Monday, November 30, 2009

Economics 01/12/2009: Irish Banks - something stirring in the dark

An interesting, but at this stage purely theoretical conjecture that can play out in the next couple of days.

I will posit it after I go over the facts that led me to this conjecture:
  1. Today's reporting on BofI and the banks in general has been focusing on the possible conversion of preference shares into ordinary shares to plug in capital holes. Considering that (a) such a conversion will de facto spell near nationalization of the banks; (b) it will destroy Government's case (supported by the stockbrokers and the banks) that preference shares represent significant cash flow positive back to the taxpayers in exchange for recapitalizations to date; and (c) such a conversion will amount to a swap of a guaranteed asset (preference share dividend) in exchange for of a falling asset (as ordinary shares are tanking and are bound to continue to tank if conversion takes place), the statement is alarming. In fact, the statement is extraordinary in nature, similar to the Banks Guarantee Scheme announcement back in September 2008;
  2. The RTE has completely failed to explore the very core idea of what effect the conversion will have on both capital reserves at the banks and the value of taxpayers' shareholdings in the banks. This might suggest that the story was potentially heavily 'managed' as a staged release as RTE business editors and correspondents should have been aware of such consequences;
  3. The extent of demand for capital post-Nama has been approximately estimable from the sheer size of impairments faced by the banks against banks balancesheets (loans to deposits ratios) and did not come as surprise for, say Anglo earlier this month. Why such a hype then all of a sudden? Did Nama haircut change dramatically? Not, Bloxham note today in the morning explicitly worked its estimates from the assumed Nama-signalled haircut of 30%. No change spotted here, then.
  4. Core tier 1 capital already includes preference shares, so conversion will only aid the banks balancesheets if and only if it will allow the banks to keep the preference shares dividend. This means that taxpayers get nothing from these shares. And it also means that things are getting so desperate in the banks that they are having trouble (potentially?) repaying these dividends to the state. What can the impetus for such deterioration be, given both banks already guided recently on expected impairments? Why did RTE reporters never bothered to ask about this issue.
  5. The whole mess of demand for post-Nama recapitalizations was predicted by some, and publicly aired in the media. In fact, my estimates from one month ago (here) accurately predicted the numbers involved. While some 'experts' from stock brokerages interviewed today by RTE's flagship News at Nine programme might have been unaware of such estimates back then, their arriving at the same numbers one month later is not really that much of a market-making news. So, again, why the hype today?
  6. RTE stated tonight that the markets anticipated 20% haircut (here). This is simply not true:
  • Per today's Davy note: "This has been reviewed by NAMA and the Department of Finance and on the basis of interaction with both and the minister's estimate of €16bn of eligible bank assets, 'the directors believe that the average discount on disposal applicable to these assets should not be greater than the estimated average discount for all participating institutions of 30%'."
  • Bloxham are working off 30% assumption.
  • Goodbody's note was a bit more volatile on assumptions: "As per BOI’s recent interim results and a November’s IMS from AIB, both banks highlight that a number of uncertainties exist as to the specific quantum and timing of loans which may transfer, the price, the fees due and the “fair value” of the consideration. In its statement, AIB refers to the previously highlighted industry average discount of 30% to the gross value of the loans and indicates - as it did at the time of its IMS - that the board’s view is that “there is no reason to believe that the average discount applicable to AIB’s NAMA assets will fall significantly outside of this guidance”. When we wrote on this at the IMS stage, we highlighted that the language here was more vague than previous utterances and note our haircut applied is 28%. Similarly, in the case of BOI, the references in the release today are all based off the generic 30% industry figure referred to be the Minister, though that the discount will vary by institution, with the Court believing this industry figure to be the “maximum loss likely to be incurred on the sale of loans to NAMA”. We are of the view though that BOI’s haircut will be closer to 18%." I'll explain in human language: AIB itself believed that average Nama discount (30%) or something close will apply, while Goody believed 28% will do. For BofI, the management believed before that 30% will apply. But Goody's believed 18% will do (why, beats me). So no evidence on 20% market consensus anywhere here, then.
  • NCB applied 30% model to both BofI and AIB in today's note. And so on.
  • Taken over all brokers and banks themselves, AIB assumed discount averages at 29.5%, not 20%, BofI assumed discount averages at 27%. Now, forgive me, but where is RTE taking its 20% market expectation from?
So now, let us summarise the evidence:
  • Banks announcement today was out of line with ordinary business;
  • Banks announcement was never probed or challenged by the official media;
  • Banks announcements were not queried by the the brokers to the full extent of conversion implications to the balance sheets;
  • Three components can have a dramatic fast impact on bank core tier 1 capital - equity collapse (not the case - banks shares are down by less than 5% today, plus the statements were released in the morning before market prices were revealed); loans collapse on a massive scale (unlikely, given that both banks guided very recently on new impairments and also unlikely given that both banks appear to be impacted simultaneously); or deposits falling off dramatically (there is no way of confirming this unless banks publish their data, but do recall September-December 2008 when deposits flight exposed Anglo to nationalization).
So something really strange is happening around the BofI and AIB in the last few days. I do not know what this might be, but some fast moving deterioration in hitting banks balancesheets.

Watch tomorrow's ticker.


yoganmahew said...

Both banks came out earlier this year saying they expected the discount to be around 20% and that only reckless banks like Angelo & Fingersbank would pay 30% (implied in their statements anyway). I believe BoI came out with it first and then AIB, but it may have been the other way around.

It was these statements as to likely dilution levels that provided a goose to their share prices in Q3.

That they are now saying 30% is a significant change. As you say, others have been saying it is unlikely that they have better quality loan books than the rest of the banks. So it should not come as a surprise. The fact that it does probably says more about who bought shares.

Bloomberg - BoI saying discount significantly less than 30%:
(17 Sep)


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jmc said...

Dont forget that a significant chunk of the bank deposits were/are either cross depoits from the other banks or deposits from the gov/central bank. Unwind those depoits to 2005 levels and all bank are in an even worse position than currently stated. In Anglos case 30 billion worse if my memory is correct.

Fearganainim said...

Could they be exposed here?

Great Blog by the way.