What will be the impact of this Promissory Note deal?

Brendan Burgess

Brendan Burgess

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Moved from another thread - Brendan

I suspect that the government might need to do sums on this as well.

At the moment the effective interest rate on the Promissory Notes is either 0% or 0.75%. (Fiona Reddan has a good article explaining how they work in today's [broken link removed].)

If this is replaced with a 3% bond, we will end up paying a lot more.

I am concerned that the government will in effect surrender a 10 year cheap tracker for a 27 year SVR mortgage.
 
To quote Seamus Coffey (From the Nama Wine Lake Blog) on the net effect of this transaction, we do appear to be in line for a net benefit.
"NAMA bonds don’t form part of our debt so I would expect our debt to drop by €16bn or 8% from 122% to 114%. We will pay interest only on whatever instrument we replace the promissory note with and for illustration, if we replace it with a 4% 10-year bond, then on the estimated €10bn, we will pay €400m interest compared with about €1.8bn this year for the promissory note. We will make similar savings in 2014 and 2015, though the savings reduce after that. This consequently means we can potentially cut the adjustment this year by €1.4bn and the Budget in December would be €1.7bn of adjustments rather than €3.1bn.”
 
Brendan Burgess said:
Hi Firefly

I suspect that the government might need to do sums on this as well.

At the moment the effective interest rate on the Promissory Notes is either 0% or 0.75%. (Fiona Reddan has a good article explaining how they work in today's [broken link removed].)

If this is replaced with a 3% bond, we will end up paying a lot more.

I am concerned that the government will in effect surrender a 10 year cheap tracker for a 27 year SVR mortgage.
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Bit of a sore brainer. But listening to news at one and Colm McCarthy in particular it seems that these bonds will be essentially six month floating rate loans, SVR if you like.

So that is no different from the current situation except that under the PNs we were paying down the capital rather faster. Also the high interest on the PNs contributed to the budgetary deficit (the capital had already been recognised in 2010).

So we get extended SVR borrowing and (this is cosmetic I think) our annual deficit reduces from c. 1.9bn to c.7bn.

As Colm pointed out, as an SVR this could look very expensive in a few years time, but maybe then we can afford to start paying them down.

A good deal yes, but a far, far cry from "tearing them up" promoted by Brian Lucey, Peter Matthews, Karl Whelan et al. At least Fierce Doherty was simply just a crude defaulter, the other geniuses argued that since it was Central Bank money nobody got hurt if we simply tore them up.
 
I think people are overestimating the benefits of this.

NAMA bonds don’t form part of our debt
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They may not form part of our official debt figures. But we still owe the money.

At the end of this transaction our total national debt will remain the same. It may be that the official,statistical, debt figures will be different. But that is not that relevant.

on the estimated €10bn, we will pay €400m interest compared with about €1.8bn this year for the promissory note.
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Again, these savings are a complete mirage. The effective rate on the Promissory Notes is 0.75%.

  • The government pays a higher rate on the Promissory Notes
  • But it pays it to IBRC which it owns
  • IBRC borrows , ultimately, from the ECB at 0.75%
  • So IBRC, which we own, makes a profit of the difference between what they pay the ECB and what the Government pays IBRC
It seems from the reports that the long term bond will be issues at 0.75% interest.



So there is only a small benefit to the Irish government from this deal.



The repayment period has been stretched from 10 years to 35 years(?).



That is good. If I have a 10 year cheap tracker and the lender extends it to 35 years at the same cheap rate, then that is a good deal.

If they make it interest only for 35 years, then it's a great deal.

I would be grateful for it, but the annual cost of servicing the mortgage in the earlier years has not changed.
 
44brendan said:
To quote Seamus Coffey (From the Nama Wine Lake Blog) on the net effect of this transaction, we do appear to be in line for a net benefit.
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brendan

You are getting me into serious trouble. I was astonished that Seamus Coffey could get this so wrong that I thought maybe it was I who misunderstood it.

Séamus was only quoting Nama Wine Lake to correct him!

This is what Séamus actually says in his reply

"
There should be no change in the debt. It is the correct that the NAMA bonds don’t effect the debt, but the NAMA bonds are being used to “buy” the IBRC loans. The NAMA bonds are not replacing any government debt so the debt ratio will not fall. Something will be created to replace the Promissory Notes and the net impact of that change in the debt ratio will be nil.


