Promissory notes - tracker mortgages swap?

Scofflaw

It's regularly asked how on earth the negotiations on the promissory notes could be particularly complex - and the flip side of that confusion is the belief that the issue is being spun out to an eventual refusal. There's been no real suggestion as yet how the restructuring deal might work.

However, there's a piece from Simon Carswell in the IT today about the "complex technical negotiations" on the promissory notes, which suggests that what may be being attempted is a swap of the promissory notes against tracker mortgages currently in AIB and Permanent TSB.

The "tracker mortgages" were one of the more desperate attempts to achieve market share in the banks' battle for the bubble - they're mortgages with rates just above ECB rates. As such, they offer pretty much nothing in terms of profits to the banks, and are largely, in fact, loss-making. On the other hand, they are an asset of the banks worth the convenient total of €34bn.

Carswell's suggestion - and one that seems very fully fleshed out and with sources other than sheer inspiration - is that the deal being pushed by the Commssion would involve pulling the tracker mortgages out of AIB and Permanent TSB, putting them into IBRC to replace the promissory notes, and paying AIB and Permanent TSB with a 30-year low-rate loan from the EFSF:

THE RESTRUCTURING of the Anglo Irish/ Irish Nationwide promissory notes and the removal of the Irish tracker mortgages at Allied Irish Bank and Permanent TSB is still very much a work-in-progress.

There are various options, however, being weighed up in technical discussions for a draft paper by the troika and State authorities.

The aim is to reduce €31 billion of the €35 billion bailout costs of Anglo and Irish Nationwide and at the same time cleanse the other State-owned lenders, AIB and Permanent TSB, of loss-making loans that are acting as a drag on the banks.

http://www.irishtimes.com/newspaper/finance/2012/0316/1224313381216.html

What does it achieve?

First, it lowers the impact of the promissory note arrangement by extending the payments, as well as, of course, removing that politically unwelcome March 31st payment.

Second, it aligns all the various timeframes neatly - the mortgages are a 20-30 year asset, which would be balanced against a 30-year loan.

Third, it improves the profitability of the banks by removing the loss-making tracker mortgages from their assets.

Fourth, it allows another €34bn of deleveraging of the banks, bringing them closer to their target loan to deposits ratio - but without involving a sale of assets, something likely to be a bad thing to be at this year, with an expected €3 trillion in bank assets being sold off across Europe in 2012 as other countries' banks also deleverage.

Fifth, the tracker mortgages, while unprofitable, are solid assets acceptable everywhere, which should allow the banks to reduce their borrowings from the Central Bank. The promissory notes, on the other hand, are only good at the Irish Central Bank, and are not acceptable as collateral anywhere else.

So the swap produces 2 banks with improved profitability, better assets, and an improved loan to deposit ratio, which may be more tempting to external investors in the same way BOI was, and might give us three banks instead of the two "pillar banks" currently on the cards. It also concentrates the toxic assets in IBRC, which becomes much more clearly demarcated as the "bad bank" (and finally achieves systemically important status).

From the point of view of the State, the anomaly of the promissory notes is removed, and replaced with a straight-forward long term sovereign bond, while the improved position of the banks should reduce their current complete reliance on state funding. And while replacing the promissory notes with a bond might not seem like much of a deal, bear in mind that the bond, unlike the notes, would not require regular repayments of capital in the form of the annual March 31st billions, but would instead form part of the regular rollover stock of public debt - and the notional value of that debt is already on our books, because the whole value of the PNs was booked up-front. So the replacement of the PNs with a regular 30-year bond doesn't change our public debt to GDP ratio, but removes the requirement to burn €3.1bn in cash every spring.

So, in summary, the option is for the government to borrow the value of the notes from the EFSF, put it into AIB and PTSB, move the tracker mortgages from AIB/PTSB to IBRC, and eliminate the notes...without, of course, tripping over competition rules in respect of BOI.

I can see, I think, why they might not have this tied up neatly in the next fortnight. If it comes off, though, you might just find your tracker mortgage - if you're lucky enough to have one - moving to Anglo.

cordially,
Scofflaw

later12

Lets start on page 1, line 1: Irish negotiations with the ECB have failed.

1.
This is not an ECB deal. There is nothing in this suggestion which indicates any 'movement' on behalf of the ECB. What is happening seems to be a negotiation between Ireland and the EU heads of state over an EFSF loan.

Although its terms are more favourable, it is, therefore, something far more serious and rigid. The PNs were not sovereign bonds; I am assuming this is a loan from the Eurozone sovereigns, to wit the EFSF, on foot of a sovereign bond issue. That is unfortunate

Or, will this issue be a traded sovereign indenture which has ESBPF certificate sellotaped on? I would assume it would be the former.


