February 2010 1
IcesaveWe demand a reasonable Icesave agreement to avoid
national bankruptcy
February 2010 2
We demand a reasonable Icesave agreement to avoid national bankruptcy
Icesave is not a debt of Iceland• The UK and Dutch governments are claiming reimbursement for payments of €3.91bn to Icesave
depositors of the failed Landsbanki Bank• These payments were much greater than the EU maximum guarantee and were made to save their own
banking systems. All depositors have been reimbursed• Iceland adhered to flawed EU banking directives, which were not designed to deal with a complete
collapse of a local banking sector as experienced by Iceland• The UK and Netherlands demand a state guarantee of Icesave deposits, but there is no mention of a state
guarantee in the EU directives
Forced obligations taken on with sovereign safeguards• In the Brussels guidelines, agreed upon by the EU and all parties to the dispute, Iceland agreed to cover
Icesave deposits in accordance with EU banking directives (which do not specify a state guarantee of deposits)
• It was also agreed that the resolution would take into account the unprecedented situation of Iceland and enable the restoration of its economy
• In August 2009 Iceland consented under duress to reimburse the disputed €3.9bn, but with safeguards that protected against national bankruptcy
• These safeguards were subsequently rejected by the UK and Netherlands
February 2010 3
We demand a reasonable Icesave agreement to avoid national bankruptcy
Economic warfare by the Dutch and UK governments• The UK used anti-terrorist laws against Iceland, a co-founder of NATO• Iceland has been denied clarification of the disputed Icesave claim in a court of law• Only half of Landsbanki’s assets can be used to cover the guarantee stipulated by EU directives. The other half is
commandeered by the UK and Netherlands to arbitrarily reimburse depositors beyond the EU minimum• Excessive interest rates of 5.55% mean that the UK and Netherlands profit from the forced reimbursement by Iceland• The UK and Netherlands are blocking vital IMF loans until Iceland accepts their claims
A grave risk of bankruptcy for Iceland• The banking collapse made Iceland’s external debt one of the highest in the world• Iceland’s exposure is unsustainable. The Icesave obligation is equal to 50% of Icelandic GDP, equivalent to £700bn for the UK
or €270bn for the Netherlands• Key economic variables indicate that Iceland will be unable to meet the repayments in foreign currencies stipulated by the
Icesave loan agreements
A new solution is needed• The assets of Landsbanki assets are valued at €6.6bn (£5.7bn or ISK1,164bn) above the €3.9bn being claimed from Iceland
for the minimum deposit guarantee• Responsibility and costs for flawed banking regulation must be shared and Iceland should receive compensation for
reputational damage due to the use of anti-terrorist law• Iceland must be able to restore its economy in conformity with the Brussels guidelines
February 2010 4
The Icesave obligation in numbers
•UK and Dutch claim € 3.91 billion against Iceland
€ 3.91 billion•Ex
pected obligation per Icelandic family is € 48,000
€ 48,000
•The obligation bears a high interest rate of 5.55% compared to the 15 year gilt rate of ca. 4.40%
5.55%
•Icelandic population is 317,000 – the size of a small city in Europe
317,000
•The Icesave obligation is about 50% as a percentage of Icelandic GDP
50%
•Only about half of Landsbanki’s assets can be used to cover the guarantee stipulated by EU directives
51%
February 2010 5
Landsbanki bank• Does NOT pay interest
on the claim
Iceland• Pays 5.55% interest• Receives no interest
UK / Netherlands
Iceland pays the interests
0% 5.55%
Iceland pays €2.02 billion of
interests
The estate of Landsbanki does not compensate the interests of the Icesave obligation
February 2010 6
No accumulation of foreign exchange
Significant amount of debt maturing• Iceland will not pay up it’s debt
at maturity until 2016 without refinancing. Hence more debt has to be paid after 2016
3.1%• Iceland has to pay on average
3.1%* of GDP annually in foreign exchange only for Icesave
Trade surplus of goods and services has been above 3.1% in only six
years of 64 (1945-2008)
20162009 2023
* Based on Morgunbladid 5 February 2010
February 2010 7
The current agreement is bad in comparison
• The current agreement– Iceland pays 5.55% interest. That equals 1.26% spread on the base rate– The base rate, the OECD CIRR rate in €, was 4.29% in June 2009. Note that at that time, the
base rate in £ was 3.94%. Hence the spread on the pound obligation was 1.61% - despite the use of the anti-terrorist legislation against Iceland
• Bradford & Bingley – floating LIBOR with lower spread– The UK bank Bradford & Bingley was taken over by the FSA in 2008. Deposits were moved
to other financial institutions. The FSCS guaranteed deposits and was funded with a loan from Bank of England and later the British Government
– This sets an example of financing of depositary guarantee funds• Floating LIBOR plus spread for seven years, fixed 5.55% interest thereafter
– Since the accrued interest for the first seven years are such a significant amount it would be better if the obligation would bear floating rates, not fixed
• UK and Dutch would get all payments from Landsbanki for seven years– UK and Dutch would receive all payments from Landsbanki, tha Iceland would otherwise
get– The involved parties would negotiate on the payments of the remaining principal
Looking at a few examples it becomes clear that the current agreement puts unnecessarily heavy burden on Iceland. All the examples assume a seven years grace
period and maturity of 15 years
February 2010 8
Comparison – a few examplesMillions of € Reference rate Spread Principal in
seven yearsTotal paid
Current agreement CIRR in €, 4.29% 1,26% 2,901 2,685
Bradford & Bingley 12 month LIBOR 0.32% the first three years.1.00% thereafter
2,374 2,036
Floating rate 12 month LIBOR the first seven years.Fixed 5.55% thereafter
1.26% 2,568 2,280
UK and Dutch receive everything that the estate of Landsbanki pays the first seven years. Iceland will cover what is left
No interest for the first seven years. Fixed rate of 5.55% thereafter
1,414 854
InDefence is not taking a view on these examples. They are here to show that the current agreement is bad compared to other options.
