Sigrún Davíðsdóttir's Icelog

Owning one bank, Landsbanki and, as seems, soon becoming the owner of the second one, Íslandsbanki, the Icelandic government needs to decide on if to privatise the banks again and then how it should be done. Bjarni Benediktsson leader of the Independence Party has aired his idea that five percent should be given to the nation. The most famous example of a privatisation based on giving away shares was the rather notorious privatisation in Russia in the 1990s. Considering that this created an easy way for some oligarchs to acquire public good for little this hardly seems like the brightest idea. In general, the state should not be in the business of handing out presents but maximise returns on behalf of the nation.

At the weekend’s party conference, Bjarni Benediktsson minister of finance and Independence Party’s leader aired his idea that the state could create the largest possible shareholder base in the three new banks by giving every Icelander shares in the new banks. His suggestion was 5%. At present, the state owns 13% of Arionbanki,  97.9% of Landsbanki and might soon own the whole of Íslandsbanki, where it currently owns 5%.

The party conference, a biannual event, was held as the party’s standing in the polls is record-low, at 21%, compared to 25% in the elections 2013, far from the 35% to even above 40% in earlier decades.

It is no doubt a well-intended idea but the fact that the party leader throws this out as just an idea is intriguing, perhaps also rather worrying, considering that this regards a state asset. So far, Benediktsson has been more associated with planned policy-making rather than the top-of-my-head policy prime minister Sigmundur Davíð Gunnlaugsson has become known for.

It was also interesting that Benediktsson mentioned Icelanders were 300.000 when they are actually 330.000 – after all, Icelanders take great pride in the fairly rapidly growing nation. And most of all: Benediktsson does not seem to remember that privatisation via gifts has indeed been tried before – in Russia.

When this dawns on Benediktsson and his advisers they will learn the whole story of the origin of the wealth of some of the largest oligarchs of the 1990s, who organised a buy-out for a pittance of large chunk of these shares to the popolo. Not a very edifying story. After all, a hand-out of this kind seems unthinkable in the kind of well-governed countries Iceland likes to compare itself to.

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“Is this a retrade?” creditors will be asking themselves as they scrutinise the agreement reached between the Icelandic Task Force, the government’s advisers, and representatives of the three estates. As regards LBI and Kaupthing, probably not – relevant decisions will be made according to the June 8 agreement. However, Glitnir is a different case: yes, it is a retrade but the June agreement was probably never going to work for Glitnir. the main thing is that the present agreement with Glitnir and earlier with LBI (and Kaupthing probably by the end of this week), which means that the yoke of the capital controls will be off Icelandic shoulders.

Without much ado LBI announced last week that it was ready for a composition following the June 8 guide-lines. The LBI situation is very different from Glitnir and Kaupthing – LBI has hardly any ISK assets to speak of, it doesn’t own Landsbankinn, the Icelandic state does. The relative ease can be seen from the fact that the LBI stability contribution is only ISK14bn. The lion share of the LBI funds goes to priority creditors, i.e. the UK Treasury and those who bought the claims of the Dutch Central Bank earlier this year but the stability contribution will be paid by those holding general claims.

Kaupthing is due to pay ISK120bn in stability contribution according to the June 8 guidelines and will most likely do so. Will its main Icelandic asset, Arion bank, also end up in public ownership? That is unlikely, the constellation in Kaupthing is entirely different compared to Glitnir. Kaupthing’s only ISK asset is Arion bank, whereas Glitnir had around ISK150bn in ISK cash and assets, in addition to Íslandsbanki, i.e. the problem of foreign-owned ISK assets is much greater in Glitnir than Kaupthing.

Consequently, Glitnir was a much harder nut to crack. The task force accepted Glitnir’s solution in the letter Glitnir sent in, as did the other banks, in connection to the June 8 plan; i.e. the task force accepted that the solution Glitnir suggested fulfilled the stability criteria. However, at a closer scrutiny – most likely done by the CBI (which should have been kept closer to the negotiations because they have the necessary insight but weren’t) – it became clear that no, it actually did not. Therefor a retrade, i.e. a new agreement for Glitnir.