2.
Are we muddying the issue of the Anglo PNs by un-necessarily mixing the deal up with tracker mortgages? They are separate issues. Should their resolutions be separate? Should their resolutions be separate if one solution is particularly unpalatable?

Instead of rushing into this agreement, the Government ought to first consider other ways of cleaning up the Irish banks' loanbooks and negotiation of a restructuring of the PNs on their own account.

The trackers, in line with our (it must be said, very flexible) European friends outside of the ECB, might be addressed elsewhere without necessarily having anything to do with the ECB Promissory Note.

I recognize that negotiating with the ECB has not been easy for the Government, but I think most of us would infer that the Government had yet to change into a pair of trousers for these negotiations to date.


3.
What discount will there be on the tracker mortgages?
What effect will this have on AIB's and PTSB's books?
How will the funding gap be bridged?

Recapitalisation of AIB and PTSB?


4.
(a) How will the IBRC meet its new capital requirements on foot of the use of its higher risk weighted assets? (b) What if asset quality depreciates further, for example in line with increasing ECB rates &/ an Irish recession?

Recapitalisation of Anglo?


5.
In the likely event of a second Irish programme, whether or not that includes a voluntary exchange (restructuring) on sovereign or official debt, have the authorities considered the possibility that a loss of deposits in a private bank might again materialise, leading to a return to dependence upon ELA?


6.
How will the 31st March 2011 payment be handled?
It's far too late to have this entire affair dealt with by then.


I am not saying that the suggestion outlined by Simon Carswell is a 100% bad idea. Clearly there are some positive aspects to it.

But we don't know the whole story, we don't know the whole cost of all of this. We will have to see the working paper before some of the above (and more) questions are answered.

We do know one thing. The big winners in the above scheme, were it to be realised as set out by Simon Carswell, would be the ECB. That is not necessarily a criticism of the plan, but it is rather interesting that the ECB can enjoy such benefits as a reward for apparent refusal to engage with the Irish authorities, or certainly a refusal to budge on the Promissory Note.

woodoo

As the banks are making losses on the trackers and then trying to claw back money from variable rate customers. This could be good news for variable rate customers.

Scofflaw

later12 wrote:

This is not an ECB deal. There is nothing in this suggestion which indicates any 'movement' on behalf of the ECB. What is happening seems to be a negotiation between Ireland and the EU heads of state over an EFSF loan.

While it's being pushed along by the Commission, it's a troika arrangement. From the IMF's conference call:

QUESTIONER: I'd like to come back to the -- are you referring to specifically the Anglo-Irish promissory note and the work that's going on there? Is that what's being referred to here?

MR. BEAUMONT: Yes, promissory notes are part of the technical work that's ongoing.

QUESTIONER: At this point would you say you're optimistic about receiving a favorable outcome for Ireland on that or not?

MR. BEAUMONT: We're optimistic in the sense that we continue working quite hard on this issue. Together with the staff of the European Commission, the ECB and the Irish authorities, substantial work is being invested into this, so that I think all parties are working hard to make it possible.

QUESTIONER: Are you optimistic about the potential outcome in terms of -- in the process?

MR. BEAUMONT: Like I said, we are applying a good deal of resources to this on all sides so that I think we all have a positive attitude to achieving this goal.

QUESTIONER: Is it a near-term thing? Is it a medium-term thing? Do you think there will be some outcome? First of all, when do you think we'll see -- produced by the Troika, number one? And then when you think we'll see a final outcome on the -- prom note issue?

MR. BEAUMONT: No timetable has been agreed for the technical work in progress. We'd like to move it along reasonably quickly, but at the same time we need to achieve a certain degree of consensus among all the parties so that there is no firm timetable.

QUESTIONER: Is there a certain amount of consensus at this point or are you meeting some -- resistance from other members of the Troika -- ECB? Can you give us a flavor of the level of consensus there at the moment?

MR. BEAUMONT: I think that there is a lot of consensus among the staff involved. It's still a work in progress, but fundamentally the underlying concept has attracted a lot of consensus.

QUESTIONER: Just to be clear, you're saying there is a lot of consensus within the Troika on this particular issue?

MR. BEAUMONT: Yes, among the troika staff.

But perhaps, of course, the IMF are only claiming consensus...I'm sure the ongoing narrative of the ECB as perpetually intransigent will survive.

cordially,
Scofflaw

later12

The original effort itself (straightforward restructuring of the notes) probably would have involved a troika 'consultation' too - all of the interactions with programme states tend to operate like that. But essentially, PN Restructuring was a question for the ECB.

This new deal most certainly involves the troika - but the ECB arm of the troika has absolutely no reason in the world to be anything except delighted at a deal which improves the quality of Irish collateral held by the ECB and with an aim of reducing dependence on ELA operations. If I were an ECB participant I would just, nod, smile and keep my mouth shut.

