# The proposed promissory note/tracker bonds swap



## Brendan Burgess (18 Mar 2012)

I am trying to get my head around this. Have I got what is [broken link removed]correct?

*How we got here *

1) The government gave the IBRC a Promissory Note for €30 bilion. They  said to the IBRC "We will make the following payments to you over the  next 20 years, with most of it being paid over the next ten years. In  particular, we will pay you €3.1bn on 31 March 2012" 
2) The IBRC went to the Central Bank and raised cash based on that ( which it used to repay the depositors and bondholders) 
3) The Central Bank is charging IBRC interest, but as the Central Bank is an organ of the state, it is effectively interest-free to the state.
3) AIB and PTSB gave its customers €34 billion of cheap tracker mortgages. 

*Current balance sheets*

The government owes IBRC €30 billion, €3 billion of which must be repaid at the end of March
The IBRC owes the Central Bank €30 billion 
AIB and PTSB have trackers with a nominal value of €34 billion ( and equivalent borrowings from the ECB at 1%)

*Stage 1*

1)    The Irish government issues a 30 year bond (to the European Financial Stability Fund ?) and receives cash in its place
     (We don't know what the EFSF proposes to charge on this bond, but let's assume it's 3%)
2)    It gives the cash to IBRC in exchange for the Promissory Note 

Stage 1 result - The government now has a 30 year EFSF bond on which it  is paying 3% interest instead of a Promissory Note which is effectively  interest free as it was issued by the Central Bank.

*Stage 2*
3) The IBRC uses the cash to buy the tracker mortgage book of AIB and PTSB 
4) The IBRC uses the mortgage book as security to replace the Promissory Note 
5) AIB and PTSB use the cash to repay the ECB 


The new balance sheets

The Irish government owes €30 billion to the EFSF instead of to the Irish Central Bank 
The IBRC now has a mortage book instead of its promissory note 
AIB and PTSB has €30 billion less in assets and €30 billion less in loans from the ECB 


*Summary from the government's point of view. *
It is exchanging a 10 year interest free loan for a 30 year loan charging 3% interest.


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## Brendan Burgess (18 Mar 2012)

*Analysis 

*The government is muddying the waters by making a connection between the problems of the Promissory Notes and the Trackers.  It makes the problem and the proposed solutions more difficult to understand. 
They should be dealt with separately so that people realise that this deal will cost the taxpayer more in the long-term. 

*The Promissory Notes are interest-free *
This seems to be missed by most people. The government pays interest on the Promissory Notes to the IBRC. But it owns the IBRC so it's like a husband paying interst on a loan to a wife and she puts the interest back in their joint account anyway. It doesn't matter to the husband whether the interest rate is 0%, 3% or 30%. He gets it back. 

*A better solution would be to borrow the €3 bllion Promissory Note payment from the EFSF
*
The Irish government has to pay €3b to the IBRC by the end of this month. Why not simply borrow that from the EFSF?   That way we have a loan of €3 billion at 3% interest, instead of a loan of €31 billion at 3% interest.


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## Brendan Burgess (18 Mar 2012)

*Shifting the tracker mortgages from the books of AIB and PTSB has advantages, but shifting them to IBRC is not the right answer.

*A struggling borrower who owes €200k to PTSB at the moment will feel  much less enthusiastic about keeping up the struggle if they owe the  money to IBRC, formerly known as Anglo. They will say "Anglo has cost me a fortune. They have written off the loans of developers. Why should they not write off my loan?"  Just imagine the fuss which the independents in the Dáil will make if IBRC, formerly known as Anglo, seeks to repossess someone's home! 

If PTSB Mortgage Administration  wants to take legal action to recover the money, they will need the  approval of IBRC - in other words another layer of bureaucracy.

 Presumably AIB and PTSB will continue to administer these loans although they will  no longer own them. They are going to be less diligent about collecting them than they are at present. It's likely that bad debts will increase. 


*Transferring the AIB and PTSB trackers is a good idea
*The banks will appear more profitable and can return to normal lending sooner. 
They may also become attractive to investors and so the government can sell them. 

*But perhaps the trackers could be sold to a newly independent EBS?
*Overall, it would be better if borrowers owed money to a bank than to the IBRC.  There was no justification for merging the EBS with AIB. It could be demerged and become the run-down home for the trackers. 

