Wednesday, September 30, 2009

Economics 01/10/2009: External Debt - still a problem

As of 30 June 2009, per CSO’s today release, “the gross external debt of all resident sectors (i.e. general government, the monetary authority, financial and non-financial corporations and households) amounted to almost €1,689bn. This represents a drop of €7bn or 0.4% …compared to the level shown (€1,696bn) at the end of March 2009.”

“…the bulk of Ireland’s external debt arises from the liabilities of IFSC financial enterprises and also that most of its overall foreign financial liabilities are offset by Irish residents’ (including IFSC) holdings of foreign financial assets.” Hmmm… again this over-emphasis of IFSC. One note of caution - we do not actually know if these 'assets' are valued at fair rates (we do not know what percentage of these assets is valued at mark-to-market, and what percentage is valued at hold-to-maturity bases), so some questions to the quality of the assets can be raised.

“Liabilities of monetary financial institutions (credit institutions and money market funds) consisting mostly of loans and debt securities were almost €691bn, a drop of almost €27bn on the 31stMarch 2009 stock level and down €117bn on the June 2008 level.” In other words, our banks are de-leveraging… as in charts below… but at whose expense?

The reduced liabilities of MFIs “are broadly reflected in the significantly increased Monetary Authority liabilities of €103bn, up by over €98bn since June 2008. These obligations are to the European System of Central Banks (ESCB)...” Aha, de-leveraging by loading up on those ECB loans, then?

But wait, there is more: “The liabilities of other sectors including those of insurance companies and pension funds, treasury companies and other relevant financial enterprises, as well as non-financial enterprises were €624bn, remaining relatively flat compared to end-March 2009. However, compared to end-June 2008, these liabilities had increased by €28bn.” Yeeeeks – banks de-leveraging is pushing ‘other sectors’ – aka the real economy – deeper into debt.

But wait, there is more: “The level of general government foreign borrowing increased by €10bn to €72bn between March and June this year and was €29bn up on the June 2008 level.” Ooops, banks are costing us here too (as do our social welfare rates and public sector wages bills).
Pull one end of the cart up, the other end sinks?

Some details on top of CSO’s release:
Table above shows percentage increases in debt levels across sectors and maturities. Pretty self-explanatory. The Exchequer is borrowing short and increasingly so. But the Exchequer is borrowing long as well, and rather aggressively as well. Monetary Authority is truly remarkable. Incidentally, MA borrowings are mostly short-term (higher than 3:1 ratio to long-term).

Banks (oh, sorry, MFIs) are cutting back debt more aggressively this year than in 2008. And, strangely enough, they are cutting more long-term debts than short-term debts (in proportional terms). Of course, this in part reflects bad loans provisions and pay downs of Irish subsidiaries debt by foreign parents.

Other sectors are rolling up accumulated interest and amassing new loans. Short-term liabilities net of trade credits are up over two years, trade credits flat over last year. What does it tell you about importing activities?
Shares of MFIs in total debt thus are falling across the years, as are FDI shares, but everything else is rising.

Looking at short vs longer term debt issuance by sector:
Monetary Authority is now almost all short-term, Government is increasingly short-termist as well. Maturity mismatch risk is rising as is, but with Nama (a rolling 6-months re-priced bond against 10-20 years work out window on loans) maturity mismatch risk on Government balance sheet will go through the roof.
MFIs short term debt is now also declining, while long term debt has been declining for some time. It would be interesting to have this broken down by foreign vs domestic lenders, but there is no such detail in CSO figures, despite CSO's constant repeating that the figures include IFSC. If IFSC is so important to this analysis - why not report it separately?

Other sectors are relatively flat, which is bad news. Trade credits flat as well.

Overall, lack of significant de-leveraging and in some cases, continued accumulation of liabilities, in the real economy.

Economics 30/09/2009: Unemployment crisis continues

Per CSO release today: “The seasonally adjusted Live Register total increased from 428,800 in August to 429,400 in September, an increase of 600. In the year to September 2009, there was an unadjusted increase of 183,422 (+76.4%). This compares with an unadjusted increase of 192,672 (+77.9%) in the year to August 2009.”

Are things improving? Declines in LR appear to point to two major factors at play here:
  • Main sources of layoffs are flattening out, including construction and retail services. This is a sign of stabilization, but it is not a sign of impending improvement, as likelihood of these sectors aggressively rehiring staff is slim in the foreseeable future;
  • Large movements from the LR are also a function of more people dropping out of the labour force and signing up for welfare benefits, while ceasing job searches.
“The average net weekly increase in the seasonally adjusted series in September was 150, which compares with a figure of 1,350 in the previous month. The standardised unemployment rate in September was 12.6%” - flat on August.

“In the month, the estimated number of casual and part-time workers on the LR was 38,268 males and 32,590 females.” In August, the same figures were 37,749 males and 32,354 females. And so on: table illustrates
How do you explain this? A friend of mine used to be a broker, now drives a taxi. Per official stats, he is doing fine. Per his own state of mind, he is doing the necessary thing to survive. This is the difference between voluntary under-employment and self-employment and its forced version. CSO’s latest figures show the latter.

So per some commentators out there, “the unemployment rate, which didn’t rise this month – the first time that has happened since December ‘07” and this is an improvement. For me, this is like telling someone who’s house just burnt down that all’s fine – there won’t be another fire for a while.

I am still sticking with 14-15% forecast for 2009 peak unemployment, though it might be looking like a bit downside from 14% is possible. Who know – Christmas season (aka desperation levels in retail sector) will tell.

