Showing posts with label AIB. Show all posts
Showing posts with label AIB. Show all posts

Monday, June 20, 2016

20/6/16: Creating Fiscal Space. Or Money Growing on Trees


You might excuse an average punter for thinking things are going the beleaguered Irish Health Services ways with some EUR500 ml added to the spending bin (http://www.thetimes.co.uk/article/eu-ruling-means-extra-540m-for-health-fbpnqcqb8?shareToken=699206929a359223e8662e8ae88a18d2). After all, even the good folks of The Times bought into the positive story.


But, such a conjecture is wrong. What really is happening, thus? In simple terms, the Eurostat reclassification of the Government conversion of AIB preference shares into ordinary shares generates several implications:

  1. Preference shares represent a preferred (or senior) claim on AIB assets in the case of default or dilution compared to ordinary shares. That is the basics corporate finance and as such implies that State conversion of shares adds new risk to the State holdings, as well as reduces the value of that holding. It does create a marginal improvement in the AIB’s outlook for selling shares in the markets, however.
  2. The conversion also raises official State deficit and spending volume for 2015, which has no direct material impact on 2015 spending, except via two channels: Channel 1 is the impact that added spending has on future (2016) spending; and Channel 2 is the GDP effect - as AIB transaction added some EUR500 million to State official spending, that EUR500 million is now an addition to 2015 GDP.
  3. Because State spending for 2015 is now EUR500 million higher, and because our 2015 deficit was still below the approved (by the EU) target, the State is allowed - by the EU rules - to spend extra cash this year.
  4. Although Ireland has funds ‘available’ for such increased spending, the funding will come from borrowing. The reason for this is simple: Ireland is still running a general deficit. Not a general surplus. If the State were to spend EUR500 million of ‘added fiscal space’ on activities for which it is borrowing funds under pre-existent budgetary commitments, the deficit would have dropped - in 2016 - by, roughly, that amount. However, if Ireland were to spend it on a new spending line or to increase spending above previously planned, the funding will come via borrowing from some other activity, such as repaying Government debt.


In simple terms, there is no free lunch. Irish State does not have extra EUR500 million floating around that it did not have before. No matter what you classify things as, basic accounting means: unless you got paid by someone EUR500 million, you have to borrow EUR 500 million in order to spend it.

Simples. But not for Irish media that keeps confusing deficit financing via debt for resources.

Sunday, February 2, 2014

2/2/2014: IMHO-AIB Pilot - First Results


IMHO just published the results of the ongoing IMHO-AIB project for the first 55 days of the scheme operations:
https://www.mortgageholders.ie/blog/posts/progress-update-on-initiative-between-imho-and-aib-ebs-haven

The core numbers are sizeable enough to represent a good sample of borrowers and provide a strong basis for arguing that the independent, professionally provided and borrower-centric advice does work.

I want to stress that all credit for delivering on these results goes to the brilliant frontline team at IMHO!

Sunday, November 17, 2013

17/11/2013: Mortgage holders in difficulty to avail of new initiative from tomorrow: IMHO


Tomorrow, the new IMHO pilot programme for AIB/EBS/Haven clients in mortgages arrears and distress comes on line. Key points of contact: www.mortgageholders.ie or via 1 809 623 624.

The full press release on the initiative is available here:  https://www.mortgageholders.ie/blog/posts/mortgage-holders-in-difficulty-to-avail-of-new-initiative-from-tomorrow

All details on the initiative purpose and set up are available here:  http://trueeconomics.blogspot.ie/2013/11/5112013-my-op-ed-for-journalie-on.html


Note: to preclude any confusion or accusations against IMHO or myself: I do not provide frontline client-facing advise or services. I am a member of the board. Sadly, given past experiences with some commentators, I have to state this. 

Tuesday, November 5, 2013

5/11/2013: My op-ed for Journal.ie on IMHO/AIB initiative

Yesterday, Irish Mortgage Holders Organisation (IMHO) announced the new pilot scheme to help Irish mortgagees in dealing with their lender, the AIB Group (see details here: http://trueeconomics.blogspot.ie/2013/11/4112013-imhos-latest-initiative-to-help.html).

My op-ed on Journal.ie explains this new initiative and the background to the project: http://www.thejournal.ie/readme/imho-aib-group-mortgage-arrears-1160947-Nov2013/

Monday, November 4, 2013

4/11/2013: IMHO's latest initiative to help distressed borrowers


Today was a big day for Irish Mortgage Holders Organisation. Here's our announcement:
https://www.mortgageholders.ie/blog/posts/imho-launches-an-initiative-for-aib-ebs-haven-borrowers

It is a big step for many distressed borrowers and we hope that other banks will follow the AIB Group steps and start treat seriously the need to help homeowners secure independent and client-focused professional advice regardless of people's ability to pay.

The scope of the crisis we face is unprecedented. Here's a reminder:
http://trueeconomics.blogspot.ie/2013/09/592013-sunday-times-september-1.html
and the latest data on arrears:
http://trueeconomics.blogspot.ie/2013/08/2382013-irish-mortgages-arrears-q2-2013.html

Thursday, June 20, 2013

20/6/2013: Stalled Irish Banks Reforms: Sunday Times, June 16, 2013


This is an unedited version of the Sunday Times article from June 16, 2013


The latest data from the Central Bank shows that in two years since the current government took office, Irish banking sector is not much closer to a return to health than in the first months of 2011.

Objectively, no one can claim that the task of reforming Irish banking sector is an easy one. However, credit and deposits dynamics in the sector point to the dysfunctional stasis still holding the banks hostage. Despite ever-shrinking competition and vast subsidies extended to them, Irish banks are not investing in new technologies, systems and models. Banks’ customers, including businesses and households, are thus being denied access to services and cost efficiencies available elsewhere. In short, the Government-supported model of Irish banking is failing both the sector and the economy at large.


In April this year, total inflation-adjusted credit advanced to the real domestic economy, as measured by loans to Irish households and non-financial corporations, stood at EUR175,419 million. Since Q1 2011, when the current Government came to power, real credit is down EUR32,302 million. This figure is equivalent to roughly twice the annual rate of gross investment in the economy in 2012. Total credit to non-financial corporations has now been in a continuous decline for 48 months.

Half of this contraction came from loans over 5 years in duration. These loans are more closely linked to newer vintage capital investment in the economy, generation of new jobs, R&D and innovation activities, as well as new exports, than loans with shorter duration. Let’s take this in a perspective. The fall in total longer duration lending since mid-2009 is equivalent to losing 70,000-90,000 direct jobs. Factoring in interest income plus employment-related taxes, the foregone credit activity has cost us close to the equivalent of the tax increases generated in Budgets 2012-2013.

It would be fallacious to attribute credit supply declines solely to the property related lending. Based on the new data reported this Thursday by the Central Bank, loans levels advanced to private enterprises have fallen, between Q1 2011 and Q1 2013 in all sub-sectors of the economy, with largest loans supply declines recorded in domestic, as opposed to exports-oriented, sub-sectors.  All loans are down 6%, while loans to companies excluding financial intermediation and property related sectors are down 5.8%.

However, on the SMEs lending side, some of the steepest loans declines came from the exports-focused enterprises, such as ICT sector, where credit has fallen 9.7% on Q1 2011, or in computer, electronic and optical products manufacturing where loans are down 6.5%. Even booming agriculture saw credit to SMEs falling 5.7% over the last two years, while credit for scientific research and development is down 13.3%.

The picture is, in general, more complex for the levels of credit outstanding in the SMEs sector. On the demand side, in Ireland and across the euro area, there has been a noticeable worsening in the quality of loans applications filed with the banks during the crisis. In a research paper based on the ECB SAFE enterprise level survey data for euro area SMEs, myself and several co-authors have identified the problem of selection biases in companies’ willingness to apply for credit. In simple terms, SMEs more desperate for funding due to deteriorating balancesheets are more likely to apply for credit today. In contrast, healthier firms are more likely to avoid applying for bank credit.

