Ierland maakt schoon schip met loodzware bankenerfenis

7/30/2019 Ierland maakt schoon schip met loodzware bankenerfenis

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KBCECONOMIC RESEARCH (GCE)

ECONOMIC UPDATES 12FEBRUARY 2013

Austin Hughes and Siegfried Top

Update on Ireland:

Promissory notes deal paves the road for successful programme exit

The facts:

The Irish Parliament voted on a deal to dissolve the Irish Bank Resolution Corporation (IBRC),thus eliminating one of the most visible reminders of the Irish banking crisis.

In tandem with this liquidation, the Irish government swapped 25 bn short-term promissorynotes, which were used to recapitalize Anglo Irish Bank during the financial crisis, for longer-

term Irish government bonds.

This development has the effect of easing Irelands debt burden somewhat over the next fewyears. This occurs both through a reduction in the amount of sovereign refinancing over the next

ten years and also through slightly lower interest payments.

Last week, the Troika concluded the 9th review of the Irish EU/IMF-programme, acknowledgingthe strong adherence to the programme, and discussing a durable exit from programme

financing. This new deal, together with the ECBs Outright Monetary Transactions and a potential

lengthening of the maturity of EFSF/EFSM bonds by the Council, will lay the foundations for a

successful exit of the programme at the end of 2013.

The impact of the new deal on KBC Ireland can be seen as positive, mainly for two reasons.Firstly, the general operational background has improved, as the economic outlook looks better

after this deal, with the need for new austerity measures having somewhat eased. Secondly,

there has been an immediate positive financial impact, which is most visible in the lower

government bonds yields and the improved liquidity and funding environment.

Deal on IBRC and the promissory notes

Last week, the Central Bank of Ireland (CBI) and the Irish government struck a deal on the liquidation ofthe IBRC (Irish Bank Resolution Corporation, the wind down vehicle for the merger of the failed Anglo

Irish Bank and Irish Nationwide Building Society). This was linked to a decision to replace the so-called

Promissory Notes, which were used to recapitalize Anglo Irish during the financial crisis with a portfolio

of long term bonds with maturities between 2038 and 2053. The Promissory Notes originally amounted

to EUR 30 bn, and were used among other assets - by IBRC as collateral for 40 bn of central bank

funding (Emergency Liquidity Assistance, or ELA).


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Under the new deal, IBRC will be dissolved in an orderly manner and thus be removed from the financial

landscape. Its remaining loan assets will go to the government bad bank NAMA. The liquidation of IBRC

means the Irish Central Bank takes charge of the promissory notes that had been used as collateral

against the Emergency Lending Assistance provided by the Bank to IBRC. In turn,some 25 bn short-

term promissory notes (weighted average life of 7 years), have been swapped for longer-term Irish

government bonds (avg. 34-35 years). This results in an end to related ELA funding. As IBRC is liquidated,

the Central Bank acquires the ownership of the new bonds. It will initially hold these bonds but gradually

sell part of them, to avoid to create a precedent of monetary financing the main fear of the ECB.

According to a Central Bank statement The bonds will be placed in the Central Banks trading portfolio

and sold as soon as possible, provided that conditions of financial stability permit. The disposal strategy

will of course maintain full compliance with the Treaty prohibition on monetary financing.1

However, a

too sudden sell-off will be avoided, in order not to be disruptive to financial stability, and thus not

impede efforts to regain full bond market access.2

It has been suggested that the average length of

holding of these bonds will be about 15 years.

Financial sector consequences

IBRC will be removed from the financial landscape. Special liquidators will wind up all of its business and

operations. Remaining assets and liabilities will be transferred to NAMA. Assets and subsidiaries will also

be valued, and partially sold. Eligible depositors, bondholders and counterparties will be repaid under

the Deposit Guarantee Scheme and Eligible Liabilities Guarantee (ELG-) Scheme. The vast majority of

IBRCs original deposit book had already moved to Allied Irish Bank and Permanent TSB. So, any impact

on deposits is likely to be limited. This cost would fall under the Deposit Protection Account maintained

by the CBI. Claims under the ELG could cost the Irish State between 0.9bn and 1.1 bn according to

government estimates.

The government also has to pay shortfalls that may occur in the swap between NAMA and the Central

Bank. These one off costs will offset any interest rate savings on the new structure for 2013 and in all

likelihood there will be a marginally negative impact on this years budget arithmetic (the Department of

Finance estimates this at just 25 million). Any remaining assets after the unwinding of all secured

liabilities will be available for the benefit of the pool of unsecured creditors. This will depend on the

value ascribed on the assets in the valuation process. It is expected that no assets will be available to

repay subordinated liability holders.

As was noted by the EU/IMF review, further good repair of the financial sector is underway, which willallow a removal of the costly ELG-Scheme (see table 1). This will also improve domestic banks

profitability, as funding costs of banks are still pushed up by the high fees from this ELG-Scheme.

1Central Bank of Ireland, 7 February 2013.