Now, to that other pesky issue – labour force participation. One issue of growing importance is youth unemployment. This is contracting per LR figures. But this contraction is likely masking two factors at play:
  1. there is significant seasonality - much of youth employment is part time and linked to higher activities in summer months (hotels, recreational etc sectors), plus
  2. there is a number of those who are simply dropping out of the labour force (either those who would have joined, but are not joining now that the jobs evaporated, or those who have been out of work for over a year and stopped searching, or those who have gone back to school or who continued in school transitioning to a new programme).
Per QNHS released earlier this month: "Almost all of the decline in the size of the labour market is attributable to a decline in participation of almost 36,000.” Now, remember, that was for Q2 2009 – pre summer months. “This is shown by a fall in the participation rate from 63.7% in Q2 2008 to 62.5% in Q2 2009.” To me, this indirectly confirms that drop-outs from the labour force are most likely to be our younger workers. In QNHS see Table 9: labour force participation rates have fallen by age group as follows for April-June 2007 to April-June 2009:
  • 15-19 age group from 29.1% to 22.1% (7 percentage points down)
  • 20-24 age group from 77.0% to 73.6% (3.4 percentage points down – less than half of decline in younger category)
  • 25-34 age group from 85.5% to 84.7% (0.8 percentage points down)
  • Economy-wide from 64.0 to 62.5% (1.5% percentage down)
So youths are dropping out of labour force at a rate nearly 5 times those of the average decline.

Hmm… things are improving, rapidly. Dom Perignon 1988 uncorking time, yet?

Economics 30/09/2009: Global Financial Stability Report

Update: There is an interesting note in one of today's stockbrokers' reports: "AIB is to review its selection process for a successor to Eugene Sheehy, according to reports this morning. The Government will not endorse an internal candidate based on renewed signals according to the article. Separately, Minister Brian Lenihan said it was "inevitable" that further public capital will be required by the country's banks after the NAMA transfers."

Two points:
  1. If Government is so aggressive in staking its control over AIB's selection of a CEO, why can't the same Government commit to firing the entire boards upon initiation of Nama? Governments change overnight, so why banks' boards are so different?
  2. I must confess, I like Minister Lenihan's belated (this blog and other analysts have said months ago that there will be second round demand for funding post-Nama due to RWA changes triggered by Nama, and then due to second wave of defaults within mortgage and corporate loans portfolia) recognition of a simple financial / accounting reality. Strangely enough, the brokers themselves never factored this eventuality in their projections of Nama effect on banks balance sheets.
Oh, another little point: Minister Lenihan was last night explaining on RTE that BofI and IAB both raised circa Euro1bn bonds each with the issues oversubscribed by a healthy margin and that these were 3-3.5 year bonds. we should be impressed, then? Au contraire: those foreign investors (in the case of BofI 92% of the bond issue gone to foreign institutionals and banks) are making a rational bet that Ireland will continue to guarantee depositors through 2014 if not even longer, and that the Exchequer will rather destroy the households than see banks go under. In other words, the markets priced Irish banks now as being effectively fully guaranteed by the state - bondholders, shareholders, unsecured debt holders, furniture and office suppliers, staff - you name a counterparty working with Irish banking sector... they are all now implicitly guaranteed by you, me, ordinary taxpayers in Tallaght and elsewhere across the nation. Some success, then.

News: IMF's Global Financial Stability Report Chapter 1 is out today. This is the main section of the report and it focuses on two themes:
  1. Continuation of the crisis in financial markets - the next wave of (shallower, but nonetheless present) risks to credit supply in globally over-stretched lending institutions; and
  2. Future exist strategies from the virtually self-sustaining cycle of new debt issuance by the sovereigns that goes on to mop up scarce liquidity in the private sector, thus triggering a new round of debt issuance by the sovereigns (irony has it, I wrote about the threat of this merry-go-round link between public finances and private credit supply back in my days at NCB - in August 2008).
The report is a good read, even though it is a voluminous exercise - check it out on IMF's main website (at this hour I am still working with press access copy).

Ireland-specific stuff:
Nice chart above - Ireland was pretty heavy into ECB cash window back in 2007, but by 2009 we became number one junkies of cheap funding. Like an addict hanging about the corner shop in hope of a fix, our banks are now borrowing a whooping 7% of their total loans volumes through ECB. This is a sign of balance sheet weakness, but it is also a sign that the banks are doing virtually nothing to aggressively repair their balance sheets themselves. Why? Because Nama looms as a large rescue exercise on the horizon.
But, denial of a problem is not a new trait. Per chart above, through 2006, Irish banks were third from the bottom in providing for bad loans despite a massive rate of expansion in lending and concentration of this lending in few high risk areas (buy-to-rent UK markets, speculative land markets in Ireland, UK and US and so on). Now, taking the path the Eurozone average has taken since then, adjusting for the decline in underlying property markets in Ireland relative to the Eurozone, and for the shortfall on provisions prior to 2007, just to match current risk-pricing in the Eurozone banks, Irish banks would have to hike their bad loans provisions to 3-3.75%. And this is before we factor in the extremely high degree of loans concentrations in property markets in Ireland. Again, why are we not seeing such dramatic increases? One word: Nama.
Lastly, table above shows the spreads on bonds in the US and Eurozone. Two note worthy features here:
  1. The rates of decline in all grades of bonds and across sovereign and corporate bonds shows that they are comparable to those experienced by Ireland. This debunks the myth that Irish bonds pricing improved on the back of something that Irish Government has done ('correcting' deficit or 'setting a right policy' for our economy). Instead, Irish bond prices moved in-line with global trends, being driven by improved appetite for risk in financial markets and not by our leaders' policies;
  2. Current spreads on Irish bonds over German bunds suggest market pricing of Irish sovereign bonds that is comparable to US and European corporates. In effect, Ireland Inc is not being afforded by the markets the same level of credibility as our major European counterparts. One wonders why...