The people who might be concerned, however, are the EU Commission, and it is they and the heads of state who I imagine now need to be won over under this new approach. Hence, perhaps, one might perceive new relevance to Mr Noonan's rendez-vous with Francois Baroin last Thursday.

After all, it is the guarantors of the EFSF and the ESM who, it is speculated, now are being asked to assess a risk and make a commitment, not the ECB.

Kev.

Very good post which makes alot of sense..

It would be great relief for PTSB SVR customers as rates should be lowered and the offloading of trackers would give the PTSB no more excuses

Scofflaw

later12 wrote: »

The original effort itself (straightforward restructuring of the notes) probably would have involved a troika 'consultation' too - all of the interactions with programme states tend to operate like that. But essentially, PN Restructuring was a question for the ECB.

This new deal most certainly involves the troika - but the ECB arm of the troika has absolutely no reason in the world to be anything except delighted at a deal which improves the quality of Irish collateral held by the ECB and with an aim of reducing dependence on ELA operations. If I were an ECB participant I would just, nod, smile and keep my mouth shut.

The people who might be concerned, however, are the EU Commission, and it is they and the heads of state who I imagine now need to be won over under this new approach. Hence, perhaps, one might perceive new relevance to Mr Noonan's rendez-vous with Francois Baroin last Thursday.

After all, it is the guarantors of the EFSF and the ESM who, it is speculated, now are being asked to assess a risk and make a commitment, not the ECB.

Ah - yes, from that perspective, yes, there's something in it for the ECB, with the difficulties being primarily in the new EFSF funding commitment and the possible concerns over competition rules. But that's hardly an odd outcome, given that at root the promissory notes are a currency issue.

The question, though, is not whether the deal makes sense from the ECB's perspective, despite the importance of it needing to do so, but whether it makes sense from Ireland's perspective. As far as I can see, it does so. It's obviously not as nice as the idea of just writing off the PNs, but I don't think that's ever been on the table.

cordially,
Scofflaw

later12

Kev. wrote: »

offloading of trackers would give the PTSB no more excuses

Offloading could certainly help alleviate the SVR rate. But the rising SVR is also, in part, thought to be reflective of the overall arrears and outstanding risk problems in the Irish system, which could remain significant if trackers are shunted into IBRC.

Scofflaw wrote: »

The question, though, is not whether the deal makes sense from the ECB's perspective, despite the importance of it needing to do so

Just to be clear here, why is it important for it to do so? The ECB administer the EFSF's accounts in Frankfurt and it observes proceedings, but the ECB most certainly do not control EFSF lending to member states nor risk protection of sovereign issues. EFSF credit has a specific liquidity collateral allocation and if the ECB were to try and change that, they would have to change it for all EFSF issues.

So no, I don't think they ECB's agreement is particularly important here, though they have every reason to be completely delighted about it, and such is their right.

...but whether it makes sense from Ireland's perspective. As far as I can see, it does so.

Until we know the cost of any (it seems, likely) recapitalisation and the official working paper setting out the proposals, I don't think we can really be sure of that.

NIMAN

If this was to get the go ahead, how would I, as a holder of a tracker mortgage, notice any difference?

Would I?

Slydice

NIMAN wrote: »

If this was to get the go ahead, how would I, as a holder of a tracker mortgage, notice any difference?

Would I?

only that yer bank had changed

Scofflaw

later12 wrote: »

Just to be clear here, why is it important for it to do so? The ECB administer the EFSF's accounts in Frankfurt and it observes proceedings, but the ECB most certainly do not control EFSF lending to member states nor risk protection of sovereign issues. EFSF credit has a specific liquidity collateral allocation and if the ECB were to try and change that, they would have to change it for all EFSF issues.

So no, I don't think they ECB's agreement is particularly important here, though they have every reason to be completely delighted about it, and such is their right.

I base that on the presumption that since the promissory notes were central bank money creation - and hence a monetary operation - their removal form the system would also be of interest to the ECB, while the movement of assets within banks would also be relevant to them, given their heavy involvement in the Irish banks' ELA. However, you may be correct.

later12 wrote: »

Until we know the cost of any (it seems, likely) recapitalisation and the official working paper setting out the proposals, I don't think we can really be sure of that.

There I tend to agree with you. One thing that seems possible, or even likely, here, is that the actual cost of this option will be larger than the real cost of the promissory notes. Unfortunately, it's going to be hard for anyone to say that very credibly, because everyone has been busy making a hullabaloo about the headline cost of the notes, and it's quite possible the arrangement will be lower than that.

cordially,
Scofflaw

squod

Scofflaw wrote: »

Fifth, the tracker mortgages, while unprofitable, are solid assets acceptable everywhere, which should allow the banks to reduce their borrowings from the Central Bank. The promissory notes, on the other hand, are only good at the Irish Central Bank, and are not acceptable as collateral anywhere else.

