It is in Europe's interest that Ireland's return to private funding goes smoothly
The deal struck last week to restructure the debt of Anglo Irish Bank marked a milestone in Ireland’s long journey to secure bank debt relief.
Precise estimates about the savings vary. Pat McArdle argued in these pages that the effect of the deal was to lower the burden of the promissory notes by a third, or €8 billion, in today’s money, while the Government estimated that the State’s borrowing requirement should drop by €20 billion over the next decade.
But as the Government was enjoying its moment in the sun, attention was already turning towards the next phase in the campaign to address the cost of bailing out Ireland’s banks as the State prepares to re-enter private debt markets by the end of the year.
First stop was this week’s gathering of euro zone finance ministers. As usual, the meeting took place on the eve of a meeting of finance ministers of all 27 EU member states (chaired in this instance by Minister for Finance Michael Noonan as president of the European Council), but as always the real action took place at the Eurogroup meeting on Monday – the place where strategies and decisions on the core euro zone countries are discussed and adopted.
While Cyprus was on the agenda – the working out of the bailout of the Mediterranean island is the single most pressing issue facing the euro zone – much of the discussion was dedicated to the working of the European Stability Mechanism (ESM), the EU’s pemanent bailout fund.
The successor to the European Financial Stability Facility (EFSF) and the European Financial Stabilisation Mechanism (EFSM), the ESM was officially established in September last year after Germany’s constitutional court approved the establishment of the permanent fund after a constitutional challenge.
While the fund has already been used to capitalise Spain’s banking sector via the sovereign, the more contentious issue of direct bank recapitalisation is now on the agenda.
Direct bank recapitalisation will happen only once the Single Supervisory Mechanism of Europe’s banking system is up and running. That is at least another year away.
Euro zone finance ministers have been given a deadline of the end of June to come up with an “operational framework” for the fund’s direct recapitalisation plan.
However, there are mounting divisions between the members over whether the ESM should shoulder the burden of existing impaired bank assets, and whether the fund should retrospectively apply to previous recapitalisations.
Ireland has consistently argued that AIB and Bank of Ireland should be eligible for direct recapitalisations but there are signs that this possibility is receding. Part of this reflects a general scaling back of the scope and ambition of the fund.
Sources in Brussels confirm that the portion of the fund dedicated to bank recapitalisations is to be capped at less than €80 million, the amount of paid-in capital contributed by the countries, with the cap likely to be lower.
In part this is to protect the credit profile of the ESM fund itself. Recapitalisation of banks is perceived as more risky than investments in sovereigns. The ESM’s credit rating was already cut to Aa1 from Aaa by Moody’s in December.
The euro zone ministers also discussed on Monday the possibility of attracting private investment to sit along ESM money in direct recapitalisations. The European Investment Bank and IFC already operate such a scheme, although it is unclear whether this would work when the recapitalisation of troubled banks is involved.
Some sort of burden-sharing with the sovereign is now inevitable. That would again reduce the amount of uplift countries such as Ireland would gain from direct bank recapitalisation.
Behind the scenes discussions are taking place between Irish and euro zone officials about the forms of debt relief.
While the IMF has called for any ESM direct recapitalisation to be based on long-term value, in reality any ESM investment would likely to be based on current value. The National Pension Reserve Fund valued the State’s shareholding in the pillar banks at the end of 2011 at €8.1 billion.
One senior EU source close to the discussions has questioned whether direct recapitalisation is a suitable instrument for Ireland.
“It would be counterproductive to say to the markets we are unable to pay this debt,” he said. “Even Spain has indicated it does not want to use the instrument. It would not be a positive signal as Ireland tries to get back to the markets.”
He points out that gaining ESM investment would also mean the State surrendering its shareholdings in the banks – ie its assets as well as liabilities in the banks would transfer to the ESM.
This at a time when Ireland hopes to be back in full market funding and better shape economically.
While the statement of June 29th included a specific commitment to look at the Irish case, it never contained a specific reference to ESM recapitalisation, he notes.
The Government’s position is still that Ireland is securing debt relief through ESM direct recapitalisation, although Noonan and Enda Kenny stressed last week that it was a “medium to long-term” strategy.
“We’re at the early stage,” the Minister for Finance said on Monday. “This is not something that is going to conclude quickly. This is a medium-term strategy but, with the ground we’ve gained on the promissory note arrangement, we can afford to wait for the next phase as long as the commitment that was made on June 29th last is still the commitment.”
Positive mood music
But while the mood music from Brussels is less positive in relation to ESM direct recapitalisation for Ireland’s pillar banks, there are more positive signals towards the other proposal on the table – lengthening the maturity of Ireland’s and Portugal’s bailout loans.
The proposal was put forward in January, with sources indicating the idea was generated in the first instance by the Portuguese, with Ireland co-opting itself at the last minute.
The technical issues surrounding an extension of maturities of different EFSF and EFSM loans used to finance the Irish bailout are currently being discussed by euro zone officials, with finance ministers expected to deliver their verdict early next month. Such a solution, according to a senior EU official, would be advantageous to Ireland on a number of fronts, by helping to smoothen out Ireland’s debt maturity profile in the years immediately following the exit from the bailout, locking in a favourable 3 per cent interest rate, and reducing the debt burden in the short to medium term.
Crucially, it would also have few negative implications for the ESM itself.
The potential of any agreement to lengthen the maturity of Ireland’s bailout loans was highlighted by Conall McCoille of Davy Stockbroker this week.
He argues that the decision to consider the terms of the loans could be more significant than the deal on the promissory notes, substantially reducing Ireland’s funding needs through 2015-20.
Such a deal could potentially reduce Ireland’s funding needs by €43 billion, more than twice the €20 billion reduction in the NTMA’s funding requirement out to 2023, arising from the promissory note deal.
This calculation presumes the IMF would also agree to extensions on the proportion of loans it contributed to the Irish bailout.
The outcome of the Irish bid for debt relief may rest, to an extent, on the tricky relationship between the IMF and the Eurogroup in their response to the euro zone crisis. The Washington-based body has differed from Europe in response to the crisis, arguing, for example, for more debt writedown in the case of Greece, and more recently urging the ESM to directly recapitalise banks.
Despite the widely held perception in Ireland of the IMF as a friend of Ireland, gaining agreement from the fund for a reworking of loan maturities is no small task.
Granting a precautionary credit line to Ireland as it emerges from the bailout is one thing; actually changing the terms of a loan is another.
Whatever the outcome, the Government’s argument that helping Ireland to regain market access is essential for Europe has proved to be a clever strategy.
Euro zone finance ministers and the IMF have both publicly stated the need to prioritise Ireland’s return to private market funding over the coming months.
As all parties sit around the negotiating table, it is clear that it is in Europe’s interests that Ireland’s journey back to full private funding goes smoothly.
Ireland has a strong hand to play.