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.

Economics 20/7/10: Is Zombie Nama propping up Mummified Irish Banks?

As the independents – Brian Lucey, Karl Whelan, Peter Mathews and myself – have warned (actively denied by the Government and its backyard ‘experts’), Nama Tranche II turned out to be yet another unmitigated disaster.

Nama paid €2.7bn for loans that its experts valued at €5.2bn. Of course, these ‘experts’ include many who were responsible for some of the most disastrous valuations of the Celtic Tiger era and are now ‘entrusted’ as being ‘experienced’ with re-valuing their own errors, while collecting a handsome pay packet courtesy of the Irish taxpayers. The implied average discount these folks put on the loans this time around is 48%. Anglo failed to transfer its loans – some €7-8bn worth – due to delays caused, per what I am hearing, by a rather shoddy documentation quality.

Per RTE: “The biggest discount on the second batch of loans was for those from Irish Nationwide. NAMA paid the society just €163m for loans of €591m, a discount of 72% [an increase of 14% on Tranche 1]. The figures for AIB and EBS were 48.5% [on €2.73bn marking a 6.5% increase on Tranche 1], and 46.5% [on €35.9mln and an increase of 9% on Tranche 1] respectively, while the Bank of Ireland discount was 37.8% [on €1.82bn - an increase of 2.8% on T1].” Overall, Nama now has in its vaults €20.5bn worth of loans (or rather largely worthless paper few years ago labeled as loans) for which it paid at a discount of 50.7%.

The loans are concentrated - related to just 23 property developers who are deemed to be 'second tier' aka less flamboyant than those in Tranche 1 and most likely, less experienced too.

It makes me laugh when I recall how our stock brokerage 'analysts' were chirping a year ago that a 20-25% haircut would be warranted by market valuations of these loans.

However, the real problem with all of these numbers is that while the discounts might sound impressive, they are not reflective of any reality. Instead, they are now fully bootstrapped to the capital commitments issued to the banks by Brian Lenihan. You see, as we warned from the start – and this too was vigorously denied by the Government – the heavier the haircut, the greater will be banks’ demand for capital, the greater will be the share of bank equity owned by the taxpayers. Mindful not to take too much stake in BofI – for that would produce poor optics internationally – Brian Lenihan is content to oversee a 38% discount on its loans. Having pumped capital up to 50% of risk-weighted assets transfers to Nama for AIB, the Minister is equally happy not to impose heavier haircuts on AIB Tranche 2 transfers than 50%. Hence the ‘magic’ 48.5% figure. Ditto for EBS. Sounds precise – not 49%, nor 48%. But in the end – the number is most likely utterly bogus.

To put some fluff in the air about ‘Nama is a tough player with the banks’, Tranche 2 hammered INBS and most likely will hammer Anglo. Unless, that is, Anglo fatigue has finally reached Upper Merrion Street buildings. In this case, a discount can be less than that for INBS. Not because Anglo loans have miraculously become sterling in quality, but because the DofF might be just slightly concerned that the bank will come with a fresh capital demand.

So instead of pricing the loans to market, Nama now appears to be pricing them to keep required post-Nama recapitalizations at the levels consistent with earlier Government capital commitments.

In the end, however, a 48% average discount is still a gross overpayment on these loans. Let’s do a back of the envelope calculation here.

25% of Nama loans are ‘cash generative’ – i.e. paying some sort of an interest repayment on interest due. Suppose – just for the sake of making an assumption – that 50% of those cash generative loans are paying full interest due and 50% are paying ½ interest due. Assuming average interest rate on the loan of 8% (a generous assumption, given that banks were lending at lower rates than that) and cost of refinancing banks funds at 3% (well below current yields on banks bonds, even way lower than the latest Exchequer yields of 5.25%, but let’s be generous), if the cost of managing loans at 1% (consistent with Irish banks’ margins), then:

• 75% of Nama loans are losing have a negative yield of 12% (annual loss on interest alone);
• 12.5% of Nama loans are losing 2% pa in net costs, plus 8% rolled up interest, implying their negative yield of 10% pa;
• 12.5% of Nama loans are losing net 8% pa.
  

Expected average annual loss on Nama overall portfolio is therefore 11.25% pa. Value this at x3 revenue flow. Nama portoflia of loans would have a negative, yes, negative, - 34% break-even valuation in the market. Just on the back of interest and costs alone, the value of Nama purchased portfolio of loans should be no more than 66 cents on the euro of face value.

Next, subtract the percentage of loans that are unsecured – while allowing for the expected recovery, subject to the risk. Suppose that 20% of loans taken on by Nama are unsecured (again, likely to be conservative assumption). Suppose these are distributed across the same 12.5%, 12.5% and 75% sub-portoflia following a uniform distribution (again, this is a generous assumption as lower quality loans are more likely to be less secured in the real world). The value of the entire package of loans is now worth only 59 cents on the euro.

