Anglo Irish Bank back in the news

As promised in the previous post on Ireland, here is an interesting e-mail from a reader discussing some of the facts around the Irish banking system bailout - particularly as it relates to Anglo Irish Bank:

The Irish Independent newspaper carries recordings of two bank employees, John Bowe and Peter Fitzgerald, discussing the finances of the insolvent bank Anglo Irish Bank (rebranded as IBRC : Irish Bank Resolution Corporation). Both men held senior positions at Anglo at the time.

In September 2008, Anglo requested a meeting with the then Minister for Finance Brian Lenihan requesting a government bailout to solve their “liquidity problem”.

The other Irish banks also lobbied Lenihan and this led to the creation of the Bank Guarantee indemnifying all of the Irish retail bank liabilities to the value of €450 billion.

The Guarantee’s introduction caused consternation in Ireland, UK and throughout the Eurozone because it saw deposit flight from the UK banks to Irish banks (Alistair Darling at the time had strong words with Lenihan).

Anglo claimed that its problems were temporary and that it needed bridging liquidity when in fact the bank was gravely insolvent.

Anglo’s accumulated reserves and shareholder funds were eviscerated, with questions arising about loans to directors, an alleged Guiness-type share support scheme and a bizarre cash where deposits from other Irish banks were put on deposit at Anglo at their balance sheet date to artificially boost their deposit balance for reporting purposes (see link). 

Anglo Irish Bank would eventually receive funding totalling €30 billion before being rebranded in July 2011 to the name IBRC : Irish Bank Resolution Corporation.

A series of promissory notes were created to cover the cost of €30 billion cost of refinancing, all funded by the hard pressed Irish taxpayer IBRC was subsequently liquidated in March 2013 (see discussion).

The Irish Independent newspaper claims to have a lot of tapes which it intends to publish here. The conversations that were taped using the banks recording system were recorded a few weeks prior to the Anglo meeting with Brian Lenihan in September 2008. 

You will hear the Anglo bankers talking about how they told the Irish Central Bank about what it (ICB) needed to do to save the Irish banking system, by saving Anglo.

It is explosive stuff and the contents of these tapes has led to a lot of public anger about the bailing of this insolvent bank.

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From our sponsor:

After sticking it to Ireland a few years back, EU "fixes" the bank bailout plan

Ireland was the one country in the Eurozone "periphery" that seemed to be bucking the trend (see post). Many had hoped that the nation will be able to withstand the Eurozone recession due to its strong trade balance. Exports were really humming until global growth stalled last year (see post). Ireland's trade balance turned negative again and does not seem to be recovering. Furthermore, domestic demand is now weakening.

Source: Barclays Capital

As a result Ireland's GDP contracted and the nation followed the rest of the Eurozone into a recession - just over 3 years after the Great Recession.

Source: Barclays Capital

Given Ireland's high government debt to GDP ratio (Ireland ranks third in the Eurozone after Greece and Italy), this is bad news. The hope was that the government can manage down its leverage as the GDP grows, but that's not how things turned out.

Source: Tradingeconomics

Unlike most of the other Eurozone nations whose debt to GDP trajectory was much more gradual, Ireland's ratio shot up rapidly in a matter of 4 years.  What makes Ireland somewhat unique in the Eurozone is that this debt spike is directly related to Ireland's bank bailout. The sad part is that Ireland's EU "friends" had a great deal to do with this. Here is why.

In the last couple of days the EU reached an agreement on dealing with failed banks.

The Express: - The European Union has today agreed to force investors and wealthy savers to share the costs of future bank failures, moving closer to drawing a line under years of taxpayer-funded bailouts that have prompted public outrage.

After seven hours of late-night talks, finance ministers from the bloc's 27 countries emerged with a blueprint to close or salvage banks in trouble.

The plan stipulates that shareholders, bondholders and depositors with more than 100,000 euros should share the burden of saving a bank.

If Ireland were allowed to implement anything resembling this provision during the financial crisis, its debt to GDP would never have reached anything close to the current levels.

