Showing posts with label Irish bank losses. Show all posts
Showing posts with label Irish bank losses. Show all posts

Saturday, July 2, 2011

02/07/2011: Was banks Guarantee 2008 a subsidy to foreign lenders?

Please note: the figures below are estimates, based on Table A.4.2 data from the Central Bank of Ireland for 6 covered banking institutions liabilities as of September 2008. These charts illustrate the comment I provided to the Quarterly Journal of Central Banking - forthcoming issue for Q3 2011.
First, straight forward composition of liabilities as shown in the chart above.

Next, the same expressed as percentages of total liabilities:
Finally, assumptions and calculations of total implicit subsidy from the Irish taxpayers/Exchequer to foreign liabilities holders:
Click on the chart to enlarge and see assumptions and calculations. Euro area residents accounted for €39.572 billion of our banks' liabilities or 6.42%, while non-Euro area residents accounted for €218.836 billion or 35.5% of total Ireland-6 liabilities at the time the Guarantee was issued. Thus, Euro area residents received an implicit subsidy from the Irish taxpayers to the tune of €5.5-6.7 billion over the time of the Guarantee - well in excess of the life-time cost of 1% reduction in the interest rate on our EU loans.

Of course, this is a crude estimate based on official provided and expected default rates on assets held by the Irish banks - excluding Anglo and INBS. Which means it is likely to be an under-estimate. Expected losses at INBS and Anglo are multiples of those assumed for the Ireland-4 covered in the main PCARs. With Anglo & INBS thrown into the mix, subsidy to Euro area residents rises to ca €8 billion.

Another issue here is that I am using estimates through 2013 only. This means that, like the CBofI I am assuming (ad hoc) that post-2013 IRL-6 will be able to cover their own losses without resorting to taxpayers capital injections. This assumption, in my view, is absolutely unrealistic.

Finally, no allowance is made here for the Irish Government underwriting of the funding debts incurred by the banks vis-a-vis ECB and CBofI - the debts which, at least in the case of Anglo & INBS, should be treated as largely reckless lending to insolvent institutions and which should not be a liability of the taxpayers.

In the end, in my opinion, Irish Government had no business underwriting a Guarantee for any of the liabilities in excess of €130.2 billion of domestic deposits and €2.813 billion of its own deposits with the IRL-6.

Note - another issue not addressed in these estimates, but also likely to increase the implicit subsidy extended to Euro area residents is that Monetary & Financial Institutions deposits figures cover IRL-20 banks regulated here, which include a large number of deposits from Euro area banks that are within IRL-20.

Wednesday, March 2, 2011

02/03/2011: Village Magazine - March edition article

Here is an unedited version of my column in the current edition of the Village magazine

Top legislative/policy priorities for the new Government should focus on addressing the four crises we face – the banking sector renewal, the debt crisis, the need to dramatically reform our economy and the long-term reform of our political and governance systems. The inter-connected nature of these crises implies that some of the reforms undertaken in one of the areas, such as, for example, fiscal adjustments, will have a positive long term effect in other areas, e.g. in stimulating private sector economic growth.

Given the constraints of the space, let me deal here first with the decisions that should take priority for the new Government over 2011 in the areas of banking and finance.

EU/IMF ‘bailout’ package: the new Government will be forced, willingly or not, to renegotiate the terms of the original agreement. Given the level of debt carried by this economy courtesy of the previous Government commitments, the question of the need for such a revision of the ‘deal’ is no longer a valid one. Instead, the real question we face is what path to a ‘default’ or debt restructuring do we take and resolving this issue should be the top of our Government agenda.

Overall, there are three possible scenarios that the new Government can face in this respect.

The first one – the scenario of exogenously imposed resolution – implies that the impetus for altering the terms of the original November 2010 agreement can come from the EU itself under the auspices of the broader EFSF reforms. Under this scenario, expected eagerly by many pro-status quo or ‘do nothing’ advocates, the EU is likely to marginally reduce the cost of the EFSF funding to, say 5% from the current 5.83% and potentially extend the duration of the loans (up to 20-30 years), while creating a ‘flexibility fund’ which will make additional funding available to Ireland post-2013, but at higher rates of interest incorporating any future increases in the ECB core policy rate. In exchange for such a ‘rescue from previous rescue’ package, Ireland will be asked to accept the need for enhanced fiscal coordination– re: tax harmonization.

The second path is of structured and orderly ‘default’ involving banks debts. Under such a scenario, Irish Government should first prepare significant buffers for dealing with the funding failure in the currently insolvent banks. Since not all of our Government-guaranteed banks are insolvent, this means that the damage limitation is relatively better contained than the current full exposure scenario. In fact, an orderly restructuring will require replacing the blanket Guarantee with the one that covers fully only the deposits held in the Irish banks. This will significantly reduce taxpayers’ future exposure to the banking sector.

