Ireland Eyes Payback for Averting Europe’s Lehman: Euro Credit

Ireland Eyes Payback for Averting Europe’s Lehman
A workman removes the Anglo Irish Bank Corp. logo from the bank's former headquarters on St Stephen's Green in Dublin, Ireland. Photographer: Aidan Crawley/Bloomberg

In Ireland’s Finance Ministry, officials are engineering a maneuver that may make the difference between default and financial survival.

The impetus for the plan is the cost of bailing out Anglo Irish Bank Corp. and Irish Nationwide Building Society. The nation paid an initial 31 billion euros ($42.2 billion) to save the two lenders, averting what Central Bank Governor Patrick Honohan called a “European Lehmans” in a nod to the collapse of Lehman Brothers Holdings Inc. in September 2008.

To cut the final bill of at least 48 billion euros, including interest, Finance Minister Michael Noonan may seek to exploit the euro region’s debt crisis by tapping the area’s expanding rescue fund. That would deliver money at lower interest rates and over a longer period than selling bonds, reducing what Noonan has called the “extraordinarily expensive” tab as the state seeks to win back economic sovereignty.

“Ireland is really on the fringe between debt sustainability and unsustainability,” said Dermot O’Leary, chief economist at Dublin-based Goodbody Stockbrokers. “The cost of funding this every year could play a big part in the difference, ultimately, between the two scenarios.”

Ireland’s 10-year borrowing cost, which reached 14.22 percent in July, dropped below 8 percent on Sept. 28 for the first time this year, and is currently at a nine-month low of 7.53 percent. The cost of insuring against the nation defaulting for five years has dropped to 677 basis points from 804 during the past two months, according to CMA prices, implying a 44 percent probability of Ireland failing to meet its obligations.

The International Monetary Fund said Sept. 7 it expects Ireland’s general government debt to peak at 118 percent of gross domestic product in 2013, equivalent to almost 200 billion euros. That’s up from 25 percent of GDP in 2007.

Ireland was last year forced to seek 67.5 billion euros of aid, after its banking woes became too big to handle alone. On Sept. 30, 2008, the then government guaranteed most of the debts of its biggest banks, with the state agreeing to inject about 62 billion euros into the financial system to date.

The government must “use all our persuasiveness powers and ingenuity to get the burden of the debt down,” Noonan said in an interview aired by Dublin-based RTE Radio on Sept. 26, adding that he’s seeking to cut billions of euros off the overall cost of bailing out Anglo Irish and Irish Nationwide.

Promissory Notes

As the bill for the two banks soared last year, then Finance Minister Brian Lenihan decided to hold off injecting all the 31 billion euros into the two banks straight away. Instead, he promised to give them the cash over 10 years, by issuing promissory notes -- essentially IOUs -- to the lenders for the full amount.

That tactic avoided Ireland having to raise the money in one effort as its own borrowing costs surged. The banks in turn used the notes as collateral to borrow funds from the Irish central bank.

After being rebuffed by the European Central Bank on a plan to impose losses on senior bond holders in the two lenders, Noonan said he’s turning his attention to an “alternative piece of financial engineering to the promissory note arrangement.”

“Rescuing Anglo helped maintain stability across the European banking system, but has put a heavy burden on the Irish state,” said Alan Ahearne, an adviser to Lenihan who oversaw the promissory note arrangement and negotiated the bailout accord. “Any arrangements to ease that burden would help Ireland to stay ahead of its program targets.”

Penal Rates

The government pays an annual 8 percent to the banks on the notes, a rate Prime Minister Enda Kenny described this week as “penal.” The Finance Ministry a day later put the cost at 17 billion euros over 20 years.

“The goal is to reduce this interest charge,” said O’Leary at Goodbody. “This could potentially be done by agreeing an additional long-term loan from the EU with a lower interest rate.”

In addition, the state has to pay interest on the borrowing to fund the bailout. For every 3.1 billion euros, that amounts to 115 million euros per annum, the Ministry said, based on the rate Ireland’s partners are charging for its rescue fund.

On July 21, European leaders empowered the euro zone’s 440-billion euro ($633 billion) rescue fund, the European Financial Stability Facility, to aid troubled banks by lending to governments to inject into lenders.

Cutting Costs

By taking a loan from the fund, Ireland could pay off the promissory notes, saving 17 billion euros instantly. More savings would flow, assuming the state could borrow at a lower rate from the European fund than investors would charge to make good on its capital pledge to the banks.

“The proposal will in effect raise the amount of borrowings from the EU/IMF by 30 billion euros which would be repayable at competitive rates most likely beginning in fifteen years,” said Jim Ryan, an analyst at Dublin-based Glas Securities, in a note. “From the government’s perspective, it delivers additional funding and ensures the funding burden for the state is probably manageable until 2016, without introducing private sector involvement.”

Noonan’s willingness to spare senior bank bondholders, in recognition that his plans risked worsening a funding crisis for banks across Europe, may win him support for tapping the EFSF, according to O’Leary.

“There is an argument that Ireland has taken one for the team in bailing out Anglo,” said O’Leary. “The country’s taxpayers are the fall guys as the bank’s senior creditors are spared.”

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