February 2010 9
Extensive risk factorsForeign exchange risk can cause a weak Krona over the next years
• The obligation is denominated in foreign currencies which is different from an obligation in the domestic currency
• Creditors holding general claims benefit from a weaker krona. Because the claim has been fixed in kronas, a weaker krona means that priority claims will be paid in full and general claims will be partly paid
• The foreign exchange risk is partly due to Icelandic law as they force the claims to be fixed in kronas at the exchange rate of 22 April 2009
Risk associated to the recovery of Landsbanki assets• There has not been an independent assessment on the asset value of Landsbanki• Because of the interests that Iceland has to bear, it is of great importance when the
payments from Landsbanki are being made. The later the payments are made, the higher the obligation becomes for Iceland
The obligation reduces economic growth• When a part of the fiscal budget exits the economy because of Icesave it reduces economic
growth and leads to a lower standard of living. This is mentioned in a paper from the Institute of Economic Science (IoES) at the University of Iceland
February 2010 10
A weaker currency means less recovery and greater obligationIf the krona weakens from current level the obligation will grow since it is denominated in foreign currencies. Unfortunately the payments from Lansdbanki will not increase to the same extent. Hence the net obligation will grow on a weakening of the krona. If the krona revalues the recovery rate will not change that much. We take into account that the assets of Landsbanki are mainly denominated in foreign currencies.
40% 30% 20% 10% 0% -10% -20% -30% -40%0
300
600
900
1200
1500
0%
20%
40%
60%
80%
100%
Recovery left Obligation leftRecovery as a % of obligation right
Changes in the exchange rate of the krona % - negative numbers indicate devaluing
Billi
ons o
f kro
nas
February 2010 11
There are two recovery rates
1. Recovery rate of Landsbanki claims– This is the proportion of claims that are met by Landsbanki assets– If a claim is worth 100 and 80 are paid back by the bank, the recovery
rate is 80%– This proportion never gets above 100%
2. The proportion of the Icesave obligation (principal) that gets paid by Lansdbanki assets– If the obligation is 120 and 80 are paid by the bank then 67% of the
obligation is met by Landsbanki assets• The claim on Landsbanki is krona denominated but the obligation
is in € and £.– Therefore these two recovery rates are not the same
• See some examples on the next page
February 2010 12
There are two recovery ratesThe FX rate effects both of the recovery rates Graphical presentation
CLAIM
100
OBLIGATION120
80
67%80%
Here, 80% of the claim is paid back but that payment only covers 67% of the
obligation
40% 30% 20% 10% 0% -10% -20% -30% -40%40%
60%
80%
100%
Claims recovered % Obligation recovered %
Changes in the exchange rate of the krona (positive numbers indicate strengthening)
February 2010 13
Recovery risk• No one outside of Landsbanki has valued the banks
assets– The portfolio is partly in kronas but mainly denominated
in foreign currencies– Foreign denominated loans to domestic parties are often
paid in kronas. Therefore krona assets are a greater proportion of the asset portfolio than on might think at first
• The value of the assets depends inter alia on the exchange rate of the krona– Depends on how the value develops in the denominated
currency– Depends on the exchange rate of the krona. A weaker
krona gives greater value in kronas– The final recovery rate (rate of claims recovered) never
exceeds 100%– The recovery rate surges of the krona devalues but
plunges if the krona revalues. See graph to the right
• There will be no payments from Landsbanki until legal disputes have been settled. That could be in 2011 at best, perhaps laterCollection in billion
kronas 2009 2010 2011 2012 2013 2014 Later TOTAL
Assumed recovery 191 124 78 183 55 204 333 1,168
To Iceland 97 63 40 93 28 104 170 596
The x-axis shows percentage changes of the exchange rate from current level. Positive numbers indicate strengthening and negative numbers weakening
40% 30% 20% 10% 0% -10% -20% -30% -40%50%
60%
70%
80%
90%
100%
Claims recovered %
Changes in the exchange rate of the krona (positive numbers indicate strengthening)
February 2010 14
Economic growth reduced permanently
Icesave reduces economic growth
• Payments due to obligations is money that will not be spent on other things eg. investments or consumption• Less economic growth means lower standard of living
The risks have not been systematically identified
• In this situation, where the uncertainty is high and amounts are great it is in fact the risks that are of most importance• It is not good enough to consider a base case and certain variations
Not enough fiscal surplus to meet Icesave payments
• The IoES find the forecast of fiscal surplus by the Ministry of Finance optimistic• The IoES also believes that further debt raising is needed to pay the Icesave obligation
IoES* criticises the Central Bank for not systematically identify the risks associated to Icesave
Iceland will become a production economy
*IoES is the Institute of Economic Studies in Iceland
