Monday, December 6, 2010

Economics 6/12/10: IMF stress tests for Irish banks

Here are three things that are worth asking about the latest details of the EU/IMF 'rescue' package released over the weekend. All relate to the issue of banking sector restructuring:

  1. According to reports, some €2 billion will be available to enable the banks to sell €20 billion worth of assets (which, of course, implies sales of performing loans, as all other assets, such as foreign divisions, auxiliary services providers, asset management branches etc have already been flogged or put on the market). As reports issued today specify: the funds may come in the form of a loss protection or as a guarantee for asset purchasers. These €2 billion come on top of the €10 billion set aside for the immediate re-capitalization of the banks, and on top of further €25 billion in contingency funding allocated. So it appears that it either comes from the Exchequer side of the EU/IMF deal, reducing deficit financing available to the Government or, alternatively, on top of the €67 billion in lending extended under the whole deal. In effect, the EU/IMF will now engage Irish taxpayers funds (remember - these €2 billion are loans) to sweeten the bitter pill for buyers of Irish banks assets. A small, but lovely morsel of taxpayers income that will be spent on artificially propping Irish assets for sale.
  2. According to the Irish Times, stress testing scenarios deployed by the IMF in pricing the overall demand for taxpayers funding for the banks involved the following assumptions: losses of 10% on buy to let mortgage books and 6.5% for residential mortgages. These assumptions underwritten the demand for €25 billion in contingency funding, spread as €15 billion in required capital, plus €10 billion additional cushion. This is rather interesting and worrying. Buy-to-let mortgages are most certainly completely under water right now, given collapsed rents and capital values, as well as more recent vintage of these mortgages. If investment and commercial books are facing up to 35-40% losses currently (as consistent with the Government own estimate of €50 billion final cost of banking sector recapitalization), is it safe to assume that buy-to-rent mortgages will tank at 10%? Similar questions arise with respect to 6.5% assumption on mortgages defaults. In fact, we already know that over 100,000 mortgages are either in official distress or under renegotiated repayment holidays or interest rates adjustments. This pushes the effective default and at-risk of default numbers will in excess of 6.5% as of today.
  3. If contingency fund of €10 billion were to be taken as covering any losses in excess of 6.5% defaults on mortgages and 10% default on buy-to-rents, then this amount is expected to cover: (1) Haircuts by Nama on additional €14 billion in loans transfers (cost ca €6-7 billion at past haircuts), plus (2) Losses in excess of assumed rates on mortgages and buy-to-rents, plus (3) any further losses on investment and development books, plus (4) any further losses on derivatives exposures. This is hardly realistic of a cushion. So it appears that the IMF was either not given the full realistic picture of the Irish banks balance sheets, or it is seriously underestimating the demand for future losses cover in the banks.
Either way, the numbers continue to suggest that the €67 billion package of loans will not be enough to provide simultaneously a cover for Exchequer deficits and the funds required to underwrite losses and capital requirements of the banks. Somehow, the Irish Exchequer will have to make up for this shortfall.
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