Long shot but recapitalisation is a possibility

There is no clear cut argument why Ireland should get a retrospective bank recapitalisation through the European Stability Mechanism (ESM). Then again, there is no clear cut argument why Ireland should not get such a deal.

The obvious downside is that there is a disproportionate amount of political energy and focus directed towards securing a deal on a bank recap for what in the end amounts to little more than a pyrrhic victory.

Of course, just as in the case of the promissory note deal, there is always the chance that the Government could surprise on the upside.

The Government had to get the ECB over the line to restructure the €28bn in promissory notes, which was completed last February. There was huge opposition among the eurozone’s creditor nations.

But Mario Draghi understood something had to be done on the promissory notes to make Ireland’s debt position more sustainable and boost the chances of a successful exit from the EU/IMF programme.

A deal on a bank recap would have to win approval from every eurozone finance minister. Even though European Commission president, José Manuel Barroso, has backtracked on comments about the Irish banks being a major contributory factor to the euro crisis, it is safe to assume this is the narrative held by many senior figures in euroland.

In the run-up to the crisis, the image depicted by the German media in particular, was that Ireland was the wild west of the financial markets. Rules were arbitrary and regulation was lax.

Ireland was a symptom of the structural shortcomings of the single currency. The Government can legitimately say it took one for the team when it committed to repay in full all bank liabilities apart from a small amount of junior debt. Anglo Irish Bank and Irish Nationwide were both hopelessly insolvent. Why should investors get their money back from a failed business?

Taxpayers have pumped €30bn into Bank of Ireland, AIB, and Permanent TSB. The State has almost fully exited Bank of Ireland and is on schedule to make a profit of roughly €2bn on its original investment. The Government paid roughly €25bn for 99.8% stakes in AIB and PTSB. Both banks are moving in the right direction, although the latter’s future viability hinges on EU approval of its restructuring plan.

It is likely the combined current market value of both banks would be less than €5bn. If the Government were successful in securing a recap for the banks, what are the chances of eurozone finance ministers paying anything above current market value?

In such a scenario, the Government would be giving away the future upside potential. It would be far more lucrative to wait for the banks to return to profitability and sell them to private investors.

Moreover, it would be far more effective if the Government secured a deal on the €48bn of tracker mortgages that are a huge barrier to the banks returning to profitability. These mortgages track the ECB’s main interest rate, which is at a historic low. Consequently the return on these products is less than the banks’ cost of funding.

The Department of Finance had been working on a solution that would see the banks guarantee the first 10% of losses on tracker mortgages, with the Government guaranteeing the rest of the book. The ESM would overlay the Government guarantee with its own guarantee, which could then be used to open up a funding line with the ECB.

The proposal faces implacable opposition from the ESM and ECB. However, if it were eventually successful, it would probably deliver much greater gains than a bank recap.