Plan B - Lausn fyrir Ísland án AGS og annara aukaefna

Plan B

Proposal: NOK 50 Billion Revolving Credit Facility

Executive Summary

The Icelandic Economy in Numbers

12.0%

7.2%

17.9%

17.9%

-11.0%

16.7%

-8.4%

-15% -10% -5% 0% 5% 10% 15% 20%

Central Bank Policy Rate

Unemployment Rate

% Fiscal Budget Interest

% Fiscal Budget Health Care

Import Growth

Export Growth

GDP Growth

Source: Ministry of Finance, Central Bank of Iceland. Growth figures for 2009 (actual and projected), fiscal budget costs for 2010

Why a NOK Facility? Iceland and Norway share common heritage, geopolitcal interests and economic

ideals

Iceland is currently in a stalemate with the IMF, despite good faith offers to settle Icesave liabilities with the U.K. and Dutch governments

A NOK 50 billion revolving credit facility (RCF) would enable Iceland to rebuild its economy, normalize international business relations, protect the Nordic welfare state and maintain its credit rating

The facility would anchor a prudent economic plan designed to mitigate Norway´s risks as a lender, and offer more flexibility and greater certainty of success, at a lower cost, to Iceland, as a borrower, than the IMF program, due to a commitment fee and interest rate on only borrowed amounts

Alternatively, Iceland faces abandoning the IMF program, withdrawing offers for equitable and fair out-of-court settlement of the Icesave liabilities and maintaining capital controls, to the detriment of all parties involved

As an emerging economic power, Norway can take a leaderhip position in solving a pressing economic issue that is damaging relations between fellow NATO members and challenging the integrity and existence of institutions in the United Nations systems

The Economic Plan in Action

Action Time

1. Obtain a NOK revolving credit facility

2. Let Alþingi settle Icesave liabilities

3. Exchange government FX bonds

4. Lift foreign exchange controls

5. Lower Central Bank policy rates

6. Rebuild the economy

7. Maintain credit rating

8. Repay NOK revolving credit facility

Now

1-2 Months

1-6 Months

3-9 Months

6-9 Months

½-2 Years

2-7 Years

7-10 Years

Side-by-side Comparison

IMF Stand-by Agreement Plan B

Rigid due to inflexibility of IMF program

Expensive due to structure as a term loan and bulky draw-downs irrespective of financing needs

Uncertain as other parties are prevented from dispersing funds

Flexible due to structure of financing as an RCF

Economic due to low financing costs (interest rate on only borrowed funds, but commitment fee on remainder)

Certain, both in execution and probability of success, due to liquidity

Iceland and the IMF

The IMF and Iceland Iceland should be the “poster child” of the IMF and its rebuilding the

proudest achievement of the Fund Iceland privatized government-owned banks and firms

The country is a free market-based democracy, anchored on Alþingi, the world´s oldest parliament

The economy is one of the most transparent in the world

Its management of natural resources has fostered sustainable fisheries, green power generation and a clean environment

Even though a Stand-by Agreement was signed on November 19, 2008, intervention by the U.K. and Dutch governments has prevented dispursement of the SDR1.4 billion ($2.1 billion) facility Dispursements under the IMF facility are conditioned on settlement of

Icesave liabilities, on the terms demanded by the Dutch and U.K. Governments

Dispursements on other bi-lateral facilities are also conditioned on IMF dispursements, including the €1.8 billion facility with the Nordic countries

Iceland and the IMF (cont´d) On September 2, 2009, Iceland´s Alþingi passed law providing for the conditional

guarantee of the Icesave liabilities after lengthy negotiations

The liabilities arose from foreign branch deposits of a privately-owned Icelandic bank, (Landsbanki), which were managed in accordance with European directives, including the backing of a depositors’ insurance fund that was similarly structured to other depositors’ insurance funds

These deposits had investment grade ratings and Alþingi assigned them priority ranking in the emergency legislations following the bank collapse to protect depositors and their insurance funds

The net present value of the Icesave guarantee is equal to the debt of Landsvirkjun, Iceland´s national power company (Statkraft)

The guarantee is only conditioned on Iceland not waiving its rights as a sovereign nation, and even agreeing not to seek legal action against the use of terrorist legislations by the U.K. governement against it

By guaranteeing these liabilities, the government is assuming significant legal risks that could result in lawsuits by other creditors of Landsbanki for unjust enrichment

