Monday, May 11, 2009

Economics 12/05/2009: housekeeping & AIB

For those impatient to see analysis of the AIB Interim Results H1 2009 - scroll down to the last entry.

We are launching Ireland Russia Business Association tomorrow - the official D-day. Invitation is here. The website is next and we are currently getting this built, alongside a separate blog for IRBA. Of course, from next week on I will be in Moscow (with our trade mission) and later in St Petersburg in June for St Petersburg Economic Forum. I will be blogging from there - occasionally - so stay tuned...

And upon my return back to Dublin, I will be hosting a round table discussion on Sustainable Finance: Academic-Practitioner Interface at the Infinity Conference in TCD, June 8. The round table will be dealing with issues of facilitating a research interface between industry and academia in the area of sustainable (IIIrd generation sustainability concept) finance.

Here is an excellent article on how Schengen Visa Regime is turning Eastern European border into a new 'Velvet' Curtain. Of course, one can also add that in Ireland's case, lack of Schengen harmonization is resulting a ridiculous situation whereby people from non-EU states working in this country cannot travel on business to the rest of EU or the UK without having to spend days applying and queuing for visas and paying for these. Hours and days of work are being lost, businesses are paying for this and workers are wasting health and time doing needless pages upon pages of applications and documents collecting...

And here is another interesting thingy - for the upcoming European elections, you can actually see the records and votes, and attendance, and days worked, and more... for all our MEPs - here:

I am not going to do detailed analysis, but Proinsias De Rossa ranks second in the entire Parliament in terms of Parliamentary Questions tabled and 43rd in terms of speeches delivered. I might not agree with most of what the man has to say, but at least he deserves a credit for asking questions.

Eoin Ryan ranked 35th in terms of Motions for Resolutions. Ryan was ranked 456th in terms of Reports Amended by him, above De Rossa - ranked 492nd. In terms of reports drafted, De Rossa ranked 101st, Ryan 170th. In terms of opinions issued, De Rossa ranked 208th, but Ryan ranked 25th. Attendance to plenary meetings: De Rossa scored 499th (97.85% loyalty to political group in voting, 73.21% loyalty to the member state, 85.23% attendance record); Ryan's stats were slightly poorer (82.26% - making him more independent than De Rossa, 87.95% - making him more focused on Ireland's votes, with attendance of 83.22%) giving him a ranking of 553. Mary Lou MacDonald failed to register on the radar at all, although her specific record is there as well: here.

AIB Interim Management Statement (available in full: here) my analysis in blue, IMS original text in black.

Operating Profit: Profit before bad debt provisions has been good in the year to date and up on the corresponding period in 2008. However, this outcome benefited from base period effects, most notably higher costs in the early part of 2008.

Read: the cost base has been trimmed and there isn’t much else we can do from here on. Of course, AIB won’t admit it, but it basically has the same number of employees on its books as at the peak of the growth cycle. In exchange for taxpayers’ money, the three banks have not laid any staff, so it is the taxpayer who is paying wages for over-bloated staff ranks in the Big 3 Irish banks.

The outcome reflects the very strong performance of Capital Markets and Global Treasury in particular, driven by interest rate management activities. Performance in our other operating divisions is in line with our expectations ...down relative to the same period last year.

It does appear that AIB is lending out to other banks and is borrowing from ECB – this is the rates wedge that can be exploited by the Treasury via ‘interest rate management activities’.

Costs are being very actively managed and are down by a higher percentage rate than income at this point. Downward pressure on income is expected as the year progresses due to a continuation of poor economic conditions and dislocated funding markets.

One would presume this is due to management efforts to extract value out of operations?.. Ah, nope, it is more likely due to the positive impact of the following factors:
  • Lower ECB rates spilling over into lower financing costs;
  • Declining spreads due to taxpayers’ guarantee and capital injection;
  • Lower financing rates on property and other operating credit lines;
  • Lower cost of physical capital and capacity;
  • Lower bonuses.
All of this has very little to do with banking.