Discussing the Glitnir agreement on Rúv October 20 minister of finance Bjarni Benediktsson stated that “we (i.e the government) intervened in the process at the right time.” Another way to look at it is that it took the government two and a half years of wrestling to agree to sing from the same hymn sheet and accept that should the process be consensual the only sensible way was to negotiate the outcome with creditors.

After deducting priority claims the stability contribution amounts to 80% of the ISK assets in the tree estates or 20% of their total assets – interestingly, numbers that have been swirling in the air from 2012. Something in this direction has always been the obvious solution. The delay in acting on it was the political price.

The contribution, which in June amounted to ISK334bn – ISK14bn from LBI, ISK120bn from Kaupthing (given that the finalising brings no further changes) and ISK200bn from Glitnir – will now most likely amount to almost ISK380bn, with the increase coming from the new Glitnir agreement.

The June plan versus the new plan

Benediktsson mentioned that the government had intervened, a word which could for years not be uttered aloud. In the October 20 statement it is for the first time mentioned that there were indeed negotiations. This was necessary because contrary to what the task force stated in June the Glitnir June proposals did indeed not fulfil the CBI stability criteria.

So what is the difference between the June and the new proposals (see the details here)?

The key item is Íslandsbanki. At the end of last year the bank’s capital was ISK184bn of which ISK175bn or 95% belongs to Glitnir, 5% to the Icelandic state (which owns 5% shares in the bank).

The June plan was to lower the capital by a dividend of ISK37bn, i.e. dividend paid out in ISK, in addition to dividend paid out in foreign currency, amounting to ISK16bn, roughly reducing the bank’s capital down to ISK120bn. The dividend paid out in ISK was to go towards the stability contribution, i.e. to the Icelandic state; the foreign currency dividend to creditors.

The plan was all along to sell the bank for foreign currency, i.e. convert this ISK asset into foreign currency asset so the creditors could easily be paid out without upsetting the holy grail in all of this – Iceland’s balance of payment.

Further, the June agreement stipulated that 60% from the expected sale in foreign currency would go towards the stability contribution, i.e. paid in foreign currency whereas the Glitnir’s creditors would get 40%.

The June snag

So far, so sensible. Except this apparently so perfect plan had one snag: Íslandsbanki did not have the financial strength to pay all this dividend in addition to the deposits of the failed banks, which creditors could take over at composition (the three estates have deposits in the three banks – Landsbankinn, Arionbank and Íslandsbanki – amounting to ISK109bn in ISK and ISK138bn in foreign currency at end of 2014; table vii-2).

This problem became clear in July when Glitnir and Íslandsbanki came to an agreement regarding the recapitalisation of Íslandsbanki which involved extending the maturity of Glitnir’s deposits in Íslandsbanki. The stability contribution clearly had to be paid out in cash, not by a bond.

So what are the changes made in the new plan?

The creditors pass on the ISK16bn dividend (that should have been paid out in foreign currency) and they also pass on the 40% in the hoped-for foreign currency sale of Íslandsbanki (which frankly did not seem about to happen, also because the foreign owners might not suit the political commanding heights in Iceland) – in total, they pass on ISK63bn.

What do they get in return for this sum? They don’t need to refinance a subordinate foreign currency loan, which the Icelandic state placed in Íslandsbanki, set up to entail Glitnir’s domestic operations. In Glitnir’s accounts end of June 2015 this is put at ISK20bn.*

Thus, what the creditors are in reality giving up is ISK16bn + (0.4 x 120bn) – 20bn = ISK44bn or 25% of their share of Íslandsbanki capital of ISK175bn. The task force is offering them to buy the bank at price to book 0.75.