If normal market conditions return, it's possible that the EBS could become a viable entity again. 

*What price will IBRC pay AIB and PTSB for these trackers? 
*In a sense it doesn't matter as both seller and buyer are state owned. If IBRC overpays for them, then the state owned AIB and PTSB will have stronger balance sheets and won't need further recapitalisation.


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## Duke of Marmalade (18 Mar 2012)

_Boss_ think shamrock. Ignoring BoI, we have three leaves of the one State - the Father being the government, the Son being AIB et al and IBRC being the Unholy Ghost.

At present the the Father owes the Ghost a promise and the Son has these loss making Tracker Mortgages. The essential feature of the endgame is that the Ghost switches his PNs for the TMs and the Father replaces the promise to the Ghost with (NAMA style) bonds to the Son. _(I don't think they will get away with their issuing a long term bond to that other Blessed Troika in return for cash injected to the Son_.)

So, ignoring that last point, which is not really relevant, it all just appears to be a rearrangement within the leaves of the Shamrock.

But there is a big difference. The Ghost owes a stack of dosh to the Devil (through the ELA given by the devil's advocate in Ireland, the CBI.)

The PNs represent in effect a reasonably aggressive repayment (high coupon plus capital paydown schedule) of that ELA. To replace these PNs with long term and low yielding TMs would prolong considerably this monetary financing of the Ghost. It would be as if with hindsight the CBI had printed the money and handed it out in TMs. I can't see the Devil buying that

BTW the 3bn due to be paid on PNs this month has to come from Troika financing - there is no other source of funds. From the Shamrock's point of view the PN/TM swap replaces EFSF interest payments with ECB Target2 interest (see below), a slight gain in current conditions.

From the Father's point of view there is the considerable gain that it makes it easier to meet the deficit targets set by the Troika. What they would really like to get away with is having the same access to the Troika bail out fund, thus possibly reducing the need for more austerity. Again I can't see them getting away with that.

_Technical note: when the 3bn is paid down on the PNs, IBRC pays down 3bn of ELA with the CBI and the CBI in turn has its Target2 deficit at the ECB reduced by 3bn. The Target2 deficit reflects the fact that so many (including repaid IBRC bondholders) have withdrawn funds from the Irish banking system and deposited them somewhere else in the Eurozone. _


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## Duke of Marmalade (18 Mar 2012)

I see _Brian Carey_ addresses this in the _Sunday Times_.  He differs from my version in that he sees ELA being replaced by very long term funding from the ECB.  It is not clear whether he sees the TMs in AIB et. al. being replaced with cash raised by long term EFSF loans or being replaced by NAMA style bonds directly from the government.

What this amounts to is soft very long term funding.  There is no reduction in actual indebtedness, just a very long finger.

I really can't see how the ECB/EU or even the IMF would agree to this.

In any case, it is not in Ireland's long term interest, as Department of Finance "sources" in the _Sunday Times_ point out.  We should start paying off our debts and getting our fiscal house in order, not looking for a "never, never" palliative.


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## Brendan Burgess (19 Mar 2012)

Hi Duke

I was trying to simplify things, not make them much more complicated! 



> The PNs represent in effect a reasonably aggressive repayment  (high coupon plus capital paydown schedule) of that ELA.



I don't think that the Promissory Notes have a high coupon. The coupon is effecively zero. The government pays a high coupon, but it pays it to the IBRC, so it doesn't actually matter if it pays 0%, 3% or 10%. 

The problem with the Promissory Notes is that the bulk of the liability has to be repaid within 10 years. 



> There is no reduction in actual indebtedness, just a very long finger.



This is the key point in all this. When we repay €3 billion at the end of this month, we have to draw it down from somewhere else. That somewhere else is effectively the troika.  Our net debt on 31 March will be the exact same. We owe the  ECB/Central Bank €3 billion less and we owe the Troika €3 billion more.


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## Centaur (19 Mar 2012)

Thank you, Brendan and others, that discussion has cleared up a number of questions for me.

Am I right in saying in a nutshell that the Irish Central Bank was allowed to temporarily create €30bn of money to rescue Anglo but that this money created has to be extinguished over the next 10 years by external borrowing?


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## Brendan Burgess (19 Mar 2012)

Centaur

You got it in one.