During the financial crisis a great deal of the unsecured debt of Irish banks was held by the UK's and the Eurozone's banks. And neither the EU nor the ECB wanted to haircut these bonds. In order to "keep the peace" in the EU banking system, these bonds were not written down, forcing the Irish government to make the bondholders whole. It had no resources to do so and was forced to borrow tremendous amounts in order to cover these obligations. As losses on property portfolios inherited by the government mounted, so did the government debt (government guarantee had to cover increasingly larger losses). The austerity drive generated by this high government debt caused unemployment to spike and destroyed domestic demand. It may be a decade or longer before the nation fully recovers. Now that Ireland had paid the high price for covering its banks' obligations, the EU is about to implement the rules to force haircuts on unsecured creditors - something they refused to do for Ireland just a few years ago.

The next post will contain an email from a reader describing some of the ugly facts around the bailout of the Irish banking system.

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From our sponsor:

Ireland hit hard by spring slowdown; markets don't show it yet

It seems that the markets are discounting many of the risks that have plagued Ireland's economy in recent years. Ireland's stock market has significantly outpaced the S&P500 in the last few months - ISEQ is up 20% over the past year.

Source: Ycharts

The nation's sovereign bond yields, which are the lowest among the Eurozone "periphery" nations, are near multi-year lows. All is well in the Emerald Isle.

Ireland 10y government bond yield

But is this exuberance - particularly in government bonds - justified at this stage? After all, Ireland is still heavily dependent on its export sector, which has slowed this year with the decline in global demand (chart below). And a material deceleration in growth could potentially put a strain on the nation's fiscal situation.

Ireland's exports and imports (source: CSO)

With domestic demand remaining anemic, the slowdown in exports is quickly translating into weakness in the nation's manufacturing activity.

Markit: - The Irish manufacturing sector moved further into contractionary territory during April, with output and new orders each declining for the second month running amid signs of deteriorating economic conditions. Falling workloads in turn led firms to reduce employment and purchasing activity. Meanwhile, input cost inflationary pressures eased to the weakest in nine months.

Ireland Manufacturing PMI (source: Matkit)

In order to raise domestic demand, the unemployment needs to fall from its stubbornly high level of 14% and the banking system needs to heal. As the manufacturing sector struggles and Ireland's banks continue to undergo rapid deleveraging (chart below), the prospects for improved domestic demand in the near term are grim. Ireland remains highly vulnerable to fluctuations in global economic growth. With the spring slowdown upon us, its financial markets can't be immune either.

Source: Central Bank of Ireland

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From our sponsor:

Ireland takes major steps toward recovery

Back in April we discussed Ireland's attempt to restructure the so-called promissory note (see discussion and diagram). It seems that last night they finally succeeded.

NYTimes: - The Irish government reached a deal on Thursday to restructure debt tied to local struggling banks, as the country tries to shrug off the financial burden that it inherited during the recent debt crisis.

The hard-fought agreement, which followed 18 months of negotiations with the European Central Bank, will have Ireland swap 28 billion euros of so-called high-interest promissory notes — a form of i.o.u.’s — that were used to bail out Anglo Irish Bank in 2009 for long-term government debt.

Although crucial details of the agreement were not immediately disclosed, it appeared to mark another important milestone in Ireland’s slow emergence from a banking and real estate crisis that has cut living standards, caused unemployment to soar and left cities scarred by half-finished building projects.

During the crisis the Irish government made the holders of Anglo Irish Bank senior unsecured debt whole instead of forcing them to take a haircut. The nation was pressured by the EU to do so because so many European banks had held Anglo Irish Bank bonds, and the EU was concerned about contagion. That was a mistake because it cost the Irish taxpayer 20% of the GDP. Ireland therefore pressured the EU and the ECB to allow them to swap the promissory note (PN) for long-term government debt  (34yr average maturity) - effectively as a payment for taking it "for the team"  in 2009. The outcome is quite positive for the nation as it improves Ireland's fiscal situation going forward.

Barclays Capital: - First, from a political perspective, the Irish government had strongly committed to ease the terms of the PNs, in part as a compensation for the costly bail-out of senior unsecured bondholders of Anglo Irish bank, which resulted in costs of c.20% of GDP for the Irish tax payer. Quoting the Irish prime minister, “this government is undoing the disastrous banking policies that brought this State to the brink of national bankruptcy”.

