What is the cost of the Anglo and INBS Promissory Notes?

Brendan Burgess

Brendan Burgess

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The government issued €30.6 billion of Promissory Notes to Anglo and Irish Nationwide in 2010.

These were issued in different tranches with, I understand, an average interest rate of 4.6%. ( Edit: Corrected below to 6%, but the principle is unchanged) They will be repaid over 20 years with the final repayment in 2031.

The total payments of capital and interest will be €47.9 billion according to the Minister for Finance

This is just like a repayment mortgage of €30.6 billion.

[broken link removed] has argued that the total cost of these notes will mount to €75 billion.

New figures provided to Pearse Doherty from the Minister for Finance show that the cost of the promissory note will ultimately be €74.63 billion by the time it is paid off in 2031. This includes the capital repayments, the interest payments to Anglo and the cost of servicing the state’s debt in borrowing this sum.

“This is a staggering amount of money, equating to almost half the total government debt this year ....
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Let's deal with this "half the total government debt this year comment" first.

The net government debt at the end of 2011 will be around €150 billion. So €75 billion is arithmetically 50% of €150 billion.

But the actual Promissory Notes included in this €150 billion is around €28 billion. So it amounts to around 20% of government debt. This is still a huge figure, but the 50% of government debt is a massive exaggeration.

How much would a house costing €100,000 cost over 20 years at 4.6%?
If I rolled up the interest for 20 years and made no repayments, I would owe €246,000 after 20 years.

So what do you think? Does the house cost €100,000 or €246,000?

The answer is €100,000 in today's money or €246,000 in 2031's money.

Let's talk about the present value of money for a moment

I have want to buy a car and the price is €10,000. I pay €10,000 for that car. What is the price? €10,000.

If I don't have the cash and I borrow it over 5 years at 5% interest, I will make total repayments of €11,300.

The car still costs me €10,000. It does not cost me €11,300.

To understand this better, let's say I have €10,000 in cash and I want to buy a car for €10,000 and a new kitchen also for €10,000.
I buy the kitchen for €10,000 in cash and I get a car loan for €10,000 on which I will pay €11,300 over the next 5 years.

So is the car more expensive than the kitchen? Of course it is not. They are both the same price. €10,000.

Let's look at the time value of money another way.

Let's say that I sell a car today for €10,000 and put the €10,000 on deposit for 10 years at 5%. I will then have €16,000.

So how much did I sell the car for? By Sinn Féin's calculations, I have sold it for €16,000. But everyone else understands that I have sold it for €10,000


So what is the cost of the €30.6 billion of Promissory Notes ?

How much does the car cost? €10,000
How much does the kitchen cost? €10,000
How much do I sell the car for? €10,000.

What is the cost of the €30.6 billion of Promissory notes? €30.6 billion. No more. No less.
 
Hi Brendan,

This is a useful post. I think there are some worthwhile contributions on both sides but sometimes there is a lack of clarity on the definitions of the numbers used.

The real cost of the Promissory Notes is €30.6 billion. The nominal cost of the Promissory Notes is €75 billion according to Sinn Fein (I actually think it could be €85 billion). It is a pity that they do not make the distinction between present value and future value.

If I put €30.6k on deposit in a bank for 20 years at 5.5% it will have grown to around €85k by 2031. How much do I have on deposit now, 31k or 85k?

If I borrow €30.6k from a bank over 20 years at 5.5% and roll-up all the interest I will owe €85k by 2031. How much do I owe now, 31k or €85k?

The answer to both of these in 2011 terms must be consistent and, of course, the answer in both cases is 31k.

The Promissory Notes are a financial minefield. The interest rate is higher than the 4.6% you indicate. See here. The final €9 billion tranche has an annual coupon of 8.6%. The average interest rate is likely to be closer to 6%.

It is also important to realise what happens to these interest payments. In 2013 the Exchequer will pay about €1.8 billion of interest to Anglo and INBS as a result of the Promissory Notes. This forms part of the €75 billion figure used by Sinn Fein.

However the banks used the Promissory Notes to get actual cash from the Central Bank. Anglo and INBS must pay the Central Bank interest for the use of this facility. It is not clear what this will be precisely but given the numbers involved it will be well in excess of €1 billion.

This money is the profit the Central Bank makes for providing this liquidity to the banks. Each March the surplus from the Central Bank is paid over to the Exchequer. A lot of the interest payments will be returned. This further reduces the €75 billion figure used by Sinn Fein.