There is no chance that this move will reduce the amount of budgetary adjustments to be introduced over the next few years. The adjustment amounts will be maintained and instead the deficit targets will be revised.
We are not going to gain twice from this. There will be funding gains in the medium term, possible NPV gains in the long term but the deficit reduction programme will not be altered. This is supposed to make our debt more “sustainable”. Reacting to this by running higher primary deficits would not achieve that.
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As far as I can gather from the multitude of information out there on the process, the net effect of the deal will be as follows:
- It will crystallise the promissory notes and ELA funding issues to IBRC into NAMA Bonds (effectively but not practically government debt).
-The rate on these Bonds will be same as Govm't borrowing rate (ie. .75%)
- previous high rate was a condition imposed by the ECB. I note that interest was paid to the ICB, but there was an inference that the payments did not benefit the ICB as the money was effectively taken out of circulation. i.e. similar to burning banknotes.
- New Bonds will be fully Govm't guaranteed but over a longer term. I think NAMA Bonds are repayable by 2020!!
- The net effect will reduce our annual budget deficit, but is not likely to effect the current austerity programme. i.e. The books will still have to be balanced in line with the Troika agreement.
Indications are that while it is better than a slap in the face with a wet fish, it doesn't involve any real extra money in our pockets. However the alternative, could seriously effect our economy and effect any chance of meeting budgetry targets.
I'm hoping someone can explain it all to me in more simplistic terms!!
 
dereko1969 said:
I'm not sure how close this mirrors what actually happened but Karl Whelan had a piece in Forbes late last year that spelled out some large benefits from this

http://www.forbes.com/sites/karlwhe...g-the-promissory-notes-with-a-long-term-bond/
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Hi Derek

A very good article which backs up everything I say.

At the moment, we have cheap money with an average maturity date of about 7 years. This is being replaced by cheap money with an average maturity date of 35 years.
 
- The net effect will reduce our annual budget deficit,
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A lot of people are saying this. Apparently the capital repayment element of the €3.1 billion payment is treated as part of our current budget deficit. I don't understand why this would be. But it has really no impact on our total borrowing.
 
Brendan Burgess said:
A lot of people are saying this. Apparently the capital repayment element of the €3.1 billion payment is treated as part of our current budget deficit. I don't understand why this would be. But it has really no impact on our total borrowing.
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My understanding is that the capital element of the PNs i.e. 30Bn, or whatever, was recognised in the 2010 deficit. So each year the capital element of the 3.1bn is ignored in the budgetary arithmetic (already counted in 2010) but the interest element of c.1.9bn is new deficit. In this sense the rate of interest on the PNs is relevant.

But Seamus Coffey has got it absolutely spot on. This easing of the budgetary arithmetic will not affect one iota the fiscal demands placed on us by the Troika or indeed by the markets if we ever re-enter - there is no relaxation here for our fiscal consolidation requirements. The Government, and Labour in particular, should be careful not to overplay this "victory", for the 2014 budget is still going to be every bit as difficult as the 2013 one was.

Indeed if this in any way gets the Croke Park Beardies to argue that there is now scope to ease off the austerity pedal, the government has shot itself in the foot.

So is it a win at all? Well, it does amount to long term monetary financing (the ECB's great ideological no-no) and monetary financing is traditionally much cheaper than long bond borrowing - currently 0.75% versus 4%. Under the PNs we were required to quite rapidly ease off the monetary teat, now we can enjoy it for 35 years:)

Another very obvious benefit is sheer cashflow. That 3.1bn had to be raised, now we only need to raise 0.7bn. That makes it easier to re-enter the market, which is I presume the main reason that the IMF were in support and the ECB has reluctantly conceded.

Finally, for the Fierce Doherty's of this world, we have crossed a Rubicon. In the words of Charlie Haughey we have copperfastened this obligation. The PNs were always a bit dodgy and walking away from them might have got some sympathy from our EU colleagues. There is no walking away from Government Bonds without bringing the house down.
 
This looks like a terrible deal. From the [broken link removed]

The average interest rate on the new bonds will begin at just over 3%, compared with an interest rate of well over 8% on the Promissory Notes.
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I am assuming that the 3% is correct. The 8% is not correct. The correct rate on the Promissory Notes is 0.75%.

It depends on to whom the 3% is paid. If it's paid to the Central Bank, then it doesn't matter.
 
the interest element of c.1.9bn is new deficit. In this sense the rate of interest on the PNs is relevant.
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OK, I get it now. This artificial figure is used instead of the true cost to the state which is around €250 million (€31 billion @0.75%)

The Promissory Notes were a great deal. This new one looks terrible.
 
Brendan Burgess said:
OK, I get it now. This artificial figure is used instead of the true cost to the state which is around €250 million (€31 billion @0.75%)

The Promissory Notes were a great deal. This new one looks terrible.
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Can you explain where/how/why the two figures, 0.75% and 8%, come from?
 
The coupon rate on the final tranch of the Promissory notes is indeed 8.2%.
Im not sure where the 0.75% is coming from........
 