Given that Landsbanki and Kaupthing will pay respectively ISK14bn and ISK120bn in stability contribution and Glitnir will now pay additional ISK244bn, the total is ISK378bn.

The most important outcome is that is the one Benediktsson has long been advocating, as has i.a. the IMF and the CBI: a consensual agreement, meaning that creditors take this as a final solution and will not sue the Icelandic state neither for this nor earlier actions, i.a. tax on the estates in 2014. No legal wrangling, no litigation all over the world that could delay the lifting of the capital controls for unforeseeable future. The stability tax is out, the stability contribution in.

Through the prism of Icelandic politics

Nothing can be understood in this lengthy process since Kaupthing and Glitnir presented their composition plans in 2012 and 2013 except through the prism of Icelandic politics.

Panic politics is now a passé possibility for the Progressive party. At ca. 10% in polls, compared to 24% in the elections in spring 2013, prime minister Sigmundur Davíð Gunnlaugsson could in theory have attempted to raise hell and claim that the difference between the tax and the contribution was unacceptable and he was the man fighting Iceland’s case to wring more out of creditors than the paltry ca. ISK400bn compared to ISK850bn from the tax. However, with the standing of the Pirate party in the polls – ca. 35% over the last few months – any discontent is more likely to fatten the Pirates rather than the progressives.

The June plan was to a certain degree presented on false premises by putting so much emphasis on the tax and how much it would bring. The risk linked to the non-consensual stability tax was humongous, compared to low risk of a negotiated and consensual stability contribution. These numbers have lingered on in the debate, thus kept on skewing it.

It took less than six years to bankrupt the privatised banks (they were fully privatised by end of 2002), many Icelanders will now feel uneasy that the state now owns not only one but two banks. However, that is a challenge for Icelanders to solve and will test how much, if anything was learnt following the 2008 collapse.

A good deal for Iceland?

Is this a good deal for Iceland? And is this a good deal for creditors? Yes. Both parties have a great interest in bringing the matter to a close. Iceland needs to move out of the shadow of the capital controls and now that the economy is booming again (perhaps dangerously so but that’s another saga) it’s paramount to make full use of the good times. The creditors will want to run for the exit, with whatever they get in order to invest elsewhere and get out of the sphere of Icelandic politics.

Both parties will be asking themselves what is the price of risk. Reducing uncertainty will be a profit for both parties and not the least for Icelanders themselves. In addition, Iceland should be worried about the reputational risk. As I have pointed out earlier the path towards a deal has, from the point of view of foreigners “been tortuous, with new deadlines, conflicting messages from Icelandic politicians and deals that are a deal until the authorities think of something else. Some may think this is maverick and cool, little Iceland fooling the financial markets. Others will beg to differ.”

I have earlier written extensively on all aspects of the estates and capital controls so please browse and search if you are looking for specific issues.

*Update: as stated, creditors don’t need to refinance the loan – not easy to measure the time value of money involved. They do however get what remains of the loan as a payment for Íslandsbanki, which means that their gain is a bit more than ISK20bn, to be precise.

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Now that a deal with creditors of the three largest banks – Kaupthing, Glitnir and Landsbanki – has been drawn up and is being finalised (by the end of the week?), there are issues for Icelandic authorities to consider.

From the point of view of foreigners, the path towards a deal has been tortuous, with new deadlines, conflicting messages from Icelandic politicians and deals that are a deal until the authorities think of something else. Some may think this is maverick and cool, little Iceland fooling the financial markets. Others will beg to differ.

Iceland, as any other country, needs investment, i.a. in infrastructure and that will partly have to be financed by foreign loans. Yes, financial markets have short-term memory and there will always be young gung-ho traders rearing to do a deal. But large institutional investors, such as pension funds and other long-term investors, who are often somewhere behind the large infrastructure investments, may think differently after struggling or seeing others struggle to get their share of the assets in the failed banks.

