€1bn bond sale reduces 'funding cliff' facing Coalition

Fri, Aug 24, 2012, 01:00

A FURTHER €1 billion was sliced off the “funding cliff” facing the Government at the end of the EU-IMF bailout programme as the National Treasury Management Agency sold a new type of debt to investors for the first time.

The borrowing by the Government yesterday, this time from domestic pension funds, came again at a high cost, with the average interest rate (or yield) on the amortising bonds being 5.91 per cent at an average maturity of 16 years.

That compares with the 3.5 per cent at which the State borrows from the troika and is near the rate at which €4.2 billion in new money was borrowed from mostly overseas investors last month on the sale of long-term bonds.

The NTMA conceded that the high cost of the borrowing was not desirable but said it was “part of the pathway” back to a full and sustainable return to the bond markets.

“It is a gradual process of re-entry into the market,” said Oliver Whelan, director of funding and debt management at the NTMA. “Each time you borrow, the yields will hopefully come down somewhat. The more money you have, the more willing investors will be to give you money.”

Dermot O’Leary, chief economist at Goodbody Stockbrokers, described the high interest rate on the bonds as “a means to an end”.

“They are unsustainable rates in the medium-term but not in the short term,” he said. “The more comfort Ireland can give the market on the amount of funding done, the better. That should lead to a reduction in yield as a result of the increasing confidence.”

The NTMA said the original “funding cliff” of €11.9 billion due on a bond maturing in January 2014, the first major payout by the State after the programme ends, had now been reduced by 80 per cent to just under €2.4 billion.

John Corrigan, chief executive of the agency, said the sale of the amortising bonds marked a diversification of the State’s sovereign funding programme.

Minister for Finance Michael Noonan said the sale of bonds yesterday and last month showed that the State’s “ability to emerge from the programme and return to a more normal funding cycle is building at home and abroad”.

Amortising bonds pay out an equal annual amount comprising interest and principal to investors whereas standard bonds pay investors interest every year and the principal when the debt matures.

Five bonds sold yesterday have maturities ranging from 15 to 35 years.

The NTMA expects further sales of amortising bonds as pension funds complete funding plans in line with changes announced by the Pension Board in June.

Pension trustees must show how they intend to tackle deficits in high-cost defined benefit pension schemes, which guarantee members a percentage of their final salary on their retirement.

The NTMA expects to raise up to €5 billion on amortising and inflation-linked bonds over the next 12 to 18 months.

Market sources suggested that the ESB’s pension fund, one of the biggest in the State, was a big buyer of the amortising bonds, though a company spokeswoman said the trustees of the fund did not comment on investments.

RISK AND RETURN WHAT IS AN AMORTISING BOND?

Amortising bonds pay investors an equal sum each year over the life of the debt – comprising interest and a partial payment of principal on the loans.

This is in contrast with standard bonds, which pay out interest annually and the principal at maturity.

The bonds sold by the National Treasury Management Agency raised €1 billion and are tied to five Government bonds with maturities of 15, 20, 25, 30 and 35 years.

Much like a mortgage, the debt repaid in the initial years comprises mostly interest, gradually moving towards full payments of principal as the debt matures.

Given that the majority of Irish defined benefit pension schemes are in deficit, the new sovereign bonds will be attractive to pension trustees. They can sell annuities linked to the sovereign bonds to help plug the holes in pension funds as they give certainty on a long-term stream of income at a time when they must show how they plan to fund future liabilities.

The cost of annuities sold by pension providers have until now been linked to German bond yields.

With the yield or interest rate on this debt falling so low, the cost to a pension provider of buying an annuity has been very high.

The average yield of 5.91 per cent on the amortising bonds sold by the NTMA yesterday means that Irish pension companies can fund annuities at a cheaper rate.

The new bonds come with risks. On traditional annuities, the risk of the issuer of the bond defaulting rested with the insurance company. On the new sovereign annuities, this default risk passes to the pension scheme and, in turn, the members of the scheme.

Given the risk associated with Irish government debt at the moment, investors will be taking a greater exposure to a State that is not seen as being as creditworthy as the likes of Germany and France.

Pension fund members will have retirement payments from their nest eggs linked to the prospects for the Irish economy.

But given the fact that pensioners are going to be earning very little from German and French bonds, taking on some form of risk on Irish bonds may be the price to pay for higher returns.

There is clearly an element of “putting on the green jersey” at play as Irish pension funds can support the State’s efforts to fund the exchequer’s requirements and help the return to the markets, while at the same time take on higher-yielding investments for members and tackle their deficits.