Tuesday, September 29, 2009

Monday, September 28, 2009

Economics 29/09/2009: Socialism is Bad for Your Health

International health services ratings 2009 Euro Health Consumer Index (EHCI) were published today. These provide comparisons for a number of EU countries, plus Switzerland and Canada. Tables below show Irish performance over 2006-2009 in the rankings and the performance of our closest peers - small European economies.

Summary of overall performance:
Before looking at the tables, here are some facts:
  • All leading healthcare systems (top 4 in the table) have separated provider of services (mixed models of private, publicly-owned but independent, locally-owned & non-profit) from payee (state) for services.
  • Of top 10 performers, 5 have fully separate functions of service providers and payees for service, 3 others have a mixed system. In contrast, Ireland has not even a mixed system, with all primary, emergency and non-elective medical service providers being captured by the state.
  • Ireland is ranked a lowly 14th this year, although it is a marked improvement on the past years performance (see below).
  • Fully nationalized system of healthcare practiced in Canada scores marginally worse than Ireland in patients rights and access to information. Only Latvia, Portugal, Romania and Spain score worse or equally poorly as Canada in this area.
  • Canada scores worse than Ireland in waiting times for treatment. The only other country that scores as poorly as Canada in this area is Latvia.
  • In terms of healthcare system outcomes (designed to gauge basic treatments effectiveness), Canada scores as highly as Ireland, with both countries ranked between the 4th and 8th places.
  • In terms of range and reach of health services provided within the system, Canada (100) scores marginally above Ireland (92), with Canada ranked between 12th and 14th places, while Ireland ranks between 15th and 22nd places.
  • In terms of access and quality of pharmaceuticals within the system, Canada ranks between 26th and 27th. Ireland ranks between 2nd and 8th.
  • Thus, contrary to the noise about 'socialised medicine for Ireland's future' movement within Irish Left, global data shows year after year, that using objective criteria, socialised medicine is bad for your health.
Now more detailed tables compiled by me from previous years' reports:

Economics 28/09/2009: Aggressive pre-Nama re-writing of loans?

Corrected version (hat tips to Adrem for correcting my math and for suggesting a good question to follow up on)

I was told today, by a senior banker, that banks have been actively re-writing non-performing loans (since at least April this year) under new contracts with extended principal and interest holidays in covenants. These, in preparation for Nama, are priced at higher rates so they can get more on the loans once Nama discount applies.

This makes sense.

Do the math - assume:
  • 20% cross-collateralized Euro100mln loan (see explanation of this below), written in 2006
  • 3 years rolled up interest at 19.1% accumulated at 6% pa - which gives us loan face value at placement on the bank watch list of Euro119mln
  • New covenants set in April 2009 at 9%pa, with no interest yield or principal repayment required for the next 3 years.
  • On the date of Nama initiation, then, the loan is performing with expected yield of 9% on Euro119mln.
  • Now, suppose the LTV ratio of the loan is 75% of principal (meaning the value of the underlying collateral was 133mln in 2006)
  • Assume that collateral value has fallen 30% (an under-estimate to be palatable to all optimists out there), which means that with 20% cross-collateralization writedown, plus 2% inflation annually since 2006 (cumulative inflation discount of 6.1%) collateral now is valued at 63mln,
  • By the time new covenants on the loan kick in in 2011, the rolled up interest on the loan and principal will mean total loan value will be roughly Euro 154mln.
  • Now, to break even on this loan Nama will have to pay 1.5% interest charge on bonds, plus 0.5% management cost (including bank fees), implying that 3 year average mark-to-market writedown (at 2% pa or 6.1% cumulative) plus inflation at 1% pa on average (3% cumulative) is (1-63mln/154mln*0.91)*(100%)=62.7% (assuming no growth in the property market between now and 3 years from now).
Remember that figure in the Irish Times article signed by 46 economists, including myself? It stated that the real value of 90bn worth of distressed loans is around 30bn. That implied a mark-to-market writedown of just 67%! When published it caused Garret Fitz to go ballistic and the entire pro-Nama crowd to shout "Extremists are at the gates!" Not that far off from 62.7%.

Of course, this is an illustrative example. But notice that it assumed very modest decline in underlying assets value (30%) to date, plus a very generous (75%) LTV ratio. House prices alone are already down by more than 30% from the peak.

Challenge the rest of my assumptions?

Whether you do or not, one thing is clear - if you are a bank you had no incentive to manage your stressed loans since the very least this April. And you had a massive incentive to push up the face value of the loan without forcing it to become non-performing. The latter can be done by re-writing the loan with new roll up covenants.


Banks gave multiple loans on same properties in several forms -
  1. most commonly, a property was valued several times consecutively and whatever capital gains accrued on the property, these gains were re-mortgaged under new loans;
  2. also commonly, capital gains were priced out of new building permits being extended to the properties. I am aware of several cases of mega deals (hundreds of millions borrowed) where a developer/investor bought a site with the site itself being collateralized for this first round of borrowing at the market value, then rezoned it, taking out a new loan against the site value after rezoning in excess of original loan, then obtained a planning application and re-collateralized the site again;
  3. less commonly, the banks simply did not check if a collateral property has already been pledged elsewhere.
What happens here then?

Suppose a site was bought for 100mln at 75LTV, so that the developer borrowed 75mln for it. New zoning applied lifting the site value to 200mln, providing another 75mln loan facility at 75%LTV on 200-100mln capital gains. The building permission was then granted that, say lifted the site value to 300mln, and a new loan was taken out at 75LTV. Total value of the site was 300mln. Suppose each step in borrowing and capital gains took 1 year (a very short period of time), suppose interest rate was 5%. This means that:
Loan 1 now totaled Euro83mln
Loan 2 now totaled Euro78.8mln
Loan 3 now totals Euro75mln.
At loan 3 origination, LTV ratio on the entire site was 236.8/300=79%.