ECB data also shows that Ireland’s problem of discouraged borrowers is much worse, than the euro area average. For example, in Ireland, 21% of all SMEs that did not apply for credit stated that they did so for fear of rejection, almost 3 times the rate of the euro area average and nearly double the second worst performing economy – Greece.


On the funding side, Irish banks have been and remain the beneficiaries of an unprecedented level of funding support compared to their euro area counterparts.

A recent research paper from the Dutch think tank CPB, titled "The private value of too-big-to-fail guarantees" showed that through mid-2012, the pillar banks in Ireland have availed of the largest subsidy transfers from the sovereign and Eurosystem of all banking systems in Europe. Funding advantages, accorded to the largest Irish banks, alone amounted, back in June 2012, to more than double the share of the country GDP compared to Portugal, and more than seven times those in Spain and Italy.

Removal of the explicit Guarantees was supposed to serve as a major step in the right direction. Alas, Irish pillar banks continue to depend for some EUR39.5 billion worth of funding on Eurosystem.  The latest Fitch report on the pillar banks shows that this reliance is likely to persist as loan/deposit ratios remain relatively high. Latest figures put Bank of Ireland, AIB and PTSB loan/deposit ratios at around 120%, 130%, and over 200%, respectively.

And there are further issues with funding in the system. By mid-2014, AIB is required to raise EUR3.5 billion to redeem the preference shares held by the National Pension Reserve Fund. Bank of Ireland will have to find EUR1.8 billion for the same purposes. In both cases there are questions as to how these funds can be secured in the current markets without either further reducing money available for lending or tapping into taxpayers’ funds.


Subsidies to the ‘reformed’ Irish pillar banks go hand-in-had with the regulatory protectionism, which completes the picture of massive transfers of income from the productive economy to the zombified banking sector.

Since 2008, Irish financial services continue to experience ongoing process of consolidation and, underlying this, the reduction in overall competition. Data from the ECB shows that the number of financial institutions operating in the country has fallen in 2012 to the levels below those recorded in 2000-2008. Dramatic declines in the fortunes of the third and the first largest lenders – Anglo and AIB - should have led to a drop in the combined market share held by the top 5 banks. Instead, the market share of top 5 credit institutions rose over the years of the crisis.

To a large extent, this reflects exits of a number of foreign lenders from the market. However, unlike in the case of the US and the UK, there are no new challengers to the incumbent players in the Irish asset management, investment, corporate and merchant banking, and credit unions sector. Neither the regulators, nor the banks have any incentives to encourage new players' entry.

And this has direct adverse impact on the overall health of the economy. When we studied the effects of banking sector concentration on firms’ willingness to engage with lenders, we have found that higher concentration of big banks’ power in a market is associated with lower applications for credit and higher discouragement.

As the result of the reforms undertaken in the Irish banking sector, our banking services are left to stagnate in the technological and strategic no-man's land.

Mobile and on-line banking systems remain nothing more than appendages to the existent services, with only innovation happening in the banks attempting to force more customers to on-line banking to cut internal costs.

Currently, worldwide, banking services are migrating to systems that can facilitate lower cost customer-to-customer transactions, such as direct payments, e-payments, peer-to-peer lending, and mixed types of investment based on combinations of equity and debt. All of this aims to reduce cost of capital to companies willing to invest. Irish financial services still operate on the basis of high-cost traditional intermediation and the Government policy is to keep hiking these costs up. Instead of moving up to reflect the true levels of risks inherent in Irish banks, deposit rates for non-financial corporations and households are falling. Interest on new business loans for non-financial corporations is up 105 to 197 basis points in April 2013, depending on loan size, compared to the average rates charged in Q1 2011. Over the same time, ECB policy rates have fallen by 75 basis points. This widening interest margin is funding banks deleveraging at the expense of investment and jobs.


Combination of the lack of trust in the banking system, alongside the lack of access to direct payments platforms means that many businesses in Ireland are switching into cash-only transactions to reduce risk of non-payments and invoicing delays. Currency in circulation in Ireland is up 10.3% on Q1 2011 average, while termed deposits are down 6.3%.

With big Pillar Banks unable to lend and incapable of incentivizing deposits growth, we should be witnessing and supporting the emergence of cooperative and local lending institutions. None have materialized so far. If anything, the latest noises from the Central Bank suggest that the credit unions can potentially expect to take a greater beating on the loans than the banks will take on mortgages and credit cards.

All-in, Irish banking system is far from being on a road to recovery so often spotted in the speeches of our overly-optimistic politicians and bankers. The credit squeeze on small businesses and sole traders is likely to continue unabated, and with it, the rates of business loans arrears are bound to rise.





Box-out:
In this month’s survey of economists by the Blackrock Institute some 64% of the respondents stated they expected euro area economy to get e little stronger over the next 12 months and none expected the recovery to be strong. In contrast, 74% of respondents thought German economy will get better and 81% forecast the same for the UK. In the case of Ireland, however, only 57% of respondents expected Irish economy to become a little stronger in a year through June 2014 (down on 75% in May 2013 survey). None expected this recovery to be strong. Interestingly, 69% of respondents describe Irish economy's current conditions as being consistent with an early or mid-cycle expansion - both normally consistent with above-trend rapid growth as economy recovers from a traditional recession. Thus, the survey indicates that majority of economists potentially see longer-term prospects for the Irish economy in the light of slower trend growth rates. Back in 2004-2005, I suggested that the Irish economy will, eventually, slowdown to an average rate of growth comparable to that of a mature small euro area economy. This would imply an annual real GDP growth reduction from the 1990-2012 average of 4.9% recorded by Ireland, to, say, 1.8% clocked by Belgium. Not exactly a boom-town prospect and certainly not the velocity that is required to get us to the sustainable Government debt dynamics.

Monday, June 17, 2013

17/6/2013: Deutsche, AIB and Cypriot Banks: 3 links

Back in 2011, I wrote about the extreme leverage ratios in some of Europe's top banks: http://trueeconomics.blogspot.ie/2011/09/13092011-german-and-french-banks.html. Deutsche Bank was at the top of the list. Now, 19 moths later it seems others are catching up: http://www.reuters.com/article/2013/06/14/financial-regulation-deutsche-idUSL2N0EO1D220130614.

And while on topic of banks, let's check this one for the record: http://www.independent.ie/business/irish/aib-will-not-repay-35bn-cash-it-owes-to-the-state-29337833.html. I wrote about this in Sunday Times last weekend, in passim, but this is more comprehensive article.

Another link of worth on the topic of banks is Cyprus banks fiasco history from ZeroHedge: http://www.zerohedge.com/news/2013-06-17/guest-post-real-story-cyprus-debt-crisis-part-1

Monday, June 10, 2013

10/6/2013: Fitch on Irish Banks


Both Fitch and S&P have in the recent past questioned the model of Irish banking sector crisis resolution on the foot of the apparent link between the banks balance sheets and the exchequer.

Today, Fitch issued another report on Irish banking sector, titled "Peer Review: Irish Banks"

The report claims that Irish banks' current ratings "are constrained by the significant risks that remain in the Irish banking system. However, support remains an important rating driver and Fitch considers that the Irish authorities' propensity to support the 'pillar' banks, Bank of Ireland (BOI) and Allied Irish Banks, p.l.c. (AIB) remains undiminished, despite the withdrawal of the Irish Bank Eligible Liabilities Guarantee (ELG) in March 2013."

Crucially, "Fitch believes that the pillar banks' performance will continue to track within the stress case scenario of the 2011 Prudential Capital Assessment Reviews (PCAR), however these tests were framed on a Basel II basis. Since then capital expectations of market participants have increased. The 2014 PCAR may revise the stress assumptions and requirements to align more closely with Basel III." The kicker is that the banks will need new capital ('might need' another state injection as opposed to 'will need' capital).