2The CBI schedule to sell bonds: 0.5 bn to end 2014, 2015-2018: 0.5 bn per year, 2019-2023: 1 bn per year,

2024 and after: 2bn per year.


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Table 1: IMF assessment of Irish bank profitability

Consequences for government budget and debt sustainability

Under the scheme, the Irish government had to pay back 1/10th

of the Promissory Notes each year,

including a yearly interest rate of 8% (altogether 3.1 bn, or 2 % of GDP), placing a significant yearly

burden on taxpayers. The 25 bn short-term promissory notes (weighted average life of 7 years), are

swapped for longer-term Irish government bonds (avg. 34-35 years), and with an estimated yearly

interest rate of 3% (floating rate, Irish spread over 6M Euribor).

The funding costs for the Irish state are thus significantly lowered. There will be a reduction in the

underlying deficit of 1 bn per year in the coming years, reducing the forecast deficit by 0.6% of GDP

annually. In the first year, the costs of the ELG-scheme will incur an estimated cost of 0.6%, thus leveling

out the gain from the deal in the first year. For technical reasons related to an interest rate holiday on

promissory notes in 2011 and 2012, Irish government debt will initially also slightly increase, to an

estimated 122.1% of GDP (up from our forecast of 121%) end 2013. Debt will however decrease faster

over time, due to the lower interest rate payments in the medium term (compounded interest benefit

are assumed at 5%).

Government refinancing needs and debt sustainability have significantly improved. Ireland reduces its

market financing requirement by approximately 20 bn in the next ten years. As the Irish government

notes, there are significant benefits from a market perspective as it ensures the liability to repay isbeyond most credit investors time horizon. This deal noted and therefore agreed to if not formally

signed off by the European Central Bank is one of several elements in Irelands debt burden that may be

eased by agreement with its EU partners. The European Council is to examine proposals currently being

prepared that could also decide on a lengthening of the maturity of EFSF/EFSM bonds for Ireland and

Portugal, as was done for Greece, in order to further smoothen the path for Ireland to regain full access

to the bond market.


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Graph 1: Irish bond yields back to normal

Growth risks tilted to the upside

With a longer maturity financing and a somewhat reduced funding costs, Irelands debt sustainability

outlook is impacted favourably. In addition, it appears that the 1 bn interest rate savings will be used to

ease the scale of Budget adjustment rather than to speed up the attainment of the 3% deficit/GDP

target. So, with the scale of near term austerity eased somewhat, Irish economic growth prospects have

been improved modestly. With no policy change, the government deficit would drop below 3 % of GDP

(2.4% according to the government) in 2015. Instead, it now seems planned budget adjustments will

amount to 4.1 bn between now and 2015 rather than the originally planned 5.1 bn (3.1 bn in 2014, 2

bn in 2015). So, the Irish fiscal stance turns slightly more favorable as a result of this deal. Moreover, the

deal can be regarded by the Irish citizens as an adherence of the Troika to the promise of the European

Council made last year, that the sustainability of Ireland would be improved. This may stir confidence of

consumers, producers and investors. In this context, the immediate impact on Irish Government bond

yields has been significant. The removal of IBRC from the financial landscape also further indicates the

restoration of the Irish financial sector. This may in turn help interbank lending (the disturbed

transmission mechanism) to be restored, and thus ease credit constraints towards the Irish real

economy.

All in all, the deal again confirms our relatively positive outlook for the Irish economy. Other factors have

recently also became more favorable. The recent improvement of the international business

environment should be supportive for the Irish exports. It should also be noted that a very strong currentaccount surplus also reflects a statistical impact from a redomiciling of international companies into

Ireland that means their international profits appear as a factor income inflow. We assume some gradual

normalisation of this effect through 2014-2016.

The slight decrease of the unemployment rate and the bottoming-out of Irish house prices also indicate

that the worst may be over for the domestic economy. Over the next few years, growth may thus

positively surprise, and be firmly above 1% this year and between 2.5 and 3% next year.

0

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4

6

8

10

12

14

Governmentbondyields,in%

Ireland

Germany


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Updated macroeconomic outlook Ireland 2013-16

2010 2011 2012 2013 2014 2015 2016

Real GDP growth (in%) -0.8 1.4 0.9 1.3 2.5 3.0 3.0

Unemployment rate (in %) 13.6 14.3 14.8 14.2 13.2 12.0 10.5

Inflation (in %, HICP) -1.6 1.2 1.8 1.9 1.9 2.0 2.0

House prices (annual change, in %) -13.7 -15.4 -12.5 0.0 1.5 3.0 3.0

Gov. budget balance (% of GDP) -31.2 -12.7 -8.1 -7.5 -4.8 -2.7 -2.2

Government debt (% of GDP) 92.2 106.5 118.5 121.0 119.0 115.0 111.5

Current account balance (% of GDP) 0.5 1.1 4.5 5.5 5.0 4.5 4.0

Ierland maakt schoon schip met loodzware bankenerfenis

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