At the moment, the entire banking system in Ireland holds €168.3bn in deposits. However, not all of these are held in the 6 covered banks. In addition, of the above deposits, €10.5bn is held under the termed contracts with maturity in excess of 2 years. Roughly, only ca €100bn of domestic deposits are held by the Irish banks and is subject to a withdrawal demand within the next 2 years. This means that to underwrite these deposits, the Government will need a funding buffer of ca €30-50bn over the next 2 years (providing a 30-50% cover). This buffer can be provided by a combination of new currency issuance by the CBofI, NPRF funds and a stand by facility from the IMF not exceeding €5-15bn. A far cry from what the Government, alongside the EU and IMF, are planning to burn already.

Of course, the scenario means that we will need to effectively radically reduce our banks exposure to their largest lender – the ECB. This can be done by restructuring the share of Irish banks debt held by the ECB and the CBofI into a combination of a 10 year loan at a fixed interest rate of 0.5% and a haircut of, say, 40%, in effect reducing the risk of future rollovers, while cutting the overall burden of repayment and the cost of financing. Along with it, the EU/IMF should also agree to a restructuring of the €67.5bn loan extended under the November 2010 agreement into, for example, a €35bn perpetual loan at 3% pa interest rate and a €30bn loan extended for 10 years at 1.5-2% pa interest. The key in both deals should be to achieve not only a reduction in the cost of financing the quasi-Governmental (banks) and Government debt, but also cutting the overall level of gross debt assumed.

The worst-case scenario would arise if the markets were to force Ireland into a disorderly default. In this case, the markets will execute a massive sell-off of Irish Government debt preceded by a complete collapse of the secondary markets in banks debts. This will leave the ECB with some €185 billion worth of Irish banks debts that will have virtually no real market value and an unknown (but sizeable) volume of Irish Government debt which will be selling at a 20-30% discount on the face value. Both, the sovereign bonds and the banks debt markets will cease. Overnight and demand deposits will be frozen and the country will find itself in the situation where the Central Bank will have to monetize the very same costs of the orderly restructuring scenario, plus the disruptive costs of a bank run at the same time. Instead of holding the buffers of cash and committed funds it might not have to draw down in full, the ECB system will end up in a situation where all cash will have to be delivered as soon as technically possible.

It is clear that a prudent Government action should be from day one to prepare for the second, less disruptive scenario.

Following the entry into the resolution process of the banks debts, the Government should swiftly address the banks balancesheets problems. Here, the actions should follow the Swedish model and start with the abandonment of the misguided Nama-based approach. The Government should order the six banks to supply – by the end of June – a full accounting of the loans they hold, with clear indication as to the riskiness of these loans with respect of the probability of their repayment, the quality of the underlying collateral and titles. By the end of August 2011, the Government should complete detailed evaluation of this information by an independent panel of economic, property, lending and finance experts. Parallel to this, the Government should set an exact target for banks bondholders writedowns to offset at least in part loans losses in the banks. All bonds repayments and interest payouts for banks debts due for 2011 should be suspended. The balance on the expected losses net of the funds recoverable from bondholders should be financed by the purchase of the direct equity in the banks by the Government at a price for banks shares at the time of the publication of the assessment exercise. The time-frame for such closing of the balancesheet gaps should be set for no later than November 2011.

Nama loans that belonged to the banks should be valued as banks’ own in the above exercise and following the completion of the valuations, Nama should be shut and loans transferred back to the banks for management.

Subsequent deep reforms of the banks strategies and operations should be scheduled for the first quarter 2012.

Parallel to this, the Government should submit to the Dail no later than June 2011 a full draft bill dealing with reforms of our personal bankruptcy codes. These reforms should at the very least:

Make past and future loans for the purchase of personal residence non-recourse against the person of the borrower and his/her future income and assets;
Reduce the period of bankruptcy restrictions to just 2 years and complete removal of the bankruptcy history from credit history after 5 years of continued financial probity performance; Replace a blanket ban on companies directorships for individuals in bankruptcy with a restriction on their holding such directorships subject to satisfactory financial probity conduct during the bankruptcy period;
Restrict applicability of the Loan-to-Value ratio covenants in forcing the liquidation of the existent loans where the borrower continues to pay at least 75% of the interest on the mortgage.

The new bankruptcy laws should come into force as soon as possible and prior to that, the Government should impose a requirement that no state-guaranteed institution can bring new bankruptcy proceedings against homeowners.

