Wednesday, August 11, 2010

Economics 11/8/10: Anglo saga continues

For about 24 hours I have resisted commenting on the Anglo latest twist in the capital hole - the EU approval yesterday of additional funding for the dead bank. But given the lack of straight forward and insightful analysis in the media, I thought I should throw int couple of direct comments on the affair.

First, consider the EU statement (available here):
"Anglo Irish Bank needs a third emergency recapitalisation to meet its obligations. ...there is no doubt that Anglo Irish Bank has to restructure profoundly in a way that effectively tackles the weaknesses of the past business model and ensures a sustainable future without continued State support."

Sadly, no Irish commentator noticed the irony that the EU is calling for a profound restructuring of the Anglo after 3 episodes of approvals of extraordinary funding for the bank by the taxpayers. Surely, if the Commission were to do its job and properly police national decisions relating to financial institutions stability, after the second call for capital from Anglo, Mr Almunia should have said something along the following lines: "Don't come back for any additional funds approval until you first provide a clear map as to how you are planning to shut down this insolvent institution."

Second, consider the timing of the approval. For some days before the approval, Irish 'analysts' and policy officials have been massaging public opinion. Various leaks and speculative statements that the bank will need more cash were floated around. Some of the Irish brokerages suggested that Anglo will need €2-4bn more in funding. Of course, while this circus was ongoing, the Government has been quietly labouring away at the submission to the EU Commission. The approval was issued on Tuesday, suggesting that the request for emergency funding extension was filed at the very latest - on Friday. This request was not subject to any parliamentary debate or other procedures that should have been deployed to ensure democratic participation in disbursing of the public money was adhered to.

Third consider Irish media and 'analysts' response to the Anglo call for cash. Of all stockbrokers, only NCB managed to comment on the Anglo call, despite the fact that Anglo's capital demands are indicative of the sector-wide problems. NCB guys actually did a good job in their morning note, saying that:
  • "We had added €23bn to our General Government Debt to GDP ratio as a result of Anglo to leave it at 98.1% at year end 2011. This additional €1.4bn now needs to be added and will add approximately 0.7% to our debt to GDP figure at year end 2011." Yeps, with Anglo latest request for funding, Ireland Inc sovereign debt is set to be 99% by the end of 2011.
  • The NCB guys are also aware, unlike, it appears Davy and Goodies, that Anglo can end up costing us (taxpayers) of sovereign bonds side as well: "The NTMA announced that its next auction on Tuesday August 17th it will tap the 4.0% 15 January 2014 bond and the 5.0% 18 October 2020 bond. The NTMA will be hoping that the Anglo issue is cleared up sooner rather than later and that clarity is given on the final requirement by the State. The uncertainty surrounding the exact amount of the transfer into Anglo is weighing on the Irish sovereign. The Irish 10 year is currently at 5.16% which is 274bps over the equivalent German bond and wider than the benchmark Portuguese 10 year which is yielding 5.079%."
Of course, most of the media have missed the two points of Anglo contagion to the broader markets:
  1. Sovereign risk rising due to Anglo uncertainty, and
  2. Corporate risk is also rising due to spillover from sovereign uncertainty to corporate assets valuations.
Finally, the whole circus around Anglo's 'news' missed the core point - Anglo started into the present mess with €71bn of 'assets' (aka loans). The total amount earmarked to date for the bank amounts to €24.354bn.

If Nama were to be believed in its LTEV estimates, Anglo's book is roughly 55% under water. This means that its post-Nama book is somewhere closer to being:
  • 1/7 of the total book (€10bn) under water to Nama or better than Nama levels - say impairment of 30% due;
  • 35% (or €25bn destined for the 'Bad' bank) is under water more than Nama haircuts - say 60-70% impairment due.
Translated to the full pre-crisis book, this implies the average recovery rate on Anglo loans of ca 43-47% across the whole book.

Let me explain the above numbers: €10bn recoverable at 70% and 25bn recoverable at 30-40% implies 14.5bn recovery on 35bn of assets left post-Nama, adding to it Nama haircuts implies recovery rate of 43-47%, ex-costs). This, in turn, implies across the book impairments of €37.6-40.5bn. Take the lower number - total through restructuring cost of Anglo can be expected to reach ca €37bn in the end or higher. Take 10% off for risk-weighting and restructurings of funding etc to boost regulatory capital.