Anyone else think this plan stinks? Isn't this just an attempt to legitimize the
central banks actions?

later12

Scofflaw wrote: »

everyone has been busy making a hullabaloo about the headline cost of the notes, and it's quite possible the arrangement will be lower than that.

It's pretty certain that the arrangement will be lower than the popularly perceived cost of the Promissory Notes.

But just in the same way as referring to the cost of the promissory notes as €42 billion + was always problematic, so too is reference to a new deal, because it is lower than €42 billion, also problematic.

The terms of the former obligations may have changed both for the better or for the worse, depending on one's outlook. For one thing, the asset quality of tracker mortgages does not satisfy the same capital adequacy as that of promissory notes. How can this problem be set against a further discount against the value of tracker mortgages in AIB and PTSB?

If these obligations are ever to be restructured,it won't happen quite so easily as PN restructuring.
There may be significant recapitalisation costs; not just in the short term, but subject to PCAR determinations in the future
We do not know the effect that a second Irish bailout may have on this deal.

Ireland cannot pretend these problems do not exist simply because the Irish people are handed some (possible) sop to do with tracker mortgages.

Scofflaw

later12 wrote: »

It's pretty certain that the arrangement will be lower than the popularly perceived cost of the Promissory Notes.

But just in the same way as referring to the cost of the promissory notes as €42 billion + was always problematic, so too is reference to a new deal, because it is lower than €42 billion, also problematic.

The terms of the former obligations may have changed both for the better or for the worse, depending on one's outlook. For one thing, the asset quality of tracker mortgages does not satisfy the same capital adequacy as that of promissory notes. How can this problem be set against a further discount against the value of tracker mortgages in AIB and PTSB?

If these obligations are ever to be restructured,it won't happen quite so easily as PN restructuring.
There may be significant recapitalisation costs; not just in the short term, but subject to PCAR determinations in the future
We do not know the effect that a second Irish bailout may have on this deal.

Ireland cannot pretend these problems do not exist simply because the Irish people are handed some (possible) sop to do with tracker mortgages.

This is the problem I have with it - at a political level, so much has now been invested by various opposition interests in claiming that the cost of the promissory notes is €42bn, or €47bn, or whatever large figure will generate an adequate feeling of rage, while on the other hand, so much has been invested in getting a deal on the notes, that it's going to be hard for there to be any rational debate on the deal on offer.

A warning note from John McHale on the Irish Economy blog:

From Simon’s reporting, one proposal seems to be along the following lines: AIB/Permanent TSB would swap their trackers for a long-term government bond. (There is no magic value creation there; presumably the value of the bond would match the value of the trackers.) The trackers would be moved to IBRC, where they would be used as collateral for a long-term, low-interest, Government-guaranteed loan from the EFSF/ESM. (The loan might have to be provided directly to the Government given EFSF/ESM rules.) The funds would be used to pay off the ELA and the promissory note would be cancelled. I would guess that the ECB would welcome this, as the promissory note/ELA arrangements have a more than a whiff of monetary financing of a government. The various swaps would be designed to be “capital neutral” for the various entities involved.

Of course, this is all speculation, and might not even be one of the multiple options under consideration. But I think the Government needs to proceed carefully if it is. For all the criticism of the promissory note/ELA arrangement, stripped of the complexity it amounts to an interest-free loan from the euro-system to the Irish State. (I say interest free because the Central Bank of Ireland’s profit on the ELA goes to the Exchequer.) The advantage of restructuring the promissory notes is that it reduces the heavy near-term funding requirements facing the Exchequer. Such funding requirements will complicate the return to the bond markets. But any improvement in the funding situation would need to be weighed against any higher ultimate interest rate cost. (One complicating factor could be the dependability of ongoing ELA.)

Holders of low-interest trackers are told to be wary of giving them up. The Government needs to be similarly wary in any complex multi-swap deal. An arrangement that leaves the EFSF/ESM out but extends the maturity of the promissory notes looks preferable.

So the primary advantage of the deal is to remove the "heavy near-term funding requirements", which is to say, the €3.1bn we're putting away every March 31st - but the flip-side is that extending the maturity will likely increase the costs.

What's interesting, coming back to the "narrative of ECB intransigence" I referred to earlier, is that - according to a Sunday Times article which I can't yet find online - the ECB is indeed somewhat concerned about the tracker-swap deal, on the basis that it does make things more difficult long-term for Ireland, while the IMF are keen on the idea because it accelerates Ireland's return to the markets - something which represents, of course, a success for the IMF.

Funnily enough, though, that will doubtless wind up represented as part of the now established narrative, and should the ECB torpedo the deal, it will simply feed the "ECB bad, IMF good" meme.

cordially,
Scofflaw