Lastly, the Government should act swiftly to put in place an independent expert panel consisting of independent economists, financial analysts and banking experts that will function as a check on the Government decisions in the area of banking and financial services reforms. The panel should be required to provide quarterly reports and testimonies to the Dail which will be made public. The panel will have the powers to propose specific measures to the Government, to request and receive any information from the banks and financial services provider (subject to upholding the required confidentiality clauses) and question any bank official. The panel remit will only cover those institutions in which the Government holds at least a 35% stake and those that are covered by the State guarantee.

Of course, the above measures will help addressing a large share of our debt problem, effectively reducing the Government and banks’ debts, while alleviating the burden of personal debt for mortgage holders. However, other changes will have to take place in the areas of economic, fiscal and political reforms. These proposals will be outlined in a follow up article, so stay tuned.

Sunday, December 5, 2010

Economics 5/12/10: Reserves requirement ratio

In response to the following tweet:

"A question. You wrote here http://j.mp/eL9QWg that the decision of the Chinese government to raise reserve requirement ratio for the commercial Chinese banks in order to cut down on their lending as "monetary tightening".

According to this article by Phillippe Legrain

http://j.mp/hnSF9w

The Republic of Ireland could have taken similar measures during the past decade to cool down the property bubble but didn't.

I thought after European monetary union, a monetary option wasn't open any more to the Republic of Ireland.

Yet what you described as "monetary tightening" in China was possible in the Republic of Ireland according to Phillippe Legrain."

My view on the topic: Legrain is correct.

As a member of the Euro zone, Ireland retained full control over one of the tools of monetary policy, known as 'reserve requirement ratio' - or capital requirement ratio. Irish regulators (CBFSAI) has a full right to increase requirement on the banks operating in Ireland to hold the proportion of their deposits and/or proportion of their loans in reserves as capital to cover any expected losses.

Such an increase in the ratio would have reduced amount of credit available in the system and would have offset the dramatic increase in lending spurred on by the introduction of higher risk products such as 100% mortgages.

At a dinner event in 2006 I told, at the time, Governor of the Central Bank of Ireland that this is exactly what he needed to do to cool down the market for mortgages lending in the Republic. His reply was along the lines that this was politically impossible to do.

That this lever of policy is still available to Ireland is best illustrated by the two recent decisions by the new Financial Regulator to hike capital requirement ratios for Irish banks to 8% Tier 1 and most recently to 12%. Unfortunately, this decision came too late.

Were Irish banks required by the CBFSAI to hold, say 12% of their risk-weighted assets in form of capital, the taxpayers would have seen their total exposure to the banking crisis significantly reduced. Instead of ca €16.2 billion in capital available to cover writedowns against the total lending of €360 billion across our banking institutions, our banking system would have had ca €34-35 billion in capital cushion against lending of €280-290 billion. (Note: these are back of the envelope calculations, but they still show the impact of raising reserve requirement ratios).


PS: for those of you who missed an excellent PIMCO note on Irish situation and EU's 'solution', here's a link. (Hat tip to Georg)

Monday, September 13, 2010

Economics 13/9/10: FT's belated recognition of Irish realities

In today's FT (here), Wolfgang Munchau clearly states that (emphasis is mine): "...Irish banking sector is insolvent, and there are questions about the capacity of the Irish state to absorb those losses. ...two years have passed [since the crisis acknowledgement by the state] and nothing has been resolved.

…As we saw last week, this strategy [of shoving bad loans under the rug via Nama and quasi-recapitalizations] came badly unstuck in Ireland. The Irish government massively underestimated the scale of the problem in its banking sector. On my own back-of-the-envelope calculations, the cost of a financial sector bail-out may exceed 30 per cent of Irish gross domestic product, if you make realistic assumptions about bad debt write-offs and apply a conservative trajectory for future economic growth.

[Note: this blog has previously (here), on a number of occasions estimated the overall impact of the net losses realized by the banks to Irish taxpayers will be in the region of €62-75 billion, inclusive of Nama. Based on the Department of Finance own figures, this can be expected to amount to 38.5-46.6% of Ireland’s 2010 GDP or 48-58.1% of our GNP. Either range of numbers is significantly in excess of Munchau’s back-of-the-envelope estimate.

However, even at 30% of annual GDP, the expected hit on this economy from the banking sector debacle is simply insurmountable.

No economy on earth can be expected to withstand a 30% contraction in its GDP over two-three years, while still running a 7-8% of GDP structural deficit in every one of these years. The insolvency of Irish banks recognized by Munchau, therefore, automatically implies the insolvency of our economy, unless the banks are isolated from the rest of our economy by a removal of the blanket guarantee on the bondholders, while retaining a guarantee on depositors.]

