Government Bonds held by the State-Owned Banks

A lot of attention has been given to the Irish government bonds held by the Central Bank of Ireland and the benefits that arise from the recycling of interest payments back to the Exchequer.  In a vein similar to this are the substantial holdings of Irish government bonds by the ‘covered’ or Irish-headquartered banks.  A breakdown of the overall interest bill is here.

Originally the covered banks were AIB, Anglo, BOI, EBS, INBS and PTSB but now only AIB, BOI and PTSB remain.  This chart shows their combined holdings of Irish government bonds since 2008.

It can be seen that around nil in the run-up to the crash in 2008 but increased substantially during the crisis and now the banks have a holding with a market value of around €19.4 billion. 

This is significant because both AIB and PTSB are almost fully state-owned so the interest paid on these bonds does not leave the broader government sector.  There are similar benefits with BOI but to a lesser extent as that is now 14 per cent state-owned.

The recent interim financial reports for 2014 from the banks allow us to see the breakdown of this €19.4 billion across the three banks.  Some extracts from the reports are reproduced below the fold but the relevant figures for end-2014 are:

• AIB: €9,107 million
• PTSB: €3,857 million
• BOI: €6,409 million
• Total: €19,373 million

These are market value figures.  The face value is probably around 15%-20% less given than the current yields are much less than the interest coupons.  Still it is likely that between them AIB and PTSB hold around €10 billion of government bonds.  If the average interest coupon is 4 per cent then €400 million of the annual interest bill is going to state-owned banks.  It doesn’t have the full circular nature back to the Exchequer as with the interest flows to the Central Bank but it not a net loss to the State either.

It could also be considered that the money the government used to bailout the banks was borrowed from the banks themselves.  And hopefully we will be able to pay this money back by selling the equity stakes we have built up in the banks so the interest expenditure never leaves the government sector.

It is also worth noting that the banks will have made significant profits on these bonds.  Their holdings grew rapidly from mid-2011 and roughly doubled (from €9 billion to €18 billion) over the next 12 months.  Two things are notable about this period when the banks purchased these bonds on the secondary market.

1. The summer of 2011 was when AIB and PTSB received most of their recapitalisation funds from the state (following the March 2011 PCAR exercise).
2. It was the period when the yields on Irish government bonds were at their highest.

The banks used the recapitalisation funds, in part, to buy Irish government bonds and have made large profits on them.  The table from AIB’s annual report shows an “unrealised gross gain” of €1.3 billion from it’s holding of Irish government bonds. 

We can imagine this being roughly double, around €2.5 billion, across the holdings of the three banks. Not only are we not paying interest to third-party investors on the money used to bail out the banks, the banks actually made a profit by using the money to buy Irish government bonds on the cheap from such investors.

Here are the extracted tables. First AIB (pdf page 265):

And PTSB (pdf page 22):

And finally BOI (pdf page 154):

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1.999

The implied 10-year yield on Irish government bonds has fallen below two percent.  And as can be seen in the table below the implied eight-year yield is less than one per cent.

The yield has been falling for the past while but the drop today is an acceleration of that.

It is hard to see how anyone would give money to the Irish government for eight years at a yield of less than one percent.  Things are improving but risks remain.  Of course, they are not really buying these on the basis that Ireland will repay the money; they are buying on the basis that Mario Draghi will step in to give them their money back.  Draghi has had undoubted success in bringing government bond yields down. Is there any chance he could have similar success in bringing economic growth rates up?

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10-year yield drops to 2.48%

Two point four eight.  Really?

It seems so.

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Bond yields tumble; should we refinance debt?

There was much talk over the weekend that the Moody’s upgrade of Irish government bonds on Friday was merely Moody’s catching up with the market.  If that was the case then it would have been reflected in little or no change on the yield on Irish government bonds this morning.  That has not been the case.  Yields have fallen considerably.  Here is a five-day chart of the five-year yield calculated here.

The drop at 8am this morning is pretty apparent.  The reputation of ratings agencies has taken a deserved battering in the past few years but their significance in financial markets seems to have remained.

Any debate about the decision not to go with a Precautionary Credit Line now seems moot.  Although the yields now back the decision the reality is that the PCL was unlikely to be used if it was in place.  Here is chart from an interesting presentation on Portugal.

Ireland’s debt financing needs over 2014 and 2015 was less than 5 percent of GDP which is much lower than Greece, Portugal, Spain and Italy.  At the end of 2013 Ireland had a cash reserve of around 12 percent of GDP which is enough to cover debt and deficit financing until the first half of 2015.  A PCL would have lasted 12 months before it would expire or require renewing.