"As Irish banks' capital ratios continue to be eroded and a return to profitability only appears feasible in the longer term, the banks may need to raise additional capital before they can contemplate a future independent of state support", Denzil De Bie, a Director in Fitch's Financial Institutions Group told Reuters.

The old kicker is that assets and capital held by the Irish banks remain weak, "with high NPLs and impairment charges, especially against commercial real estate and residential mortgage loans. Although the rate of deterioration slowed at BOI and AIB in 2012, Fitch believes impairment charges could increase during 2013 and 2014, with arrears reaching a peak in 2014, as the banks accelerate the resolution of mortgage arrears in line with new targets set by the Central Bank of Ireland in March 2013."

"Asset quality is weak in the Irish banks, with NPL ratios of 16%-40% in the Fitch-rated
institutions at end-2012. The banks also report a significant portion of their loan book to be past
due but not impaired."


Peaking of mortgages arrears per PCAR2011 starts in 2014 and goes on in 2016-2017.

"Underlying pre-provision operating profitability is structurally very weak because of the long-term, very low-yielding mortgage loans in their books. Until rates rise, Fitch considers that a return to sustainability will only be possible as the various restructuring and cost control plans of the banks begin to yield results. Fitch expects a return to operating profitability to be delayed until at least 2015 because of the continued erosion of earnings from high but reducing impairment charges."

Now, recall that per PCAR2011, Irish banks were supposed to fund their full losses out of operating profits starting with 2015. So far, Fitch is not saying there is excess (above PCAR2011 stress test assumptions) level of stress in the system, but Fitch does seem to point to the already recognised two pressure points:
- continued deterioration on the assets quality side, and
- Basel III.

And the banks are still dependent (and will remain for some time to come) on state/central bank supports: "with loan/deposit ratios still at a high 130%-230% in the Fitch-rated banks at end-2012, wholesale, government and European Central Bank funding still forms an important, albeit reducing, component of the Irish banks‟ funding bases." Why? Because deleveraging is by far not complete:


On banks doing their bit to get credit flowing to the economy:

And per stabilisation of deposits:

Friday, March 22, 2013

23/3/2013: Sunday Times 10/03/2013


This is an unedited version of my Sunday Times article from March 10.


Some two years ago in these very pages, I have described the prospects for the Irish economy as following a flatline trend with occasional volatility. In other words, back in the beginning of 2010, the economy’s prospects for the near-term future were consistent with an L-shaped recovery: stabilization followed by near-zero growth.

Taking the first three quarters of 2012, in headline terms, the above prediction has translated into 2009 to 2012 GDP growth of just 0.22% per annum, GNP decline of  0.16% per annum and domestic demand drop of 4.81% per annum. Again, let’s take a look at the above numbers from a different angle. Compared to the pre-crisis levels, the latest GDP data shows that over 2011-2012, Irish economy was able to close just 22% of the gap between GDP peak and the Great Recession trough, implying that it will take Ireland through the end of 2014 before we get our GDP back to the half-point of the Great Recession. At the same time, Domestic demand continued to hit crisis period lows in 2012 and all international projections show that 2013 will be another post-2007 low for these data series.

With these rather depressing statistics in mind, one is warranted to take with a grain of salt ever-more frequent and boisterous pronouncements from the Government that Irish economy has ‘turned the corner’. Ditto for the ever-more saccharine messages from the EU policymakers to the ‘best pupil’ in their austerity policies ‘class’.

And the most recent data – through Q4 2012 and January-February 2013 – is offering no signs of any statistically significant improvements in the economy compared to the rather abysmal 2012.

Mortgages arrears were once again up in the last quarter of 2012. While the rate of increases was markedly slower than in previous quarters, number of accounts currently in arrears 21.4% year on year. As of the end of 2012, some 186,785 private residencies-related mortgages are either in arrears, in temporary restructuring or in the process of repossessions – almost 25% of all accounts outstanding  if we were to use as the base total accounts numbers comparable across the 2009-2012 horizon.  All in, some 650,000-700,000 Irish residents are currently under water when it comes to paying on their original mortgages. Some turnaround in the economy to witness.

Data for January-February 2013 on new cars registrations shows that not only the motor trade is continuing to suffer from on-going collapse in sales, but that there is no indication of any substantial improvement in either the Irish households or the Irish SMEs outlook for the future. New private cars registrations are down 20% year-on-year over the first two months of 2013, while new goods vehicles registrations are down 21.4%. This shows clearly that Irish consumers are not engaged in purchasing large-ticket items and, supported by the declines in durable goods consumption evident in the retail sales data, signals that consumers have little real credence in the ‘green shoots’ theory espoused by our Government officials and business leaders. Lack of demand uplift in goods vehicles, on the other hand, shows that when it comes to capital investment, Irish businesses are also refusing to buy the hype of economic turnaround. In any cyclical recovery, capital expenditure, especially on rapidly depreciating items such as vehicles used in transporting goods for wholesale and retail trade, logistics and transportation services, is one of the leading indicators of improving economic conditions. Data for the first two months of this year shows no such uplift.

Core retail sales, once stripping out motor sales, are showing a slightly more upbeat activity. While all retail business activity has declined on average over 3 months through January 2013 compared to year ago, some encouraging signs of uplift were present in the Department Stores sales, and sales of electrical goods when it comes to volume and value of sales. Nonetheless, two factors continue to characterize Irish domestic consumption: extremely low activity from which any increases might take place, and exceptionally anemic trend in any rises we do record.

On the investment front, gross domestic capital investment remained basically unchanged in the first 3 quarters of 2012 compared to 2011,ann there are currently no signs that this situation has changed since the end of Q3 2012. We are now into the fourth consecutive year of gross investment failing to cover amortisation and depreciation of the capital stock accumulated over the years of the Celtic Tiger. Recalling that our growth success over 1992-1998 was predicated on a rapid catching up in capital stock and quality relative to our, at the time more prosperous European partners, this means that the ongoing crisis is effectively erasing any capital gains achieved post 1999.

In short, domestic side of the economy shows no green shoots of any harvestable variety. And the potential headwinds we are likely to face in the near-term future are still severe.

In property markets and when it comes to mortgages arrears, we face a long list of risks that are yet to play out.  Impacts of property taxes introduced in the Budget 2013, the upcoming lifting of the banking guarantees,  and the saga of the Personal Insolvency regime reforms all represent distinct threats to the fragile stabilisations achieved in these areas of the economy.

On business investment front risks are also mounting, rather than abating. Continued lack of bank credit and strong indications that in the near term Irish banks are likely to follow their other Euro area counterparts in dramatically hiking the retail interest rates for both existent and new loans.

When it comes to consumers’ appetite for spending, latest consumer confidence data shows significant deterioration in confidence in February, compared to January 2013 and to 2012 average. If anything, when it comes to consumers’ reported outlook for 2013, things are getting worse relative to 2012, rather than better.

Which leaves us with the Government’s old favorite signal of the recovery: Irish exports.  The hype about Irish external trade prowess is such, that even a usually somber IMF has recently waded in with a lengthy paper outlining how Ireland is likely to turn back to Celtic Tiger era prosperity on foot of booming exports.  In summary, the IMF missive, titled Boosting Competitiveness to Grow Out of Debt – Can Ireland Find a Way Back to Its Future concluded that “Ireland is poised to return to its path of strong growth and low imbalances” on foot of “enhanced competitiveness”.

The idea that ‘exports-led recovery’ is Ireland’s only salvation from the systemic and structural crises we face is not new. Previous Government put as much credence into this proposition as the current one. Alas, this idea – as I have pointed out repeatedly – is simply not reflected in the reality of the Irish economy for a number of reasons.