Over the next few weeks it is likely that the Promissory Notes will be restructured (longer term, lower interest rates). This will again reduce the €75 million figure used by Sinn Fein but there will be no real saving.

The lower interest rate will mean that there will be less interest doing the circle from the Exchequer to Anglo to the Central Bank and back to the Exchequer. The longer term means we will have longer to repay the €30.6 billion but we will still have to repay €30.6 billion.

There will be some benefit from reduced repayments in the medium term. This is useful now as we are in a difficult position with the public finances. Lower cash payments now ease the funding pressure we are under but we will have to repay the €30.6 billion eventually.

This restructuring will make loud claims about €75 billion obsolete but it will not save us money. If reducing the €75 billion will not save money it is incorrect to say that the cost is €75 billion. The cost is €30.6 billion and only reducing that will save money.
 
Séamus

Thanks for that. I haver read it twice and read Karl Whelan's piece twice. I am still trying to get my head around it. Is the following correct?


  1. The Irish government issued a series of. in effect, bonds promising to pay them off according to a certain schedule over the next 20 years. These bonds were issued to Anglo and Irish Nationwide.
  2. Anglo and Irish Nationwide gave these to the Central Bank as security for a loan. The Central Bank created €30.6 billion of new money electronically and lodged it to the accounts of Anglo and IN.
  3. Anglo and IN used this money, in the main, to repay depositors and senior bondholders.
  4. We don't know how much the Central Bank is charging Anglo and IN for this loan, but let's say it will average 4%. ( It's probably ECB + 1% which would currently be 2.25%)
  5. Over the next 20 years the government will give €47.9 billion to Anglo and Irish Nationwide.
  6. Anglo and Irish Nationwide will repay the €30.6 billion + interest to the Central Bank.
So, Anglo and Irish Nationwide are only conduits, and can be left out of this discussion as they are wholly owned by the government. Any profit or loss that they make is at the expense of another arm of the government.



So in summary


  1. The Central Bank created €30.6 billion of new money through quantitive easing and gave it to the government
  2. The government will give this back over the next 20 years
  3. The government will have to borrow this €30.6 billion , in effect, at the marginal cost of government borrowing, over the next 20 years.
  4. The interest paid by the government to the Central Bank does not matter, as it creates profit in the Central Bank which reverts to the government.
The correct present value cost of the €30.6 billion will be the Net Present Value of €30.6 billion paid over the next 20 years which is a lot less than €30.6 billion.

The NPV of the capital payments discounted at 5% is around €21 billion or at 2%, it is €26 billion.
 
Can anyone explain what this is all about then?
[broken link removed]

Minister for Communications Pat Rabbitte and Minister for Transport Leo Varadkar yesterday suggested that a renegotiation of the punitive 8.2 interest rate being paid on the €30.6 billion promissory note used to recapitalise Anglo Irish Bank will more than compensate for the €700 million paid out to unsecured bondholders of the failed bank.

Mr Varadkar claimed that the last government delayed the payment of interest on the promissory notes, leaving this Government with punitive interest rates.

He said it would depend on the interest rates negotiated and the term of maturity of the notes.

“At present the term is 10 years at over 8 per cent".
 
Hi Kaiser

As far as I can make out, the interest rate paid by the government on the Promissory Notes is irrelevant. If they get a reduction in the rate, they will simply be paying less to Anglo Irish Bank. So Anglo's losses will be higher.

The ECB allowed the ICB to create €30.6 billion in new money. They must reverese this over the next twenty years.

The only way that the Irish taxpayer is better off is if the reversal takes longer.

Changing the interest rate is not material.

Disclaimer: This whole area is very complicated and no one has explained it properly so the above is not definitely correct.

Brendan
 
Thanks Brendan - Leo & Pat should be made explain this one. The only way they're right is if we are paying the interest to someone externally, otherwise cutting the interest would just mean we are putting less capital into the bank we own, resulting in less residual capital to extract once the loan book has been run off.
 
The politicians haven't got a clue about the notes. To be honest very few people do including me. I think when they are talking about 'saving' money on the interest, it doesn't relate to the interest on the actual notes i.e. the 8.2% coupon. It actually relates to the cost of borrowing the €30 billion cash to put into Anglo to redeem the notes. The Government will have to borrow €3 billion every year to put into Anglo. When Noonon talks about the restructuring the notes, I think he means borrowing the money from the EFSF at lower interest rates than the market are offering and maybe also over the longer term. I think this is what he means by saving money i.e. the difference between the market rates and the EFSF rate.