Second, the extension of the PNs maturity and reduction in interest rates will improve the chances of Ireland hitting its future fiscal targets, including reaching a deficit of below 3% of GDP by 2015. The reduction in interest payments would either reduce Ireland’s deficit (eg, in 2013 the interest cost on the PNs would have amounted to EUR1.9bn, about 1.2% of GDP) or liberate fiscal resources to reduce taxes or increase public expenditures. Perhaps, more importantly, the maturity extension of the PNs will reduce Ireland’s funding needs in the coming years and will also facilitate the exit from official funding and the return to the markets with a regular issuance schedule, possibly in H2 2013. The PNs had costly interest payments starting in 2013 of well over 1% of GDP and would have continued in the coming years at a steep pace.

Furthermore, Ireland successfully concluded its 9th troika review, showing that the nation is on path to exit the EU bailout program by the end of the year. The markets have responded accordingly, as Irish sovereign debt yields hit another post-euro-crisis lows. Clearly the banking sector is still in the deleveraging mode (see post), as economic conditions remain fragile. But the nation has been able to overcome some major hurdles recently.

Ireland sovereign 8yr yield

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From our sponsor:

Sharp banking sector deleveraging still hampers Ireland's economic recovery

Ireland's economic activity continues to show signs of improvement, with both the manufacturing sector ...

Ireland Manufacturing PMI (source:Markit)

... and particularly the services sector PMI in expanding mode.

Ireland Services PMI (source:Markit)

As a result, private sector deposits are starting to pick up, although very gradually.

€ million (source: Central Bank of Ireland)

Unfortunately the Irish economy is still held back by its troubled banking system. Irish banks are in an incredibly sharp deleveraging mode since the financial crisis - and much of that deleveraging is at the expense of the private sector loans.

Irish bank assets: total and private sector loans (€ million; source: Central Bank of Ireland)

Irish Examiner: - ... as long as banks are deleveraging, then they will not be lending, which means credit is choked to the wider economy.

"Although there has been some sign of improvement in the deposits side in the past few months, the ongoing underlying message from the central bank data is still one of overall weakness and difficulties in the banking sector," said Merrion Stockbroker economist Alan McQuaid.

"As we’ve said on numerous occasions recently, Ireland remains a long way from where it wants or needs to be as regards credit supply/demand to get the domestic economy moving again.

"The reality is that until the banking sector crisis is fully resolved... the supply/demand for credit will stay subdued."

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From our sponsor:

Who really benefits from the weak euro?

Analysts often talk about how the weak euro helps exporters in the Eurozone, particularly Germany because of its massive export sector. But is Germany the main beneficiary? Which other nations want the euro to weaken further? BNP Paribas did some helpful analysis on the subject.

First of all it's not enough to be an exporter to benefit from the weak euro. A nation needs to be exporting outside of the Eurozone. The first chart shows who the largest "extra-Eurozone" exporters are as a percent of their total exports.

Source: BNP Paribas

Finland is at the top with close to 70% of its exports going outside of the euro area. But now one needs to ask if Finland's export sector is a major portion of its GDP. The next chart shows exports as percentage of GDP for the major Eurozone members.

Source: BNP Paribas

Finland it turns out has significant domestic demand to make its export sector an important but not a critical component of the GDP. Ireland and Belgium are now at the top. In fact nearly all of Ireland's GDP comes from net exports, offsetting ongoing declines in domestic demand. So the final question is what happens when we look at "extra-Eurozone" exports as a percentage of countries' GDP? That should tell us which nations' economies benefit the most from the weaker euro.

Source: BNP Paribas

From this we see that Ireland is by far the largest beneficiary of euro's correction. That explains in part why Ireland has been able to buck the trend of Eurozone's recession, expanding its manufacturing base while others in the Eurozone have been undergoing a contraction (discussed here).

EUR-USD

Of course it also makes Ireland highly vulnerable to a euro rally. And the euro came to life this month, driven in part by Draghi's promises to "save" the currency as well as a partial reversal of massive speculative short positions (discussed here).

In particular the EUR-GBP level becomes critical for Ireland, given the nation's large exports to the UK and the UK's difficulties in shaking off its recession (discussed here).

EUR-GBP

In fact Ireland's exports to the UK may have slowed down in Q2, making the currency level even more critical.

Irish Times: - The figures show that one in five principal freight segments had growth over the second quarter, while all other segments declined compared to the same period last year. In the first half of 2012, exports declined by 2 per cent, while imports fell by 4 per cent.

Roll-on/roll-off traffic declined in the Republic by 4 per cent in the second quarter. The majority of Ro/Ro freight from Ireland is destined for Britain. The British economy contracted between April and June with marked declines in its construction and manufacturing sectors.

