Government plan aims to ensure country’s financial survival

DEPARTMENT of Finance officials are engineering a manoeuvre that may make the difference between default and financial survival.

The impetus for the plan is the cost of bailing out Anglo Irish Bank and Irish Nationwide Building Society. Ireland paid an initial €31 billion to save the two lenders, averting what Central Bank governor Patrick Honohan called a “European Lehmans” in a nod to the collapse of Lehman Brothers in September 2008.

To cut the final bill of at least €48bn, including interest, Finance Minister Michael Noonan may seek to exploit the eurozone’s debt crisis by tapping the area’s expanding rescue fund. That would deliver money at lower interest rates and over a longer period than selling bonds, reducing what Noonan has called the “extraordinarily expensive” tab as Ireland seeks to win back economic sovereignty.

“Ireland is really on the fringe between debt sustainability and unsustainability,” said Dermot O’Leary, chief economist at Goodbody Stockbrokers. “The cost of funding this every year could play a big part in the difference, ultimately, between the two scenarios.”

Ireland’s 10-year borrowing cost, which reached 14.22% in July, dropped below 8% on Wednesday for the first time this year, and is currently at a nine-month low of 7.53%. The cost of insuring against defaulting for five years has dropped to 677 basis points from 804 during the past two months, according to CMA prices, implying a 44% probability of Ireland failing to meet its obligations.

The International Monetary Fund said earlier this month it expects Ireland’s general government debt to peak at 118% of gross domestic product in 2013, equivalent to almost €200bn. That’s up from 25% of GDP in 2007. Ireland was last year forced to seek €67.5bn of aid, after its banking woes became too big to handle alone. On September 30, 2008, the then government guaranteed most of the debts of its biggest banks, with the state agreeing to inject about €62bn into the financial system to date.

The Government must “use all our persuasiveness powers and ingenuity to get the burden of the debt down,” Noonan said in an interview on RTÉ Radio on Monday, adding that he’s seeking to cut billions off the overall cost of bailing out Anglo Irish and Irish Nationwide.

As the bill for the two banks soared last year, then Finance Minister Brian Lenihan decided to hold off injecting all the €31bn into the two banks straight away. Instead, he promised to give them the cash over 10 years, by issuing promissory notes.

The banks used the notes as collateral to borrow funds from the Irish central bank.

After being rebuffed by the European Central Bank on a plan to impose losses on senior bond holders in the two lenders, Noonan said he’s turning his attention to an “alternative piece of financial engineering to the promissory note arrangement.”

“Rescuing Anglo helped maintain stability across the European banking system, but has put a heavy burden on the Irish state,” said Alan Ahearne, an adviser to Lenihan who oversaw the promissory note arrangement and negotiated the bailout accord. “Any arrangements to ease that burden would help Ireland to stay ahead of its program targets.”

The Government pays an annual 8% to the banks on the notes, a rate Taoiseach Enda Kenny described this week as “penal.”

The Department of Finance a day later put the cost at €17bn over 20 years.

“The goal is to reduce this interest charge,” said O’Leary at Goodbody.

On July 21, European leaders empowered the eurozone’s €440bn rescue fund, the European Financial Stability Facility, to aid troubled banks by lending to governments to inject into lenders.

By taking a loan from the fund, Ireland could pay off the promissory notes, saving €17bn instantly. More savings would flow, assuming the state could borrow at a lower rate from the European fund than investors would charge to make good on its capital pledge to the banks.

“The proposal will in effect raise the amount of borrowings from the EU/IMF by €30bn which would be repayable at competitive rates most likely beginning in 15 years,” said Jim Ryan, an analyst at Dublin-based Glas Securities, in a note.

Noonan’s willingness to spare senior bank bondholders, in recognition that his plans risked worsening a funding crisis for banks across Europe, may win him support for tapping the EFSF, according to Mr O’Leary.