Tracker mortgages crucial to any deal on resolving bank debt crisis

ANALYSIS:Restructuring bank debt would put the Government outside the danger zone for indebted states

THERE MAY not be a silver bullet solution to the next restructuring of the State-owned banks but Government and troika authorities are planning to take a few shots at trying to repair them while reducing the cost of the bailouts.

The exercise involves not just trying to reduce the annual costs of paying for Anglo Irish Bank and Irish Nationwide through the promissory notes – the State IOUs on which the Government promises to pay €31 billion.

Officials are also attempting to make AIB and Permanent TSB more attractive to investors who might be willing to buy some or all of the State’s shareholding and to depositors who might help wean them off the support provided by the European Central Bank.

AIB, Bank of Ireland and Irish Life Permanent (parent of Permanent TSB) have shed €32 billion of assets in the “deleveraging” of their balance sheets, not far off the half-way mark on the road back to self-sufficiency.

The Department of Finance, however, noted in a “banking report card” in January that this year could be more difficult for further deleveraging – citing analysts’ estimates that up to €3 trillion of bank assets across Europe could come on the market.

This could drive prices lower, the department said, leading to potential fire sales of Irish bank assets and higher recapitalisation costs for the Irish institutions.

So officials must turn to a Plan B to remove excess assets at AIB and Permanent TSB. Bank of Ireland is not State controlled and is so far excluded from the planning.

The tracker mortgages at AIB, including those at subsidiary EBS, and Permanent TSB are loss-making as they are locked in at margin above the European Central Bank rate which is below the funding costs at the banks.

Removing the trackers, which account for a third of the Irish residential mortgages at the Government-guaranteed banks, improves the profitability of the banks and will deleverage them of a further €34 billion in assets, reducing their loan-to-deposits ratio towards the Central Bank’s target of 122.5 per cent.

This could tempt investors to buy some of the Government’s shareholding in the banks and lead to a repeat of the sale of a substantial stake in Bank of Ireland to private investors and the “halo effect” associated with that transaction that was helpful for Ireland.

Given how the fortunes of the banks are tied to those of the State, any restructuring of bank debt will help the country’s prospects and ease a return to the markets so the Government can borrow on its own account.

“It is a pretty sensible idea. If your intention is to sell those banks and get as much for them, you have to do something with the trackers,” said Karl Deeter, operations manager at Irish Mortgage Brokers. “If you own all the banks, it doesn’t matter if you move them from one bank to another.”

Restructuring Irish bank debt would put the Government outside what is regarded as the danger zone for indebted states.

“The best situation is that the banks are not owned by the Irish State and we get a separation of the State and the banking system,” said Dermot O’Leary, chief economist at Goodbody Stockbrokers.

“That would help risk appetite towards the sovereign. The trackers are a massive drain on profitability and it makes the Irish banks a much less attractive proposition to investors.”

Purging AIB and Permanent TSB of loss-making tracker mortgages may leave Bank of Ireland, which has €17 billion of Irish tracker mortgages, at a disadvantage.

EU competition commission officials are, however, understood to be involved in the technical discussions examining the effect of the plans under state aid rules.

The prospect of transforming Permanent TSB into a viable bank to compete against the Government’s two “pillar” banks of AIB and Bank of Ireland could make the restructuring more appealing to EU competition officials.

The inclusion of Bank of Ireland and its €17 billion in Irish trackers increases the bank assets involved to €51 billion and makes the plan a much more expensive proposition to sell to the EU authorities.

The money to pay for the tracker transfers and the restructuring of the promissory notes, it is hoped by the parties involved, would come from the EU fund, the European Financial Stability Facility.

The plan may involve tapping a 30-year loan using a 30-year Government bond as collateral. The €34 billion in trackers from AIB and Permanent TSB could then replace the €31 billion promissory notes at IBRC.

The existing repayment schedule on the notes runs until 2031 with annual payments covering €31 billion of the Anglo/Irish Nationwide bill plus a further €17 billion in interest.

The new structure would align the repayment term on the assets replacing the promissory notes to the repayment term on the liabilities owing on the EU bailout loan.

Some trackers have maturities running from 20 to 25 years, which would covered by a 30-year EU loan to the banking system.

The trackers will also give IBRC a more attractive form of collateral that could be used to raise borrowings to fund itself from the more acceptable ECB drawings.

This would appease Frankfurt, which is keen to see IBRC’s borrowings from the Irish Central Bank, which stood at €42 billion last December, sharply reduced.

Minister for Finance Michael Noonan said yesterday that the ECB was “never particularly happy” with the collateral on the promissory notes or “enamoured” by their structure, and would like “stronger collateral”.

Unsurprisingly, the Minister said the ECB would be “crucial” in any decision to restructure the promissory notes. The ECB approves the emergency loans from the Irish Central Bank to IBRC on a rolling basis.

While much of the detail in the latest restructuring is still being worked on for a draft paper arising from backroom discussions, what is clear is that a long-term solution will not be agreed by the time the next €3.1 billion payment due on the notes – March 31st.

As a result, the parties do not recognise this as a hard deadline for the wider restructuring, although an alternative mechanism could still be agreed where a €3.1 billion payment is made in kind, not in cash.

The annual repayment deadline points to another reason to agree the latest bank restructuring; for the Government it will remove the “political toxicity of an annual bullet payment”, one source said. “It ticks a huge number of boxes – it moves on the whole restructuring of the banks,” he said.

The next restructuring of the State-owned banks

How it might be done

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.

The promissory notes sit as an asset at Irish Bank Resolution Corporation, the entity that is winding down Anglo and Irish Nationwide.

There are €34 billion worth of tracker mortgages within the Irish residential mortgage books at AIB and Permanent TSB – €18 billion at AIB (and its subsidiary EBS) and €16 billion at Permanent TSB. These assets could be transferred to IBRC to replace the promissory notes – they are not far off the same value. This raises two issues – how do you pay AIB and Permanent TSB for the loans and how do you fund them at IBRC?

If the European Commission and the European Central Bank give the green light, a 30-year Irish Government bond could be accepted as collateral for a loan of the same duration at a low interest rate from the EU bailout fund, the European Financial Stability Facility.

The EU raised a 30-year bond through the European Financial Stabilisation Mechanism bailout fund in January for the Irish and Portuguese bailouts at a rate of just over 3 per cent. This costs less than the rate on the Central Bank’s emergency loans to IBRC.

This would push out the annual cost of filling the Anglo Irish/Irish Nationwide capital hole for a longer period at a lower rate.

There are several ways of accessing EFSF cash as rule changes last year mean that governments can draw down loans to recapitalise financial institutions.

The loan could be drawn down by the Government for IBRC and used to pay AIB and Permanent TSB for the tracker mortgages.

The next stress tests of the banks, which must be completed by the end of November, could set the value of the trackers at worst- case levels so there is no further capital needs by the three banks arising from the transfers.

All three are fully or virtually State-owned so this could allow the exercise to be completed without any further recapitalisations. IBRC could then fund the tracker mortgages by using them as collateral to borrow from the ECB through its regular refinancing operations and reduce the loans from the Irish Central Bank.

AIB and Permanent TSB then become more attractive to potential investors, which would reduce the State’s involvement in those banks, while IBRC is better funded and the cost of the Anglo Irish/Irish Nationwide bailouts are reduced.

SIMON CARSWELL