The Eurozone nations are impacted quite differently by the fluctuations in the euro. Ireland benefits the most from the weaker euro - far more than Germany as a percentage of its GDP. Because of euro's weakness it was the only Eurozone nation that saw its manufacturing markedly improve recently. But this also makes Ireland vulnerable to EUR appreciation, particularly against GBP.

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Ireland: in the land of the blind the one-eyed man is king

As discussed yesterday, the Eurozone manufacturing sector is in a recession, with all but one of the larger nations experiencing a contraction. That one nation that is bucking the trend is Ireland. Ireland was hit hard by the financial crisis in 2009 - before Greece and Portugal came on the scene. It took a complete recapitalization of the banking system via "bad bank" structure called Irish Bank Resolution Corporation (IBRC) that saddled Irish taxpayers with bad commercial real estate loans and properties they had to take over in order to recoup some of the losses. The government and IBRC had to borrow heavily from the IMF/EU and the ECB to execute the bailout plan. The taxpayer-owned properties are still being liquidated and the government is still trying to deal with all the debt it took on in order to complete the bailout.

Many argue that Ireland should have imposed haircuts on holders of senior unsecured bank bonds to reduce the burden on the taxpayer. Part of the problem was that it took some time for the authorities to fully value problem loans and to understand the full extent of the bank losses. Some thought that wiping out the common and preferred equity would be sufficient (which it clearly wasn't).  Plus the holders of senior bonds were mostly other EU banks. Fearing a shock to the banking system, the EU leadership pressured Ireland into making the bondholders whole at the expense of the taxpayers. Many in Ireland have been outraged by this and the e-mails we've got on the topic indicate that if the nation could do this over again, they would definitely impose such haircuts.

However having dealt with this extraordinarily costly bailout in a relatively decisive manner (something that Spain desperately needs), Ireland is gradually putting the crisis behind it. To be sure there are tremendous obstacles to overcome including high unemployment, weak property markets, and a difficult fiscal situation.

Ireland unemployment rate  (source: Bloomberg)

But the manufacturing PMI numbers show real promise that Ireland may be on the way to recovery.

Source: Markit (click to enlarge) - note that PMI below 50 generally indicates contraction

And market-based indicators also look quite good. Irish government yields have declined even in the face of Spain's escalating crisis. The spreads are still elevated, but are now less than half reached during the peak of the crisis last year.

Ireland 9y (benchmark) yield  (source: Bloomberg)

Reuters: - Ireland's surprise issue of medium-term bonds last week, the first by a country in an EU/IMF bailout program, capped a stellar year in the bond market in which the premium investors demand to hold its debt over Germany's shrank by 60 percent.

Ireland's stock market is up 10.8% year-to-date (including dividend) and has done reasonably well even against the DAX over the past year.

Irish index vs DAX over the past year  (source: Bloomberg)

Even the fiscal situation is beginning to improve.

Reuters: - The Irish government was ahead of its revenue goals at the end of July, keeping it on target to meet its 2012 deficit target under its EU/IMF bailout, but the government said it had spent slightly more than it had planned.

Tax returns were 2.5 percent, or 500 million euros ($607.98 million), ahead of target in the first seven months of the year, with income, value-added and corporation tax receipts all better than planned, the finance ministry said in a statement.

Of course given the horrific economic conditions across the Eurozone, it doesn't take much to stand out.

Reuters: - "Most of the numbers are pretty bad, there's a depression in domestic demand and the banks balance sheets are still damaged," said Stephen Kinsella, professor of economics at the University of Limerick.

"But if you look at our yield performance next to Italy and Spain, you start to see Ireland in a more favorable light," he said. "In the land of the blind the one-eyed man is king."

And tremendous risks still remain.

Reuters: - The country's prospects now depend on promised concessions from Europe outweighing the drag which the euro zone recession is having on Ireland's key export sector. Merchandise exports to the euro zone fell 5 percent in the six months to June, but total exports were up 3.8 percent.

Another major risk is that the government will be forced to pick up the tab for large new losses on property loans at state-owned banks or the National Asset Management Agency, which is bidding to recoup 32 billion euros it paid for bad property debts.

But Ireland has a four-year head start over Spain and Italy in dealing with the crisis. Slowly but surely the nation is pulling ahead of the other Eurozone nations and may in fact be on the way to recovery.

