A Briefing Note on Promissory Notes
Anglo & INBS Crash2008 – Irish property bubble spectacularly
burstsSeptember 2008 bank guarantee
◦ 2009 – Merrill Lynch states “Anglo is financially sound”
◦ 2009 – Anglo is nationalised◦ March 2010 – Anglo posts the largest loss in Irish
corporate history (€12.7 billion for 2009)◦ March 2011 – Anglo then breaks its own record (€17.7
billion loss for 2010)◦ The INBS numbers are proportionally even worse
◦ Both banks insolvent
Now - The IBRCAnglo Irish Bank = €29.3 billion
◦ Defunct – no new deposits and no new loans◦ Insolvent◦ Under criminal investigation
Irish Nationwide Building Society = €5.4 billion◦ Defunct – no new deposits and no new loans◦ Insolvent
€30.6 billion promissory notes – to pay for ELA◦ Letters of comfort◦ Never brought before the Oireachtas
€4.1 billion exchequer payments
GuaranteeThe Anglo/INBS debts were originally
guaranteed by the Irish State in September 2008 as part of the blanket bank guarantee
The Irish Government made an initial payment of €4 billion to cover Anglo’s debts in 2009. This was paid out of the exchequer finances. €0.1 billion was paid to INBS
Over the course of 2009 and 2010 it became
increasingly clear that Anglo and INBS were insolvent
Averting Collapse If the insolvent banks were to collapse their debts
would have fallen back on the Irish State and become sovereign debt - a consequence of the bank guarantee
To prevent this the Irish Government had to obtain external funding – the Eurosystem of Central Banks was the only realistic source of this funding
Anglo did not have sufficient eligible (i.e. good quality) collateral to obtain the required amount of Emergency Lending Assistance (ELA) from the Central Bank
Emergency Lending AssistanceTo prevent their collapse the Government
negotiated a mechanism with the Central Bank of Ireland setting out the conditions under which the Central Bank would provide Anglo/INBS with sufficient Emergency Lending Assistance (ELA)
This required the implicit consent of the
European Central Bank (ECB) governing council. Any future changes to the agreed mechanism
also require the consent of the ECB governing council
Paying Back the ELAThe ELA provided by the Central Bank to the
IBRC is what enables the IBRC to pay-off its obligations
Most of the bondholders have now already been paid using this ELA
The ELA is also used to pay-off creditors/depositors and to enable the IBRC to retain its banking license
Eventually the ELA has to be paid back to the Irish Central Bank
This is done through promissory note repayments
Promissory NoteThe Irish Government negotiated with
the ECB governing council to create a ‘promissory note’ as a liability owed to the IBRC (Anglo/INBS)
The promissory note is therefore an asset of the IBRC
This asset can be used by the IBRC as collateral to obtain the necessary ELA from the Central Bank
This is because the Irish Government is backing the promissory note with ‘letters of comfort’
The priceA promissory note is a negotiable
instrument ◦ one party (in this case the Government) makes an
unconditional promise in writing to pay a defined sum of money to the other party (in this case Anglo/INBS – now called IBRC), on specified future dates or on dates to be determined, under specific terms
The State’s obligation is to pay down €30.6 billion over 20 years (2011-2031)
How it worksThe promissory note repayments are paid to the
IBRC – the IBRC then reduces its ELA obligations to the Central Bank
In practical terms the Irish Government has received a loan from the Central Bank to pay off the bondholders
It is ultimately a transfer of wealth from the people living in Ireland to the bondholders that lent to Anglo/INBS
The bondholders and other creditors continue to be paid using the ELA from the Central Bank – the promissory notes represent our commitment to eventually repay the Central Bank
How much it costs The Irish Government is scheduled to make over €47
billion of promissory note related payments between March 2011 and March 2031. This is composed of: ◦ €30.6 billion capital reduction – the €30.6 billion owed ◦ €16.8 billion in interest repayments
Much of the funding for this will need to be borrowed unless the State is running substantial fiscal surpluses. This is very unlikely in the medium-term
These borrowings will therefore also have to be financed ◦ at an assumed 4.7% interest rate on borrowings the total
cost to the State will reach €85 billion by 2031◦ Some of which will eventually return to us due to the
circular nature of the payments
What happens when the ELA is paid back to the Central Bank?Central Bank of Ireland (CBI)
Asset side of their balance sheet◦ CBI reduces its ELA assets by €3.1 billion
Liability side of their balance sheet◦ CBI expunges €3.1billion from the system◦ Inflationary impact if this is not done – increasing
the money supply (monetisation of debt)
Socio economic implicationsOver 2% of GDP will be drained out of the
State each year up to 2023 to make the promissory note repayments◦ this will be through an additional €3 billion to
€4 billion of fiscal consolidation (tax increases/spending cuts)
IMF research (Leigh et al, October 2010) indicates that each 1% of fiscal consolidation: ◦ reduces GDP by 0.5% to 1% and◦ Increases the unemployment rate by 0.3
percentage points
Socio economic implicationsThe €3.1 billion promissory note payment
due to be made by the state on behalf of the former Anglo on March 31 2012 is: ◦ greater than the total cost of running Ireland’s
entire primary school system for an entire year and ◦ greater than the estimated cost to provide a next
generation broadband network for all of Ireland (€2.5 billion).
€30.6 billion is equivalent to just under 20% of Ireland’s current GDP or €17,000 for each person working for pay or profit in the State. €47.9 billion is 30% of Ireland’s current GDP.
The issueThe interest rate is not the issue
◦A red herringThe real issues are:The size of the principal
◦Reduction in the principal – write downWhen we are making the
repayments◦ Changing the schedule of repayment
–holiday, postponement
Risks in promissory note suspension/postponement?1. “The ECB will cut off funding to our
pillar banks”2. “It will impact on the European
banking system”3. “It will undermine investor
confidence in Ireland”4. “It is a condition of the EU/IMF
Memorandum of Understanding”
Are these risks plausible?
Risks to suspension/postponement?“That the ECB would cut off funding to our
pillar banks”◦ Remove funding and the pillar banks will fall◦ But this would trigger the very contagion the ECB
has been trying to prevent◦ ECB cannot give the pillar banks inferior T&C to
other Euro zone banks
“Impact on the European banking system”◦ Promissory note payments do not involve the
European banking system◦ No precedent created as IBRC is not a functioning
bank
Risks to suspension/postponement?“Undermine investor confidence in
Ireland”◦ Not a sovereign default◦ Ireland is already shut out of the markets and
locked into an official programme of assistance until the end of 2013
◦ Amelioration of the Anglo/INBS burden improves Ireland’s debt dynamics and makes Ireland better placed to pay its other debts
“A condition of the EU/IMF Memorandum of Understanding”◦ The promissory note repayments are not a
condition of the deal agreed with the troika
Decision makers - ECB Governing CouncilECB concerns:
◦ Precedent regarding repayment of debt obligations – parachute drop analogy - floodgates
◦ Adherence to rules and protocols – is flexibility legal?◦ Mildly inflationary – monetization of the debt
But the ECB need a success story◦ The Greek programme has already failed◦ The Portuguese programme is failing◦ Italy is in the firing line◦ Promissory note flexibility can help prevent the Irish
programme from failing
The need for a success story
What about the bond?€1,250m of Anglo Irish Bank
senior bonds◦Not covered by the guarantee◦Not secured against Anglo’s assets
Disingenuous to say we are not paying it
Moral hazard and the ECB