Friday, March 30, 2012

Much ado about nothing

With a lot of hope and more than a little expectation, at 4pm yesterday the Minister for Finance made a statement to the Dail on the €3.1 billion payment to be made this weekend on the Promissory Notes to the Irish Bank Resolution Corporation (IBRC).  It turned out to be a bit of a damp squib.

The key issue in this whole sorry saga is the rate at which the Exceptional Liquidity Assistance provided by the Central Bank of Ireland to the IBRC is repaid.  The 2011 Annual Report from the IBRC shows that this stood at €42.2 billion at the end of December.  This money was ‘printed’ by the Central Bank of Ireland and given to the IBRC, and it now needs to be returned by the IBRC so the Central Bank can ‘burn’ it.  Nearly three-quarters of the money to meet this requirement will come via the Promissory Notes.

It is hard to see any change at all.  The IBRC needed to get €3.1 billion of cash this weekend;  the IBRC is getting it.  The IBRC needed this money to give to the Central Bank; the Central Bank is getting it; the Central Bank will burn it.  A statement from an ECB spokesperson makes clear that they don’t see any change either.

“It is very important that the Irish state will honour the 3.06 billion euro amortisation of the promissory notes. This will reduce the emergency liquidity assistance which IBRC receives from the central bank of Ireland and thus the Eurosystem.

We certainly expect that also in the future the promissory notes will be served according to the schedule to which the government has committed itself.

As Ireland strives to regain market confidence, it is of utmost importance that the commitments of the Irish state are met in line with standing contracts and agreements.”

The Governor of the Central Bank, Patrick Honohan appeared before the Oireachtas Joint Committee on Finance last Tuesday.  The transcript is here.  In response to a question from T.D. Stephen Donnelly he said

Professor Patrick Honohan: “The question I noted in particular related to how much cash IBRC needs. In fact, the objective of the plan is to eliminate the cash need by postponing it.”

This would seem to suggest the plan was to defer the cash payment.  That could be the cash payment into the IBRC or the cash payment from the government.  The first is significant and the suggestion it that this was the “objective of the plan”.  Reducing the cash needs of the IBRC can only come about through a reduction in the cash it needs to repay its ELA obligations.  This is not how things have panned out.

The €3.1 billion cash payment to the IBRC will be made but there has been a slight change in how this payment is being funded. Instead of coming from the current funding arrangements of the State (the EU/IMF loans) it will come from a 'new' government bond.  

As a result of this there has been an increase in funding of €3.1 billion. This appears to be only for 12 months which is of little benefit given that we have funding in place for the next 21 months.   In the Minister’s statement it says:

Ultimately, it is intended that this long term Government bond will be financed for one year, on commercial terms, with Bank of Ireland who may in turn refinance the bond with the ECB.

Ultimately means “in the end; at last; finally”.  There is nothing after “ultimately”.  One year is not long term.  There has been mention of a bond maturing in 2025 but this was not included in the Minister’s statement yesterday, in his statement last Wednesday, nor by Governor Honohan this Tuesday.  I cannot find a primary source for the claim that a 2025 bond would be used but it did enter the public domain somehow. 

If the arrangement ends after one year as the Minister’s statement indicates the impact on the January 2014 funding cliff is negligible (possibly even slightly negative).   As it stands, this time next year we will need to make the next €3.1 billion payment on the Promissory Notes and also a repayment on the bond issued to Bank of Ireland.  This is clear in the statement from Bank of Ireland.

Under the terms of the Repo, IBRC will have an obligation to repurchase the Bonds from the Bank for approximately €3.06bn in cash not later than 364 days after the effective date.

Where is the IBRC going to get €3.1 billion in 12 months time?  There may be some attempt  to further extend the actual repayment of this bond but no solid information on this has been provided. There is no indication who might replace the Bank of Ireland if the arrangement was to be extended.  As it stands in 12 months time the Bank of Ireland will give this bond back to the IBRC and the IBRC must find €3.1 billion to pay for it.

If the actual cash payment can be further delayed there would be a funding gain into 2014 and, according to Governor Honohan, a minor improvement in debt sustainability.

Professor Patrick Honohan:  “In the discussion, the use of a long-term bond has already been mentioned. This is a major step forward from a sustainability perspective. The idea of a long-term bond being used in lieu of a cash payment is a very considerable step forward, considering it puts off for a long number of years the actual need to refinance those payments. In addition, the net cost of this - we can speak about complications later - will be quite low relative to alternative sources of finance. There is a very definite gain in debt sustainability. We are only talking about a fraction of the total promissory notes so we cannot say it is a decisive change, but relative to this amount, it is a considerable improvement.”

I don’t think yesterday’s move sits well with this analysis.  To sum: instead of making with the Promissory Note payment with money borrowed from the EU/IMF at 3.5% to be rolled-over over the next three to ten years, we made the Promissory Note payment with money borrowed from the Bank of Ireland at 5.4% to be rolled over next year.


  1. Yesterdays announcement seems to be more politically than economically motivated. The fact that details have been so slow emerging re 13 year bonds, interest rates etc is also worrying. With recent reports from the IMF being positive do you feel that it is time to take a tougher line with the EU in these negotiations? If for example we said that we would just burn these Promissory Notes now rather than borrowing €40 billion plus to also essentially burn them at a later date. What do you see as being benefits and consequences from such a strategy?

    1. Hi Anonymous,

      The problem is not really the EU; the problem is the ECB. We could just tear up the Promissory Notes but the real issue is the repayment of the Exceptional Liquidity Assistance that the IBRC has drawn down from the Central Bank of Ireland.

      The Promissory Notes are just the vehicle by which this was created. If we scrap the Promissory Notes we would still have the obligation to repay the ELA.

      I think there were many hopes that the rate of ELA repayment would be slowed down beginning with this week's payment. This was particularly true after Governor Honohan's appearance at the Oireachtas Finance Committee on Tuesday.

      It is very difficult to say what would happen if we unilaterally decided to delay repayment of the ELA (through say a delay on the Promissory Notes). The ECB would not be happy but it is not clear what they would do. They are unlikely to pull funding from the other banks and spark the one thing their stance seems designed to avoid - a disorderly bank debt collapse (though this is coming at a higher probability of a disorderly sovereign debt collapse).