Thursday, March 15, 2012

15/3/2012: What's up with 'collateral'?

An interesting point made today by Michael Noonan that carries some serious implications with it (potentially).

"You could take it that the ECB were never particularly happy with the level of collateral provided by the promissory notes and would like stronger collateral," Mr Noonan said in an interview with RTÉ." (as reported on the Irish Times website).

What can this mean? Collateral for the Notes themselves is Government guarantee plus letters of comfort to the CB of I. In other words, the Notes collateral can only be enhanced by making them fully-committed formalized Government debt - aka bonds. Now, Noonan in the recent past had implicitly linked Promo Notes to ESM.

And herein rest the main problem. Right now, Promo Notes are quasi-governmental obligations and as such are ranked below ordinary Government bonds (hence collateral quality concern of the ECB). Although the Notes are counted into our total debt, they are still not quite as senior as other forms of debt. This, in turn, has marginal implications in the valuation of our bonds. Although at this point this is academic, should we return to the markets, potential buyers of Irish Government bonds will consider them as secondary, since the Notes are not traded in the market and represent a tertiary (quasi- bit) claim on the state after ordinary bonds (secondary) and EFSF-IMF-EFSM (soon to become ESM) debt (so-called super-senior obligations of the state).

By converting these notes into ESM funding, the Government will in effect risk making these Notes super-senior, exceeding in seniority those of ordinary Government bonds. Now, the total amount of debt under the Notes - principal plus interest - is €47-48 billion or roughly-speaking 30% of our GDP and ca 27% of our Government debt. This is hardly a joking matter.

It can have material implications for our ability to access bond markets in the future (both in terms of amounts we can raise and rates we will be charged). But more ominously, it can fully convert quasi-public debt into super-senior public debt.

This will satisfy ECB's concerns about the quality of collateral, but it will also mean that these notes will be put beyond any hope of future further restructuring.
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