Friday, September 14, 2012

How much are the Promissory Notes worth?

This is a hollow exercise but the 2010 Annual Report for Anglo says:

The fair value of the promissory note is determined by the use of a valuation technique, based on a discounted cash flow methodology, which references observable market data. The fair value is calculated by discounting expected cash flows by reference to current observable market yields for comparable Irish government bonds.

Here are the four tranches of the Promissory Notes:

The 2010 column gives the annual coupon on the notes.   The interest rate was set using an equivalent Irish government bond at the time the tranche was issued.  The first three tranches were issued in the first half of 2010.  Tranche 4 was issued on the 31st December 2010, by which time Ireland had seen bond yields soar and entered an EU/IMF programme.  The annual coupon of the €9.1 billion in Tranche 4 is 8.6%. 

The promissory notes are like an amortising bond in which the interest and some of the capital is repaid each year.  With one-tenth of the capital amount repaid each year the average maturity of the notes is around five years.  The five-year yield as calculated by Bloomberg is currently around 3.9%.  This is nearly five percentage points lower than the coupon on Tranche 4.  What impact does this have on the fair value of the Promissory Notes?

As a simplified comparison, a €100 five-year bond with a coupon of 8.6% that yields 3.9% would have a current value of around €120.  The drop in Irish government bond yields over the past few weeks will do wonders for the aesthetics (rather than the realities) of the IBRC balance sheet.

This is indeed a hollow exercise but things like this probably account for part of the “technical discussions about technical things” we have been hearing about for nearly a year now in relation to rescheduling of the Promissory Notes.  Here is a reference from October 2011 and today in Nicosia at the informal Eurogroup meeting Michael Noonan once again referred to “technical talks”.

Maybe when these are finally concluded we will be a little like Joan Burton was in an early Dail debate on the Promissory Notes when she declared “we need a Powerpoint presentation on this.”

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