Do not guarantee more than your GDP is worth

Continuing on our theme of recent weeks on the question of the value of a government guarantee of banks' wholesale debt raisings and in particular the subject of last week, that some guarantees are more equal than others, there were further developments of note last week.

Firstly the British banks are continuing to do well. HBOS and Royal Bank of Scotland both topped-up their recent UK government guaranteed bond issues at spreads that were tighter than where they originally issued.

HBOS added £1.2 billion to the £600 million that it raised for two years at the end of October. The original bond issue priced at a spread of 122.6 bps over UK Gilts while the top-up last week saw the spread come in to 108 bps. RBS added £600 million to the £1.4 billion of three-year bonds it issued three weeks earlier, but this time at a spread of 15 bps to mid-swaps compared with 20 bps previously.

Interestingly, on Thursday when RBS undertook its top-up, the AAA/Aaa/AAA rated supranational, Nordic Investment Bank, launched a US$1.0 billion, three year, global bond issue that priced at mid-swaps plus 25 bps. NIB has the combined support of eight Nordic and Baltic sovereigns, but thankfully not the Irish.

Allied Irish Banks Plc flagged its intention to raise €2.0 billion for two years supported by an Irish government guarantee. The bonds have yet to price but investors appear set to demand a yield of 55 to 60 bps over mid-swaps to take up the bonds.

Apparently, the Irish government's guarantee of the deposits and borrowings of the Irish banks is limited to €420 billion, but this is more than double the country's GDP. So even though the bonds will carry triple A credit ratings, investors are not convinced of Ireland's ability to honour its guarantee.

While our banks and government are still arguing over the form of the guarantee that will be provided to support the banks' wholesale debt raisings, the Irish precedent could cause a problem. Our GDP is barely $1.0 trillion a year and may be heading south. RBA statistics to the end of September put the deposit liabilities of our banks and their offshore liabilities at around $1.7 trillion.