I may plagiarise that wording as it captures it so well. 

Brendan


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## Duke of Marmalade (19 Mar 2012)

_Boss_ sorry if my pale imitation of Naoimh Padraig failed dismally to enlighten the natives about this blessed mystery.

But your own parable is a tad too simple.  Yes, I can go along with an argument that says the PNs are interest free (because they are in family) but so too are the replacement bonds.  This is very clear if the bonds are given NAMA style to AIB et al but even if they are given to the ECB at say 3%, the cash received will be held in AIB et al and will earn the contra interest i.e. overall interest free.

But really, it is quite simple.  The PNs constitute a fairly rapid repayment of IBRC's indebtedness to the ECB/CBI.  It is rapid for two reasons.  Firstly there is a schedule of principal repayments and secondly the coupon is high.  I think you might be missing this last point.  Whenever a coupon is paid to IBRC it goes straight to repaying the ELA so a high coupon speeds up this repayment.

So what is being sought is quite simply a significant lengthening in Ireland's repayment schedule, so far as it applies to IBRC debt.  

We won't succeed.


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## Duke of Marmalade (19 Mar 2012)

Centaur said:


> Thank you, Brendan and others, that discussion has cleared up a number of questions for me.
> 
> Am I right in saying in a nutshell that the Irish Central Bank was allowed to temporarily create €30bn of money to rescue Anglo but that this money created has to be extinguished over the next 10 years by external borrowing?


Not quite. It has to be repaid but not by external borrowing, as that is simply replacing one loan with another. This is Sinn Fein's argument.

The target is to get us in fiscal balance *after* allowing for our repayment of the PNs. When that time arrives we will be running a primary surplus and we will be genuinely repaying our debts out of taxes and not out of new loans.

At the moment it looks as if we are simply replacing the PNs with EFSF loans but that is over simplistic. The PN repayment of 3.1Bn was very much part of the budgetary arithmetic last December and we needed that much more "austerity" to meet that obligation. If the Troika simply ignored the PN obligations when coming up with their fiscal targets then, indeed, they would not represent any repayment of indebtedness but simply a switch to different indebtedness.

This is why the government are so keen to delay these PN repayments as it would make reaching the targets easier and lessen the short term need for austerity.

But the Troika aren't stupid. If they relax the repayment schedule on bank debt they will increase the fiscal correction required. To clarify. let's say the target in 2015 is currently 3%. That is after a 1% PN repayment. If the PN repayment is postponed the target will become 2% so that we simply do not use the postponed repayment of bank debt to continue to live our daily lives on the never, never.

The government will not be able to get their cake and eat it.


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## Brendan Burgess (19 Mar 2012)

Duke of Marmalade said:


> but so too are the replacement bonds.  This is very clear if the bonds are given NAMA style to AIB et al but even if they are given to the ECB at say 3%, the cash received will be held in AIB et al and will earn the contra interest i.e. overall interest free.
> 
> .



Hi Duke

That is the bit which I missed. It is obviously a good idea to replace a 10 year interest-free loan with a 30 year interest-free loan. 

From Simon's article



> If the European Commission and the European Central Bank give the  green light, a 30-year Irish Government bond could be accepted as  collateral for a loan of the same duration at a low interest rate from  the EU bailout fund, the European Financial Stability Facility.
> 
> 
> The  EU raised a 30-year bond through the European Financial Stabilisation  Mechanism bailout fund in January for the Irish and Portuguese bailouts  at a rate of just over 3 per cent.



I took this to mean that the Irish government would issue a bond to the EFSF  and pay them 3% interest. 

But in fact, the IBRC has to borrow the money from the ECB anyway?


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## Brendan Burgess (19 Mar 2012)

Hi Duke 

Is this correct?

The IBRC borrowed €31 billion from the ECB at 1% using, in effect, a government guarantee i.e. the Promisory Notes.

The IBRC has to repay €3.1 billion of this at the end of March. 

All the rest is just internal accounting amongs branches of the same entity. 

The government wants to delay the repayment of the €3.1 billion to the ECB at the end of March.


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## Mouldy (19 Mar 2012)

If the IBRC uses the cash from the 30 year bond to buy the trackers of PTSB and AIB, is there any incentive for them to offer a deal to tracker mortgage holders to come off trackers and on to a SVR?


