Promissory note deal is worth €8bn to State


ANALYSIS:We know the annual cost of the restructured promissory notes used to bail out Anglo Irish Bank, Irish Nationwide and the EBS Building Society has fallen as repayment is extended to as much as 40 years. But what is the overall cost of this new arrangement?

The effect of the deal is to lower the burden of the promissory notes by a third, or €8 billion, in today’s money.

The table above sets out the various interest flows before and after the promissory notes deal. It is based on a 5.8 per cent cost to the exchequer (ie the original interest rate which was boosted to 8.2 per cent to compensate for the two-year “interest holiday” the previous government availed of for 2011 and 2012).

Under the old arrangement, IBRC was a major gainer, netting just under 3 per cent a year . It used the notes as collateral to borrow from the Central Bank under the exceptional liquidity assistance (ELA) facility. The Central Bank, in turn, borrowed the funds from the European Central Bank, paying just 0.75 per cent for the privilege, considerably less than the penal rate it charged IBRC.

Some of the flows were circular in that 80 per cent of the Central Bank’s profits eventually found their way back to the exchequer.

When all these factors are allowed for, the net cost to the exchequer of the promissory notes was about 4.2 per cent.

This should not be confused with the smaller 0.75 per cent cost to Ireland Inc, which was the rate the ultimate lender – the ECB – charged.

Instead of paying IBRC 5.8 per cent annually, it will now pay 3 per cent direct to the Central Bank. The Central Bank will pay 0.75 per cent to the ECB and return 80 per cent of the difference to the Government. The net cost to the exchequer thus falls from 4.2 per cent to 1.2 per cent, a gain of three percentage points. This explains most of the annual €1 billion saving that the Government has signalled.

But the period of the new loans has been extended to 34.5 years, on average, much longer than the term of the promissory notes. This more than outweighs the gains from the lower rate, with the result that the total interest bill is much greater – €21 billion instead of €9 billion – as per the bottom part of the table above.

As every borrower knows, a longer mortgage is easier to service as inflation and time erodes the real burden of the repayment.

We measure this by calculating the net present value (NPV) of the stream of future payments. The NPV of the promissory notes was about €24 billion. The deal reduces this to €16 billion.

This is a good deal, as good as could have been hoped for given that debt write-offs were never on the cards.

* Pat McArdle is an economist