The refusal by the U.K. and Dutch governments to accept Iceland´s good faith offer as a satisfactory settlement has created a stalemate between Iceland and these countries, on one hand, and Iceland and the IMF, on the other hand

Iceland and the IMF (cont’d)

Despite lengthy delays in dispursements by the IMF, the Fund appears to be influencing monetary policy in Iceland, where high interest rates are maintained to prevent the value of the ISK from falling, even though capital controls are in place

Traditional IMF programs are not tailored to the needs of small economies, transparent countries or Nordic welfare states

Because small countries have high fixed costs (infrastructure, etc.) and limited economies of scale, there are natural limits as to how much governments can cut expenditures

Belt-tightening measures implemented by IMF programs (such as incresed taxation and cuts in spending) would be felt by an entire country that is transparent; countries with large “underground” or “blackmarket” activity, however, are only partially impacted

Cuts in health care spending, coinciding with increases in interest expenses of governments (due to high interest rates), as the case will be in Iceland in 2010, threatens the very social fabric of Nordic countries

The Economic Plan in Action

Economic Objectives Iceland has three (3) basic economic objectives

To reduce unemployment rate (which is currently 7.2%)

To restructure debt of Icelandic households (and firms)

To preserve its investment grade rating

Iceland can achieve these objectives by

Attracting foreign investment

Lowering interest rates

Limiting external borrowing

A 50 billion NOK revolving credit facility (RCF) would enable Iceland to achieve all of these objectives

By having sufficient foreign exchange liquidity, Iceland could gradually lift currency controls and attract new foreign investment

Lifting of currency controls would enable the Central Bank to lower its policy rate from the current 12% level and thus facilitate new lending to the real economy

Access to liquidity would enable Iceland to gain credibility with global capital markets and rating agencies

Stabilization of the ISK exchange rate would reduce debt burden of households (and corporations) which have taken on sigificant foreign currency debt

The Economic Plan in Action Obtain NOK 50 billion revolving credit facility (RCF)

NOK 50 billion represents the maximum amount that Iceland would need to borrow over the next three years; however, it is highly unlikely that the entire facility will be drawn upon

An RCF is a more suitable form of financing than a term loan facility (TLF), where the entire loan is drawn upon immediately, for a country that faces uncertain outlays, irrespective of if the TLF amount covers all contingencies

Since the RCF carries a low commitment fee, and charges an interest rate on only borrowed amounts, it offers greater flexibility at lower costs than a IMF-type Stand-by Agreement

An RCF would also strengthen Iceland´s position in global capital markets and remove uncertainties surrounding its investment grade rating

Consummate an exchange offer and discounted buyback of Republic of Iceland foreign currency bonds due in 2011 and 2012 for longer-dated securities

The exchange offer and the buyback have high probability of success with the NOK 50 billion RCF in place

Following the exchange offer and the buyback, Iceland would have no major debt maturities in the near future and facilitate refinancing of Landsvirkjun, whose debt is guaranteed by Iceland, but which Landsvirkjun can refinance on its own merits

The Economic Plan in Action (cont´d) Lift foreign currency exchange controls

A credit facility provides credible means for Iceland to lift foreign exchange controls

Even though capital controls have been in effect for about one year, controls would have to be eased gradually over the next three to nine months and progress monitored actively; initially, the easing would focus on stemming outflows with foreign currency auctions or exit taxes

Once foreign investors’ confidence has been rebuilt, annouced, but yet-to-be-closed investments such as hospitals, data centers and industrial facalities, in addition to other new investments, can be finalized

Longer term, the stabilization of the ISK will facilitate debt restructuring for Icelandic households and firms due to high proportion of foreign currency debt

The swap facility between the two central banks could be strengthened to mitigate risks to the parties

Lower interest rates Conditions for monetary easing and lowering of policy rates are created when

capital controls have been eased

Lower policy rates, which are currently 12%, will enable banks to resume lending and the private sector to restructure its debt

The Economic Plan in Action (cont’d) Rebuild the private sector of the economy

Easing of exchange controls and monetary policy will facilitate restructuring of household and corporate debt and provide access to new credit, locally in the near term, but internationally in the long term

Corporate debt would be restructured by reducing principal amount, lowering interest rates, converting debt into equity, selling non-core assets and raising new outside equity

Household debt would also be restructured, upon which mortgages would become non-recourse to the borrower

Easing of exchange controls will additionally

Attract new investment into capital and labor intensive industry and private equity capital for start-ups and established enterprisese in restructuring