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## Duke of Marmalade (19 Mar 2012)

_Boss_ that is in essence correct but just to be absolutely sure on some details.  

The ELA is in fact provided by the CBI but the CBI get their money from the ECB.  

It is the government which is legally bound to pay IBRC 3.1bn at the end of the month.  Technically, I think, IBRC has to repay *ALL* of its ELA at the end of very month or so.  It keeps rolling over this emergency assistance but only with the approval of the ECB.  Clearly when the government pays its 3.1bn to IBRC at the end of the month the CBI will not roll over that amount of ELA at the next repo date.  

Thus in effect the government will pay 3.1bn to IBRC will pay 3.1bn to CBI will pay 3.1bn to ECB.  And for good measure, just at the present, the government will get the 3.1bn in the first place from the EFSF.


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## Duke of Marmalade (19 Mar 2012)

Mouldy said:


> If the IBRC uses the cash from the 30 year bond to buy the trackers of PTSB and AIB, is there any incentive for them to offer a deal to tracker mortgage holders to come off trackers and on to a SVR?


Not sure about the answer to this but on the central theme of this thread that IBRC, AIB et al and the government are three leaves of the same troika, it shouldn't really matter whether the Trackers are in IBRC or AIB et al.  If there us an incentive for the State to switch them to SVR when they are in AIB et al that inventive remains when they move to IBRC.

I suppose you have in mind that IBRC and AIB et al would have their own separate agendas which might not be aligned with that of the government, notwithstanding that they are owned by it.  If so that would be mismanagement by the government.


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## Duke of Marmalade (22 Mar 2012)

Okay. So we begin to see the model. IBRC will now receive 13 year bonds instead of cash for its 3.1Bn PN payment due next week.  These are what I call "NAMA style" bonds in that unlike conventional bond issuance they do not have to stand a market test. 

Those bonds will presumably be switched at some stage to AIB et al in return for TMs. I do not see a long term bond being issued directly to the ECB.


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## Brendan Burgess (22 Mar 2012)

To whom do they issue these bonds? 

Do they pay interest on them? 

They still have a Promissory Note from the state. Do they just tear up €3.1 billion of that?


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## Duke of Marmalade (22 Mar 2012)

Brendan Burgess said:


> To whom do they issue these bonds?


IBRC 



> Do they pay interest on them?


Absolutely. The rate will be interesting. I understood that the rate on the PNs was 8% so as their market value could be argued to be par. I suspect these will be like NAMA bonds with effectively rolling variable rate at around the ECB rate, maybe plus 50bp 



> They still have a Promissory Note from the state. Do they just tear up €3.1 billion of that?


It has been paid up, not in cash but with bonds. No tearing up, simply a retiring on schedule.


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## Brendan Burgess (22 Mar 2012)

Hi Duke

Sorry, I was confused, and I probably still am.

The state will issue bonds to the IBRC. 
The state will pay interest on these bonds to the IBRC (In other words, they will be interest free as it's the state paying interest to itself) 

So, in effect, the only change is to reschedule the Promissory Note. 

But where does the Central Bank come in? They now have a government bond as security instead of a Promissory Note. The IBRC doesn't actually repay any of the cheap loan from the Central Bank. 

Brendan


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## Duke of Marmalade (22 Mar 2012)

Brendan Burgess said:


> Hi Duke
> 
> Sorry, I was confused, and I probably still am.
> 
> ...


That's my read. Under the PN regime the cash would have been funded from the bail-out fund, paying EFSF interest. Under this arangement the interest is ECB type interest as the ECB will be funding IBRC by 3.1bn more than would have been the case if cash had been injected into it. But ECB refinancing is at variable rate, not sure about the EFSF rate. So there is a minor interest rate pick up for the time being.

Another technical effect is, I think, that bonds are acceptable security for ECB "normal" refinancing whereas PNs were only acceptable as security for CBI ELA. In the end of the day the funds come form the ECB.

As you have already observed, the bond itself like the PNs are somewhat irrelevant as they are between two leaves of the shamrock, but they are necessary to provide collateral security to ECB/CBI.


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## Centaur (30 Mar 2012)

Hilarious if you read back over the posts.

... and we live in an 'open and transparent' economy...

No wonder we got into this mess - it like a labyrinth.


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