Purple said:
Can you explain where/how/why the two figures, 0.75% and 8%, come from?
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The effective rate on the Promissory Notes is 0.75%.

  • The government pays 8% on the Promissory Notes
  • But it pays it to IBRC which it owns
  • IBRC borrows , ultimately, from the ECB at 0.75%
  • So IBRC, which we own, makes a profit of the difference between the 8% and the 0.75%
Fiona Reddan explains it here[broken link removed]

and Karl Whelan explains it here.

Consolidating everything, the only interest cost associated with the outstanding ELA debts stem from the fact that the Central Bank incurred a large Intra-Eurosystem liability via the TARGET2 system when the IBRC depositors and bond investors were paid off and moved their money abroad. Sourcing funds from abroad to pay off the ELA would have the effect of reducing this liability. However, the Central Bank only pays interest on this liability at the Main Refinancing Operation (MRO) rate, which is currently only 0.75%.
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Conor Brophy has explained on RTE that the Central Bank will hold the bond. Therefore the interest will be paid by government to the Central Bank. So again, the real interest rate is 0.75%

So this is a very good deal.
 
Brendan Burgess said:
Conor Brophy has explained on RTE that the Central Bank will hold the bond. Therefore the interest will be paid by government to the Central Bank. So again, the real interest rate is 0.75%

So this is a very good deal.
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I would drop the "very". Good deal yes. Kenny is completely misrepresenting the situation when comparing the 8% to 3%.

What is at stake here is that we have paid off most of Anglo's depositors and bondholders and instead we owe that dosh to the ECB. The ECB charges 0.75% at present. Now the internal arrangement between the Government and the CBI merely dictates the pace at which the CBI (i.e. the taxpayer) can pay down the ECB liability. Under the PNs we paid that down fairly sharpish and that would imply raising funds elsewhere at say 4%. Under the proposed arrangement we pay down the loan much slower, principal payments hugely delayed and only 3% coupon (notice I voided the word interest, the only interest that matters is what we pay externally).

Let us say that our market (or indeed Troika) funding rate is 4%. What is at issue is how long and for how much can we enjoy ECB monetary funding versus market bond funding, obviously for much longer under the new arrangement. In the end of the day the win is the amount of interest we pay the ECB at the monetary rate versus what we would have to pay the markets (Troika) at the long term funding rate.

There have been references to the rate being a floating 6 month rate but this must refer to the NAMA bonds which are being used to buy IBRC's assets rather than the Government Bonds being given to the CBI in exchange for the PNs.
 
"A very good deal"

As far as i can see its the same deal. We still owe 30billion, we will still have to pay a net 0.75% to finance it. The main difference is that we will pay it back over a much longer period.

Our cash flow will be much improved for the next 20 years but we end up paying a lot more interest in the end. Im not sure we can call it the deal of the century.

After all,we started out with high expectations of having the banking debt written off and now, after all the fanfare we end up with a "well below expectations" extension to the existing debt. Yes we made a huge mistake in allowing Clown Cowen to put ordinary tax payers in the dock for Anglo's commercial debt and in case anyone has forgotten, this was the big fight that Enda was supposed to take to Brussells on our behalf.

If there are some grinning, Fine Gael, faces in Leinster house this evening, Im pretty sure they are laughing their heads off in Frankfurt.We've been check-mated.

In my view its a failure and a failure thats being masked somewhat by the news grabbing IBRC liquidation
 
Dr Debt, I think we crossed postings and are essentially making the same point.

The real danger here is the over-egging of this by the Government partners and especially Labour. The dogs in the street have been expecting something like this for a long time. The rabbit getting all macho on RTE and Gilmore reverting to his Labour vs Frankfurt theme were made in full knowledge that a deal was on - but they will now bask as heroes who have won a great battle.

This should be called for what it is, a welcome relaxation of the crucifying imposition of the Seanie/Fingleton debt, but having negligible implications for the elephant in the room which is that we have the worst budgetary imbalance in the EZ.

We have a target deficit this year of 13bn. That includes 1.9bn on the PNs. The new target should be 12bn (allowing for some interest payment on the new arrangement). We haven't won a billion in foreign adventures to throw to the Bearded Ones in Croke Park.
 
An analogy:
  • Currently we own a house worth €30bn and we are paying off the mortgage over 10 years. However because our income has reduced but our outgoings have not, we cannot afford the monthly repayments. We risk losing the house.
  • So the lender offers to restructure the mortgage over 35 years.
Conclusion:
  • we have spread out the capital repayments over a longer period (thus more affordable on a cash flow basis)
  • yes, we will pay more interest over the period
  • but we get to stay in the house
And on a time-weighted basis, the money we pay in 20 to 35 years time is "worth" less than what we are paying now.

So, a (very) good deal??
 
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