Another thing worth mentioning is that Ango are currently sitting on an asset paying 8.2% and funding it at 1-2% so it has huge positive carry (profit). This money should end up back with the Government as we own Anglo.
 
Sunny said:
The politicians haven't got a clue about the notes. To be honest very few people do including me. I think when they are talking about 'saving' money on the interest, it doesn't relate to the interest on the actual notes i.e. the 8.2% coupon. It actually relates to the cost of borrowing the €30 billion cash to put into Anglo to redeem the notes. The Government will have to borrow €3 billion every year to put into Anglo. When Noonon talks about the restructuring the notes, I think he means borrowing the money from the EFSF at lower interest rates than the market are offering and maybe also over the longer term. I think this is what he means by saving money i.e. the difference between the market rates and the EFSF rate.

Another thing worth mentioning is that Ango are currently sitting on an asset paying 8.2% and funding it at 1-2% so it has huge positive carry (profit). This money should end up back with the Government as we own Anglo.
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But you just know that bit will never happen...
 
Sunny said:
Another thing worth mentioning is that Ango are currently sitting on an asset paying 8.2% and funding it at 1-2% so it has huge positive carry (profit). This money should end up back with the Government as we own Anglo.
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At that level of coupon and if they're wound down within 10 years we should probably not need to ever give them the capital.
 
John McManus has a great article on this in today's Irish Times

[broken link removed]

It works as follows. The Government pays something like 5 per cent interest on the note – the yield is around 8 per cent – which Anglo takes to the Central Bank, which accepts it as security for a loan for which it charges around 3 per cent. Anglo pockets the interest margin.


The Central Bank is in turn getting the money it lends to Anglo from the ECB at a much lower and not disclosed rate which is reported to be 2 per cent or less. It keeps the difference. The real cost to the State is the rate at which the ECB provides cash and it is far from penal.
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So yet again, the ECB is providing the Irish state and consumers with cheap loans.
 
Brendan Burgess said:
So yet again, the ECB is providing the Irish state and consumers with cheap loans.
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Yes according to this article they are giving us a cheap loan.
However there are several important questions to be answered here as per this account (which is an opinion piece mind – and nothing else).

Is this loan legal under ECB rules? If it is then why is the interest rate a secret and why is this not out in the open for general discussion throughout all national and international media?

Why are they giving us this loan in the first place?
The bank guarantee was put in place first. The troika came in and offered us a loan but in order to get that loan the ECB and EU (not IMF) demanded that the debts from Anglo be taken on board by the Irish people.

The IMF were quite happy to burn Sub bondholders and maybe more (including depositors etc.) The question is how many ordinary Irish people would have been burned by this act.

The average Irish Joe on the street was hardly an everyday punter with Anglo as there were numerous high street banks out there and few anglo branches. And anyway they should be covered to the 100K guarantees. So isn’t it reasonable to presume that it was others that would take this bigger hit? So who are they?

Sure, a few big Irish banks would have taken a hit but isn’t it reasonably accurate that the major creditors taking the hit would have been pension funds etc and other foreign credit sources? But this didn’t go well and the ECB and EU and they would not allow Ireland to do this.

[FONT=&quot]And that’s why we have this loan (no matter how cheap) in the first place and at the end of the day the Irish people has to pay back this debt even though 99% have nothing to do with this €31 Billion Bank flop.[/FONT]
 
I am not an Economist. However, I have tried to gain an understanding of the origin of this 31 Billion loan and the annual 3.1B repayments. Such as who the money is owed to and why we are tied in to an interest payment that is actually repaid to ourselves.
This http://www.nakedcapitalism.com/2012/03/philip-pilkington-the-irish-begin-to-wake-up-to-the-fact-that-they-are-repaying-money-that-is-then-burned.html is a recent article by an economist of the subject which raises a number of key concerns, which affect all of us. The inference is that all of these repayments are going down some black hole in the Central Bank and in reality there should be no requirement to pay back these funds. It would be interesting to hear any counter arguements, which reflect the economic rather than moral rationale for meeting these repayments.
 
Interesting thread which I only discovered today. Brendan and Seamus have of course got it completely right. Yet the SF misinterpretation is understandable if entirely erroneous.

Basically they are saying that we don't repay the loan at all, we simply replace it with other loans. Well of course that means that ultimately we pay an infinite amount in interest.

To resolve this conundrum we must use the net present value or time value assessement. In NPV terms an infinite payment of say 1 per annum has not got an infinite value, in fact its value is quite finite indeed.

In counting the interest on the loans needed to repay the PNs but without using NPV techniques, the SF are effectively multiple counting.
 
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