Tuesday, April 3, 2012

Restructuring the Irish promissory notes

In 2010 the Irish government bailed out (recapitalized) the Irish banks with 30bn euros. The government could not easily raise these funds in the market so it used promissory notes (PNs) instead of cash (sort of what California did when they paid salaries with IOUs during their "budget issues" in 09). These PNs are set up to pay a set amount over the next 20 years.

The promissory notes were used as collateral with the Central Bank of Ireland to obtain central bank emergency financing called ELA. That collateral did not qualify for LTRO, leaving ELA balances outstanding. Since then the banks were "restructured" creating the Irish Bank Resolution Corporation (IBRC) - the "bad bank" to hold all the wonderful real estate loans and properties. Now IBRC owes the Central Bank of Ireland money under the ELA.

This year about EUR 3.1bn of PNs was due (on March 31st), but the Irish government was in no position to pay that in cash. Instead the goal has been to kick the can down the road - as far as it can roll. The Finance Minister Michael Noonan has been trying for a while to restructure the PNs by swapping them into long-term government bonds. His negotiations with the EU/ECB have yielded only a partial result. He was able to roll just the 3.1bn due this year, but it required a fairly messy transaction. The issue is that the ELA financing is meant to be a temporary measure and the ECB wants it paid down asap.

Here are the steps for the restructuring of the PN - just the EUR 3.1bn (this time around - no guarantee this will work next time):

1. The Government issues a long-term bond that it delivers to IBRC in return for IBRC extinguishing the 3.1bn worth of PNs (it effectively pays its "promise" with long term bonds instead of cash).

2. IBRC places the bond as collateral with the Bank of Ireland (not to be confused with the Central Bank of Ireland) to borrow cash for a year. Given that the Bank of Ireland is controlled by the government, it can roll this loan indefinitely.

3. IBRC uses the cash from the loan to pay down the ELA financing and get back the PN it had out with the Central Bank of Ireland.

4. The Bank of Ireland then uses these long-term bonds as collateral to borrow from the Central Bank of Ireland/Eurosystem under the MRO or 3m LTRO programs.

Restructuring of Irish promissory notes

With this transaction, the Irish government doesn't have to use cash to pay the promissory notes, the Bank of Ireland makes a spread between where it borrows from the central bank and what it receives from IBRC, and the ECB makes sure that the ELA is paid down. Everyone is happy, right? Not exactly. This is a difficult transaction and Michael Noonan would much rather have used financing from EFSF directly. Most importantly, this is only a portion of the PN restructuring and this issue will be back shortly when the next portion of the PN is due. In 2014 the PNs due will constitute some 15% of projected cash needs of the Irish government.

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