AIB Would AIB's CEO try to justify a "prevailing rate" to another bank's CEO?

MacuSheild

Registered User
Messages
3
Let’s hypothetically say the CEO of AIB’s struck a deal with the CEO of Barclays early in 2008 to lend Barclays €30 million for 20 years. The €30 million loan is secured on a building that Barclays owns in Dublin.

€20 million of the €30 million loan is at the floating ECB Rate plus a 1% margin. The prevailing ECB Rate is 4% at the time the deal was signed in 2008, so on drawdown this €20 million part of the loan starts paying interest at 5% (ECB 4% + 1% Margin). However, there is an “option” attached, to AIB’s benefit. An option is the right but not an obligation to trigger a term in the contract. The loan agreement states that the prevailing value of the Barclays building must remain at between €40 million and €60 million during the 20 years. If property prices fall, AIB has the option to get the specific Barclays building independently valued and can revise the 1% margin upward, based on the prevailing value at the time of the valuation.

€10 million of the loan is at a fixed rate of 3%. This fixed rate will stay in place for 20 years unless Barclays chooses to exercise an “option” that has been placed in the loan documentation, for the benefit of Barclays. An option is the right but not an obligation to trigger a term in the contract. If the ECB rate falls sharply and looks likely to stay very low for a lengthy spell of the 20 year loan term, Barclays has an option at a time of their choosing to switch that €10 million to the same terms of interest as the €20 million part of the loan.

Soon after the deal is signed, European interest rates collapse because of a severe economic recession.

What’s the good news for Barclays?

The ECB part of the rate on the €20 million of the loan has collapsed to 0%, so with a 1% margin the new net rate is 1%. On top of that, Barclays has a contractual option to switch the €10 million of the loan to the same interest rate terms as the €20 million, so Barclays has an option to move the fixed rate of 3% on €20 million to 1% (ECB 0% + 1% Margin). Barclays will exercise that option quite soon if they think the recession and low ECB rates could last a long time and that interest rates aren’t likely to be at 5% or 6% for many years in about 10 years time (which would make the 3% fixed rate quite valuable in Years 11-20 of the 20 year loan)

What’s the bad news for Barclays?

If the prevailing value of the Barclays building has fallen below €40 million, AIB can substantially increase the margin in the loan agreement from the level of 1% agreed at the start of the loan. If Barclays exercises its option to switch out of €10 million loan at the fixed rate but the Barclays building can be independently proven to be worth less than €40 million, AIB can sharply increase the margin to rebuild the overall interest rate – on the entire €30 million loan. However, AIB cannot just assume a new prevailing valuation across all mortgaged properties in its loan contracts - it has to actually carry them out, one by one.

What would definitely not happen in this scenario?

1) Unlike AIB’s retail customers (who are not financial professionals and who are protected under Consumer Protection Codes), Barclays would not fail to consider the contractual option to switch from fixed to floating interest rates for part of the loan. It would not take Barclays 7 or 8 years to be alerted to how valuable that option was. If Barclays didn’t notice the option they held, AIB would be under no obligation to warn them in simple language, because Barclays are professionals

2) Unlike a similar contractual dispute with 4,000 of its retail customers (where it would take several years to deploy independent parties to value 4,000 residential properties), there is no way that AIB would not bother to have the prevailing value of one Barclays building assessed

3) Without an independent valuation of the prevailing value of the Barclays building, AIB would not dare to unilaterally advise Barclays that it had increased the standard initial margin on all ECB + Margin loans to 5% for all new deals of this nature with other banks - and retrospectively to Barclays on a specific historical transaction. There could be a catastrophic flight of interbank deposits from AIB if the wider market heard a rumor that AIB had insisted that Barclays would have to accept its prevailing “new business pricing”, regardless of what was specifically written in an individual AIB-Barclays Loan Agreement. Your word is your bond in the inter-bank markets

4) AIB would not be oblivious to the financial value to Barclays of having a 20-year long option to switch an interest rate from fixed to floating. This would be a significant financial risk for AIB over a 20 year period. If AIB was trying to hedge all of this risk by paying Deutsche Bank a fee to take on this risk for 20 years, financial professionals in both AIB and Deutsche Bank would do a lot of probability calculations to assess the value of the option. If Deutsche Bank make errors in their calculations and take on that 20 years of financial risk for a fee that is too low, AIB is under no obligation to warn Deutsche Bank because they are professionals. If AIB was in a contract dispute with 4,000 retail customers who weren’t aware that AIB might have unintentionally but unilaterally removed a very valuable financial option from a contract 7 or 8 years previously, AIB would probably be obliged to ensure that the amateur customers received a retrospective and fair value for a contractual option that (it could be reasonably argued) had been unfairly dishonoured
 