It is true that Irish exports growth has improved significantly during 2009-2012 period, rising from negative 3.75% in 2009 to a positive 6.25% in 2010 and 5% in 2011. In the first three quarters of 2012, exports of goods and services were up 6.8% on the same period of 2011.

Alas, the composition of our exports has shifted dramatically toward more services exports, as opposed to goods exports. In addition to reducing the overall level of real economic activity and employment associated with every euro worth of exports, this shift also has meant a number of changes that further divorce our external trade activity from economy. Firstly, most of employment creation in the exports-oriented services sectors, such as International Finance and ICT services, is oriented toward specialist, highly educated foreign employees, instead of domestic unemployed or underemployed individuals. Secondly, services exports are associated with greater cost (or imports) intensities as they require higher payments for patents and intellectual property, which are neither taxed in Ireland, nor are developed here. This means that while exports of services generate high revenues, much of these revenues is not captured within our economy. Thirdly, exports of services, as opposed to exports of goods, are more concentrated in a handful of giant MNCs. This fact, known as the ‘Google effect’ drives up the cost of hiring skilled workers for Irish SMEs, reduces margins at Irish enterprises, lowers investment into Irish SMEs, and actually undermines our competitiveness, rather than improving it.

In short, booming exports along the current trend can actually cost this economy its ability to sustain indigenous entrepreneurship and investment in the long run. Instead of supporting growth and recovery, the green shoots of some of our exporting activities can turn out to be super-strong weeds of the economy suffering from a classical Dutch disease where resources flow to an increasingly inefficient use in specialist sectors, exposing the society and the economy at large to future adverse shocks.

Lastly, as with other indicators, the latest data, covering only goods exports, shows that our external trade is suffering from a significant slowdown in global demand and the pharmaceutical sector patent cliff. Once again, I warned about both of these factors more than a year ago.

At the same time, on the more positive note, the ongoing US and global economic recovery should provide some support for goods exports from Ireland, especially in the areas relating to capital investment goods and equipment in months ahead.

In short, the miracle of the ‘exports-led recovery’ is simply nowhere to be seen at this point in time, despite the fact that exporting activity continues to expand and despite the fact that this activity represents the only bright spot on our economic horizon.

After five years of the greatest economic crisis in the modern history of this nation, it is time to ask our political leaders a question: at what point in time does one’s rhetoric of economic turnarounds becomes an unbearable burden to one’s political and social reputation? For the previous Government it took just under 3 years to face the music of its own making. For this Government, the clock is ticking on.




Box-out:

Having achieved a relatively underwhelming progress on restructuring the Promissory Notes of the IBRC, the Government has turned its attention in recent weeks on attempting to restructure our debts to the European sides of the Troika. However, the issue of the Promissory Notes is still an open topic. Last week at a conference in Brussels I had a chance to speak to some senior decision makers from the European Parliament and the EU Commission who unanimously voiced their concern over the potential for the ECB to alter the terms and conditions of the Irish Promissory Notes restructuring deal. ECB has two material powers to do so. Firstly, it can simply alter by a majority decision the technical aspects of the deal. Secondly, the ECB has the ultimate power to determine the overall schedule of the sales of the long-term bonds issued to replace the Promissory Notes to the private investors. This latter power is very significant. Under the current arrangement, the Central Bank of Ireland has committed to an annual schedule of minimum disposals of bonds. Based on this schedule, the cumulative long-term benefit of the deal to Ireland can be estimated in the range of Euro 4.5-6.3 billion over the 40 years horizon. Accelerating the rate of disposals by a third on average over the deal horizon can see the net gains to the Exchequer declining by more than a quarter. Hardly a confidence-inspiring outcome for the Government that put so much hype behind the deal.

Wednesday, December 19, 2012

19/12/2012: Mr Grinch Travels in Threes


It hasn't been a good month or so for irish banks... Right, true, AIB & BofI sold some paper around, covered bonds that is. And this triggered a veritable drooling of happiness from some (mostly sell-side) analysts. But then the mortgages defaults figures for Q3 came in... Boom! The IMF started sounding alrams about risks in the stalled banking sector... Boom-Boom! And now, Moody's weighing in too...

"Announcement: Moody's: Irish Prime RMBS performance steadily worsened in October 2012

Global Credit Research - 19 Dec 2012
Irish Prime RMBS Indices -- October 2012
London, 19 December 2012 -- The performance of the Irish prime residential mortgage-backed securities (RMBS) market steadily worsened during the three-month period leading to October 2012, according to the latest indices published by Moody's Investors Service.

From July to October 2012, the 90+ day delinquency trend and 360+ day delinquent loans (which are used as a proxy for defaults) reached a new peak, rising steeply to 16.52% from 15.19% and to 7.91% from 6.58%, respectively, of the outstanding portfolios. Moody's annualised total redemption rate (TRR) trend was 2.95% in October 2012, down from 3.40% in October 2011.

Moody's outlook for Irish RMBS is negative (see "European ABS and RMBS: 2013 Outlook", 10 December 2012,http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBS_SF309566). The steep decline in house prices since 2007 has placed the majority of borrowers deep into negative equity. Falling house prices will increase the severity of losses on defaulted mortgages (see "High negative equity levels in Irish RMBS will drive loan loss severities to 70%", 16 May 2012 http://www.moodys.com/viewresearchdoc.aspx?docid=PBS_SF285527). The rating agency expects that the Irish economy will only grow 1.1% in 2013 (see "Credit Opinion: Ireland, Government of", 07 November 2012 http://www.moodys.com/research/Ireland-Government-of-Credit-Opinion--COP_423933). In this weak economic recovery, it will be difficult for distressed borrowers to significantly increase their debt servicing capabilities and so arrears are likely to continue increasing.

On 15 November, Moody's downgraded nine senior notes and placed on review for downgrade one senior note out of five Irish RMBS transactions, following the rating agency's revision of key collateral assumptions. The downgrades reflect insufficient credit enhancement for notes rated at the country ceiling. All notes affected by this rating action remain on downgrade review pending re-assessment of required credit enhancement to address country risk exposure. Moody's also increased assumptions in eight other transactions, which did not result in any rating action due to sufficient credit enhancement. (See PR: http://www.moodys.com/research/Moodys-takes-rating-actions-on-5-Irish-RMBS-transactions--PR_259945).

As of October 2012, the 19 Moody's-rated Irish prime RMBS transactions had an outstanding pool balance of EUR48.97 billion. This constitutes a year-on-year decrease of 7.1% compared with EUR52.69 billion for the same period in the previous year."

So, that's EUR48.97 billion of trash which are 7.91% fully destroyed and decomposing (EUR3.87bn) and is showing signs of severe rot at 16.52% (EUR7.96bn). With 70% expected loss, at EUR8.28bn expected writedown, swallowing all funds allocated under PCARs to mortgages arrears?

Who says there's just one Mr Grinch? Comes Christmas time, its IMF & Moody's & bad, bad, bad, moral-hazardous households that just can't pay their mortgages... Time to raise those AVR mortgages costs, then, to cover the losses on errm... mortgages...

Saturday, December 1, 2012

1/12/2012: Much Hype on Little Signs: Private Sector Deposits in October


Much hoopla is doing rounds these days about the 'rise in October deposits' in irish banking system. Head of the Department of Finance has referenced the 'welcome news' in his most recent speech and the Central Bank has cheerfully noted as much in the release published last night. Alas, as usual, the reality is not as encouraging as the 'Green Jerseys' crowd might suggest it is.

Let's cut some fog of numbers here.