Secured loans are also subject to a recovery risk. In general, risk of recovery implies that over 70% for loans in arrears will be non-recoverable, ca 50% for loans under stress (e.g. failing to pay principal when it is due) and 20-25% for loans that are fully performing (e.g. those that are repaying principal and interest to the full amount). These are numbers consistent with the 1990s experiences in Sweden and UK. Translating these into our valuation, adjusted for risk of recovery implies the value of Nama-bound loans around 30-32 cents on the euro.

Other risks can be priced as well, but let us stop here.

Even with relatively rosy assumptions, the value of the loans being purchased by Nama should be at maximum 32 cents on the euro.

Allowing for assets appreciation of 10% over 3 years would imply a valuation of no more than 37 cents on the euro without applying a PDV adjustment.

We are told that Nama is being a tough buyer, paying 52 cents on the euro. Who’s fooling who here?

Incidentally, 30 cents on the euro is what independent banking expert Peter Mathews has estimated as recoverable for all development and property loans held by the banks. It is also the number that myself and Brian Lucey have arrived at in our previous estimates of required haircuts, which were based on analysis of underlying property markets.

What is now clear is that 24 months since the crisis fully exploded in our faces and 15 months after the independent analysts started telling the Government that it is committing a grave error in pushing forward the solution that, under the original name TARP was rejected in the US two weeks after it was put in place, the Irish Government remains hell-bent on pursuing this wrong approach to banks recovery. More egregiously, with Tranche II loans in, there is a strong enough reason to suspect that Nama has turned into nothing more than a façade for delaying even more capital demands from the banks until the end of 2010. The reason for this, one might speculate, is to keep our 2010 public deficit from exploding to beyond 20% of GDP.

A zombie institution (Nama) now is fully in charge of our mummified banking system. What can they do next to make things even more dynamic than that?

Economics 13/05/2010: AIB's IMS blues

AIB released its Q1 2010 IMS statement:

• It will issue 198m shares to the Government in lieu of a €280m preference coupon it will not be paying (remember the stockbrokers and the Government argued that this coupon payment will be a handsome return on our ‘investment’ in AIB?).
• AIB, subsequently will be in for an 18.6% Government stake in the bank.
• Some analysts are saying that the lack of dividend is due to AIB being precluded from paying cash dividends on debt instruments while its business case was under review at the EU.
• I would say that this represents a convenient excuse. In reality, AIB simply cannot afford a €280 million pay out, given its funding conditions and given its capital requirements.
  

There is more farcical stuff in the IMS. AIB claims that while trading conditions remain challenging in Ireland, its UK (ex Northern Ireland), Polish and Capital Markets operations are booming. Ooops, the very family silver that AIB is going to sell to cover its bad loans in the Republic is still the only set of assets that have any positive value in AIB.

IMS confirmed that AIB will need €7.4bn in new capital, and that this based on Nama discount expected to average 45%. As AIB is shifting €23bn of the bad and the outright ugly loans to Nama, this discount might change. So no speculation here…

Aside from speculation, if AIB is hoping to get some dosh for its 22% stake in the US M&T, worth estimated $2.3bn. If this target is achieved (a big if, given that large placements like these would probably attract some discount) the sale can deliver new capital of €900mln. The target for capital raising then moves to €6.5bn. Selling Polish holdings will provide maximum of €2.4-2.6bn, assuming euro holds against zloty and assuming a discount of no more of 10% on block sales, inclusive of commissions. Of course, this means that AIB will have to write down its book value on the asset side, so that the net gain is likely to be around €1.2-1.4bn to capital side.

Which leaves us with a hole of €5.1-5.4bn to plug. The UK side of business is a sick puppy, unlikely to yield any net gain on risk-weighted assets side, but let’s be generous and give it €500mln of value. On the other hand, AIB investors are raking the dosh in… well, not really. I would expect the bank to be able to sell something to the tune of €1.2bn worth of equity at the most (its current market cap is €1.22bn as of yesterday close price). Suppose this is the net (although discounts might imply much shallower rate of capital raising). Will the Exchequer be required to pump in another €3.4-3.7bn into AIB?

But wait, this is hardly a final number. Remember, so far AIB has been assuming (in its impairments provisions) that the 2009 performance will continue into 2010. It sounds conservative, until you actually pause and think. There are serious lags on some assets deterioration and on recognition of impairments. These lags are driven by two major factors:

1. On households and corporate loans side, impairments take time to build up. For example, an average unemployed person with job tenure of 6 years would have gotten around 36-42 weeks of redundancy (factoring in tax relief) when they lost their jobs back in the H1 2009. They might have had savings. At an average rate of saving of 5% of annual income over 6 years, that would add up to 30% annual income or another 16 weeks worth of income cushion. Again, net of tax the cushion rises to ca 19 weeks. This means that any serious distress on their mortgages will show up around 55-61 weeks after the layoffs. Guess that pushes the dateline for major stress on mortgages only starting to manifest itself to around May-July 2010.
2. Much of the non-Nama book of commercial and development lending that will remain with AIB has been rolled up, redrawn across covenants and so on. How long will it take for these to come up for another appraisal? I’d say on average 12-24 months. So look back at 2008-2009 loans that were non-performing then and were rolled over for 12-24 months. These will start flashing red once again sometime around 2010-2011.
   