Last edited:

MacuSheild

Registered User
Messages
3
The value of an option is a combination of intrinsic value and time value. In early 2009, it is easily arguable that thousands of AIB customers had an option to exercise a contractual right to trigger Section 3.2 and switch to the Tracker Rate - so the option started to have a very high intrinsic value as the ECB rate started to fall. The option also had a very substantial time value, as it seems that this Tracker Rate, once triggered, would stay in place until the end of the mortgage term. The Central Bank of Ireland employ actuaries and are part of a very sophisticated treasury risk management and derivatives operation within the European Central Bank. If an AIB customer who had no Section 3.2 contractual option to switch from Variable to Tracker had asked the Central Bank of Ireland in early 2009 for an option in the form of a Derivatives Contract to switch from Variable to Tracker on a 20-year 250,000 euro mortgage (e.g. the AIB customer moves to Tracker and the Central Bank covers AIB's losses), the Central Bank of Ireland could have quoted an Option Premium of about 75,000 euro that would have to be paid up-front by the AIB customer. 8 years have passed, the intrinsic value is pretty much the same but some of the time value has gone, so the same deal could have a lower premium of about 50,000. AIB is now trying to put a current value on that option of 1,000 euro and the Central Bank of Ireland (with the job of protecting vulnerable, financially unsophisticated consumers and with all the actuaries and money market dealers on staff) seems to be watching them do it
 

scotracker

Registered User
Messages
25
Hi Macusheild,

Do you think the CB knew/approved/discussed that AIB were putting the 1k in their statement on Wednesday for this cohort?

It's threefold as I can see it-

It's the correct tracker rate (ie around the 1% mark) I should now be put on, the compensation due and the monies overpaid being repaid. AIB are not complying with the CB directives in any of these areas. It drives me mad, but I am hopeful that we will get over the line on this eventually with a fight.

As Brendan said, this cohort of 4000 has now been officially recognised (albeit reluctantly) by the lender, so that is the first step. I will be writing again to CB and all the involved and local politicians in the new year.

No way am I accepting 1k for all the years of being overcharged and the stress caused. I will take 1k for every month my family was overcharged and a correct tracker rate for starters please!
 

Spike67

Registered User
Messages
22
I agree with everything you say in the above post scotracker as I am like you. It's a complete insult to offer such a feeble amount and AIB are not complying with the CB directives. I'm not accepting this 1k either.
 

MacuSheild

Registered User
Messages
3
Hi scotracker
Somebody senior in the Central Bank made a speech a few weeks ago saying all the major banks would be subject to enforcement proceedings and that all the banks were a disgrace etc. Hearing that, AIB may have deliberately tied their own hands a few weeks ago by telling the stock market that they didn't believe that they had to make substantial additional provisions for compensation. Given that they have already been branded a disgrace, AIB might want the Central Bank to begin enforcement proceedings against them, so the Central Bank is effectively responsible for making the final decisions on "not impacted" - because there will people that the Central Bank also think are "not impacted". Once they start taking the decisions, the Central Bank may also have to produce a revised and improved version of their Redress Guidance, so the banks will start pointing fingers back at the Central Bank
 

scotracker

Registered User
Messages
25
Thanks. Yes, I read this morning that analysts are expecting AIB to have to increase their financial provision to cover the scandal. This is of course AIB protecting the share price by denying this a couple of weeks ago.

I think the CB have some strong people working and leading on this and the wind is blowing in our favour. It's a pity the AIB won't just do the right thing for once in their lives. I was really annoyed on Wednesday and yesterday, but I firmly believe we will get correct redress in time. Just need to keep the pressure on and keep our cohort in the minds of the Financial Committee members in particular.

On a side note, my wife just went into to collect our financial history from a local branch of AIB. This was after a data request was submitted and we were told who to ask for and what branch to collect it from in a letter on Monday. The branch can't find the documents.
 
Top