they will need more capital.
In total, the State has provided over €30 billion to AIB (as merged with EBS), BOI and PTSB. The sale of a portion of BOI returned just over €1 billion but determining what the value of the remaining state ownership of the banks might be for future sales is not easy.
Through the National Pension Reserve Fund (NPRF), the state owns 99.8pc of the ordinary shares in AIB and 15.1pc of those in Bank of Ireland. The NPRF also holds preference shares in the banks with a nominal value of €5.3 billion. In its most recent statement the NPRF put a value of €8.1 billion on its holdings in AIB and BOI but this is subject to revision.
Separately, the Exchequer owns 99.2pc of the ordinary shares in Permanent TSB but the Department of Finance does not publish estimated values of this holding. This year, the Exchequer purchased the Irish Life pensions and life assurance company as part of the recapitalisation of PTSB. The price paid was €1.3 billion and it is hoped that this can be matched or exceeded in a subsequent sale. Finally, the Exchequer holds subordinated bonds with a value of €3 billion between AIB, BOI and PTSB.
All told, across the viable banks the State holds assets with a current nominal value of no more than €15 billion. The cost of these has been €29 billion.
The actual value of the banks will depend on how much of their capital is eroded to cover the inevitable losses that will materialise as a result of their bad lending practices during the bubble and whether they can re-price their loan and deposit products to return to operating profitability.
Should Ireland look to sell these assets to the ESM? It is worth reiterating that no decision has been taken to allow the ESM to buy state-owned financial assets. The June 29 summit agreed that, at some point in the future, the ESM could be used to recapitalise banks. There have been suggestions that if Spanish banks are recapitalised by the ESM, which is not guaranteed, that this would be retroactively applied to Ireland. This could happen but the actual benefits of this are unclear.
If it is decided that the ESM can purchase these assets, then a price of €15 billion would make little difference to the financial position of the State. There would simply be the transfer of €15 billion of financial assets for €15 billion of cash. The perception of Ireland’s financial position might improve as the gross debt figure would be reduced and concerns about possible future payments to the banks could be eased.
In order to make a real difference to Ireland’s position a price significantly above €15 billion would have to be agreed. There is little likelihood of that occurring as transactions with the ESM will be done at market value, though a negotiating position could make an argument in favour of some “long-term economic value” that would be greater than the current value.
It is also unlikely that the Eurozone’s finance ministers would allow the ESM to take over the state’s banking assets in order to make our financial position “look better”. At present there is domestic responsibility for the decisions that have to be taken in relation to loan arrears and debt writedowns, and in relation to the pricing decisions that have to be taken to return the banks to profitability.
European institutions currently do not enjoy a high sentiment and approval rating among the Irish population and becoming directly associated with the clean-up operation of the domestic banking catastrophe would only further reduce that standing. There would also be the fear that with the Irish government no longer financially tied the banking sector that the incentives in the public and private spheres to deal with the banking crisis would be warped.
Although heavily discussed, a sale of the viable banks to the ESM is unlikely. No decision to allow it has been made and a price well in excess of the market value would have to offered to make it worth our while. We will get some debt reduction from the sale of the viable banks but it will more than likely come from a future private sale.
John Fitzgerald of the ESRI has indicated that if greater economic stability has taken hold in the period up to 2020 it could be possible for the state to realise up to 20pc of GDP from the divestment of its stakes in the pillar banks. This is well in excess of 10pc of GDP which could be obtained from a market-price sale in the current distressed climate.
The debt deal for Ireland will be a change to the terms of the Promissory Notes. If suitably low interest rates and a much extended repayment term can be agreed, this has the potential to offer real savings. Selling this from a political level will be difficult as the restructuring will not involve any capital writedown. The problems in this regard are mainly as a result of overselling the June 29 EU summit.
Until the details are finalised and released, placing a value on the benefit of these changes is impossible. This year the government will have a deficit of €7 billion even before debt interest is taken into account and the €6 billion interest bill is mainly the legacy of previous deficits rather than the bank capitalisation payments. The bank debt deal is important but what really matters for Ireland’s future debt sustainability is a continued reduction in the deficit and a return to economic growth.