Loan and deposit volumes: balances remain broadly in line with the end of last year in each division [so no pay down of loans?]. In our Republic of Ireland business there has been a recent pick up in home mortgage applications but no material increase as yet in drawdowns. This increased activity reflects an attractive customer offering and very weak competitor presence in the market. [So why no drawdowns then, if AIB’s offer is so strong? may be because AIB is not originating any mortgages, despite giving pre-approvals? See their statement on the direction of loan to deposit ratio below...]

Customer deposits have stabilised in recent weeks following some outflows earlier in the year [How much in outflow?]. In the current recessionary conditions balances in current (money transmission) accounts have reduced. Customer resources, which include deposit and current accounts, are down by around 10% in the first four months of this year. This mainly reflects seasonal factors and outflows from our foreign institutional deposit base earlier in the year and a reduction from what was a very strong position at the end of 2008. Customer resources were up c. 9% year on year at the end of the first quarter.

I wonder if any of this is Irish wealth fleeing the Land of Brian (see here). I like, in particular the reference to a 'very strong position at the end of 2008'. Per 9% increase in y-o-y terms in customer resources in Q4 2008, how much of this is due to redundancy payments lodgements? How much is due to precautionary savings? and How much of it is due to a flight from other - weaker - Irish institutions, e.g Nation-vile and Anglo?

Margins: In highly competitive markets and a low interest rate environment, customer deposit margins continue to contract. The elevated price of wholesale market funding is also having an adverse effect on the net interest margin. Though negative effects are being partly offset by better margins on our lending, overall the net interest margin is expected to reduce this year.

Margins contraction is not surprising, given they are forced to pay higher rates to customers to retain deposits. What is surprising, however, is that lending margins are up. This could mean three things:
  1. Elevated charges on new loans - AIB doing their 'patriotic duty to lend' bit for the economy;
  2. Increased roll-over of debt at higher rates; and
  3. They are lending out cash to other banks - see the Treasury operations results above - and loving it.
Asset Quality: At our 2008 results announcement on 2nd March we outlined a base case and a stress scenario. The bad debt charge in the first quarter of 2009 of close to n800m was a little ahead of the upper end of that base case. Conditions across our markets have worsened and there will be further pressure on the bad debt provision charge for full year 2009.

Read this as: S***t is hitting the fan and we are in a 'stress' scenario now. For a bank whose chief executive just 9 months ago was raising dividends, this is really an admission that takes courage.

...our key macro assumptions for Ireland are now more negative than in the stress scenario presented at our results announcement. The pace of change is increasing loan impairment and bad debt charges. This continuing factor means that the previous stress scenario charge is likely to be exceeded and we now expect our bad debt charge for 2009 to be around n4.3 bn, c. 325 basis points of average loans.

This is still a denial case scenario. AIB's book is heavily geared toward property-related loans and its business lending is also heavily tied into Irish economy. With companies going bust at a rate rising some 400% since 2007 and accelerating, with house prices hurling toward -50% contraction on 2007 levels, land values heading for -70% and commercial propety values falling toward -50% mark, and with unemployment threatening to reach more than 3 times 2007 level, does anyone believe an impairment charge of 3.25%? In my view, they will face impairments of at least 6% across the entire book, or 3.5% on post-NAMA book.

Group criticised loans (watch, vulnerable and impaired) have increased in the first quarter to c. n24.3 bn, an increase of close to n9 bn [or a whooping 37%]. Republic of Ireland division represents over 70% of the increase and c. 75% of the group bad debt charge. Increases continue to be heavily influenced by downgrades in the property, building and construction sector [so, looking ahead, expect construction sector to flatten out in late 2009, but other sectors pick up the slack in exerting downward force on loans performance: households, personal & motor loans, business investment loans etc].

Informed by the deteriorating environment and evidenced by the increase in criticised loans, we are aggressively recognising impairment as it arises.

