Renewed access to capital markets for both the sovereign and the two largest banks has prompted hopes that Ireland will be able to exit multilateral support programmes successfully by the end of 2013.

The Irish government announced a package at the start of February 2013 to resolve the €28bn of outstanding debt created by the bail-out of Anglo-Irish Bank in 2008. This capped a highly successful month of deals that seemed to offer hope of rehabilitation for a country forced to take on assistance from the EU and the International Monetary Fund (IMF) in November 2010.

Unable to fund itself in the capital markets, Anglo-Irish had borrowed money from the Central Bank of Ireland (CBI) under the short-term Emergency Liquidity Assistance facility, collateralised with a promissory note for €28bn written by the Irish treasury. Anglo-Irish was subsequently merged with the equally stricken Irish Nationwide Building Society to form a wind-up vehicle for legacy assets, Irish Bank Resolution Corporation (IBRC).

Moving on

In February, IBRC was officially liquidated, and the promissory notes were rolled into a series of sovereign bonds with average maturities of more than 34 years, with the first repayments due in 2038. The yield of 8% on the promissory notes, and a €3.1bn annual repayment, is replaced with an average floating rate of 2.63% over Euribor, saving the Irish treasury about €800m a year, according to Irish investment bank Davy.

Members of the European Central Bank (ECB) governing council initially seemed reluctant to validate a deal that might technically breach the ECB’s mandate, which forbids monetary financing of governments. The deal needed a two-thirds majority of council members to approve it. In the end, the ECB issued a rather ambiguous statement, saying that the governing council “unanimously noted” the arrangement.

That compromise may have been influenced, says Rabobank senior fixed-income strategist Richard McGuire, by renewed widening of peripheral eurozone spreads in February 2013, after six months of steady tightening since ECB president Mario Draghi unveiled his Outright Monetary Transactions (OMT) sovereign bond buying framework in mid-2012.

“The Irish example has created positive contagion toward other eurozone peripherals, and the EU needs that. The ECB may have been concerned that no deal could trigger negative contagion, turning a temporary retracement of spreads into a more sustained trend reversal. But the compromise may make it less likely that Ireland will be allowed to access the OMT or the ESM [European Stability Mechanism] at a later date,” says Mr McGuire.

Back to market

The Irish authorities will be hoping that their success in resolving the IBRC debt, and in hitting targets set by the so-called 'troika' of the ECB, the European Commission and the IMF, will make access to the OMT or ESM superfluous. The National Treasury Management Agency (NTMA) successfully tapped its 2017 bond for €2.5bn in January 2013. This marked the culmination of a gradual return to the markets that started with a series of €500m issues of three-month treasury bills (t-bills) from July 2012, for the first time since September 2010.

For longer dated issuance, there was a bond swap in January 2012 that extended €3.53bn of a 2014 issue by one year, and a much larger deal in July 2012 in which €1bn of short-dated bonds were exchanged and €4.2bn of new money was invested into two new issues maturing in 2017 and 2020. The yield on the 2017 issue was 5.9%. By the time the NTMA tapped the 2017 with a syndicated deal in January 2013, it was able to pay a yield of just 3.32%.

“We would consider that we have now regained full access to the t-bill market and will continue holding smallish monthly auctions," says Oliver Whelan, director of funding and debt management at the NTMA. "T-bills helped us to get back on the radar, to bring the discussion with investors beyond the theoretical. Buyers reopened lines that were not previously there and used the t-bills as a market pricing reference point. Those active in the secondary market were re-engaged and turned up at the syndicated deal.” 

The NTMA'S working plan is to issue a further €7.5bn across the rest of 2013. Mr Whelan says the sovereign currently lacks a 10-year benchmark due to the post-crisis issuance hiatus, and is hopeful that it will be possible to launch one through a syndicated offering later in 2013. The NTMA is also in contact with pension funds on the possibility of an inflation-linked issue.

“Pension funds have to file their funding plans by the end of June 2013, then they will decide on the asset mix needed for defined benefit pension schemes to meet their funding gaps. Our conversations show that there is demand for Irish consumer price inflation in that mix,” says Mr Whelan.

The signs from the January deal were also promising. The investor base was high quality, with only 1% going to hedge funds and more than 70% going to long-term real money investors such as pension funds, insurers and long-only asset managers, with a further 24% distributed to banks. And the sovereign was certainly not relying on a captive domestic audience. While 13% of the bond went to Irish buyers, one-third went to UK investors, together with 19% to the Nordic countries, 11% to France and 7% to Germany. Beyond Europe, North American investors purchased 9% of the deal.

Maintaining progress

There could be further good news on the horizon, especially after the promissory note rescheduling. Moody’s remains the only one of the three major ratings agencies to keep Ireland below investment grade, a rating which Mr Whelan says posed difficulties for some fund mandates – especially in Asia, which took only 1% of the 2017 tap. Moody’s made positive noises in the wake of the IBRC liquidation.

“The government now has cash balances of €22.5bn, equivalent to 14% of GDP [gross domestic product], as a precautionary cushion. That takes the net debt ratio down to 104% of GDP. The NTMA has prefunded 2014 in full and is now even beginning to prefund 2015, so it is a virtuous circle of constrained supply and high incremental demand,” says Donal O’Mahony, fixed-income strategist at Davy, which was a bookrunner on the 2017 tap.

The current troika support package, which will be completed at the end of 2013, requires Ireland to hold six months’ cash and have good visibility for the next 12 months. But such large cash balances come at a price. They must be held on deposit at the CBI earning zero interest rates, creating a significant negative carry compared with the government’s funding costs.

“As the market normalises and we exit the troika programme, perhaps replacing it with a precautionary credit line, we will not need to hold such levels of cash, although they are a good sign for us at the moment until we are clear on what will happen in 2014,” says Mr Whelan.