February 2010 15
Downward spiral of the economy
Less FX flowing to Iceland than anticipated
• It is hard to argue that the trade surplus will last that long and as much as the Central Bank assumes and it is contrary to what other countries have experienced• The Central Bank forecasted (in July 2009) a trade surplus of 154bln kronas in 2009. It turned out to be 130bln kronas (assuming trade surplus of services coming at 13bln kronas in
Q4 2009)*
Emigration a real threat
• Emigration on a large scale will increase the burden of those who are left
The worse the economy of Iceland performs, the more we have to pay
• In his paper, Dr Jon Danielsson points out that if the economy does well and the exchange rates recovers the debt will be reduced• If however, the economy does poorly, the debt will increase further• This is contrary to the Brussel guidelines, on taking into account the unprecedented difficult situation of Iceland and allowing Iceland to restore its financial system and its economy
* 13bln kronas is a bit above the average for the three preceding quarters
February 2010 16
Agreed to avoid Icelandic laws• The first €20,887 in each account
should have superpriority– This was one of the safeguards
approved by Althingi in August but was rejected by UK and the Dutch
– This safeguard is in accordance to Icelandic law
– This has been avoided under the current agreement
• This might increase the obligation of Iceland hundreds of millions of euros
• The next page explains the difference graphically with an example. There we have a deposit of €50,000 and assume that 80% of claims will be met by Landsbanki
Claim of €50.000 – comparing how much UK and Dutch will receive according to the current agreement (blue
bars) and according to Icelandic law (red bars)
50% 60% 70% 80% 90% 100%0
10,000
20,000
30,000
40,000
50,000
60,000
Recovery according to agreement Recovery according to Icelandic law
Recovery rateEu
ros
February 2010 17
Iceland takes on €20.887
Iceland takes on €20.887
A single deposit becomes two
claims
Given 80% recovery Iceland pays
EU maximum guarantee Iceland’s
share
Deposit beyond
maximum guaranteeUK/Dutch
share
€50.000
€20.887
€29.113
€4.177plus interest
Recovery from
Landsbanki
Ag
ree
me
nts
Icel
and
ic l
aw
One deposit – a single claim
Given 80% recovery Iceland pays
Interest€50.000
Iceland
UK / Dutch UK/Dutch receive
92%
UK/Dutch receive
80%EU
maximum guarantee Iceland’s
share
Deposit beyond
maximum guaranteeUK/Dutch
shareIceland
UK / Dutch
Recovery from
Landsbanki
Recovery from
Landsbanki
Recovery from
Landsbanki
Recovery from
Landsbanki
February 2010 18
Icesave: differs from other obligations
• Apart from Iceland’s claim on the estate of Landsbanki there are no assets behind the Icesave obligation
• It is misleading to compare the Icesave obligation to other obligations of Iceland– If one has got overdraft and the money is not used but are kept in the bank
there are no arrangements to be made in order to pay back the overdraft– Money will flow out of the Icelandic economy over the next few decades
because of Icesave – in exchange for nothing
Debt issued•When the state treasury issues debt or obligation it receives cash or a deposit•It can be in the form of a revolvong facility
There are some assets behind the
debt•The cash is depositet or invested in secure assets eg government bonds•The money can as well be used to refinance older obligations
Usual debt
Icesave
February 2010 19
Foreign direct investment (FDI)
•FDI brings FX in at the time when the investment is made (immediate effects)
•In the long run FDI gives FX in exchange for various domestic goods and services eg. energy and work
Positive marginal effect of FDI
•Investors wish to exit with at least the same amount that they invested initially. This causes outflow of FX in the long run
Foreign exchange outflow
•FDI in FX generating companies means that the profits and hence the FX is taken out of the economy. Despite reinvesting, the investor wishes to exit eventually
•Trade balance is therefore less than one would think at first glance
The origin of income matters for the current
account balance
FDI has similar effects as external debt
February 2010 20
Foreign reserve drawed on
•Companies producing goods and service for exports eg. Saefood and energy companies owe in foreign denominated currencies more than ever before
•Hence these companies need their FX to service their debt so the state treasury will not have access to as much FX as before
State treasury not the only party in need of foreign
exchange•Due to foreign ownership and foreign debt of the exporting industry, there is an outflow of FX
•As we saw before, foreign investors want to exit with at least the amount they invested initially
FDI causes currency outflow
•Iceland needs to pay foreign debt in the next seven years. For example there is 1.3bln € due in 2011. That requires FX and has to be refinanced
•The Central Bank estimated that the owners of 250bln krona would like to exit immediately or as soon as possible
Difficult years ahead
It will be difficult for Iceland to get enough forwign exchange over the next few years in order to service external debt without draw on the foreign reserve.