Of the 5 percent of GDP debt financing needs for 2014 and 2015 about half has already been covered with the maturity of a bond on the 12th of January.  As shown here the only bond currently in issue that matures over the next two years is a €3.6 billion bond that will need to be paid in February 2015, while the one following that is a €10 billion bond that matures in April 2016.

The debt profile shown by the NTMA shows a large EFSM loan that is set to mature in 2015.

The EFSM loans, however, will have their terms extended as agreed by the ECOFIN last June but the actual change will not be determined until closer to the original maturity debt.  As the NTMA note:

EFSM loans are also subject to a seven-year extension that will bring their weighted average maturity from 12.5 years to 19.5  years.  It is not expected that Ireland will have to refinance any of its EFSM loans before 2027. However, the revised maturity dates of individual EFSM loans will only be determined as they approach their original maturity dates.

Ireland’s low refinancing needs have undoubtedly been a factor in the relatively benign move out of the direct funding phase of the EU/IMF programme.  However, given the current level of borrowing rates, it might be better to have slightly more debt to refinance at the current lower rates.  As John Corrigan said on today’s Morning Ireland (reported here):

“each one tenth of one percent of a fall in the interest rate for every billion we borrow represents a saving of about a million per annum.”

Refinancing €10 billion of debt at a one percent lower interest rate would save around €100 million per annum.  The problem with this potential saving is that we don’t have debt to refinance.  We can’t just buy existing debt as that would have to be bought at the current lower yields, i.e. higher prices.  We need existing bonds to mature to benefit from the lower rates.  As we have seen we have less than €4 billion maturing over the next two years. Maybe we should give thought to repaying the EU/IMF loans early.

This seems particularly worthwhile for IMF loans.  These have an average interest rate of around 4.2 percent (almost one percentage point over the current ten-year yield).  Ireland has accessed €22.5 billion of loans from the IMF.  This will amortise in different tranches from 2015 to 2023.

So why not pay off the relatively higher cost IMF loans with the relatively cheaper funding now available from sovereign debt markets?  The problem with this is that one condition of the overall €67.5 billion funding package is that any early repayments must be split in proportion across all the lenders.  The IMF provided one-third of the overall funding.

So if we wished to repay €10 billion of IMF loans then a further €20 billion would have to be repaid to the EU lenders (EFSF, EFSM and UK, Danish and Swedish bilaterals).  Repaying the high-interest, relatively short maturity IMF loans makes financial sense.  Repaying the low-interest, very long maturity EU loans currently does not make financial sense.

Repaying IMF loans early is sometimes used as a positive indication for post-bailout countries. Iceland has done so.  Interest rates are now at levels that mean Ireland would gain financially and reputationally from doing so.  The structure of our EU/IMF funding package means it is unlikely to happen but if bond yields were to continue to tumble…

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10-year yield at 3.49%

Here is a snapshot of Irish government bond yields as calculated by this website (go to Live Quotes ⇒ Bonds ⇒ World Government Bonds and select Ireland).

Really?

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Yield Curve

This site gives a snapshot of Irish government bond yields at different maturities.

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A Year of Bond Yields

This time last year doubts about Spain were a factor in driving up sovereign bond years for the ‘peripheral’ Eurozone countries.  The Irish nine-year government yield as calculated by Bloomberg rose from just over 8% up to near 10% in a couple of days.

Since then, for one reason or another, the path of the yield has been consistently down.   By dropping below 4.7% in the past few days the yield is at levels not seen since the summer of 2010 and well below the 7% levels that emerged in the weeks leading up to Ireland’s entry into an EU/IMF rescue programme in November 2010. 

Here is the range of Irish yields along the yield curve provided by Bloomberg:

• 1-year: 1.28%
• 3-year: 1.59%
• 5-year: 3.44%
• 7-year: 4.02%
• 9-year: 4.67%

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GDP/GNP Revisions

As pointed out in the previous post Irish national income statistics are hugely influenced by the MNC presence here.  The figures themselves are also subject to frequent revision as new information becomes available and is incorporated into the statistics.  In the fourth paragraph of the recent National Income and Expenditure Accounts the CSO said the following:

The estimates for 2011 are based upon indicators for the different aggregates and must be regarded as tentative. The provisional nature of the estimates for 2009 and 2010 must also be borne in mind. In particular, the estimates for the year 2010 in the present report must be regarded as preliminary. Many of the inquiries upon which the basic compilations rest are incomplete and to the extent that figures given for 2008 and 2009 are still partly subject to revision, projections for the year 2010 are also affected. While no guarantee can be given that published figures will remain unaltered as inquiries proceed and as sources and methods are reviewed, it is expected that any changes made in future in relation to years earlier than 2007 will have a relatively insignificant effect on the year-to-year trend in these data.