Banks on track

The weight that could still drag Ireland back into the pit remains its banking sector and the aftermath of a burst property bubble. Here again, the market seems in an increasingly forgiving mood. In November 2012, Bank of Ireland and Allied Irish Banks (AIB) both reaccessed the covered bond market for the first time since the financial crisis, and Bank of Ireland also issued a €250m lower Tier 2 bond in December. AIB followed up in January 2013 with a second covered bond deal, for €500m, which was longer-dated (three-and-a-half years instead of three years) and at a tighter spread (185 basis points over mid-swaps, compared with 270 basis points).

“We had achieved our restructuring targets and wanted to prove that we can access the markets for new commercial business. We will look at other formats now, not for any jumbo issues but to show over the next 12 months or so that we can keep access. Obviously we could still be affected by broader eurozone developments, but we would like to offer a lower Tier 2 or senior unsecured issue next if possible,” says David Duffy, chief executive of AIB since November 2011.

In January 2013, the government also sold into the market the Bank of Ireland €1bn Tier 2 contingent convertible (CoCo) bond it had bought in mid-2011 to support the bank’s recapitalisation. Davy, Deutsche Bank and UBS acted as lead managers on the deal. The offer received €4.8bn of offers, but this is not altogether surprising given that Bank of Ireland has a core Tier 1 ratio of 13.9%, compared with a CoCo conversion trigger of 8.25%.

“With a three-year maturity and such a large gap to the trigger, this was basically a bond with a double-digit coupon. But it is a sign of broader investor interest, and the Bank of Ireland share price has almost doubled since October 2012,” says Mr O’Mahony at Davy.

Even so, the share price is at about 14 cents, less than 1% of its 2007 peak of €18.5. The process of selling the government’s remaining 15% stake in Bank of Ireland, to say nothing of its 99% holding of AIB, will clearly take much longer than the return to bond market funding.

Rebuilding balance sheets

Matthew Elderfield, deputy governor and head of financial regulation at the CBI, lists the goals already achieved in the banking sector. These include the transfer of illiquid and distressed commercial real estate loans to the National Asset Management Agency (NAMA), the independent stress-test by BlackRock in March 2011 which identified €8bn in extra capital needs beyond the banks’ own estimates, and the process of deleveraging and selling down non-core assets. Mr Elderfield says those assets were mostly in the UK, but also included specialised lending activities in Ireland and overseas. Loan-to-deposit ratios have fallen to about 120%, from more than 180% before the crisis.

“The banks have done well to begin normalising loan-to-deposit ratios without firesales of non-core assets. Capital haircuts were better than the stress-test assumptions, so some capital has been written back onto balance sheets. It was also good that Ireland started early, because with the broader eurozone crisis and new EBA [European Banking Authority] capital requirements, banks elsewhere in Europe were under pressure to deleverage during 2012,” says Mr Elderfield.

Like the bond markets, depositors are showing renewed confidence, with net deposit inflows of €14bn in 2012 even as the government’s deposit guarantee expired. The termination of guarantee schemes will also eliminate the associated fees, which were a significant cost for the banks. However, two substantial challenges remaining are to work out non-performing loans in the core portfolios of the surviving banks, and to establish a new business model that can generate sustainable profits in the future.

“We had to build capability in financial solutions with a unit of about 2000 people from all over the group who took over all the activities related to restructuring mortgage and SME [small and medium-sized enterprise] loans. Then we had to rebuild the commercial enterprise. Our pricing on mortgages has gone up by about 100 basis points, we exceeded our €1bn new mortgage target in 2012 by €500m, and we issued 29,000 new SME loans for €4.8bn, compared with a target of €3.5bn,” says Mr Duffy at AIB.

He says the loan restructuring process will pick up pace in 2013, and the bank’s approach is to resolve all existing troubled loans as fast as possible. AIB employs a three-stage process of repayment and interest forebearance to stabilise client finances, a long-term plan for sustainable parts of a business, and then the write-off of unsustainable elements. A common component of that third phase consists of buy-to-let housing properties, where default rates for the banking sector as a whole were more than 25% as at September 2012.

“The aim is to keep people in their homes and preserve jobs wherever possible. We aim to have engaged with every mortgage customer in arrears within the next six months. SME loans are more complex and will take longer, perhaps 18 to 24 months, but with plenty at the front end of that period,” says Mr Duffy.

A further source of uncertainty is the Basel III capital deduction for deferred tax assets – which Mr Elderfield estimates could reach €6bn given the size of deferred taxes in Ireland’s loss-making banking sector. Ireland has also passed new insolvency legislation, which will establish an insolvency service in mid-2013.

“The new law should provide assurances for creditors and debtors, such as clearer voting procedures in insolvency. We are hopeful that it does not provide incentives for strategic defaulting, but we recognise that the eventual effects will constitute another source of uncertainty to be factored into our next stress-test at the end of 2013,” says Mr Elderfield.

Poster child?

The greatest risks to Ireland may still come from elsewhere in the eurozone. They include a corruption scandal surrounding the Spanish government and the risk of backsliding after Italian elections in March. Mr O’Mahony says Irish assets will not automatically correlate with any peripheral sell-off, as Ireland sovereign spreads are now pushing closer to outer core countries such as Austria and Belgium.

But those hoping the Irish example can provide an incentive to the rest of the bail-out recipients to stay on track may be disappointed, says Mr McGuire. Unlike Portugal, Greece or Spain, the Irish economy never suffered from poor economic competitiveness, enjoying high foreign direct investments, a well-educated and mobile workforce and strong value-added sectors such as technology and pharmaceuticals. Ireland may be dragging itself out of the pit, but the climb is steeper for other peripheral states.

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