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A Briefing Note on Promissory Notes

A Briefing Note on Promissory Notes

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A Briefing Note on Promissory Notes

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  1. A Briefing Note on Promissory Notes

  2. Anglo & INBS Crash • 2008 – Irish property bubble spectacularly bursts • September 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

  3. Now - The IBRC • Anglo 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

  4. Guarantee • The 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

  5. 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

  6. Emergency Lending Assistance • To 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

  7. Paying Back the ELA • The 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

  8. Promissory Note • The 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’

  9. The price • A 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)

  10. How it works • The 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

  11. 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

  12. 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)

  13. Socio economic implications • Over 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

  14. Socio economic implications • The €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.

  15. The issue • The interest rate is not the issue • A red herring • The real issues are: The size of the principal • Reduction in the principal – write down When we are making the repayments • Changing the schedule of repayment –holiday, postponement

  16. Risks in promissory note suspension/postponement? • “The ECB will cut off funding to our pillar banks” • “It will impact on the European banking system” • “It will undermine investor confidence in Ireland” • “It is a condition of the EU/IMF Memorandum of Understanding” Are these risks plausible?

  17. 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

  18. 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

  19. Decision makers - ECB Governing Council • ECB 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

  20. The need for a success story

  21. 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