The first estimate we will use is from the Q4 2011 QNAs released back in March and the second is from the Q2 2012 QNAs released yesterday.

The statistical revisions for GDP are shown below.

And is what has happen to the GNP estimates.

The upwards revisions make absolutely no difference to the economic reality faced by people but it does highlight the difficulties of measuring economic activity and further downplays the import that should be placed on the 4.3% rise in GNP reported yesterday.  As well as not reflecting the domestic economy it could be revised away in subsequent data releases.

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Bond Yields

The pattern of Irish government bond yields in the past few weeks has been remarkable.  Here the a six-month chart of the nine-year yield as calculated by Bloomberg.

This seems to be only term in the set provided by Bloomberg that still produces the interactive charts.  Anyway as we pointed out last week the drops have been right along the yield curve.

Since last week the falls have continued.  At the time the nine-year was at 5.3% and as can be seen above the continued decline has seen it drop below 5%.  This is all in the face of public finance data, national accounts data, employment data, retail sales data that fails to impress.  As before, this drop in bond yields should be considered a positive but one that, for the moment at least, should be viewed as transitory rather than permanent.

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Bond yields, debt and deficits

It has been an incredible week for Irish government bond yields.  This table has the indicative yield as calculated by Bloomberg for a representative set of maturities on the last day of August and as of this morning.

Term	Aug 31	Current	Change
1-year	1.79%	1.36%	-43bp
3-year	3.35%	2.05%	-130bp
5-year	5.19%	3.82%	-137bp
7-year	5.68%	4.62%	-106bp
9-year	5.94%	5.27%	-67bp

The largest proportionate drop has been in three-year yield but the drops have been right along the yield curve.  There has been no improvements in the Irish economy in the past few weeks that can explain these moves.

The announcement of Outright Monetary Transactions (OMTs) by Mario Draghi is important and at the same timeframe used above the Spanish five-year yield as calculated by Bloomberg has moved from 5.50% to 4.41%.  Clearly the moves by the ECB can explain a large part of the yield decrease but the drop for Ireland has been larger.

It is likely based on expectations of the “deal on bank debt” though this has been in the offing since the June 29th EU Council Meeting.  This week’s IMF Article IV Report on Ireland shows what could happen to Ireland’s debt ratio if this deal delivers at the top-end of expectations.

A debt ratio of around 80% of GDP by 2020 would be remarkable.  Of course, this is based on a benign growth scenario and a deal with the ESM for the viable banks (the ESM purchasing them for €24 billion) that is unlikely.  In the absence of the debt improvement agreement and underperformance of growth the following could happen.

The stagnant growth scenario sees the debt at 130% of GDP as early as 2017 and continuing the rise.  This is not a sustainable position.

Current Irish bond yields are more reflective of the “baseline growth and ESM equity and refinancing of promissory note” scenario of the first graph than the “stagnant growth scenario” of the second.

The likely outcome will be between these.  A bank debt deal that doesn’t meet expectations or lethargic growth will bring the second graph into the focus of prospective buyers of Irish government bonds.  The current run of these bonds is a positive but the yields can rise much faster than they fall.

Also, as highlighted by yesterday’s Fiscal Advisory Council Report the biggest threat to debt sustainability is the continuing deficit.  While the debt deal will affect the level of Irish public debt the deficit will determine the trajectory.

The FAC are pretty explicit that the risks are to the downside with larger deficits more likely than lower deficits.  The current plan as outlined in last April’s Stability Programme Update are for the deficit to just edge below 3% of GDP by 2015 (2.8%).   The FAC recommend a faster adjustment process which would bring the deficit down quicker, add to the likelihood that the public debt ratio will stabilise and provide buffers against growth underperformance.

Last week, updated National Income and Expenditure data from the CSO and some revisions from the Department of Finance showed that the 2011 ‘underlying’ General Government Deficit (i.e. excluding bank payments) was €14.3 billion or 9.0% of GDP.  In 2010 the ‘underlying’ deficit was €16.7 billion or 10.7% of GDP and in 2009 it was €18.8 billion or 11.7% of GDP.

[This measure of the ‘underlying’ deficit excludes bank recapitalisation payments but does not exclude banking-related revenues such as the Central Bank surplus, bank guarantee fees, dividends and other receipts.]

Since the ‘underlying’ deficit peaked in 2009, the nominal improvement was €2.1 billion in 2010 accelerating to €2.4 billion in 2011 and in terms of GDP the improvements have been one percentage point and 1.7 percentage points respectively.

