Friday, July 11, 2014

11/7/2014: Notes on German ESM vote

Here are some of my briefing notes on last night's programme on TV3 covering the latest 'seismic' news on retroactive banks recapitalisations and ESM.

Eurogroup meeting on 20th June 2013 agreed on the main features of the European Stability Mechanism's (ESM) Direct Recapitalisation Instrument (DRI).  I covered the fallout from that meeting here  and here  and here.

Note in the first post above, there is a link to Irish Government-set target of 17% of GDP for retroactive recapitalisation.
  • The objective of the ESM's DRI will be to preserve the financial stability of the euro area as a whole and of its Member States in line with Article 3 of the ESM Treaty, and to help remove the risk of contagion from the financial sector to the sovereign by allowing the recapitalisation of institutions directly.
  • This does not decouple banking sector from the sovereign, but weakens the links.
  • There is a specific provision included in the main features of the DRI, which states: "The potential retroactive application of the instrument should be decided on a case-by-case basis and by mutual agreement."
So do note: it is 'potential' (not assured access) and it is to be decided on case-by-case basis (so no 'symmetric' or 'equal' treatment) and it is 'mutual agreement' (allowing states to block any potential case-by-case deal). There is so much conditionality around this statement, one has to view it as being aspiration rather than prescriptive.

But, on a positive side, June 2013 agreement kept open the possibility to apply to the ESM for a retrospective direct recapitalisation of the Irish banks. I covered this here and the fallout from the second round deal here. The last link covers persistent opposition from Germany to retroactive recapitalisations. And if you thought this has gone away, here's the latest on that.

On June 10, 2014 the euro area member states reached a preliminary agreement on the operational framework for the ESM's direct recapitalisation instrument, DRI.
  • This framework does not guarantee that we will get our case approved.
  • It does not stipulate how retrospective recapitalization can take place (crucial detail).
  • It requires unanimous vote of ESM board of governors (which is basically Council of Ministers).
All of this was forthcoming. See my article from March 2014 on this here.

The above is also confirmed by Minister Noonan on July 3 in the Dail. Minister further stated that: "However, it will not be possible to make a formal application to the ESM for retrospective recapitalisation before the instrument is in place. It would, therefore, be premature to make any submission, be it a technical paper or otherwise, in advance of the instrument being in place."

Incidentally, Minister Noonan's pronouncements on the topic have by now converged to repeating the same statement on every occasion. compare this and this.

So a reminder: After June 2012 summit, Minister Noonan went onto "Today with Seán O'Rourke", and said he expected the retrospective recapitalization agreement to be concluded by November 2012. Now, we are looking at the earliest possible application date or application consideration date of November 2014. But even this application date is uncertain. Methodology for valuation or even structuring recapitalisations is uncertain. In the mean time, we are getting less and less certain if it makes any sense for us to even apply for this measure.

Minister Noonan on the topic again: "When one thinks through the recapitalisation retroactive option, it was always envisaged that there would be some form of exchange of shares in the banks for capital upfront, and that this capital would be used to reduce the debt. While the technical work has been done on it, there is a question of value, price and judgment in all these matters. I certainly do not wish to talk ourselves into a position where just as the banks are becoming valuable, we give them away for the second time." This was stated on July 3 this year in the Dail.

Meanwhile, Bank of Ireland shares we hold have already yielded returns that are EUR1 billion in excess of original recapitalization, excluding the cost of the Bank of Ireland-related measures to the Exchequer via higher borrowing costs in 2009-2013 period.

Value of AIB currently is around EUR11 billion, value of PTSB is virtually nil, which is less than ca EUR23.5 billion we put into the bank and PTSB.

Our borrowing costs are low, and are lower than those of other peripheral states - why would they approve a recapitalization for Ireland? See, for example, most recent pressure points on borrowing costs here.

Another pesky issue: ESM is EUR500 billion fund. But only EUR60 billion is set aside to cover all future and any potential retrospective recapitalisations of banks. Eurostat estimates Irish Government banks stake at EUR16 billion in terms of its future potential value, which means that Ireland's retroactive recapitalization will either have to be so small as to make no difference to us, or so large as to swallow some 20% or so of the entire DRI fund.

Do we seriously expect to get anything substantial from the ESM?

Let us remember that until June 2013, Germany resisted not only retroactive recapitalisations, but even forward recapitalisations. The reason German leadership changed its mind is that EU has substantially reduced any potential exposure of ESM to such recaps in the future and loaded more, not less, burden onto national banks and sovereigns. These are covered here and here.

In short, the latest news from Berlin are not a 'step forward toward retroactive recapitalisations of the Irish banks' - at the very best these are simply re-affirmations of the already taken steps and the muddle they left behind.

Meanwhile, there are 3 major points of pressure relating to Irish banks:

  1. Recaps we put in are weighing on our debt levels: 25.3 billion against 13-14bn value. There is little we can hope to get from the ESM in this context.
  2. Government bonds from Promo Notes conversion: 25 billion against nothing. There is nothing in the ESM that allows us to swap these bonds for anything that is cheaper. Instead, the real impact can be achieved by significantly delaying sales of these bonds to private markets, which is not related to the ESM but is rather an ECB action.
  3. State of banks balance sheets - arrears and tracker mortgages (EUR36 billion in AIB and PTSB). Professor Karl Whelan has an excellent note on trackers here.

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