Iceland needs to secure a foreign reserve for the next 15-20 years
If Iceland runs out of the foreign reserve there will be a default on external debts
February 2010 21
History of running a trade deficitSince 1945 there has been trade deficit in 44 years out of 64 (until 2008). On average the deficit has been 2.2% of GDP. Note that the figures on the x-axis show the centre of the interval. For example “0%” is the interval from -0.5% to 0.5%.
<-6% -5% -4% -3% -2% -1% 0% 1% 2% 3% 4% >4%0
2
4
6
8
10
12
Trade balance as % of GDP
Num
ber o
f yea
rs
February 2010 22
Trade balance of goods and services as % of GDP – Icesave will not be financed by trade surplus
Iceland has a history of running trade deficit. In 1994 there was a record surplus, 5.15% of GDP. In seven years out of 64 (1945-2008) the surplus has been greater than 3.1% - the average annual payment of the Icesave obligation in 2016-2024. That is without mentioning other obligations that has to be serviced as well.
19451948
19511954
19571960
19631966
19691972
19751978
19811984
19871990
19931996
19992002
20052008
-20.00%
-15.00%
-10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
Trade balance as % of GDPAverage payments of Icesave obligation as % of GDP assuming 88% recovery
Year
Surp
lus/
defic
it
February 2010 23
A weak krona for the years to comeFX used to pay
Icesave
• Iceland needs excessive FX to pay back the Icesave obligation
• That FX is gained by external debt, FDI or positive balance of current account
Less supply of FX in Iceland
• As the state treasury needs more FX there will be less supply in the market
• Most likely the capital controls have to be in effect for the next few years in order for the state treasury to get hold of FX
FX becomes more expensive, the krona weaker
• Less supply of FX means higher price of FX given the same demand
• Less supply of FX means contraction in imported goods
• There might be restrictions on imported goods
How will the state treasury obtain FX belonging to the private sector?
February 2010 24
Terms• Economic statistics are from Statistics Iceland,
http://www.hagstofan.is and from the Central Bank of Iceland, http://www.sedlabanki.is
• Calculation assume the exchange rates of 14 January 2010. Then EURISK was 180,29 kr/€ and GBPISK was 202,28 kr/£. On 22 April 2009 the claims were fixed in kronas at the exchange rate 169,20 kr/€ and 191,10 kr/£
• Calculations are based on the excel file by Jon Danielsson (see right) with some additions
• Information on Landsbanki’s assets and liabilities are found here http://www.lbi.is
• This document is based on information that was known at the end of January 2010
References• The Bradford & Bingley terms
– http://www.fsa.gov.uk/pages/Library/Communication/Statements/2008/bradford_bingley.shtml
• The IoES report (in Icelandic)– http://www.mbl.is/media/34/1634.pdf
• Report from the Central Bank 15 July 2009 (in Icelandic)– http://www.sedlabanki.is/lisalib/getfile.aspx?itemid=7199
• Landsbanki Assets and Liabilities– http://www.lbi.is/Uploads/document
/091124%20Survey%20of%20Assets%20and%20Liabilities.pdf
• Article by Dr Jon Danielsson, Morgunbladid 15 January 2010– http://risk.lse.ac.uk/icesave/files/english-7.pdf
• Excel file with calculation – Dr Jon Danielsson– http://risk.lse.ac.uk/icesave/files/reikningar.xls
• Report by InDefence on Icesave (in Icelandic)– http://dl.dropbox.com/u/3133573/umsogn_indefence_um_icesave_samni
nga10july2009.pdf
• The OECD CIRR rates– http://www.oecd.org/dataoecd/21/52/39085945.xls
Webpage: http://www.indefence.isEmail: [email protected]
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