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Spain's banks face Ireland style recap; will include sub debt haircuts and triggering CDS

As discussed here in April (see this post), Spain's banking system needs Ireland-style bank recapitalization. And that's precisely what Spain's banks are going to get. The "bad bank" entity, unceremoniously named the Asset Management Company (AMC), will become the proud owner of bad property loans. This is the equivalent of the Irish Bank Resolution Corp.

EFSF bonds will be used instead of cash for recapitalization (discussed here back in June). The banks as well as AMC will be able to use the EFSF bonds as collateral at the ECB.

Source: Barclays Capital

The theory that somehow EFSF financing will not force haircuts on debt holders is nonsense. Haircuts are coming and they will be particularly painful for subordinated debt holders. The subordinated component of these banks' capital structures is quite large.

Barclays Capital: - ... the Spanish authorities will amend existing legislation by the end of August to ensure full participation in the liability management exercises. We expect the new legislation to give the Spanish authorities the power to alter the terms of existing subordinated debt in a way that is detrimental to bondholders...

Spanish banks have large subordinated capital structures. There is €64bn of subordinated debt outstanding at Spanish banks, of which €38bn is tier 2 and €26bn is tier 1. We estimate that €15bn of capital could be raised through a combination of voluntary and mandatory subordinated liability exchanges.
...
We expect these transactions to include a coercive element. For example, early stage transactions could be voluntary, but could contain a collective action clause (CAC). If activated, which usually occurs when voluntary participation in the transaction is above a certain threshold, the CAC would reduce the claims of the holdouts by modifying the terms of the instruments. If this fails, Spanish authorities would be able to invoke the powers granted to them under the new legislation to effectively reduce the bond principal through statutory means.

What makes this process especially difficult is that many of the sub debt holders are retail customers of these banks.

WSJ: - According to the draft, Spain will have to introduce a new law by the end of the summer that would allow losses to be forced on subordinated debt holders and hybrid capital holders. Many subordinated debt holders are ordinary depositors.

And the losses at Spanish banks continue to pile up. Unwilling to write off or mark down bad debt quickly, Spain's banking system is taking in losses in a painful liner fashion (see chart below - those who have seen a number of economic charts over the years will recognize that this linear pace of write-downs looks artificial). The latest release from the Bank of Spain (see this post from Kostas Kalevras) once again shows an increase in "Doubtful debtors" balance.

Doubtful debtors (€bn)

The subordinated debt CDS for Spanish banks is widening as loss expectations increase. Given the anticipation of significant haircuts on the subordinated debt, the sub to senior CDS spread ratio, particularly for the weaker banks has risen in the past week.

Source: Barclays Capital

Expect a number of these sub CDS to trigger as the recap process goes into full gear and true losses are recognized.

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Ireland's advice for Spain

Bloomberg/BW has a good article out this morning describing the advice Ireland is giving Spain on dealing with the banking system.

Nine hundred miles northwest of Madrid, Irish analysts wring three lessons from its own banking crisis, among the worst in history.

[1.] First, quickly present an accurate estimate of the bad loans.
[2.] Second, force banks to face up to losses, possibly through the creation of a so-called bad bank.
[3.] Third, share as much of the loss as possible with bank bondholders.

“Spain should face the economic reality, even if they have to value property loans at discounts of 40, 60 or even 80 percent,” said Alan Ahearne, former economic adviser to Brian Lenihan, the finance minister who presided over Ireland’s response to the near-collapse of its financial system. “If the real losses aren’t faced up to, who’s that going to fool?”

Sadly, if Ireland took a more aggressive stance with the bond holders of their banking system, the nation would be in a much better shape today. But because Ireland was pressured by the Eurozone to spare the bondholders (most of whom were other Eurozone banks), the nation relied mostly on equity recapitalization - which hurt the taxpayer tremendously.

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Restructuring the Irish promissory notes

In 2010 the Irish government bailed out (recapitalized) the Irish banks with 30bn euros. The government could not easily raise these funds in the market so it used promissory notes (PNs) instead of cash (sort of what California did when they paid salaries with IOUs during their "budget issues" in 09). These PNs are set up to pay a set amount over the next 20 years.

The promissory notes were used as collateral with the Central Bank of Ireland to obtain central bank emergency financing called ELA. That collateral did not qualify for LTRO, leaving ELA balances outstanding. Since then the banks were "restructured" creating the Irish Bank Resolution Corporation (IBRC) - the "bad bank" to hold all the wonderful real estate loans and properties. Now IBRC owes the Central Bank of Ireland money under the ELA.