So who is then left to finance it? The Chinese, as the British government is so enthusiastic about. Icelanders have a huge problem in general with foreign ownership, wonder if it’s any easier if it’s a foreign dictator and not just a foreign greedy hedge fund, as creditors are normally called in the Icelandic parlance.

Another worrying aspect, in terms of Icelandic financial stability, is carry trade. Eh, for real? Yes, for real. Carry trade – trading on interest rates differential – brought Iceland under capital controls in November 2008, following the banking collapse. It is stirring again.

In summer, soon after the June 8 plan on lifting capital controls was announced, foreign currency from carry trade deals started to appear in Icelandic stats. There were some inflows in July, more in August. It might now amount to 2% of GDP I’m told, far from the 44% it was in November 2008 but still… suddenly growing fast.

I thought that part of the explanation might be creditors in the three estates hedging but I’m told that is very unlikely (possibly in LBI but probably not and would not explain it all). The truth is that Icelandic bankers are again – and before their last mess is mopped up – selling this fantastic product: carry trade on the Icelandic krona in high-yield Iceland. Look around, there might even be some right now close to you in New York. And London is always close to Iceland.

The Icelandic Central Bank, CBI, has earlier put in place prudence rules, in order to counteract the carry trade situation in autumn 2008. But I wonder why Icelandic bankers still think it’s a good idea to tour the financial megapoles to sell this product that proved so toxic in 2008. Lessons learnt? I hope the CBI is paying good attention, tooth and claw.

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The Icelandic state will take over Íslandsbanki from creditors of Glitnir, according to a press release from Ministry of finance. This means that the June 8 agreement with Glitnir creditors has been changed. However, the trade off is certainty for a possible future upside. Given the Icelandic political climate, that is probably not a bad deal.

LBI, old Landsbanki, has already announced its intention to do a composition and is on track with it, meaning that it must already have the blessing of the government.

Kaupthing will most likely finalise its composition this week. That means that all the three banks are on track towards a composition and a stability contribution.

And the delayed Financial Stability report from the Central Bank of Iceland is now out, published on Friday to no fanfare. Intriguingly, in the introduction there is no mention of the stability tax, only the consensual contribution, levied on the estates, exactly as is now being done.

Updated to include the para on the FS report.

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As far as I understand, Icelandic officials are in London to finalise agreements regarding the estates of the three failed banks – Landsbanki (LBI), Glitnir og Kaupthing. The agreements are a necessary step in the plan to lift capital controls, long in the making.

The agreements agreed to in June were only lose outlines. The recent work aims at spelling out the precise meaning, terms and conditions.

Creditors in Glitnir and Kaupthing own respectively the new banks, Íslandsbanki and Arionbank. These two entities are also the largest part of the estates’ Icelandic assets, which cause the problem: these assets can’t be paid out in foreign currency, as the creditors, mostly foreigners, would prefer.

Glitnir has been trying to sell Íslandsbanki to foreigners but it so far without success.

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The Icelandic Supreme Court has sentenced (in Icelandic) three ex-managers of Landsbanki to jail sentences. Two of them – the bank’s CEO Sigurjón Árnason and director of corporate lending Elín Sigfússdóttir – had earlier been acquitted by Reykjavík District Court. The Supreme Court sentenced the two to respectively 3 1/2 years prison and 18 months prison. The third manager, Steinþór Gunnarsson director of proprietary trading had been been given a nine months suspended jail sentence, which the Supreme Court turned into nine months in prison.

The case was yet another example of bankers being convicted for breach of fiduciary duty, i.e. causing losses by fraudulent lending where laws and the banks own rules were broken, in addition to market manipulation. In this particular case over ISK5bn were lent to Ímon, a company with no assets except the Landsbanki shares bought for the fraudulent loans from Landsbanki on September 30 and October 3 2008, only days before the bank collapsed.