First, Domestic Group of banks:

  • Total Deposits in Domestic Group of banks (covering all banks registered to operate in Ireland) rose from €206,363mln in September to €208,633mln in October. In other words, deposits rose 1.1% m/m (reversing a -0.19% contraction m/m in September 2012).
  • However, total deposits in Domestic Group are down 16.6% y/y in October 2012, oops... volatility in m/m figures seems to be clouding the minds at the 'Green Jerseys' clubhouse. And worse:
  • More worrying: 3mo average deposits through October 2012 are down 7.9% on 3mo average deposits through July 2012, and are down 16.8% on 3mo average through October 2011. 
  • Likewise, 6mo average through October 2012 is down 10.0% on 6mo average through April 2012 and is down 15.4% on 6mo average through October 2011.
  • Some might say that these averages are down because of some exits of banking institutions from Ireland, but that is simply false, as data for Covered Banks (see below) shows an even more disastrous trend.
  • Now, October 2012 levels of total deposits from Irish Residents are down 16.6% on October 2011, down 31.2% on October 2010 and down 32.8% on October 2009. Only Borat would cheer these trends with a 'Good news' headline.
Much of the above data trends is driven by the Monetary & Financial Institutions deposits changes. Much, but not all. 
  • Government deposits with Domestic Banks rose 25.9% m/m in October having posted a 6.0% rise in September 2012. Year on year, Government deposits are up 44.8% in October 2012 and they were up 2.4% in September 2012. Virtually all trends on Government deposits are up.
  • In contrast, Private Sector deposits with Domestic banks grew only 1.16% m/m in October 2012 and 2.2% in September 2012. 
  • In longer term trends, Private Sector deposits didn't fare that well: 3mo average through October 2012 rose 0.06% on 3mo through July 2012, while it was up 0.73% y/y. 6mo average was up 1.2% in October 2012, compared to 6mo average through April 2012, but down 1.25% in y/y terms.
  • Now, for dysmal science analysis of the Private Sector deposits: in october 2012, Private Sector Deposits in Domestic Group of banks were up 2.2% on October 2011, down 13.0% on October 2010 and down 18.0% on October 2009.
  • Borat back, please.
Let's take a look at the levels of change in Domestic Group deposits:
  • Cheerful increase in total Irish residents' deposits in Domestic Group of banks amounted to €2,270mln in October compared to September 2012, with only €923mln of that - less than half - accumulating in Covered Banks. Looks like foreign banks are beating Irish zombies in the deposits gathering game.
  • There was a rise of €1,663 million in Private Sector deposits in the Domestic Group of banks in October, compared to September. Of this, only €574mln - roughly one third - landed in Irish banks, with 2/3rds going to foreign banks.
  • Borat would say that the above shows success in restructuring Irish banking system. More even-headed analysis suggests success in foreign banking system operating in Ireland.
Now, Covered Banks (aka Irish Banking Zombies):
  • Total Residents' deposits in Covered Banks were up €923 million in October 2012 (+0.59%) m/m, reversing a -0.01% decline in September. Y/y deposits are down 19.63% - worse performance than in September 2012 (-19.26%).
  • Let's put things into perspective: in a year to October 2012, Irish Residents' deposits in Covered Banks shrunk €38.5 billion. In the 'cheers inducing' month of October 2012 they rose €923mln. Simple math suggests that it will take us 48 months of these 'improvements' to get back to where Irish Residents' deposits were back in October 2011.
  • But there's more: Total Residents' deposits in Covered Banks in October 2012 were -19.63% below October 2011, -36.35% below October 2010, -37.64% lower than in October 2009. You get my point - Covered Banks (which were supposedly reformed, repaired, recaped per Department of Finance & CBofI, ages ago) are still performing woefully worse than foreign banks operating in Ireland.
  • Government deposits with Government-owned banks rose €695 million m/m in October (+27.2% m/m and +45.92% y/y), outstripping increases in private deposits of €574mln (+0.55% m/m and +3.3% y/y).
  • Private Sector Irish Residents' deposits with Covered Banks fell -0.75% on 3mo average basis through October 2012 compared to 3mo average through July 2012, although these are up 2.80% y/y. On another positive note, 6mo average for Irish Residents' Private Sector deposits with Covered Banks rose 1.8% on 6mo average through April 2012.
  • Nonetheless, Irish Residents' Private Sector deposits with Covered Banks in October 2012 were still down 15.8% on same period of 2010 and down 20.7% on same period 2009.
  • Switching back to more positive bit of news: Private Sector deposits with Domestic Banks were up €3.121bn in October 2012 y/y, and up €3.379bn for deposits with Covered Banks, which means that y/y Irish Covered Banks are generating stronger activity in attracting Private Sector Residents' deposits than foreign banks.
Here are some charts illustrating the above trends:









Sunday, October 7, 2012

7/10/2012: Goldman on Euro Area banks


Some very interesting stats on the Euro Area (comparatives) banking sector from the recent (October 4) research note from the Goldman Sachs (link here). Here are some bits:

In a recent (October 4) presentation to retail investors in Cork I was speaking about the mismatch in non-financial corporations funding sources between the US and Euro Area. My conclusion was that in the medium term (2013-2015) Euro Area corporates will be forced to increase issuance of corporate bonds since their preferred source of funding - banks lending - is going to stay subdued on supply side, while the equity issuance cannot absorb simultaneous deleveraging of the banking sector, and demand for increased equity from the corporate sector, especially as Governments across the EU are going into 'tax-em-to-hell' mode when it comes to potential investors.


Here are two charts from GS note on the same:




And where are banks largest, dominant players in the economy? Why, in usual suspects...


Now, what's the problem with the above chart? Oh, let's see: Swiss and UK bankers are bankers to the world, with more exposures to assets outside their countries than inside. Irish banks listed include some IFSC banks, but... adjusting for that and adjusting for GNP/GDP gap, Irish figure is as follows:

  • Covered banks: 295% of GNP as of Q2 2012 (using 2011 GNP)
  • Total Assets of Domestic Group of banks as of August 2012 are 447% of 2011 GNP. Of these, 318% are purely assets relating to Irish residents.

Thus, if we are to control for the international exposures of the banks, the same relative position for Ireland is most likely to be maintained as in the chart, albeit the numbers will be smaller across all banking systems. And now think of adjusting these for the quality of assets held... and weep.


And here's a note for Michael Noonan and his friends at Irish banks: this time it is NOT going to be much different:
Do note the above is in nominal Yen, which is kinda telling - Japanese banks have not grown since 1990, inflation-adjusted, through probably 2009-2010. And that with Japanese printing cash and piling up public debt like there is no tomorrow between 1990 and today. What hope is there for the return of lending and profitability in Irish banking ca 2014 that the Central Bank and the Government and the banks have been betting on throughout their disastrous disaster management practices 2008-present?


Lastly, here are two tables neatly summarizing the epic fiasco of European (and Irish - see second table) banking:


Do note prominent positioning of Ireland's zombies, right there, with Tier Last Marfin, B of Cyprus, and Dexia...


Now for a quote... but wait a second first a preliminary set up: Irish Government claims that new regulatory regime will be a departure from the past for Irish banking. The same Government claims that too much competition in Irish banking was contributing to regulatory failures. So a duopoly of BofI + AIB zombies should foster more effective regulatory regime, right? Oh... Goldman on that (italics mine):

"At the other end of the spectrum, countries with central banks as their supervisor have generally done better, the two exceptions being the Netherlands and Ireland (where supervisors fared badly owing to the huge size of the banks that these countries had relative to their GDP – the sheer size of these made it much too difficult to supervise these, ‘too big to save’ banks in these cases)." So, tell me - if having TBTF banks = "much too difficult to supervise" banking system, how will having Duopoly banking system help supervisory effectiveness? Answer: it will hinder such effectiveness. Instead of being captive to a bunch of banks, Irish regulatory regime will be captive to two banks - incidentally, the very same ones that led capture of regulators back in 1990s-2000s.

Let's stop the reading here...