I assumed in my calculations on the blog that 20% of loans are written against sites that are cross-collateralized - so that other banks hold claims against the same site.

This assumption is based on a guess. It can be challenged if someone has any evidence on better numbers.

Now, that means in example above that some 20% of the site value was cross-collateralized with another bank. If it was the first loan that was cross-collateralized, LTV rises to (236.8+20% of 75)/300=252/300 or 84%. If all three loans were cross-collateralized at 20%, the resulting LTV is (236.8*1.2)/300=284/300 or 95%.

So here you have the maths on Nama - 75LTVs on each loan in reality can mask a 95% LTV of total loan package.

Economics 28/09/2009: Anglo moving staff & loans to Nama

Ahead of actual establishment of Nama, Anglo Irish Bank has internally been reallocating moving staff and loans to Nama - even before the debates in the Dail and the legislative vote on Nama.

Source close to the bank has informed me that Anglo management have internally established that
  • 100 staff members are being transferred to Anglo Nama division to be located in their new offices on Burlington Road. The staff transferred is non-lending personnel and transfers might proceed even before the legislation establishing Nama is voted on.
  • Anglo Irish Bank will face an 18 months moratorium on new lending (which begs the question as to what its staff will be doing if a large chunk of its business will be transferred to Nama, while another sizable chunk is expected to be sold in the US).
  • Staff at the bank - on selective basis - were given a questionnaire as to their preferences for either staying with the bank, going to Anglo's Nama division or leaving the lender. This process - initiated some weeks ago - has now, allegedly, been completed.
  • There has been no signalled decision on what will be the full number of staff transferred to Nama division and what staff cuts will follow at the main bank.
  • Top 20 borrowers' loans are also being transferred (ahead of Nama establishment) to Anglo's Nama division, in effect providing for advanced transfer of loans to yet-to-be-approved entity. The source used the words 'unofficial transfer'.
To reiterate - this information comes from sources close to the bank.

If these developments are confirmed, they raise several important questions relevant to Nama:
  1. Putting aside the issues of legislative process being pre-emptied by the beneficiaries of Nama transfers, what has been done to assure due attention has been given in the participating banks to managing the loans? If Anglo (and possibly other banks) are ready to unroll the entire infrastructure of managing Nama loans today, how much of their internal resources (that could have been used to properly manage stressed loans) have been diverted to the preparatory stages of Nama processes?
  2. The banks cannot set up internal divisions to manage Nama loans unless they have had some certainty on who will pay them for this function in the future and how much they will be paid. Once again, to date, Government has failed to clarify these crucial provisions. A commitment to keep 100 staff in Anglo Nama would be expected to cost the bank around Euro 15-17mln per annum in staff costs, plus additional leasing and administrative costs.
  3. Decision to move to a specified office location on new premises should be carefully vetted to avoid any potential conflicts of interest (e.g developer owning the building in which the new Nama-related division will be located should not be amongst those whose loans are being transferred to Nama). Again, has this work been performed already, suggesting that the banks are rushing off the start line before the start signal is actually given?
If I were either a Green member of the Dail or an opposition representative in the Legislature, or indeed a backbencher of FF, I would certainly like to know how commitments of resources, contractual obligations etc can be entered in with respect to Nama ahead of the forthcoming vote...

Sunday, September 27, 2009

Economics 27/09/2009: Leverage across Ireland Inc

Crunching through the IMF database on Financial Stability reveals some serious structural problems in Irish Government&Monetary Authorities positions, as well as in Banks and Non-Banking Sectors of economy. These are long-term themes worth considering.

First General Government & Monetary Authorities:
Chart below shows how extreme is our recent performance in terms of maturity mismatch risk on our General Government & Monetary Authorities debt, with Ireland now leading the group of comparable economies in terms of overall share of short-term (highest risk) borrowing relative to total borrowing.
Chart below shows that we also lead peer group of countries in terms of issuance of new debt despite the fact that the peer group includes such 'sick puppies' as Latvia, Estonia, Greece, and Hungary (some subject to IMF rescues in the last 18 months). Although IMF database does not contain comprehensive data on Iceland, it is clear that Ireland is fiscally in worse shape than all of the APIIGS and even Latvia, Estonia & Hungary. Furthermore, despite Q2 2008 announcements by the Irish Government that it will undertake significant corrective measures on fiscal insolvency side, chart below shows that our 'corrective measures' to date have been mostly about borrowing more in international markets, while the chart above shows that, increasingly, this borrowing is short-term.
Chart below provides an index of General Government and Monetary Authorities debt, setting Q4 2002 level of debt at 1. This dramatically illustrates the scale of Irish insolvency, with debt accelerating from Q1 2006 at a rate far in excess of all other peer group countries.
Banking Sector:
Looking at our banking sector, total sector debt in Ireland now exceeds all other peer countries debt, despite the fact that many of these countries have bigger economies and populations than Ireland. It is fallacious to attribute this result to the presence of IFSC institutions, as the data above is comparable with Hong Kong and Luxembourg - both of which are major IFS centres themselves.
In line with other borrowing trends, Irish banking sector now runs the second highest proportion of short term debt liabilities relative to all debt liabilities. As expected, our banking sector maturity mismatch risk is only marginally lower than the same risk in the general government and monetary authorities accounts.

Who's more reckless in risk taking, you might ask, the Exchequer or the Bankers? Sadly, when it comes to maturity mismatch risk, it is the Exchequer.The rate of debt accumulation in Irish banking sector, however, is in rude health, with banks in this country deleveraging much faster than the Exchequer (which is leveraging up instead of paying down debts, and this is before Nama), the Corporates (see below) and the Households. In other words, while the entire country is scrambling to help bankers, it is other sectors of economy that are bearing increasing burden of rising debt exposure.

