Bank debt possibilities left open by Merkel's ambiguity
BUSINESS OPINION:SO NEAR, yet so far. Just when a transformational deal on Ireland’s historic bank debts was within our grasp, the German chancellor seems to have dashed our hopes.
Or has she? The first and most obvious point to make about Angela Merkel’s comments is that she has changed her position several times as the euro crisis evolved, but only when she thought she could bring Germany with her. The most positive interpretation that can be put on her remarks of last week is that the German public is not yet ready to foot the bill for Ireland’s banks.
But things are heading in the right direction. On a recent visit to Dublin, Joachim Faber, the chairman of Deutsche Börse and a senior adviser to German financial behemoth Allianz, said some very important things.
He accepted the Irish recovery had to be underpinned by “unconventional means”. He noted Dr Merkel had a very good sense of what the majority in Germany was thinking and the views of the population had shifted considerably under her leadership over the past two years. He had “no doubt but that Germany will shoulder its responsibilities”.
The second point is that we have not helped our cause by rubbing the Germans’ noses in it. With hindsight, Ireland made too much too quickly of the breakthrough agreement last July, but the exuberance was understandable. We have now been put back in our place.
So how do we work with Dr Merkel now? Well, the first thing is to listen to what she is saying. The key word apparently lost in all the noise of the last few days is “direct”.
The German chancellor has ruled out “direct” assumption of historic bank-related debt by the new permanent rescue fund, the European Stability Mechanism. This opens up a universe of indirect measures with which the Germans may be able to live. Front and centre in this regard is refinancing of the €30 billion Anglo promissory note with the European Central Bank.
The holy grail in this regard would be to kick it out over an extended period at a very low interest rate. This would solve half the problem and, given Ireland will still be responsible for repaying the debt, it should tick the box with Dr Merkel.
Finding a Germany-friendly way to deal with the other €30 billion odd of bank-related debt is a little trickier. This is pure Irish sovereign debt, even though the money was ploughed into AIB, Bank of Ireland and Irish Permanent as equity to shore up their capital.
The plan here seems to be for the new rescue fund to take equity stakes in the so-called pillar banks. The Government would then use the cash to repay sovereign debt.
There are various estimates as to what the Government’s bank stakes could be worth, ranging from €12 billion to €16 billion. They are based on the value attributed by the National Pensions Reserve Fund with some allowance for long-term economic value.
Paying down national debt by this amount would very significantly improve Ireland’s debt dynamics and sovereign ratings.
It remains to be seen if a deal along these lines is acceptable to the Germans. Much depends on what happens in the wider European context and how far Dr Merkel brings the Germans in the meantime. But even if it proves a bit too much for them, all is not lost. The deputy governor of the Central Bank, Matthew Elderfield, held out the possibility of opening a new front in this battle last week in a speech in Cork. He said that at some stage next year the Government – along with the troika – will take another look at the banking system and its level of capitalisation.
To paraphrase the deputy governor, it will be a glass half full/glass half empty moment. From one perspective, the Irish banking system is the best capitalised in Europe, with huge capital buffers as a result of Government investment, and it’s very unlikely they will run short of capital in the next few years.
The other perspective is that, despite the massive investment, Irish banks are still not fixed. They are dragging their feet in dealing with the problems in residential and commercial loan books. It is a Pandora’s box they are absolutely terrified of opening.
Not only that, they are going to find it very hard to return margins to a level that will make then profitable over the longer term. By this analysis it’s quite possible they will need another recapitalisation in the near term.
You don’t need to be a genius to see that any such recapitalisation could be done by the new rescue fund and, once that door is opened, it’s game on.