Update: In a fair criticism of the GS report, it ignores Solvency II implications, although does cover Basel III and Dodd-Frank. Solvency II omission was pointed out by the @creditplumber / David McKibbin. 

Wednesday, October 3, 2012

3/10/2012: AIB hikes mortgages rates. Government plays banjo.


The logic of Irish Government's policy on the banking crisis:

Fallacy 1:
Government Position: Irish Government claims that it is protecting and shoring up Irish banks so they can start lending into the economy.
Irish Banks Position: jack up variable mortgages rates, thus taking money out of the economy.

Fallacy 2:
Government Position: Irish 'savings rate is irrationally high' so we must reduce the rate of savings to incentivise demand.
Irish Banks Response: jack up variable mortgages rates, thus reducing domestic demand.

Fallacy 3:
Government Position: Mortgages crisis must be dealt with while protecting family homes, where feasible.
Irish Banks Response: jack up variable mortgages rates, thus making homeownership less sustainable for many financially stressed homeowners.

Fallacy 4:
Government Position: Strategic defaults must be avoided.
Irish Banks Response: jack up variable mortgages rates, thus incentivising more strategic defaults.

Fallacy 5:
Government Position: Property markets must be returned to healthy functional state (aka: price increases are good, price drops are bad).
Irish Banks Response: jack up variable mortgages rates, thus pushing more properties into distress sales and removing more borrowers out of the pool of potential home buyers.

Which part of this 'market' is rational?

Saturday, April 14, 2012

14/4/2012: Sunday Times 8/4/2012 - Irish banks: The Crunch is Getting Crunchier

This is an unedited version of my Sunday Times article from 08/04/2012.

A year has lapsed since the much-lauded publication of the first set of the Prudential Capital Assessment Review results – the stress tests – by the Central Bank of Ireland.

Covering the four core banking institutions subject to the State Guarantee, AIB, Bank of Ireland, Irish Life & Permanent and EBS, the tests were designed to be definitive. Once recapitalized by the Exchequer in-line with the PCAR, Irish banks were supposed to be returned to health – recommencing lending to the SMEs and households, returning to normal funding markets around 2013, while continuing to shed loans to improve their balance sheets.

The PCAR made some major predictions with respect to the banking sector performance over 2011-2013 that were not subject to Nama-imposed losses and, as such, are expected to continue into the future. Chiefly, the Central Bank allowed in its stress scenario for the lifetime losses of €17.2 billion on the residential mortgages books of the four institutions. Only €9.5 billion of these were forecast to hit in 2011-2013. Owner-occupier mortgages losses provided for 2011-2013 amounted to just 60% of the above. Post-2013, it was envisaged that the Irish banking system will be able to fund remaining losses out of its own operations with no recourse to the Exchequer assistance.

Having published the PCARs, the Irish Government proceeded to take a break from the banking crisis. Throughout the second half of 2011 there was a noticeable ‘We’ve sorted the banks’ mood permeating the refined halls of power.

Fast-forward twelve months. Annual results for the four domestic State-guaranteed banks for 2011 are, put frankly, alarming. Set aside for the moment the entire media spin about ‘lower 2011 losses compared to 2010 records’. Once controlled for Nama effects on 2010 figures, the data shows acceleration, not an amelioration of the crisis on the mortgages side.

Excluding IBRC, total amount of owner occupied mortgages that remain outstanding on the books of AIB and EBS, Bank of Ireland and PTSB comes to €71.8 billion or 63% of all such loans held by the banks operating in Ireland. According to the Central Bank of Ireland, 12.3% of all mortgages held in Ireland were 90 days or more in arrears – some €13.9 billion. Of these, the four State-guaranteed banks had €7.7 billion owner-occupier mortgages in arrears, representing 10.8% of their combined holdings. Given banks’ provisions, by the end of 2012, the expected combined losses on mortgages, can add up to 60% of the total 2011-2013 losses allowed under PCAR.

And this is before we recognise the risks contained in a number of mortgages restructured in 2009-2010 that will come off the forbearance arrangements. Many are likely to go into arrears once again in 2012 and 2013. Recall that the entire Government strategy for dealing with mortgages defaults rests on the extend-and-pretend principle of delaying the recognition of the loss by giving borrowers some relief from repayments, e.g. via interest-only periods. This approach is patently not working.

Looking at EBS and AIB results tells much of the story behind the forbearance risk factor. In 2010, the two banks had 16,992 restructured residential mortgages amounting to €3.7 billion. Of these, residential mortgages amounting to €3 billion were interest-only. Of all forbearance mortgages, 92% were classed as performing. By 2011, AIB and EBS held 32,266 forbearance residential loans totalling €6.2 billion – almost double the levels of 2010. Total amounts of mortgages in forbearance arrangements that went into impairment or arrears over the course of 2011 jumped more than seven-fold. One third of the forbearance mortgages are now in arrears.

While Bank of Ireland data is not as comprehensive on 2010 and 2011 comparatives, current (end of 2011) levels of restructured mortgages run at €1.25 billion, of which €249 million were impaired or past-due more than 90 days. This means that €999 million worth of restructured mortgages remain at risk of future arrears. PTSB report for 2011 shows restructured mortgages rising from €1.7 billion in 2010 to €2.1 billion, with those in arrears rising three fold to €524 million.

Taken together with the aforementioned 2010-2011 dynamics, changes to the insolvency regime imply that mortgages losses can exceed Central Bank’s forecasts for 2011-2013 period. Of all four banks, Bank of Ireland remains the healthiest, and the likeliest candidate when it comes to mortgages-related losses. Of course, the banks can continue extending recognition of the losses past 2013, but that will mean no access to non-ECB funding at the time when ECB is increasingly concerned about extending more loans to Irish banks. Worse, with the first LTRO maturing in 2014, Irish banks will be staring into a new funding storm, when their healthier competitors all rush into the markets to fund their exits from LTRO.

Which, of course, means that the entire Government exercise of shoving taxpayers cash into insolvent institutions is unlikely to resolve the crisis. The core banks will continue nursing significant losses well into 2014-2015, with capital buffers remaining strained once potential losses are factored in. And this, in turn, will keep restrained their lending capacity.

Recent Central Bank estimates show that Irish economy will require up to €7 billion in SMEs lending and €9 billion in new mortgages in 2012-2014, while banks are to accelerate deleveraging of their loans books to meet lower loans to deposits standards. At the same time, there will be huge demand for Irish banks lending to the Exchequer, once some €28 billion of Government debt come to mature in 2013-2015. As we have seen with the Promissory Notes ‘deal’, so far, the Government has difficulty getting Irish banking system to buy into Government debt in appreciable amounts.

In other words, we are now staring at the basic conflict inherent in running a zombie banking system that continues to face massive losses on core assets. At the very best, the choice is: either the banks’ will lend to the real economy, while foregoing their support for Exchequer post-2013; or the state uses banking sector resources to cover its own bonds cliff, starving the real economy of credit. The first choice means at least a shot at growth, but the requirement for more EFSF/ESM borrowing (Bailout 2). The second choice means extending domestic recession into 2015.

It is also likely that we will see amplifying politicization of the banking system, with credit allocated to ‘connected’ enterprises and politically prioritized sectors, at the expense of overall economy. Reduced competition – from already below European average levels, judging by the ECB data – will continue to constrain credit supply.

The lesson to be learned from the 2011 full-year results for Irish banks is a simple, but painful one. Banks going through a combination of a severe asset bust and a massive debt overhang crisis are simply not going to survive in their current composition. We need to carry out a structured and orderly shutting down of the insolvent institutions, in particular, IBRC, EBS and PTSB. We also need to restructure AIB. At the same time, we should use the process of liquidation of the insolvent banks to incentivise emergence and development of new service providers.

This can be done by using assets base of the insolvent institution to attract new retail banking players into the market. This process can also involve enhancing the mutual and cooperative lenders models.