This case, called the Ímon case, was one of the first cases of suspicious lending to surface after the banks collapsed in early October 2008. The case became symptomatic for the three banks’  lending patterns where the banks lent money to asset-less companies to buy the banks’ own shares, with only the shares as collateral in the days, weeks and months before the banks failed, as share prices were collapsing. As so many of these loans the Ímon lending was later described in detail in the Special Investigation Committee report, published in April 2010.

With this sentence, top managers from both Landsbanki and Glitnir have been sentenced to prison. There are still on-going cases against Glitnir managers.

Updated 9 Oct., clarifying the loan and lending date.

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With the June plan on lifting capital controls the Icelandic government had finally managed to agree on a way out of controls or rather, the two government leaders had. But the implementation still left a room for disagreement. A recent letter to the governor of the Central Bank from the In Defence group, active during the Icesave debate and close to prime minister Sigmundur Davíð Gunnlaugsson showed unease among a certain faction of Icelandic politics. A delay in publishing the CBI’s Financial Stability report, scheduled for October 6, including a summary of the so called “stability contribution” indicates that something has been brewing. – The question is how deep this disagreement runs and if there still are political obstacles to be overcome.

Although strongly denied all along that there was any difference of opinion, the comments on lifting the capital controls from prime minister Sigmundur Davíð Gunnlaugsson and minister of finance Bjarni Benediktsson pointed in different directions. Benediktsson stressed solutions that would take the shortest time and steer clear of legal risks whereas Gunnlaugsson emphasised the funds the state would acquire. The difference was ironed out in June when a plan to lift capital controls was presented.

At the presentation all the emphasis was put into presenting the “stability tax” – and later a law on that tax was passed. However, following talks with creditors of the failed banks an agreement on “stability contribution” was what the creditors wished for, as did those who wanted to avoid legal wrangling and a stalled process to lift the capital controls.

In a recent letter, the In Defence group (set up by individuals opposing the attempt by the left green government to reach an agreement with the British and Dutch government) indicated that the stability tax would be better solution than a stability contribution. The letter was addressed to Már Guðmundsson governor of the CBI, who has already answered the group, clarifying the bank’s position.

October 6, the CBI Financial Stability report was due to be presented (including a summary of the stability measures and the plan for lifting the capital controls; only a summary of known facts, nothing new as far as I understand) but at the last moment the publication was postponed.

The CBI explanation was that there had not been enough time to present the stability contribution as expected, i.a. to the Alþingi economics and trade commission. According to the CBI there had been a last minute addition to the report, which still needed to be presented to the minister of finance. Interestingly, there is no date as to when this could happen.

Creditors of the estates of the three largest failed banks have recently agreed to what they are due to pay in stability contribution: Glitnir ISK200bn, Kaupthing ISK120bn and Landsbanki ISK14bn, in total ISK334bn. The tax would probably be just between ISK600 and 700bn.

In terms of practicality the difference is i.a. that the contribution is already agreed on whereas the tax is not and would most likely be disputed, causing further delays for Icelanders in escaping the capital controls. When the plan was presented in June it sounded as if there were two equally viable routes: a high tax or a lower contribution.

This was rather unfortunate since the debate in Iceland is now evolving in the direction of “why accepting a lower contribution when a higher tax can be harvested?” – A very misleading question, originating in the June presentation, again an attempt to paper over what seems to have been an unsolved disagreement all along.

As the Icelandic economy has been doing well, there were viable solutions to lifting the controls and these were put forth in the capital controls plan. As Benediktsson has stressed, the plan would provide the final solution to the problems keeping the controls in place. The wobbles now will test Benediktsson’s grip of things.

The question is if the In Defence letter is a sign that the group’s earlier close ally, the prime minister, is having doubts about the agreement with creditors. His party has a strikingly low following in polls, ca. 11% compared to 24% in the 2013 elections. It has been clear for a long while that now the economy is doing well the greatest risk regarding Iceland is political risk – and it still is.

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