Furthermore, an important footnote to Nama: chart below also indicates that the likely direction of Nama funds once banks receive state transfers will be to further reduce leveraging in the banking sector. As I have predicted earlier, Nama will be used to pay down more expensive interbank loans, with preciously nothing going into economy in the form of new credits.Index of total debt for Banks shows the rate of debt increases (leveraging up) since Q4 2002.

Non-banking Corporate Sector:
Total debt in Irish corporate (non-Banking) sector stands out as an outlier in the reference group of countries. This is an apt illustration of Corporate Ireland's obsession with leveraged buyouts, M&A binges at the top of corporate valuations and other debt-financed 'growth' deals done by Irish companies.

The above chart clearly shows the extent of the risk that is inherent in Irish Corporate Finance structure and the high probability that Nama will be followed by a new wave of banks balance sheets deterioration - this time on Irish corporate side. It also indicates that a restart of 'normal credit cycle' in Ireland will require an actual and drastic deleveraging of Irish companies, not a new lending out by the banks to prop up debt-ridden enterprises.

Chart below reinforces this point, by showing that our corporate debt represents an excessively high proportion of overall debt.
Not surprisingly, growth dynamics in Irish corporate debt were equally extreme as chart below illustrates.
Interestingly, Irish corporate borrowing activities remained relatively static when compared to the growth rate in total debt obligations of the country.Perhaps the only 'good news' is that most of our corporate borrowings were in form of longer term debt - a sign that any crisis in corporate insolvencies due to debt overhang will be delayed in time relative to other sectors (Government, Banks and even households).

Direct Investment decline:
Lastly, a quick look at direct investment flows to Ireland (from debt side). As the country engaged in uncontrolled debt spree, overall role of direct investment in economy has fallen in time from over 15% of total debt stocks to under 12%.

Friday, September 25, 2009

Economics 25/09/2009: Euroarea improving growth

Eurocoin is out for August and it is showing a positive reading for the first time in 15 months:
So it is time to upgrade a notch my forecasts.

Interesting detail - Eurocoin turn around is under-pinned by rising (though still negative) trend in industrial production, business surveys (both PMI and EU Commission) still staying on the negative side, with Commission survey being particularly gloomy. Consumer surveys are still in dire straits, with exception of Italy (happy summer, folks) and Spain, though Spain is now looking poised for a double-dip consumer recession. Stock prices still are posting poor performance except for Spain and to a lesser extent Germany. Exports are at zero growth rates across the Eurozone, but are modestly positive in Germany, France and Spain.

Net result - a mixed bag of continued weaknesses (abating) and some strengths (very modest).

Economics 25/09/2009: Don't believe 'our recovery plan' drivel

I like some of our brokers guys and gals, I really do – they are intelligent, ambitious, outwardly mobile in their outlook and hard working. They often spot the rat, although usually warn of its existence only privately. But the current Nama and Lisbon ‘debates’ are just too much for them to bear without assuming the usual 'hand in the sand' positions.

First Davy strategist was telling us all that everyone criticizing Nama is a ranting lunatic (at the very best) or a deceitful manipulator (at its worst). I obliged to reply here.

Now, Bloxham folks lined up to spout nonsense as well. Here is an example from today’s morning note: “A Yes vote [in Lisbon Referendum] would be seen as positive [one assumes by the markets] and would keep recovery plans on track ahead of the critical NAMA vote…”

I don’t give a damn how Bloxham modeled their assertion on the markets' assessment of an outcome of the Lisbon vote. The Wall Street Journal disagreed with them. Studies performed on sovereign default spreads in the Eurozone and bond spreads are inconclusive one way or the other. But one thing is certain when it comes to spotting a lie in their statement: an assertion that either Lisbon or Nama or both can ‘keep [Irish] recovery plans on track’.

This is a first class bullshit.

One minor point why this statement makes absolutely no sense is that the 'distance' between the Lisbon vote and Nama vote is going to take place within a couple of weeks there after, around October 14-16. If Irish economy is so critically sick that a difference of two weeks can push it off the track, I wonder if Lisbon vote would be of any priority for our stock brokers at all.

Now to a bigger lie in the above statement:

In order to keep plans on track, one must first have a plan. Or at least and inkling of one. A handful of morsels of thought saying: we want to do A to achieve B… and a short list of actions to be taken to get there. This is a starting point for any logical ‘keeping on track’. And, guess what, unless you are smoking the same stuff folks at Bloxham are, there are no plans. Let me repeat: there is no plan for an Irish economic recovery.

Fiscal crisis: this is Government’s own backyard, so we should expect that at the very least here the Cabinet has done some homework on getting a plan for recovery started. Nope. McCarthy Report and Taxation Commission Report – two key pieces of policy strategy are now largely binned by the Government. It is clear that there is no will in our Triumvirate to do anything serious about the expenditure side of the fiscal crisis. Even Bloxham guys would probably agree that in the current conditions there isn't anything new they can do on tax side of things either - short of turning us all into serfs. The fiscal stabilization ‘plan’ presented officially by DofF following the Supplementary Budget 2009 was a re-hashing of the exactly identical ‘plan’ from January 2009 which was rehashing the ‘plan’ from October 2008 Budget. All three were not realistic in their assumptions and expectations and all three had not a single year of declining nominal current public expenditure between 2008 and 2013.

Economic crisis (domestic economy): this Government produced only one strategy document on domestic economy. Don’t call it a policy document, for it is too vague and lofty to be a policy. Their vision of the future of Ireland Inc was, and remains, in a nutshell, a combination of lab coats with Petri dishes in hands growing thoughts and knowledge in the foreground and windmills spinning out green energy in the background. The ESB is in existence too, with new sparkling headquarters and, one assumes, smokestacks belching CO2 to offset green energy from the windmills. If Bloxham folks think this drivel passes for a plan, good luck to them. Domestic consumption is being killed off by reckless tax increases. Domestic investment is being kept below the water line by absurd taxes on capital, charges on capital-intensive activities and depressed savings of the households. Households are prevented by the Government from de-leveraging and will be facing increasing costs of mortgages and credit post-Nama due to banks hiking up charges and margins.