Given current funding difficulties, it is hard to imagine any significant uptick in lending in the Irish economy from the traditional banking platforms. Thus, we need to create a set of tax and regulatory incentives and enablers to support new types of lending, such as facilitated direct lending from investors to SMEs. Such models already exist outside Ireland and are gaining market shares around the world, in particular in advanced Asian economies.


The State Guaranteed banking model is, as the 2011 results show, firmly bust. Time to rethink the strategy is now.


Charts:



Box-out:

On the positive front, Q1 2012 Exchequer results released this week showed total tax take rising to the levels, not seen since 2009. Total tax revenues came in at €8,722 million, just below €8,792 in 2009. Year on year tax take is up 16.2%. But hold that vintage champagne in the fridge for a moment. Tax revenues for Q1 this year include reclassified USC charges which used to count as departmental receipts instead of tax revenues. The department of Finance does not provide estimates for how much of the income tax receipts is due to this change, but based on 2010 figures it is close to ca €525 mln. They also include €251 million of corporation tax receipts from 2011 that got credited into January 2012 figures. Netting these out, tax revenues are up 8.2% year on year – still appreciable amount, but down 7.6% on 2009. Compared to Q1 2008 – the first year of the crisis, we are still down in terms of tax receipts some 26.2%. Even at the impressive rate of growth, net of one-off changes, achieved in Q1 this year, it will take us through 2017-2018 before we get our tax take to 2007-2008 levels. As the Fianna Fail 2002 election posters used to say “A lot done. More to do.”

Saturday, January 14, 2012

14/1/2012: Irish banking crisis - on a road to nowhere

This is an unedited version of my Sunday Times article from January 8, 2012.


In the theoretical world of Irish banking reforms, 2012 is supposed to be the halfway marker for delivering on structural change. Almost a year into the process, banks are yet to meet close to 70% of their total deleveraging targets, SMEs are yet to see any improvements in credit supply, households are yet to be offered any supports to reduce their unsustainable debt burdens, longer-term strategic plans reflective of the banks new business models, now approved by the EU not once, but twice are yet to be operationalized, and funding models are yet to be transitioned off the ECB dependency.

In the period since publication of the banking sector reforms proposals, total banks core and non-core assets disposals are running at some €14 billion of the €70 billion to be achieved by the end of 2013. Even this lacklustre performance was heavily concentrated in the first nine months of 2011, when few of Irish banks competitors were engaging in similar assets sales.

Since then, things have changed. Plans by the euro area banking institutions, already announced in Q4, suggest that some €775 billion worth of euro area banks’ assets will come up for sale in 2012. That is more than 8.5 times the volumes of assets disposals achieved in 2011. And 2012 is just the tip of the proverbial iceberg. According to the Morgan Stanley research, 2012-2013 can see some €1.5-2.5 trillion worth of banks assets hitting the markets. With 2012 starting with clear ‘risk-off’ signals from the sovereign bond markets and banks equities valuations, the near term future for Irish banks deleveraging plans can be described as bleak at best.

Further ahead, the process of rebuilding capital buffers, in both quantity and quality, can take core euro zone banks a good part of current decade to achieve. In this context, Irish banks deleveraging targets are grossly off the mark when it comes to timing and recovery rates expectations.

Progress achieved to-date leaves at least €35-40 billion in new assets disposals to be completed in 2012 – two-and-a-half times the rate of 2011. The two Pillars of Irish banking alongside the IL&P are now facing an impossible dilemma: either the banks meet their regulatory targets by the end of 2013, which will require deeper haircuts on assets and thus higher crystallized losses, or the 2013 deleveraging deadline is bust. In other words, Irish banks have a choice to make between having to potentially go to the Government for more capital or suffer a reputational cost of delaying, if not derailing altogether, the reforms timetable.

This is already reflected in the negative outlook and lower ratings given by S&P to AIB last month. The rating agency stressed their expectation of the slowdown in assets deleveraging in 2012 as one key rationale for the latest downgrades. Post-recapitalization in July, AIB core Tier 1 regulatory capital ratios stood at a massive 22%, the fact much lauded by the Irish authorities. However, per S&P “AIB’s capital ratio… will be between 5.5% ad 6.5% by 2013” due to materially “higher risk weights [on] capital, estimated deleveraging costs, as well as further capital erosion from the core business”.

Bank of Ireland finds itself in a better position, but, unlike AIB, it has much smaller capital reserves to call upon in the case of shortfall on July 2011 recapitalization funds.

Another area of concern for Irish banking sector relates to funding. Central Bank stress tests (PCAR) carried out in March 2011 assumed that by the end of 2013 Irish banking institutions will be funded on commercial terms. This too is subject to significant uncertainty as euro area banks enter a period of rapid bonds roll-overs in 2012-2014. Overall, the sector will face ca €700 billion of bonds maturing in 2012 and total senior debt maturing in 2012-2014 amounts to close to €2.2 trillion once ECB’s latest 3-year long term refinancing facility is factored in. For comparison, in 11 months through November 2011, euro area banks have managed to raise less than €350 billion in capital instruments, and various senior bonds. Again, international environment does not provide any grounds for optimism about Irish banks ability to decouple themselves from the ECB supply of funds.

In the short run, Irish Pillar Banks dependency on central banks’ funding is a net subsidy to their bottom line, as central banks credit lines come at a fraction of the expected cost of raising funds in the marketplace. This makes it possible for the banks to sustain their extend-and-pretend approach toward retail borrowers.

However, in the longer term, reliance on this funding represents major risks of maturity mismatch and sudden liquidity stops. The latest data clearly shows that the major risk of Irish banking sector becoming fully dependent on ECB as the core source of funding is now a reality. Reductions in the emergency liquidity assistance loans extended by the Central Bank of Ireland are now matched by increases in ECB lending to these banks. A recent research paper from the New York Federal Reserve shows that Irish banks continue to account for the largest proportion of all loans extended by the ECB to the banking systems of the euro area ‘periphery’.

Lacking functional banking sector, in turn, puts a boot into Government’s plans to use reforms as the vehicle for reversing credit supply contraction that has been running uninterrupted since 2008.

Another major risk inherent in the Irish banks’ funding and capital dependencies on Central Banks and the Government is the risk that having delayed for years the necessary processes of restructuring household debts, the banks can find themselves in the dire need of calling in the negative equity loans. This can happen if the Irish banking sector were to be left lingering in its quasi-transformed shape when ECB decides to pull the plug on extraordinary liquidity supply measures it deployed. While such a prospect might be 2-3 years away, it is only a matter of time before this threat becomes a reality and the very possibility of such eventuality should breath fear into the ranks of Ireland’s politicians.

As the current reforms stand, the sector will not be able to provide significant protection against the ECB policies reversal, even if the Central Bank-planned reforms are completed on time. The reason for this is simple. Our twin Pillar banks will be facing – over 2013-2018 – a rising tide of mortgages defaults and voluntary property surrenders, as well as continued mounting corporate loans losses as the economy undergoes a lengthy and painful debt overhang correction, consistent with the historical evidence of similar balance sheet recession.



While the capital for writing these assets down might have been at least in part supplied under PCAR 2011, the banks have no means of managing any added risks that might emerge alongside the mortgages defaults, such as, for example, the risk of their cost of funding rising from the current 1 percent under the ECB mandate to, say, 6 or 7 percent that private markets might charge.

For all the plans for banking reforms proclaimed for 2012 by the Central Bank and the Government, in all likelihood, this year is going to see more mounting corporate and household loans writedowns, amidst the continuation of the extend-and-pretend policies by the banks. The longer this process of delaying losses realization continues, the less viable the remaining banks assets become. And with them, the lower will be the credit supplied into the real economy already starved of investment and funding.


