Irish Get Seismic Shift as Banking Deadlock Breaks: Euro Credit

Irish Prime Minister Enda Kenny
Enda Kenny, Ireland's prime minister. Photographer: Aidan Crawley/Bloomberg

Ireland’s bid to avoid a second bailout may be buttressed by what Prime Minister Enda Kenny called a seismic shift in European policy.

After 13 1/2 hours of talks ending at 4:30 a.m. in Brussels today, leaders of the 17 euro countries opened the door to recapitalizing banks directly with the European Stability Mechanism, instead of through the government, once Europe sets up a single banking supervisor.

“The fundamental principle of the ESM providing the funding to break the link between the sovereign and the bank has now been established,” Kenny said after the summit.

Kenny said the burden on Irish taxpayers may be eased by the accord as what seemed “unachievable has now become a reality.” Ireland’s ambition to regain economic sovereignty and borrow in the bond market after an almost two-year absence had been cast into doubt by the European debt crisis. Before the meeting of leaders, investors fretted that Italy might have to follow Spain in seeking aid.

Kenny has been pressing European leaders to share the burden of rescuing Anglo Irish Bank Corp. and is pushing the European Central Bank to commit to funding the financial system.

Irish October 2020 bonds, regarded as the benchmark, rose today, with the yield falling 65 basis points to 6.46 percent, more than a percentage point shy of the level that pushed the state into an international rescue in 2010.

‘Can’t Cope’

With the debt crisis intensifying, German Chancellor Angela Merkel gave in on expanded steps to stem the market turmoil.

Once an “effective” bank-supervisory system is set up, the ESM could, “following a regular decision, have the possibility to recapitalize banks directly,” according to the summit statement. Kenny said there will be now be an opportunity to “reengineer” the Anglo Irish debt.

“I’m a little worried about the absence of detail here and the timetable looks very ambitious, but this doesn’t detract from the big picture signal and it’s a major change in the crisis approach,” said Harvinder Sian, a senior fixed-income strategist at Royal Bank of Scotland Group Plc in London. “Merkel gets oversight of banks, and Spain and Ireland get freebie loans that don’t hurt sovereign balance sheets.”

Relief for Ireland may not be instant, as joint EU banking supervision, seen as a way to make oversight more independent of national regulators, takes time. The EU will consider proposals by the end of 2012, according to the statement.

Irish Environment Minister Phil Hogan told national broadcaster RTE on June 27 that he hoped the summit will help them understand that the nation “can’t cope with its banking debt on top of its sovereign borrowings.”

Debt Load

The cost of rescuing the banking system will push the country’s debt this year to 116 percent of gross domestic product, compared with a euro-region average of 92 percent, according to European Commission figures.

Ireland experienced the costliest banking crisis among advanced economies since the Great Depression, according to the International Monetary Fund. The state last sold bonds in September 2010, as investors started to shun the government’s debt amid concern that the scale of the banking crisis could tip the country into bankruptcy.

With the economy stabilizing after shrinking about 15 percent since 2007, Finance Minister Michael Noonan sketched out a plan in December to return to international credit markets.

The country’s debt agency would begin with a sale of short-term Treasury bills in the third quarter, followed by a return to longer-term debt markets later this year. That would presage a full re-entry to the markets in the middle of next year.

IMF Estimates

The current Irish aid program runs out at the end of 2013. The IMF estimates Ireland will need to raise about 14 billion euros ($17.6 billion) next year in addition to the rescue funds. A complication is that Irish borrowing costs are above the 5 percent rate that analysts say is the limit of sustainability.

The cost to insure against Ireland defaulting using five-year credit-default swaps fell 32 basis points to 580 today, according to data provider CMA. That implies about a 40 percent probability of the nation failing to meet its obligations within five years. Swaps to cover Spanish debt cost 550 basis points and 505 for Italy.

Kenny wrote in a June 7 letter to EU President Herman Van Rompuy that more must be done to “break the vicious circle between the sovereign and banking crisis.”

Anglo Irish

The Irish campaign centers around three elements. First, the government wants European help to refinance the rescue of Anglo Irish. While the government has agreed to pay off the lender’s debts to the ECB over a decade, it wants to spread the payments over a longer time, potentially by accessing a loan from Europe’s new bailout funds.

Irish Central Bank Governor Patrick Honohan said in a speech today that the agreement by European leaders may open the way to help tie up the “loose end” of financing the former Anglo Irish, now renamed IBRC.

Second, the government wants an ECB commitment to provide medium-term funding for the banking system. Third, it wants help to strip unprofitable home loans from Irish banks to clean them up and ready them for a future sale. The government controls three of the four biggest domestic banks.

“Some caution is needed given the fact that as ever in Europe, nothing will happen immediately,” analysts at the fixed-income firm Glas Securities in Dublin said in a note. “All that needs to be decided now is who underwrites this all.”

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