Economic crisis (external economy): apart from IDA’s advertising campaign launched last week by our unfortunate choice of a Tanaiste, there is no plan for improving competitiveness of Ireland Inc vis-à-vis foreign investors and domestic exporters. There are no reforms in the pipeline to help improve their operating costs, capital costs, costs of electricity, gas, water supply, costs of currency risks on sterling and dollar side, costs of labour, health & safety, costs of buying out trade unions into agreement not to derail investment and production, costs of state-controlled and regulated transportation, energy, communications, etc services.

Financial crisis: half-thought through idea of Nama is unlikely to do anything significant to improve flow of credit in this economy – I wrote on many occasions about the risk of capital being transferred out of the country and about banks’ incentives to pay down inter-bank lenders, plus about potentially zombie banks and development markets, dormant / dead property market and other potential downsides to Nama, so no need to repeat this here.

So, my dear friends at Bloxham, what is the exact ‘plan for recovery’ that we will 'keep on track' if we vote Yes to Lisbon and/or Yes to Nama? Name one, please…

Thursday, September 24, 2009

Economics 25/09/2009: Notes on trade flows

Per separate CSO release (see national accounts and broader trade flows discussion here), however, the positive trends in exports shown in the figures for Q2 2009 have not held into Q3: seasonally adjusted exports fell by 8% in July 2009, relative to June 2009 and imports hit a new low point for recent years.

June 2009 exports showed some bounce (due to volatility) having increased by 5% relative to May 2009 while imports decreased by 9%. Thus, July changes erase positive momentum in exports and continue to exacerbate negative movements in imports.

Given that for volatile time series during the periods of contraction seasonal adjustments can mask true extent of falls, taken on an unadjusted basis, the value of exports in July 2009 was 5% down on July 2008, while the value of imports was down 31%. The value of exports in June 2009 was up 5% on June 2008 and the value of imports was down 24%.

This is worrisome, as H1 2009 posted overall rise in exports of 2% on yoy basis. This was led by MNCs-dominated sectors: medical and pharmaceutical products increased by 22%, organic chemicals by 19%, other transport equipment (including aircraft) by 262% (€414m) and professional, scientific and controlling apparatus by 11%. On the back of large layoffs in the sector, computer equipment decreased by 27%. Capital investment cycle hit hard electrical machinery (down 28%), industrial machinery down 37%, telecom equipment fell 23% and power generating equipment contracted by 45%.

Imports decreased 21% in H1 2009. Aside from predictable cars and retail goods, investment-related goods imports also contracted severely: computer equipment by 40%, specialised machinery by 54%, industrial machinery by 36% and electrical machinery by 16%.. Petroleum products imports fell by 38%, signaling that MNCs might be reducing output here, while increasing value of output registered to Ireland (transfer pricing). Ditto for small increase of 4% in medical and pharmaceutical products, and organic chemicals also rising by 4%, - both major inputs into allegedly booming pharma and medical devices sectors. Goods from the United States increased by 34% - again a sign of more value being booked on importation side of MNCs.
Table above shows that MNCs-dominated sector of chemicals and related products (pharma etc) has increased its overall share of exports in June 2009 and in H1 2009. Other sectors remained relatively stable with modest increases in the share, except for computers-dominated machinery and transport equipment sector. But there is more trouble ahead:
In bold in the above table I have marked those sectors where there has been expanding imbalance between exports and imports. This imbalance suggest to me that international companies are shipping fewer inputs into Ireland, while managing to ship more outputs. This can only be done in a wondrous world of accounting procedures designed to reduce tax exposure.

Again, banana republic…

Economics 24/09/2009: There used to be a real economy in there...

Enough of Nama, for now. Data from CSO is coming thick.

Initial estimates for the second quarter of 2009 show year on year declines in both GDP (-7.4%) and GNP (-11.6%), with the gap between GDP and GNP widening. Compared with the corresponding quarter of 2008, GDP at constant. Quarter-on-quarter, GDP remained constant in Q2 2009, while GNP slid 0.5%. It is worth recalling that GDP-wise Q1 and Q2 2008 were already negative growth territory, so current ‘stabilization’ comes on top substantial declines taken in 2008.

Predictable sources of declines: consumer spending (down 6.8% yoy), capital investment (down 24.4% in Q2 2009 yoy), net exports are up yoy boosted by MNCs (goods manufacturing) and by collapse in imports. Industry output down 11.3% yoy and within construction sector – 30.8%. Every sector is posting fall-offs.

Incidentally, do tell me there is demand for credit out there that urgent we have to break the back of the entire country to repair it. I can't see one - capital investment tanked, so companies are not in a mood to invest in future capacity (see stocks changes, too), while personal consumption is bouncing at the bottom, every time a little lower. Oh, I get it, if only the banks were issuing new loans, we all can go out, borrow some more dosh to pay for... hmm... Brian Cowen's excesses in spending? But back into non-Nama land:

Q1 2009 annual rate of decline was 13.1%, so Q2 decline looks positively slower at 11.6% when it comes to GNP at constant prices. For GDP these figures were 9.3% and 7.4%. But, of course, one has to remember that Q1 2009 annual changes were against Q1 2008, when both GDP and GNP grew by 0.1%. Q2 2009 changes, however, came on top of 0.4% growth in GDP and 0.6% growth in GNP.

In constant euros, our Q1 2009 GNP, at €35,182mln was comparable to the level of income in Q1 2005 (€35,238mln), while Q2 2009 GNP of €35,175mln was below that recorded in Q2 2005 (€35,862mln).