It will be important to see how aggressively they do this. Remember - the more they write down today, the heavier will be the total discount that they will face post-NAMA. How? Suppose you have a loan valued on your books at €100 today. Scenario 1: write down the loan value on the books by, say 10% - remaining face value is €90. Here comes NAMAsaurus - with an offer at 25% discount - you get €67.5 on the loan that originally stood at €100. Scenario 2: pretend nothing is wrong with the loan. NAMAsaurus takes a bite at the same discount (they'll have to, simply because they are short talent or staff numbers or both to examine every loan) - you have €75 on your hands. So tell me if you can spot a rational reason for AIB to take 'aggressively' to 'recognizing impairment'?

Increases in the levels of criticised loans in other sectors are now more evident in the Republic of Ireland. Mortgage arrears stand at c. 2.0% of total mortgages at the end of March up from c. 1.5% in December 2008 and impaired loans have increased to n234m [that is a 33% increase in mortgage arrears and this is just the beginning as it takes time for these to build up due to redundancy payments cushion and savings cushion - both of which have to be exhausted before mortgage payments stop. Now, average tenure on the job in Ireland is ca 5 years. This means average statutory redundancy is 10 weeks pay. Add to this consolation 'bonuses' some lucky souls are getting - say we are at 12 weeks pay. Take tax out and spread over existent balances - you are getting closer to that 9% increase in y-o-y terms in Q4 2008 customer resources mentioned above. So we have: potentially, redundancy payments have been inflowing into customers accounts. These are sufficient to cover mortgages with a cushion of, say, x1.5 times the pay length covered - i.e. 18 weeks or 4 months, roughly. That spike in unemployment in January-February 2009 will be felt in mortgage default terms only around May-June! So expect the numbers to nose dive rapidly in months to come. Even more revealing in the light of this is the subsequent fall of 10% in January-April 2009 in customer deposits - this, given inflow of redundancy payments can mean that some (those who can?) are shifting money out of AIB... and they might be doing this by B&B-ing cash abroad... away from Genghis Brian Khan...]

Capital: Our capital remains well in excess of regulatory requirements. Our core tier one capital ratio was c. 5.5% at the end of March and will be strengthened in the event that the n3.5 bn Government recapitalisation proposal is approved at the Extraordinary General Meeting on 13th May. We have previously announced our aim to further increase our core tier one capital by n1.5 bn and will advise progress on this initiative as it takes place. [With recapitalization in place AIB should have just around 10% T1 - 2-4 percentage points shy of the international industry standard. And this is before fresh writedowns... In absence of that €1.5bn capital injection, I fear AIB will not be able to retain 8% core ratio post Y2009 writedowns - let alone post-NAMA. Although this is my suspicion at this time as we await for more detailed statement at EGM].

Funding: ...Market conditions improved during April and we successfully increased our existing Government guaranteed issue maturing in September 2010 by n1 bn to n3 bn. There was good demand for the issue and overseas investors subscribed for 78% of the additional amount. We have also recently seen very good demand for private placements. [I wonder how much of this latest issue is contingent on the markets expectation that the Government guarantees will have to be extended beyond 2010. In fact, AIB, by piling on the debt that it will have to roll over comes September 2010 - for it won't have funds to simply repay it -is, willingly or not, you judge, creating the emergency conditions for the Government to extend the guarantee scheme... Oh, and by the way - do they mean the ECB discount window when they are talking about 'private placements'?]

Over time, we continue to target a reducing loan to deposit ratio although the already referred to reduction in customer resources since the end of 2008 has subsequently increased that ratio.

So, as deposits are down, loans/deposit ratio can fall only if... loans fall even more than deposits. How can this be achieved with a AIB offering "attractive customer offering and very weak competitor presence in the market" for mortgages? Ah, you say - by aggressively attracting new deposits. Indeed, that would be the case, except then, of course, you are offering higher rates than your competitors, e.g the Anglo, which in turn shrinks your margins... which you have just promised to protect (above)...

And the conclusion to all of this is - AIB's statement to the economy: "We love you, man, but we've got numero uno problem of getting these pesky loans to deposits ratios down... so bugger off, you would-be-borrower!"

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