For 2012, it looks like the rate of improvement will slow although it will be this time next year until that can be ultimately confirmed.  Most projections are for a deficit this year of around €13 billion or 8.3% of GDP and one of €12 billion or 7.5% of GDP in 2013 (though this is influenced by the of the ‘interest holiday’ on the promissory notes).

After seeing the deficit fall to 9.0% of GDP in 2009, the current plan is that it will fall by justa further 1.5 percentage points over the next two years to 7.5% of GDP.  This will add €25 billion to our borrowings.  Even by sticking to the terms of the Excessive Deficit Procedure there will still be a deficit of €5 billion in 2015.

The banking disaster beginning from 2008 has added about €45 billion to the general government debt.  The ‘underlying’ deficits over the same period have totalled around €63 billion.  Another €38 billion of deficits are expected to be accumulated over the next four years.  It is possible that the table of bond yields shown above won’t always look as positive.

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Bond Prices Rise

Here is a screen-capture of yesterday’s Daily Outstanding Bonds Report from the NTMA.

And here is the equivalent from today’s report.

The price of all Irish government bonds rose today and the associated yields to maturity fell accordingly.  The biggest change seems to have been in the February 2015 bond which rose in price from €104.87 to €106.19 and is now yielding 1.86%.  This is the only inversion, albeit minor, in the yield curve as the January 2014 bond is yielding 1.89%.

On the 26th of July, the NTMA re-launched Ireland’s government bond programme.  Among the steps taken that day a new October 2017 bond was issued.  This had a coupon of 5.5% and on the day the bond sold for €98.27 per €100 unit giving a yield of 5.9%.  As can be seen above the bond is now trading at €106.88 and purchasers at that price are getting a yield of less than 4%. The price of the bond has risen nearly 9% in seven weeks.

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Changes along the yield curve

The following image are screengrabs from Bloomberg for the yield on Irish government bonds over the past three months.  The top two are the 8-year and 5-year yields, while those across the bottom are the 3-year, 2-year and 1-year yields.  Click the image to enlarge.

The actual bonds on which these indicative yields are derived can be seen in the NTMA’s Daily Outstanding Bonds Report.

There are two things worth noting.  First, is the continued upward-sloping yield curve for Irish government bonds.  The yields as calculated by Bloomberg go from 1.59% over one year to 5.90% over eight years.

Second, is the differing performance of the bonds over the past three months.  The longer term yields in the top row show a big shift in the aftermath of the EU summit of  at the end of June but show little change since then.  The eight-year has slowly edged below six percent but the five-year is largely where it was in the days after the summit.

On the other hand the shorter term yields of three years and under have all declined steadily over the past three months.  The three-year and two-year were declining in advance of the summit, experienced a small drop after it and have continued downward since.

Over the past three months the three-year yield (which is well outside the window of the current EU/IMF funding programme has gone from over seven percent to just under three and a half percent.  The two-year was also above seven percent but in just three months has now dropped to just two and a half percent.  The clear view is that the D-day bond due to mature in January 2014, which at one stage represented a funding cliff of around €12 billion, will be repaid. 

This January 2014 bond is now yielding around 2.2% is now trading at a price of around €102.40 per €100 unit (coupon 4.0%).  Last July, this bond briefly fell to as low as €65 per €100 unit.  That is a rise of nearly 60%.

The one-year yield has also declined recently but that is within the timeframe of the EU/IMF funding.   It might also be a factor that trading volumes over this period may be low but the NTMA report does show that there are trades occurring at these yields.

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Irish government bond yields

Bloomberg calculate a number of indicative yields for government bonds at different maturities.  For Ireland they currently provide 1-year, 2-year, 3-year, 5-year and 8-year yields.  The yield curve is upward sloping with the following yields (as of 15:45)

• 1 year: 1.91%
• 2 year: 2.74%
• 3 year: 3.73%
• 5 year: 5.38%
• 8 year: 6.04%

Over the past month or so there has been a contrast in performance between those at the shorter end of the range (less than three years) and longer maturities.  This chart from Bloomberg compares the performance of the 2-year and 8-year yield relative to their positions 3 months ago.

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A Year of Bond Yields

It is now a year since the Irish government bond 9-year yield as calculated by Bloomberg peaked at 15.5%.  As of today it is just under 6.3%.

The peak last July was the result of uncertainty in the run-up to the July 21st EU Summit.  There were strong rumours that Private Sector Involvement (PSI) and bond writedowns would be a feature of all bailout programmes.  Greek and Portuguese yields shot up similarly.