Gross domestic capital formation has fallen to €7,659mln in Q2 2009 down from €8,217mln in Q1 2009. We are now at the lowest level in capital formation terms since the end of 2002 (as far as these series stretch). Physical change in stocks has totalled -€911mln in Q1 and Q2 2009 the greatest cumulative drop for half-year of any year on record (since the start of 2003).

Two charts below illustrate some less apparent trends:
Services balance is deteriorating as financial and legal services exports are suffering. Of course, our hospitality and tourism exports have fallen off as well, thanks to economically illiterate Budget 2009. This is a point of alarm. Our exports of services are now below those recorded in 2007 in constant prices. Our total exports have fallen 2.5% in Q2 2009 (yoy) – a less deeper cut than in Q1 2009 when total exports contracted 3.0%. Goods exports have fallen 3.1% in Q1 2009 and 3.7% in Q2 2009, so things are getting worse here. Services exports contracted 2.8% in Q1 2009 and -0.9% in Q2 2009. Imports overall have declined 10.6% in Q1 and hen 7.1% in Q2 2009 – better than before, but still third deepest fall since the series revision in Q1 2004. Goods imports are down 22.3 in Q2 2009 yoy – marginally better than 24.8% contraction in Q1 2009.

Table below compares trade performance relative to corresponding quarters of 2007:

The above chart shows that taxes, public administration and defence contributions to GNP are falling over time – since Q1 2007 and despite April Budget and October 2008 budget, this fall continues today. This is not to be confused with the falling cost of Government in terms of taxation-exerted drag on growth. The decline in Government share of GNP is reflective of two things:
(1) there has been a marked decline in capital investment (i.e we still waste piles of cash on non-investment activities);
(2) the rising interest rate bill on Government debt is now adversely impacting GNP.

Now, GNP/GDP gap illustrated…
Self explanatory, really.

Now, recall those evil Americans who, according to our Taoiseach and his Cabinet members, gave Ireland this recession... Chart below illustrates:
Yeps, they (Americans) sneezed, Europe got a slight fever, the UK is out with a major flu and Ireland is... well... Ireland is busy dumping tens of billions in cash it does not have on public sector wages, social welfare payoffs and, next best thing to Partnerships - Nama...

Wednesday, September 23, 2009

Economics 23/09/2009: Cost of Nationalization

Today's note from Davy Stockbrokers throws into public domain a challenge and an accusation:

"Regrettably, the public debate on NAMA has been anything but rational and dispassionate. Confusion, misinformation and, at times, rank deception has run riot over the past several months... Tellingly, the brunt of discussion has majored on an anti-NAMA rant, with scant exposition of any credible alternatives."

If Davy is so dismissive of the 'alternatives' - of which there have been several rather involved ones - then Davy should be even more dismissive of the Nama proposal itself, for the Government still has no estimates for costs, returns, time horizons, detailed haircuts, borrowing terms for Nama bonds etc - after 6 months of working on it with an army of civil servants, highly paid consultants and having the likes of Davy on their side!

"Nowhere is this more depressingly obvious than in relation to the nationalisation option, wherein protagonists have tended to confine their treatises to a short paragraph or three, and where the potentially ruinous funding consequences for both the banks and sovereign have been glossed-over..."

Of course, unlike Davy or other stockbrokers, it is the independents: Brian Lucey, myself, Karl Whelan and Ronan Lyons who actually bothered to estimate - to the best of our resources - the expected costs of Nama to the taxpayers. Instead of focusing on the benefits and costs to the taxpayers, Irish stockbrokers focus on benefits to the banks and their shareholders. This is fine, and I will not accuse them of doing anything wrong here - their clients are, after all, not taxpayers, but shareholders. But it is rich of Davy team to throw around accusations of us, independnt analysts, 'glossing over' aspects of Nama - we are not the ones being paid by anyone for doing this work.

The emphasis on 'estimate' and 'expected' is there to address Davy accusations of 'rants' or 'deceptions'. If estimates are rants, Davy-own entire daily research output can be labeled as such.

But Davy folks are correct in one thing - we, the critics of Nama, have not produced an estimate of nationalization option cost. Instead, it was, me thinks, Brian Lenihan who promised to produce such estimates. May be Davy note was addressed to his attention?

Seeing the eagerness with which Davy folks would like to see some numbers on nationalization, below is the summary of estimates of such an undertaking developed by Peter Mathews (you can see his article on this in Sunday Business Post (here) and confirmed and elaborated by myself and Brian Lucey. (Again, note, one can only assume that our Davy folks do not read Sunday Business Post's Markets Section.)

I have argued in my Nama Trust proposal (aka Nama 3.0) (here) that we can avoid nationalization by buying out equity in the banks to support writedowns and then parking this equity in an escrow account jointly owned by all taxpayers. The banks will, then be owned by the Trust, not by the Government. Their shareholders will be Irish taxpayers as individuals, not the Government. The Trust will be there simply to provide a time buffer for orderly dibursal of shares over time.

Now, whether you call it 'nationalization' or 'Trust' or anything else, the problem with the banks in Ireland is that they need to write down something around 40% of the troubled assets values. This can be done by gifting them bonds (as Nama will do), or by buying equity in the banks in exchange for the same bonds, except, as below shows, at much lower cost.

In the first case, you get a promise of repayment from the banks and a pile of heavily defaulting loans. In the latter case, you get shares in the banks.

In the table above, the first set of red figures refers to the amount of equity capital that will be need for repairing banks baance sheets today (it can be issued form of bonds, just as Nama intends to do, which will be convirtible through ECB repo operations at the same 1% over 12 months). The amount we will need to put into banks under 'nationalization' or Nama Trust option is Euro30.88bn.