Box-out:

Irish banking sector structure envisioned under the Government reforms plans will not be conducive to an orderly deleveraging of the real economy and simultaneous repairing of the banks balance sheets. Sectoral concentration, in part driven directly by the Government dictate, in part by the massive subsidies provided to insolvent domestic banks, will see a colluding AIB & BOFI duopoly running circles around the regulators, supervisors and politicians.

How serious is this threat of the duopoly-induced markets distortions in post-reform Irish banking? Serious enough for the latest EU Commission statement on Bank of Ireland restructuring plans to devote significant space to outlining high-level set of subsidies that the Irish authorities are planning jointly with ECB.

No one as of yet noticed the irony of these latest amendments to the Government plans for the banking sector reforms: to undo the damaging effects of state subsidies to the incumbents, the EU and the Government will offer more subsidies to the potential newcomers. Such approach to policy would be comical, were it not designed explicitly to evade the real solution to the banking sector collapse in this country – a wholesale restructuring of the sector, that would have used insolvent banks’ performing assets as the basis for endowing new banking institutions to serve this economy.


Tuesday, September 6, 2011

06/09/2011: Recapitalization of Irish Banks 2011

On August 31, 2011 Irish Government committed €17.3 billion of our - taxpayers - money to underwrite banks recapitalization following the PCAR 2011 exercise carried out by the CBofI. Three "banks" - BofI, AIB and IL&P received the funds. Here is the official summary of how these funds were distributed. No comment to follow.

Thursday, June 2, 2011

02/06/2011: Latest shenanigans at the banks

Two junior bondholders in Allied Irish Banks - Aurelius Capital Management and Abadi Co – are taking the Irish government to court today over the AIB plans to impose burden-sharing on some bondholders in failed banks. Aurelius is a distressed debt investment vehicle which also holds debt of Dubai World so it should be well familiar with the case of haircuts.

These are not investors who bought Irish banks bonds at their full value, but those who pick up distressed debt at a significant discount. However, it is their right to maximize their returns on such investments.

Let us recall that AIB is the sickest of the 4 banks reviewed under the original PCARs back on March 31 this year. Under the stress tests, AIB is expected to lose €3.07bn on Residential Mortgages (all figures refer to stress scenario, 3-year time frame), €972mln on Corporate loans, €2.67bn on SMEs loans, €4.49bn on Commercial Real Estate loans and €1.4bn on Non-mortgage Consumer loans and Other loans. The grand total expected 2011-2013 losses under stressed scenario is €12.6bn or almost ½ of the total expected stress scenario losses across IRL-4 banks of €27.72bn.

Of the €24bn capital buffer for IRL-4 required by the Central Bank PCAR exercise, full €13.3bn is accounted for by AIB.

Which implies that AIB – accounting for just €93.7bn of the €273.94bn of loans held by the IRL-4 at the time of PCARs (just over 34.2% of the total loans of IRL-4) is responsible for over 55.4% of overall capital demands. It is, by a mile, the worst performing bank of IRL-4... Really, folks, 'Be with AIB' as their old commercials would say.

So in the case of AIB, Finance Minister Michael Noonan – the majority shareholder in AIB – is now attempting to impose losses of between 75 and 90 percent on €2.6bn of the bank’s subordinated debt. This means that the bond-holders are expected to contribute just 15-16% of the total cost of the latest bank recapitalization programme. This, of course, is a drop in a sea of pain already levied against Irish taxpayers.

The problem in Ireland is that the so-called subordinated liabilities orders (SLO), which the government is using to force a deal on bondholders is untested in law. Bondholders can claim priority over shareholders in the event of insolvency. But the banks are now existing solely on government life-support. Although they are complete zombies, they are not technically insolvent. This in turn means their equity retains some – if only tiny – value. The Irish Government in the case of AIB driving bondholders’ haircuts can be seen as the means for improving that value to the shareholder at the expense of bondholders, since equity will benefit from lower debt and changes in the capital structure.

In the case of AIB this means two possible things:
  • If the court finds in favour of Aurelius and Abadi, the deal is off the table or will be more expensive to execute (lower haircuts), which will in turn imply greater demand on taxpayers to step in. Of course, this also means the Gov in effect destroying a large portion of its own shares value.
  • If the court rules in favour of the Gov, the deal is on and we have a precedent for aggressive burden sharing. This, however, will only benefit the majority state-owned banks, i.e. Anglo, INBS, EBS and AIB, and only with respect to savings on subordinated debt.
The problem is in the timing of this burden sharing – the previous Gov insistence on paying on bonds in full means that we, the taxpayers, are now on the hook for losses on our shares in the banks via dilution. You don’t have to go far to see what happens here. Just look at Bank of Ireland (below).

Normal process of banks workout should have been:
  • Step 1 – Impose losses on shareholders, while preserving depositors by ring-fencing them via specific legislation to remove equivalent status between senior bondholders and depositors. Such legislation can be enacted on the grounds that depositors are not lenders to the activities of the banks, but are clients of the banks for the purpose of safe-keeping of their money. It is also justified from the point of view of finance, as depositors are being paid much lower rates of return on their money, implying lower risk premium
  • Step 2 – Impose losses on bondholders via a combination of robust haircuts and debt-for-equity swaps, but only after depositors are protected
  • Step 3 – For any amounts of capital still outstanding per writedowns requirements, the Government can then take equity positions in the banks.
This sequence of actions would have prevented depositors runs and repeated taxpayer equity dilutions. It would also have given the Government a mandate to take over and reform failed banks.

By doing everything backwards, we are now in a veritable mess. This mess was not caused by the current Government – it is the toxic legacy of the previous Government which made gross errors in managing the whole banking crisis. This mess is extremely hard to unwind and my sympathies go here to Minister Noonan who is at the very least trying to do something right after years of spoofing and wasting taxpayers money by his predecessor.

Note: The Government is aiming to cut around €5bn from the total bill for bailing out Irish-6 banks. Imposing losses of up to 90 percent on junior bonds in AIB, Bank of Ireland, Irish Life & Permanent and EBS Building Society is on the cards:
  • IL&P said it would offer 20cents on the euro for €840m of debt
  • EBS wants to pay 10c to 20c on the euro for around €260m of subordinated bonds
  • Bank of Ireland is pushing up to 90% discount on €2.6 billion worth of subordinated debt. Bank of Ireland said it would offer holders of Tier 1 securities just 10 percent of the face value of their original investment, and holders of Tier 2 securities 20 percent.
It is revealing, perhaps, of the state of our nation’s policy making that over a year ago myself, Brian Lucey, Peter Mathews, David McWilliams and a small number of other commentators suggested 80-90% haircuts for subordinated bondholders. We were, of course, promptly attacked as ‘reckless’, ‘irresponsible’ and ‘naïve’. Yet, doing this back then would have netted taxpayers savings of more than double the amount hoped for today.

And this is before the savings that could have been generated from avoiding painful dilution of equity holdings acquired by the Government in Irish banks. How painful? Look no further than the unfolding Bank of Ireland saga.

Bank of Ireland's lower Tier 2 paper is trading at 37-40 cents on the euro post-announcement of the after the announcement that T2 will be offered an 80 percent discount alongside with a ‘more attractive’ debt-for-equity swap. Tier 1 paper holders are offered 10 cents on the euro cash ex-accrued interest. Shares swap will factor in accrued interest to sweeten the deal. The debt-equity swap is so powerful of a promise that BofI shares have all but collapsed over the last few days losing over 62% of their already minuscule value. Of course, with Government holding 39% of equity pre-swap, the taxpayers have suffered the same loss as the ordinary shareholders, all courtesy of perverse timing of equity injections by the previous Government.

And there’s more. Even if successful in applying haircuts and swaps to junior bondholders, Bank of Ireland will still need to raise additional €1.6bn from either new investors or existent shareholders (including the Government). Which means even more dilution is to come.