End of the Anglo affair cost comes to roughly speaking €33bn. That's the amount we can expect to pay in the end. The latest €24.4bn count is, therefore, only less than 3/4 of the saga. So here's my forecast - by end 2011 Anglo will ask for ca €10bn more in our cash and by the end of 2012 - for up to €13bn more than the amounts already advanced. The only way these figures can be made smaller is if Nama grossly overpays Anglo for Tranche 2 and 3 loans.

Anyone noticed that? Not really. Just as no one noticed that Anglo is going to, in the end, cost every working person in this country something of the order of €19,600 - a hefty bill for rescuing Anglo's bondholders for every household of two trying to pay a (negative equity) mortgage and get kids through school.

Instead, our media keeps on asking Minister Lenihan rhetorical questions along the lines 'How much more?' and lamenting 'unexpected Anglo demands for more cash'. Per all publicly available information on this site, Peter Mathews' site and Irish Economy site, all I can say: "Expect more of the 'unexpected', folks".


Jagdip Singh said...

" * 1/7 of the total book (€10bn) under water to Nama or better than Nama levels - say impairment of 30% due;
* 35% (or €25bn destined for the 'Bad' bank) is under water more than Nama haircuts - say 60-70% impairment due."

How do you justify this level of impairment (30% for the good and 60-70% for the bad)?

The Anglo 2009 accounts indicated non-NAMA loans of €36.5bn with €4.9bn of provision ie 13.4% of impairment.

Lloyds half year report indicated impairment on its Irish loans (mortgages, personal and commercial loans) of 18%.

Why do you consider the non-NAMA Anglo loans to be so much more risky? By the way I don't disagree with the principle of what you say at all - applying Lloyds Irish impairment of 18% to Anglo's non-NAMA loans would probably mean another €2bn capitalisation is needed on top of the €24.5bn already announced. It's just how do you arrive at 30% for the "good" loans and 60-70% for the "bad bank" loans?

Also what effect do you consider the reported €2-3bn of seed capital required by an Anglo Newbank will have on our national finances?

yoganmahew said...

I agree with you entirely that it is not unexpected that Anglo will cost at least 35 bn:
From June last year:

Given that the losses to Sweden's banks amounted to about 14% of assets, coming up with a 50bn figure for the cost to the banks of the collapse of the property bubble is simple.

What is not simple, though, is allocating the losses. In Anglo's case, I think there has been too much focus on the loans and too little focus on the gambling that went on. We see from the WestLB case that Anglo was betting on its own account. How much of this was it doing? How much of its very large derivative trading book are bets that have gone wrong?

Anglo is not bipedal, it may not even be octopoid... there are many shoes left to drop...

Anonymous said...

It is strange that Anglo need to consider an extra 1.4bn to cover a technical accounting issue whereby the NAMA bonds received are not worth par (as they pay such poor interest rates)and AIB and BoI treat them at par. What would the impact on govt % ownership be if they all took the same accounting treatment.

Brian Flanagan said...

Your cost estimate of €33 billion excludes:
1. Losses incurred by shareholders in Anglo
2. Financing costs. Ignoring timing differences, the annual cost at 5% pa is about €1.65 billion a year. That's €16.5 billion over ten years.
3. Resultsnt premium on Exchequer borrowings.
4. Impact on economic growth.

Paddy Orwell said...

Constantin, I think you are being slightly (but only slightly) harsh on the media given that David McWilliams has yet another anti-NAMA article in the Indo today:
While his analysis might not be as thorough as yours he is reaching a wide audience.
Keep up the good work all the same!

Fungus the Photo! said...

These are merely estimates. All based on the idea that property has value over the interest due on the funding.

Tick tock! Tic Tok!

Ooops, no value left at all ...... but who will be surprized at that? In the meantime, Ireland will have lost a decade in resolving the land mess. But there will still be another decade to go after that. Japan has refused to write off the bad bank loans incurred in the 1980s. They still exist and public debt is 200% of GDP. Clearly, the debt will grow until it can grow no more. Ireland has chosen to recognize commercial debt, slowly, over the long term, as in economic value of NAMA land. Thus Ireland will get 150% of the much reduced GNP by the end of that process. But there is no specific term. When will this be?

Like Japan, I suspect this will occur when the taxpayers and lenders are so sick that they refuse to contribute. There is a long way to go then! Yet the destination will be the same?

ottogunsche said...

Thanks again Constantin.

For the layman like me it is important to read insightful commentaries provided by you.

We get one interpretation from the powers that be and we then get your interpretation which is backed up by analysis and has a basis.

Please do keep up the good work.

This sort of analysis is vital for me and many others.