Release pools of domestic liquidity that have remained untapped due to controls on the flow of capital

Relieve pressure off local pension funds that can now recycle foreign investments into the country and fully participate in the upside offered in recovery

Maintain investment grade credit rating

Maintenance of investment grade credit rating is both in Iceland and its creditors’ best interests

Combination of prudent fiscal policy and active balance sheet management with an RCF will be well received by both rating agencies and capital markets

Repay the NOK 50 billion revolving credit facility

The facility could be prepaid early by Iceland by either drawing upon funds from the IMF, under a renegotiated program with the Fund, or issuing a bond in international (or local NOK) bond markets

Alternatively, a combination of internally generated funds and market-based financing on investment grade rating terms would secure repayment of the facility in accordance with indicative terms

Why can foreign exchange controls be lifted?

Factors increasing supply of foreign currency Iceland would have siginficant foreign exchange liquidity with the RCF in

place

Iceland’s external position has improved considerably, with strong growth in exports and a siginficant decline in imports

Factors reducing demand for foreign currency With foreign exchange controls in effect for nearly one year, and an

established off-shore market in the ISK, a significant portion of short-term investors (“hot money”) has already exited

Local currency yields on Icelandic Government bonds are still significantly higher than for comparable Western countries

The off-shore and the on-shore ISK markets are converging with current difference of 10%, compared to a peak of 25%

Yields on €-denominated bonds of the Icelandic Government have fallen significantly and are converging with local currency bond yields

Private sector foreign currency debt to Icelandic banks is being restructured or converted into ISK

Government Bond Yields

8.4%

7.6%

4.1%3.5% 3.5% 3.4% 3.4% 3.2%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

Source: Bloomberg

Iceland Credit Default Swap Risk Premium

Source: Bloomberg

Why Iceland must lift foreign exchange

controls?

Foreign exchange controls violate the four freedoms

enshrined in the EEA agreement

As an economy with capital intensive industries, Iceland

will find it difficult to attract the new foreign investment it

needs unless controls are eased

Companies are holding onto foreign currency, rather than

recycling it into the domestic banking system, despite the

favorable trends in net exports

Financial Considerations

Estimated Financing Needs

Amounts 2010 2011 2012 2013 Total

In ISK Billions

Budget Deficit (Surplus) 87.4 22.6 - 39.0 - 92.9 - 21.9

Foreign Debt Payments - 228.8 44.0 2.3 275.1

Total 87.4 251.4 5.0 - 90.6 253.2

Cumulative Total 87.4 338.8 343.8 253.2

In NOK Billions

Cumulative Total 4.0 15.3 15.6 11.5

Source: Data from Ministry of Finance. Excludes 2009 data, including cash.

Uses of Funds The RCF will be earmarked for refinancing, strengthenting

of reserves and general purposes, but Iceland is highly unlikely to borrow the entire NOK 50 billion amount

Peak funding requirements of Iceland will reach ISK 343.8 billion (NOK 15.6 billion) by the end of 2012

Projected budget deficits in 2010 and 2011 will total ISK 110 billion (NOK 5.0 billion) but would most likely be funded in the domestic market

Foreign principal debt payments in 2010-2103 of ISK 275 billion (NOK 12 billion) will most likely have to be funded, but with the RCF, Iceland can effect an exchange offer into longer debt and a discounted buyback, thereby siginficantly reducing borrowings for these purposes

One-third of the facility has been earmarked for strengthening of reserves, likely to be drawn down in the near term; however, the emphasis will be on prudent and gradual lifting of exchange controls and maintenance of reserves at healthy levels

The remaining one-third of the RCF would be earmarked for contingencies and as such unlikely to be drawn upon

0

10

20

30

40

50

Indicative Term Sheet

Borrower

Amount

Facility

Availability

Repayment

Covenants

Annual Fee

Interest Rate

Margin

Lenders

Drawdown

Purpose

The Republic of Iceland (“Iceland”)

NOK 50 billion

Senior Unsecured Revolving Credit Facility

7-year, Cancellable by Borrower at any time

One-third in each of years 8,9 and 10

Similar to Iceland´s EMTN Program

0.25% on Undrawn Amounts

NIBOR plus Margin on Borrowed Amounts

0.75% to 1.25%, depending on rating

The Kingdom of Norway, Norges Bank

Subject to an agreed-upon economic plan

Refinancing of foreign debt, strengthening of currency reserves and general purposes