As it was, PSI was limited to Greece while Ireland and Portugal were ‘rewarded' with significant reductions in the interest rates on their EU loans.  Irish yields dropped precipitously in the weeks after the summit, in part driven by the decision to limit PSI to Greece and also because of purchases by the covered banks who used some of the recapitalisation money they received last summer to buy Irish government bonds.

This has proven to be a good investment for the banks.  The most recent Money and Banking Statistics from the Central Bank show that the covered banks holdings of Irish government bond are worth €16.3 billion.

The yields fell to around 8.5% by early September and stayed around there until Spanish  borrowing costs exploded in late November.  The Irish 9-year yield briefly threatened to return to the 10% mark, but the jump in late November was followed by a steady decline to 7% over the next two months.  This fall began a couple of weeks before the ECB launched its Long Term Refinancing Operations (LTRO) that provided close to €1 trillion to eurozone banks.

For the next three months the yield hardly budged from 7% before a step-up to 7.5% in mid-May following further Spanish uncertainty.  The announcement at EU summit on the 29th June last of possible direct bank recapitalisation by the ESM and the mention of some retrospective action in the case of Ireland saw the yield drop to 6.3% where it has been since.

One thing is clear over the year: changes in Irish government bonds yields have very little to do with domestic developments.  All the big changes over the past year have been driven by external or official events.  Economic data in Ireland has largely been moribund over the period with no discernible upward or downward pattern.

Uncertainty was of the biggest determinants of the yields.  Uncertainty about the size of the hole in the banks pushed Ireland out of bond markets and into an EU/IMF rescue programme.  Uncertainty about the possibility of PSI pushed the yields nearly 16% last July.

There is still a good deal of uncertainty: will the budget deficit continue to fall?  what do the recent EU statements mean for Ireland?  where will the growth come from?  We must wait to see what the answers will bring.  It will take some more ‘good news’ to bring the yields to 5% and lower which makes sustainable borrowing costs more likely.

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Five-year yields

As expected last night’s eurogroup meeting of eurozone finance Ministers didn’t deliver a whole lot in public.   It wasn’t expected to.  All the statement really shows is the timetable to implement some of the decisions taken at the EU summit on June 29th. 

In the context of EU decision-making the proposed timetable for an ECB-centred eurozone banking supervisory structure is lightning fast.  It remains to be seen what can be delivered by the proposed end-2012 deadline.

Here are some five-year government bond yields as calculated by Bloomberg (as of 10:45)

• Greece 61.19%
• Portugal 9.77%
• Spain 6.13%
• Ireland 5.46%
• Italy 5.42%
• Belgium 1.58%
• France 1.02%
• Austria 0.86%
• Netherlands 0.86%
• Finland 0.80%
• Germany 0.35%
• Cyprus
• Estonia
• Luxembourg
• Malta
• Slovakia
• Slovenia

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Bond Yields

After three months with barely a budge the Irish government 9-year bond yield as calculated by Bloomberg jumped back over 7% in the last few days.

The yield did rise as high as 7.7% earlier but is now back to around the 7.4% level it began the day at.  There have be no domestic changes to explain the move in recent days and the driver is uncertainty in Greece.  On this day last year the equivalent yield was 11.2%.

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Greek 10-year bond yield

Here is the Greek 10-year bond yield as calculated by Bloomberg for the past month.

The impact of the ‘default’ finalised last week is very evident.  But even with that the yield remains at 18%.  The Bloomberg nine-year equivalent for Ireland is at 6.9%.

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The recent bond swap

A recent look through Bank of Ireland’s preliminary report for 2011 revealed the following nugget of information on page 64:

On 25 January 2012, the National Treasury Management Agency offered bondholders the opportunity to exchange their existing holdings in respect of the 4% Treasury bond 2014 for a new 4.5% Treasury bond maturing in February 2015. The Group converted €1.3 billion of its Treasury bond 2014  into the new 4.5% Treasury bond 2015.

The NTMA announced that €3.53 billion of the Janurary 2014 bond was switched to the February 2015 bond.  Bank of Ireland accounted for 37% of the total amount swapped.

At the 31st of December  2011 BOI held €5,149 million of Irish government bonds on its balance sheet.  This is 6.0% of the total outstanding government bonds of €85,317 million.

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Bloomberg yield goes below 7%

Apropos of nothing in particular the Irish government bond 9-year yield as calculated by Bloomberg finished the day at 6.93%.  This is the first time it has finished below 7% since the 1st of November 2010.

Of course, actual yields on trades performed through the Irish Stock Exchange have been below 7% for more than a week.

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All yields now under 7%

Here is a snapshot from yesterday Daily Outstanding Bonds Report from the NTMA.

At there closing prices in trades put through the Irish Stock Exchange yesterday all Irish government bonds were yielding less than 7%.

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