What next for Promissory Notes?

Wednesday 09 May 2012 14.56

Tony Connelly, Europe Editor, in Copenhagen

The government is putting the best gloss it can on the Anglo promissory notes deal, but opinion is divided as to how much has been achieved.

The exchequer doesn’t have to find €3.06 billion immediately, and it can potentially ease the state’s return to the bond markets in early 2014. On the other hand the deal will still cost the state €90m in costs, and it will have to be revisited in one year’s time.

In simple terms, instead of making at €3.06 billion payment to IBRC (formerly Anglo), the state has issued a 13 year bond which will allow the bank to secure the payment via a one year refinancing operation through Bank of Ireland (BoI).

Because BoI has to clear the arrangement through shareholders who meet in May, NAMA will step in to provide a bridging loan.

Given the complicated nature of the arrangement it’s not surprising that the ECB statement issued last night (March 29) appeared faintly distasteful.

The ECB “noted” the arrangement – in other words it didn’t “welcome” it – and went on to tartly insist the Irish Government stick to the future repayment schedule it signed up to.

On the face of it, this seemed a slap down to the government’s hopes that the payment deferral provides time to negotiate a longterm solution to the problem, via the completion of a much vaunted Troika paper which would implicitly carry ECB, European Commission and IMF approval.

Arriving in Copenhagen for a meeting of eurozone finance ministers Michael Noonan was, however, sanguine. “It’s a very matter-of-fact statement, it’s the kind of statement we expected, there’s nothing surprising in it,” he said.

It is fair to say, however, that the ECB statement reflects broader unease with the promissory notes issue.

The way the promissory notes deal works is that the government provided Anglo and Irish Nationwide with IOUs in order to meet liabilities of some €31 billion. Those notes allowed the banks to secure Emergency Liquidity Assistance (ELAs) from the Irish Central Bank because the they didn’t have the required collateral to access cheap financing directly from the ECB.

As such, the Irish government still has an obligation to “pay back” that cash for the renamed IBRC. But instead of making €3.1 billion payments every year for the next 10 years the government wants a longer repayment schedule at a lower interest rate.

The ECB is cautious about the arrangement for two reasons.

Firstly, Frankfurt’s role is to provide liquidity to banks in the euro area, not to provide it to governments. They are constantly vigilant that there is no blurring of the distinction in whatever arrangement is arrived at.

So if the Irish government is looking to save money by re-engineering the promissory notes then that raises alarm bells within the ECB that the distinction is being blurred. It’s for that reason that Frankfurt is satisfied that Bank of Ireland is involved in the payment deferral: it’s a private bank which can access ECB funding because it has the correct collateral. It also keeps the Irish state at an arms length from ECB liquidity.

The ECB mantra is that the overall stability and credibility of the euro area must be safeguarded at all times.

The second reason is that the ECB doesn’t like banks being addicted to ELAs because it is contrary to the smooth operation of the Eurosystem. Banks should get their loans in the normal ECB financing method.

In order to access that financing, banks in the euro area need collateral, and of course collateral is exactly what the IBRC lacks.

One option that is being looked at is to go to the European Financial Stability Facility (EFSF) for that collateral. The EFSF already provides one third of Ireland’s bailout and in total it has pledged €200 billion to Ireland, Greece and Portugal.

Theoretically the EFSF could grant Ireland a €30 billion bond and with that bond as collateral the IBRC could access the ECB’s normal financing operations.

The EFSF bond could then have a very long maturity date and carry a low interest rate, something similar to what Ireland’s interest rate was reduced to last summer, ie 3pc plus a small margin to cover borrowing costs.

A well-placed EU source has confirmed to RTÉ News that technical discussions have taken place on the idea, but they hadn’t yet reached political level. Interestingly the use of the EFSF to recapitalise banks is already being looked at for Greece.

When Greece underwent its highly publicised debt restructuring in February there was a sweetner to encourage banks to take part in the bond swap, and to recapitalise those Greek banks which lost substantial capital in the debt write down.

The idea being looked at is for those Greek banks to get a low interest bond from the EFSF which could then be used as collateral to access the ECB directly.

The official government line is that the EFSF is one a number of options being looked at, but that everything is up in the air while the Troika continues to complete its paper on the issue.

The benefit of the EFSF route is that it would automatically take the IBRC off its need for ELAs from the Irish Central Bank, and that would satisfy the ECB.

The drawback is that any bond coming from the EFSF is guaranteed by the triple A creditor countries which underwrite the fund. Each time the EFSF is tapped it requires political, often parliamentary support from those countries like Finland, Austria, Germany and the Netherlands which have been most implacable in their opposition to countries appearing to get easy terms.

The other problem is that if the government was given a long-term, low-interest bond from the EFSF in order to solve the Anglo promissory notes once and for all, it would erode the EFSF’s lending capacity, just at a time when the world is hoping to see it merged with the incoming European Stability Mechanism (ESM).

The more bites taken out of the EFSF, the less it can act as a bulwark to the €500 billion-strong ESM, even if the EFSF is used in parallel only on a temporary basis.

When asked about the use of the EFSF or the ESM Michael Noonan said this: “The bigger the firewall the more potential there is for the European authorities to different things… but the priority for us is not the strength of the ESM. The priority for us is that the ECB provide us with continuing low-cost funding, and that’s going to be the key piece of the negotiation.

“The use of the EFSF, say for the issuance of a bond, obviously the ECB would favour that because it would improve their collateral significantly. But that in itself would be of little use to Ireland unless we got the commitment of ongoing medium-term, low-cost funding from the ECB,” he said.

The government has a year to make its case. It wants to reconcile the longterm financing costs of the IBRC in a way which doesn’t add to, but eases, the state’s longterm repayment burden. It will have to convince the ECB first, but if they are to go the route of the EFSF then they will have to convince a range of hard-pressed, bail-out weary governments (and their taxpayers) across the eurozone.

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