This year about EUR 3.1bn of PNs was due (on March 31st), but the Irish government was in no position to pay that in cash. Instead the goal has been to kick the can down the road - as far as it can roll. The Finance Minister Michael Noonan has been trying for a while to restructure the PNs by swapping them into long-term government bonds. His negotiations with the EU/ECB have yielded only a partial result. He was able to roll just the 3.1bn due this year, but it required a fairly messy transaction. The issue is that the ELA financing is meant to be a temporary measure and the ECB wants it paid down asap.

Here are the steps for the restructuring of the PN - just the EUR 3.1bn (this time around - no guarantee this will work next time):

1. The Government issues a long-term bond that it delivers to IBRC in return for IBRC extinguishing the 3.1bn worth of PNs (it effectively pays its "promise" with long term bonds instead of cash).

2. IBRC places the bond as collateral with the Bank of Ireland (not to be confused with the Central Bank of Ireland) to borrow cash for a year. Given that the Bank of Ireland is controlled by the government, it can roll this loan indefinitely.

3. IBRC uses the cash from the loan to pay down the ELA financing and get back the PN it had out with the Central Bank of Ireland.

4. The Bank of Ireland then uses these long-term bonds as collateral to borrow from the Central Bank of Ireland/Eurosystem under the MRO or 3m LTRO programs.

Restructuring of Irish promissory notes

With this transaction, the Irish government doesn't have to use cash to pay the promissory notes, the Bank of Ireland makes a spread between where it borrows from the central bank and what it receives from IBRC, and the ECB makes sure that the ELA is paid down. Everyone is happy, right? Not exactly. This is a difficult transaction and Michael Noonan would much rather have used financing from EFSF directly. Most importantly, this is only a portion of the PN restructuring and this issue will be back shortly when the next portion of the PN is due. In 2014 the PNs due will constitute some 15% of projected cash needs of the Irish government.

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Ireland for sale

As strong reactions to the post on Ireland continue to come in, here is something else to consider. Ireland's infrastructure is now for sale. The first set of assets that are being sold are of course the commercial real estate properties that got Irish banks (and the government) into trouble to begin with. The bankrupt property developers have turned the keys over to the banks who passed them on to the National Asset Management Agency (Nama) as part of the "bad bank" bailout program. And the sales must happen quickly.

Bloomberg: The Dublin-based asset manager must sell 9 billion euros of property loans and real estate to meet a 7.5 billion-euro debt- repayment goal by the end of 2013, Chief Executive Officer Brendan McDonagh said in an October interview.

But there is more than real estate properties for sale. The state's share of Aer Lingus for example is being shopped around. Seeing opportunities in Ireland's infrastructure, which is also on the auction block, China now moves in. Cheap infrastructure has always been interesting for the Chinese and Ireland is no exception.

People's Daily: "There are enough opportunities for Chinese companies to invest in infrastructure in Ireland. We have a lot of infrastructure that is publicly owned, and part of it is going to be sold in the next two to three years," said O'Leary.

"They (the assets) are valued at 3 billion euros ($4 billion), including energy, gas, electricity, ports, roads and water," he added.

The sale is on and everything must go.

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Some Irish banks unable to qualify for LTRO are tapping Bank of Ireland's ELA

The Emergency Liquidity Assistance (ELA) are temporary loans provided by the Eurozone's National Central Banks (NCBs) to banks in their jurisdiction. These loans are outside of those provided by the ECB, such as the LTRO program. The idea was to allow for some discretion for the NCBs to help their domestic institutions in a crisis situation that is specific to that nation, as opposed to a Eurozone-wide issue managed by the ECB. Unlike the ECB's lending programs where the risk is shared by the Euro-system, the NCBs bear the risk on ELA loans. The ECB can in fact stop the NCBs from providing specific ELA assistance if it is deemed to interfere with the ECB's overall policy actions.

With the massive LTRO lending program by the ECB, one would expect that the Eurozone banks would repay their ELA loans and roll them into the ECB's 3-year loans. That seems to be what in fact happened for some nations such as Belgium, but the roll was only partial for Ireland. The Central Bank of Ireland still has some €45 bn of ELA loans outstanding.

