Getting money back from Anglo?

On the release of Anglo Irish Bank’s half-year results to the end of June 2011, chief executive Mike Aynsley said the following:

"I would be cautiously confident that we are going to get a better result then we had previously expected," chief executive Mike Aynsley told reporters on Friday.

The nationalised lender expects to have shut down by 2020 and Aynsley said he believed the final capital bill for the bank would come in a range of 25-28 billion euros.

"I think it is going to be towards the end (bottom) of that range," Aynsley said.

This all seems ok but note the focus on the “final capital bill for the bank”.  We have provided €29.3 billion of capital to Anglo; Aynsley reckons they will need €25 to €28 billion (with the hope that it will be closer to €25 billion); so there will be a “capital surplus” to be returned to the State.  Good news? Maybe not if we take a closer look at the “total bill for the bank”.

It would be good news if we were “only” providing €29.3 billion to Anglo.  As it is we will be providing much more.  The outstanding balance on the Promissory Notes earn interest for Anglo which must be paid by the State.  As we saw previously the interest rate on some of these notes is very high.  Here is a table from earlier.

The annual interest rate ranges from just over 4% for Tranche 1 to nearly 9% for Tranche 4 when the 2011/12 “interest holiday” is factored in.  The accumulated interest bill over the lifetime of the  Promissory Notes is anticipated by the Department of Finance to be over €13 billion as shown in this Information Note.  We can expect that almost €11 billion of this interest will accrue to Anglo.

This €11 billion is interest income for Anglo and is not capital so is counted as operating income.  Mike Aynsley expects the nationalised Anglo to have an operating loss of €25 to €28 billion in its lifetime.  We can use the June 2011 Income Statement (page 22) to see the huge role of the Promissory Note Interest in determining this loss.  Here is an abbreviated version of the income statement

Anglo reported a loss of €105 million for the first six months of the year, but the largest single income item for Anglo is the €644 million of interest it received from the State for the Promissory Notes.  Without this inflow Anglo’s losses would be much higher.  If this is true for this six month period, it is also true for the remainder of Anglo’s lifetime.

Mike Aynsley might feel that while nationalised that Anglo will generate a loss of €25 t0 €28 billion and will therefore be in a position to return some of the €29.3 billion capital poured into the bank.  But this loss is only possible because of the €11 billion of interest that the State is providing to Anglo.  

The fact the the State must pay interest to Anglo as a result of putting in capital through the device of a Promissory Note is in contrast to some of the capital injections into the functioning banks which see the banks pay an interest rate to the State.

It is clear that without this Promissory Note interest income Anglo losses would be greater than Aynsley’s assessment and would probably be around the €29.3 billion we have provided or, depending on interest rates, even closer to the €34 billion “worst case scenario” that was suggested at the time the Promissory Notes were provided to Anglo. 

To say there may be a “capital surplus” to be returned to the State is technically true.  To say it is because losses are lower than expected is not. 

UPDATE: Here is a table that summarises a discussion in the comments.  The interest totals used here are just the cumulative totals from the Department of Finance Information Note.  All numbers are in billions of euro.

The €13.1 billion interest is based on the assumption that the Promissory Notes and interest will be repaid on a linear basis of €3.1 billion per year until 2025. The €18.4 billion interest cost on the money used to fund the Promissory Notes is based on an interest rate of 4.7% for the period to 2025.  Both of these assumptions are subject to change.