Munchau goes on to say that: “We know from economic history that countries enter into longish phases of stagnation after a financial crisis.

[My estimates based on the IMF and OECD models of fiscal and financial crisis imply that Ireland can expect at least another 33 quarters of continued crisis pressures in Exchequer finances, house prices and asset markets, as well as a permanent decline in the potential rate of economic growth to below 1.5%]

Ireland suffered an extreme crisis. In the light of what we know, the safe assumption to make for Ireland – and Greece – is that there will not be much nominal growth in the next five years. If you make that assumption, you realise Greece will almost certainly not be in a position to repay its debts. While Ireland’s situation is marginally better, there are justified doubts about the country’s long-term solvency.”

[The above are not some idle words. They are, as I mentioned early, fully in line with the existent econometric models of crises based on historical experiences in the advanced economies in the past.]

Per Munchau: “….In Ireland, the cure would consist of nationalisation and wiping out the bondholders of Irish banks through bond-to-equity conversions.”

[Needless to say, since April 2008 I am on the record – in the press, media, on this blog, in public meetings and private briefings to the policymakers – these are exactly the first steps that need to be taken in order to begin – note, just to begin – the process of restoring order to our banking system. Irony has it – on a number of occasions, I have written to the Financial Times precisely about these issues, raised by Mr Munchau, with, needless to say, not a peep back from the broadsheet offices].

Monday, August 23, 2010

Economics 24/8/10: Anglo Tranche 2 goes 'Boom!'

Two weeks ago in a post on Anglo (here) I provided a quick explanation of my forecasts for why the mid range expected capital hit on the entire Anglo book of ca €72bn worth of loans (original face value) will be in the region of €33bn. This estimate referred to the mid-range assumptions.

In the light of today's speculations/reports (here) that the final Tranche 2 haircut on Anglo loans will be 61.93% I am now more confident in my original lower- and mid-range estimates, though adjusting my upper margin loss estimate down a notch.

To repeat my projections are:
  • Worst case scenario for Anglo requires €38.6bn (down from €38.9bn)
  • The mid-range is €33bn in total hit (same as earlier)
  • The best case scenario is €30bn (same as earlier)
Some details: Tranche 2 of Anglo loans was valued at €6.75bn. Combined total amount of loans transferred to Nama in Tranche 2 is €11.9bn on an average discount of 55.6%. Tranches 1 & 2 combined is €27.2bn of the total €81 bn planned with an average discount of 52.3%. If this discount stands, remaining Tranche 3 transfers of €53.7bn to be completed by February 2011 will incur capital hit of RWA-adjusted €28.1bn - to a combined Nama-induced capital loss to all 6 banks of €42.3bn. Nama expects further €12bn to be transferred by the end of September - a highly unlikely deadline, at least if Anglo-INBS stuff were to be included here. Provisions by the

As telling as the haircuts are the assumed LTEVs - in Tranche 1 the implied LTEV was 11 percent. In Tranche 2 this is down to 9 percent. Since Nama marks to November 2009, this change can be explained either by lower quality of loans being taken on board (bad news for Nama, better news for banks) or by Nama aggressive drive into raising cash flow (good news for Nama, bad news for the banks).

Now, to my valuations. Table below summarizes:
Notice, I allow for interest margins of 1.5% pa in my mid-range assumptions. This is rather unlikely. To end of 2009, interest margin on Anglo loans (performing) was roughly 1% and this did not reflect Nama costs. In addition, my mid-range scenario assumes Nama recovering 100% of the principal amount of the loans - something that I believe to be equally unlikely. Either way, mid-range estimate implies that Messr Aynsley and Dukes will be coming in with new demands for cash soon - to the tune of €8.5bn more based on my mid-range scenario.

Thursday, July 22, 2010

Economics 22/7/10: Banks downgraded - expect more fireworks

After hammering Irish sovereign ratings, Moody’s rightly took the shine off the six guaranteed banks’ bonds. Not surprising, really, and goes to show just how meaningless the term ‘stable outlook’ can be. Now, few facts:
  • Moody’s has downgraded the long-term ratings for EBS Building Society and Irish Life & Permanent from A2 to A3, stable outlook didn’t help much here.
  • Moody’s also downgraded the government-guaranteed debt of all six guaranteed institutions: AIB, Bank of Ireland, EBS, Anglo, IL&P and Irish Nationwide.
  • Prior to the latest downgrade, AIB and BofI both had stable outlook, and this has been maintained.
  • The reason for the downgrades was the reduction in the government’s ability to support the banks stemming from the sovereign debt downgrade announced Monday.
What’s next, you might ask? Barring any news on loans impairments etc, the growth prospects for banks will have to be the key. And here, folks, there isn’t any good news. No matter how you can spin the thing.