The bondholders will remain intact (so no additional cost of buying them out).

This upfront cost is over Euro 23bn cheaper than Nama. And it can be further reduced if we get at least subordinated bond holders to take a debt-for-equity swap, which they might agree to as they will be taking equity in much healthier banks.

The second and third red figures refer to the expected recovery on this equity purchase in 5 years time (not 15 as in the case of Nama). And all assumptions used to arrive at these two scenarios are listed. The figures are net of the original Nama cost. In other words, under these two scenarios, we can generate a healthy profit on Nama Trust, which we cannot hope to generate in the case of overpaying under the proposed Nama scheme.

In addition to the table above, I run another third scenario that assumes:
  • 5% growth pa in banks shares (as opposed to 15% and 10% growth under scenarios A and B);
  • Banks fully covering 1.5% cost of Government bonds (as in scenario B);
  • Banks paying a dividend to the Exchequer of 2% on loans (net of bad loans) and charging 0.5% management fee, so net yeild is 1.5% on loans (as in Scenario B).
The bottom line in this scenario was ca €9bn in net return to the Exchequer on 'nationalization' within 5 years of operations.

Back to Davy note: "...the potentially ruinous funding consequences for both the banks and sovereign have been glossed-over..." Well, let me glance it over.
  1. Nationalization can be avoided per my Nama Trust proposal, so there goes entire Davy 'argument'.
  2. If the banks balance sheets are repaired with a 40% writedown of bad loans under the above costings while Nama would achieve only 30% writedown at a much higher cost, what 'ruinous' consequences do Davy folks envision for the banks? Their balancesheets will be cleaner after the above exercise, than after Nama!
  3. If Irish Exchequer were to incur the total new debt of €30bn (per above proposal) and will end up holding real equity/assets against this debt, will Exchequer balancesheet deteriorate as much from such a transaction as it would from an issuance of €54bn in new debt secured against toxic assets such as non-performing loans? Again, it seems to me that a rational market participant (perhaps not the Davy researcher authoring the note) would prefer to lend to a state with smaller debt and real assets against it than to the one with higher debt and dodgy assets in hand.
Back to Davy: "...the retention of impaired assets on bank balance sheets ...would continue to cast a deep pall over perceived solvency risks in the Irish banking system, leaving this country still bereft of the necessary refinancing flows from which green shoots might grow."

I would suggest that this statement is itself either a deception (deliberate) or a wild speculation (aka rant). There is absolutely no reason why fully repaired banks (with 40% writedown on the loans under the above costings and as opposed to Brian Lenihan's proposed Nama writedown of much shallower 30%) cannot have access to the same lending markets as banks post-Nama would. However, under the above proposal:
  • Irish Government will take much lower (24bn Euro-lower) debt on its books, implying healthier bonds prices for the Government into the future - some savings that won't happen under Nama;
  • Banks enjoy much more substantially repaired balance sheets (again, not the case with Nama);
  • There is no second round demand for new capital from the banks (not the case with Nama as proposed).
So, again: judge for yourself. When is the insolvency risk for Irish banking system higher:
Case 1: more substantially repaired banks balance sheets and more fiscally sound positioned Exchequer; or
Case 2: lesser writedowns of bad loans and more indebted Exchequer?
If you vote for Option 1 (as any rational agent in the market would do), you vote for the above 'nationalization' exercise.

Lastly, Davy note lands a real woolie: "When all is said and done, NAMA is not a bail-out of developers, or bankers, but of a banking system and its host economy. In that respect, it is a bail-out of ourselves."

Under Nama, developers will be able to delay or avoid insolvency declarations and subsequent claims on their assets. If this is not a bail-out, it is a helping hand of sorts.

As per 'repairing economy' - there is absolutely no evidence to support an assertion that Nama will have any positive economic impact, but given that it will impose much higher cost than alternatives on households, it can have a very significant negative impact on the economy. Perhaps, Davy think that households are simply there to be skinned and that our economy does not depend on them.

Then again, Davy folks thought CFDs and leveraged property deals were gods-sent manna.

Now, let us get to the more rational side of economic impact debate:
  1. Under my proposal above, banks get deeper repairs, so they will be healthier and their reputational capital will not be based on a handout rescue, but on actually having equity capital injection. This is a net positive that Nama does not deliver;
  2. Under my costings above, the Exchequer and/or households end up being investors with a strong prospect of higher net recovery value over shorter term horizon than in the case of Nama. This is a net positive that Nama does not deliver;
  3. Under the above exercise, the banks will not be able to unilaterally take liquidity arising from the injection overseas, so whatever liquidity is generated, will have to stick to our shores, and thus to our economy. They still can use this liquidity to pay down their expensive inter-bank loans, but at least they won't be able to run investment schemes with taxpayers' money abroad. Shareholders might look badly on this one, since the shareholders will be not foreign institutional investors, but domestic taxpayers. This is a net positive that Nama does not deliver;
  4. Under the above exercise, we won't have to pay Nama staff and consultants any costs - banks will continue dealing with their bad loans. This is a net saving that Nama does not deliver;
  5. Under the above Irish taxpayers won't have to face a massive tax bill of 54bn, but a smaller (though still massive) bill of 30bn. This is a net saving that Nama does not deliver;
  6. Under the above proposal Irish banks will be able to access the same ECB window on the same terms as any other bank in the Eurozone. The will also be able to do the same with Nama, so there is no additional cost when it comes to borrowing.
  7. Under the proposal above Irish Government debt will be €23bn lower (and adding the second round recapitalisation demand under Nama - €29bn lower) than in the case of Nama, providing potential easing to our cost of borrowing. This is a net benefit that Nama won't deliver.
I can go on with these arguments. But I am afraid it will be a bit too much rant for our Davy folks.