Source: GS

So why would Irish banks not roll their ELA into the 3-year 1% LTRO? There is only one explanation. In spite of the much looser collateral requirements under the latest LTRO program, the collateral posted by the Irish banks under the ELA loans just doesn't qualify for LTRO. These Irish banks still need the liquidity but simply don't have the collateral the ECB would find palatable.

This is an important development to watch because it indicates continuing stress in the Irish banking system - with some banks so tapped out, they don't have enough ECB-eligible collateral. It also poses a risk to the Central Bank of Ireland that is not shared by the Eurozone (for now), particularly given that Ireland is in no position to bail out its central bank.

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On second thought, hold off moving that business to Ireland

As many readers have mentioned in their emails (some quite angry), the previous post was not really about moving your business to Ireland. It was pointing to some dire economic difficulties the nation is facing. And this morning we got two further confirmations of these difficulties:

WSJ: Government data released Thursday showed that gross domestic product fell 0.2% from the third quarter, having fallen by 1.1% in the third, a figure that was revised from a 1.9% contraction.

That places Ireland in a recession under the definition of two successive quarters of declining GDP. The Irish economy last contracted for two straight quarters in late 2009.

Ireland GDP (Bloomberg)

But there is a more ominous sign of Ireland's troubles. Ireland has to make a EUR 3.1bn promissory note payment due next week and the government just doesn't have the resources (readily available) to pay it. So the Finance Minister is negotiating with the EU to basically kick the can down the road (roll the debt). The idea is to make the payment not in cash but by delivering a newly issued bond.

Reuters: "We are now negotiating with the EU authorities, and principally with the ECB, on the basis that the 3.06 billion euro cash installment ... could be settled by the delivery of a long-term Irish government bond," Finance Minister Michael Noonan told parliament.

The payment will be replaced with a bond maturing in 2025, a source with knowledge of the negotiations told Reuters.

The government has been negotiating with its international creditors - the European Central Bank, the European Commission and the International Monetary Fund - to replace a 30 billion euro promissory note with another instrument, lengthen the maturity and cut the interest rate.

Ireland borrowed cash under these promissary notes to bail out its banks. And it's been trying for a while to roll this debt.

Reuters: Dublin has pursued a months-long campaign to reduce the cost of its bank rescue by refinancing around 30 billion euros worth of promissory notes - the IOUs used to recapitalize failed lenders Irish Nationwide Building Society and Anglo Irish Bank, now merged as the Irish Bank Resolution Corporation (IBRC).

Irish 5-year CDS has widened to 617 bp this morning, which is still way below the highs of 1180 bp reached on 7/18/11. Sovereign risk is alive and well, and Ireland could be in the crosshairs.

Update: See Comments (below) for the latest on Michael Noonan's proposal and the ECB's rejection.

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Why Ireland is the place to move your business

If you have some capital and want to become really competitive, here is why you should move your business or expand your operations to Ireland (other than the fact that it's a beautiful country).




1. There are plenty of English speaking workers in need of a job. So there won't be any problems recruiting.

Ireland's unemployment rate (Bloomberg)

2. And you don't have to pay them much. Particularly in comparison to some other European nations, Irish labor has become quite inexpensive.

Unit labor costs (Source: OECD, hat tip Kostas Kalevras)

3. Now if you want to make sure these employees stay with you for a long, long time, you can help them buy homes near their job. After all home prices in Ireland are becoming a great deal cheaper, at least on a relative basis. Makes for a very effective employee retention package.

Nominal declines in home prices from the peak (Source: GS)

Home price appreciation YOY (Source: GS) 

4. You can even help them get a loan, because you know they are not getting it from their local bank.

Source: Bank of Ireland 

5. Now with cheap and loyal labor, there is nothing stopping you, particularly if you have access to capital. That's because your local competition certainly has no way of getting a loan.

Loans to non-financial corporations in Ireland from Jan 11 to Jan 12 (€ million)

6. And don't worry about credit conditions improving any time soon and local competition coming back. With banks owned by the government and credit availability/liquidity tightening, your competition won't stand a chance. It won't be long before you own them.

Ireland's contribution to the Eurozone's M1 money stock from Jan 11 to Jan 12 (€ million)

So as long as you don't have to sell your products to anyone locally, Ireland is the place to be for a growing company. And by the way, your corporate tax rate will be way lower than many other places you are considering setting up shop.

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