BofI and AIB are disposing of their performing assets – divisions and businesses in the US, UK and elsewhere – in order to plug the vast holes in their balance sheets caused by their non-performing assets.

And it’s a fire sale: Polish BZWBK – 70.5%-owned by AIB – is the only growth hopeful in the entire AIB stable. Yesterday, some reports in Poland suggested that PKO Bank Polski, Banco Santander, BNP Paribas and Intesa San Paolo are the only ones remaining in the bidding. Neither one can be expected to pay a serious premium.

Take a look at M&T in which AIB holds a 22.5%. Not a growth engine, but a solid contributor to the balance sheet. The US bank Q2 profit quadrupled as it is facing the market with structural aversion to banks shares. So M&T is losing value in the market as it is gaining value on AIB’s balance sheet. But hey, let’s sell that, the gurus from Ballsbridge say, and pay off those fantastic development deals we’ve done in Meath and Dundalk.

Likewise, BofI are selling tons of proprietary assets, including proprietary wholesale services platforms, which are performing well.

Will the money raised go to provide a basis for growth in revenue in 2010-2012? Not really. BofI needs new capital. Not as badly as AIB, but still - €2.9bn capital injection in June is not going to be enough to cover future losses. It is just a temporary stop-gap measure to cover already expected losses plus new regulatory capital floors. Future losses will require future capital.

AIB is desperate. €7.4bn is a serious amount of dosh and there are indicators they’ll need more. Of course, in order to properly repair its balance sheet, AIB will need closer to €10bn this side of Christmas (as estimated by Peter Mathews - see here).

However, the bank won’t make any noise about that for political reasons.

Even after getting no serious opposition to their banks recovery plans for some two years already, the Government is starting to get concerned about continuous and never diminishing demand for capital from our banks. This concern is not motivated by the suddenly acquired desire to be prudent with taxpayers’ cash. Instead it is motivated by the optical impressions Irish banks appetite for Exchequer funding is creating around the world. Sovereign ratings are now directly being impacted by banks weaknesses and some investors are starting to ask uncomfortable questions about viability of AIB outside state control. There’s an added sticky issue of Irish Government deficit potentially reaching 20% of GDP this year should our banks come for more cash.

And they will... not in 2010, possibly, but in 2011, once Nama last tranche closes in February (or thereabouts - remember, it has blown through few deadlines already and can strategically move past February 2011 with closing off its purchases, to allow more time for banks to play the 'Head in the Sand' game).

If you want to see what is really happening in our sovereign bonds markets, check out the next post on this blog, which will be covering this.

Monday, April 19, 2010

Economics 19/04/2010: INBS - Titanic hits the ocean floor...

INBS has reported a €2.49bn loss for FY 2009 on the loan book just under €11bn, with roughly €8.5bn of this attributable to development and investment in property markets. Provisions amounted to €2.8bn, so in other words, the Kingdom of Irish Local Finance has managed to pile up an impressive 25.5% impairment charge on the book that has already taken a hit in 2008. Between 2008 and 2009, INBS has managed to post impairments of 30%.

Actually, here is a better view: 96% of all losses are on commercial development books, which means INBS has been lending money to folks whose default rates are currently running at more than 33% yoy! These are recognized default rates, which conceal the fact that many of the INBS' loans (just as in the case of other banks) would really be deep in red, were they not re-negotiated and switched into 'interest holiday' loans back in 2008-2009. Now, remember the numbers released by Nama? 2/3rds of the loans not paying interest. Apply that to the INBS books - the expected impairment charge for 2010-2012 will be around €5.7bn. And that's only for the non-householders' loans...

The numbers are truly outstanding by all possible measures.

INBS's administration expenses rose to €46mln from €45mln in 2008, and the bank has managed to accumulate €7 million in professional fees as one-off expenses, presumably relating to the management efforts to shore up the hull of a sinking boat.

Per Irish Times report, CEO Gerry McGinn said the greatest management challenges were in relation to the commercial loan portfolio. "The society has manifestly been seriously under-resourced in many areas of its business activities and support functions, but most especially in commercial lending," he siad.

Under-resourced? As if throwing more cash at staff and consultants would have prevented them from issuing so absurdly poorly priced and analyzed loans?

At this stage, especially given Mr McGinn's denial of the reality (that the INBS is a burnt-out force with not a modicum of decorum to pretend that it can act as a functional lender) any more taxpayers cash directed to the INBS would be a pure and gratuitous waste!