Taking responsibility, the ESM way

Well, see if you can make out what they’re saying here.

That’s the statement on direct ESM recaps of eurozone banks, which the finance ministers of Germany, the Netherlands, and Finland jointly issued on Tuesday.

Reuters has puzzled over it:

…one senior euro zone official familiar with the discussions that took part in Helsinki said: “All I can say is that the statement means that ESM direct recapitalization should not be used to take care of old problems.”

The FT has puzzled over it:

This was an apparent reference to banks shored up and wound down under Ireland’s €64bn bank bailout programme.

Although officials did not clarify how the new principles would apply to current cases, the statement also called into question whether the scheme would apply to Spain’s most troubled banks, which are scheduled to be bailed out with eurozone money in November.

And it’s puzzling to us. We see ‘legacy asset’ and usually think of things like impaired loans, assets in run-off, and bad banks, which are managed separately from banks. At least at first glance, we assumed that’s what they meant. Namely, that these are assets which the ESM might not want to end up managing.

Again, the sentence in question is “2) the ESM can take direct responsibility of problems that occur under the new supervision, but legacy assets should be under the responsibility of national authorities”. Is that just setting out a division of labour? The ECB and the EBA have their own powers and operations, but they also outsource a lot of things to national central banks. In part because NCBs have the expertise, in part because they have the jurisdiction, and in part because European institutions like these don’t have the staffing levels to do everything on their own.

So maybe reading something as sweeping as ‘old problems’ into that statement is way too far. But then, the above ‘basic principles’ do still come across as tricky on this point of converting old recaps into direct ESM recaps — if one wants to stick with the more dramatic interpretation.

Along these lines, we suppose the northern governments could be trying to nail down that direct investment in banks by the ESM shouldn’t be retroactive after all, or replace existing state-backed capital. That would clear up an ambiguity in the original statement on ESM recaps, from June.

This would hit Irish hopes for example. That’s maybe inevitable however you look at this odd little satement. Anglo for example, which sank the Irish state, is pretty clearly in “legacy asset” run-off, with a plan for full resolution in 2020, and which might be difficult to unpick now. A restructuring plan for the promissory notes which also back Anglo would need a deal with the ECB, rather than the ESM. But would “legacy asset” stuff preclude the ESM substituting for the Irish government stakes in AIB, Bank of Ireland, and ILP? They’re all going concerns.

Then there’s the idea of the ESM directly backstopping any future Irish bank recaps which come under supervision. This seems pretty clear-cut, but then what if those recap arrangements also include creating legacy asset vehicles. One last case, via Nomura’s analysts Dimitris Drakopoulos and Lefteris Farmakis (who wrote a hefty note on direct ESM bank recaps and peripheral debt this week – in the usual place):

Permanent TSB (PTSB) is the banking subsidiary of Irish Life and Permanent (ILP), which is set to be separated when Irish Life is sold to private investors. So far PTSB has been the problematic child of Ireland’s adjustment programme, missing deleveraging targets (that BoI and AIB have met comfortably) and surprising negatively with the rise in its mortgage arrears.

More than half of PTSB’s balance sheet (which was €43.8bn by H1 2012) consists of ‘tracker’ mortgages (€22.5bn) generated during the property market boom in 2004-8. The mortgages are very low yielding currently and are impairing profitability because of the bank’s cost of funding. Furthermore, as principal repayments kick in (around 3-5 years after origination) arrears are set to increase further, eroding the capital provided to ILP.

While we will not cover the restructuring plans in detail here, the main interesting parameter is a split of the PTSB by end of September to three units: (i) the core retail bank, which will be the viable bank franchise; (ii) an asset management unit (AMU) to house legacy assets, which includes poorer quality and impaired assets; and (iii) the U.K. residential mortgage operation, which will be divested as soon as possible. The AMU would hold about one-third of PTSB assets, mostly non-performing or high-risk residential mortgages, low interest trackers, and non-core business.

All we want is a little clarity.

And we haven’t even got into Spain.

By Joseph Cotterill and Lisa Pollack

Related link:
Germany to Ireland and Spain: drop dead – Karl Whelan

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