Neither (1) nor (2) is provided for (as far as risk capital goes) under the current €7.4bn new capital requirement. By the time the demand on these hits, AIB will have no assets left to sell. Then what?

How I know that AIB is once again has its head stuck in the sand on future impairments? Well, this morning’s IMS tells me as much. For its non-NAMA loans, AIB is expecting bad debt charges to be matching 2009 rates. IMS says that bank’s €27bn residential loans book is continuing to perform “better” than the sector averages (as if there is any meaningful average here to be had). And significantly it says that residential bad debt charges are currently not significantly different from 2009. The non-NAMA exposure to property in Ireland will be €12bn of which €9 is investment and €3bn land and development. These are still material at this stage, as any further writedowns on this part of the book are going to hit capital base again.

On the macro side of its balancesheet, AIB is still going to be a sick bank with loan to deposit ratio declining from a severely unhealthy 146% to a still unhealthy 124% post-Nama. And this is really rosy, folks. And the cost base and margins are unlikely to improve. Take for example deposits costs – AIB’s IMS highlighted the reality of high cost of attracting new deposits. Wait till Government starts hovering dosh from the punters through the new Post Office bonds. Supply of deposits will drop. And then, wait for the ECB to cut its discount window operations again, should things improve in the euro area funding markets. AIB, alongside BofI, is heavily dependent on being able to roll the collateralized borrowings from ECB. AIB’s term funding as a percentage of wholesale funding is massively up from 30% in December 2009 to 41% by end Q1 2010, reflecting a €6bn of issuance.

So can anyone explain just how on earth can AIB escape a de facto nationalization?

Economics 12/04/2010: Nama's economic distorionism

An interesting quote from the just-published paper (Claessens, Stijn, Dell’Ariccia, Giovanni, Igan, Deniz and Laeven, Luc A., Cross-Country Experiences and Policy Implications from the Global Financial Crisis. Economic Policy, Vol. 25, Issue 62, pp. 267-293, April 2010). I reported on this paper last year at length, when it was still an IMF Working Paper.

“An example of distortions between financial institutions and the fiscal conditions is the extension of guarantees in the case of Ireland to the largest banks. Prior to the extension of guarantees, the CDS-spreads for the large Irish commercial banks were very high. Post guarantees, bank CDS-spreads declined sharply, while the sovereign spread increased. Measures like these, now numerous in many advanced countries today, distort asset prices and financial flows.”

This goes hand-in-hand with the EU assessment of Nama as a market distorting mechanism, which, as reported last week by Irish Independent, was concealed from the public when our Minister for Finance issued a press release claiming that Nama was fully supported by the EU Commission.

Further per Claessens et al: “Guarantees on deposits and other liabilities issued by individual countries have led to beggar thy neighbor effects as, starting with Ireland, they forced other countries to follow with similar measures.”

This statement in effect condemns Irish Government claim that our Guarantee was a success because it was copied by other countries. Instead, as Claessens et al confirm, the Guarantee forced risk from Ireland onto our trade and investment partners. Not exactly a high moral ground.

“The rapid spread of guarantees led to further financial turmoil in other markets. Many emerging markets not able to match guarantees suffered from capital outflows as depositors and other creditors sought the safe havens. Distribution of risks sharply changed over time and across circumstances."

More importantly, both – the revealed note from the EU and the above academic assessment – provide a significant warning in terms of the future of the banking and property sectors in Ireland. Given the systemic nature of distortions, subsequent exits and scaling back of foreign banks presence in the country, the lack of transparency and fairness in the property markets, it is now virtually assured that post-crisis interventions Irish banks and property markets will remain in their zombie state. Japan-styled recession is a looming threat for Ireland Inc.


Of course, you wouldn’t notice this, if you were listening to some of our heroic stock brokers – especially those folks like Bloxham who back in mid 2008 ‘forecast’ that ‘markets do come back’. In their latest strategy statement, issued last Friday, the Bloxham’s boys have managed to outperform themselves in terms of Green-jerseying (emphasis is mine):

“Ireland is undergoing some of the heaviest self imposed penalties for the fiscal over exuberance of the 2000s of any EU economy since the global credit crisis began in 2008. From budgetary austerity measures to public sector wage cuts, from crushing additional taxes both personal and indirect, to a mega-costing banking recovery plan; all in the name of stabalisation and repositioning as a viable economy. As Ireland passes through the next major set of hurdles (the transfer of assets to NAMA and the recap of the banking system), the market reaction so far has been favourable.”

Any evidence of this?

“10-year sovereign Irish bonds are still trading at 146 basis points above German bonds, compared with 280 basis points at the worst point for the Irish system in March 2009. Compared with Portugal at 126 bps over Germany, Irish spreads still have strong progress to make.”

The more the things improve in the wake of all the measures passed by the Government, the more the spreads stay the same? Indeed: “Irish sovereign debt costs have remained static in the past week, while Greek debt costs balloon by 100 bps. In relative terms, Ireland sovereign performance has been exceptionally good since the “Super Tuesday” announcements from the National Asset Management Agency (NAMA), the Financial Regulator and the Minister for Finance.”

But hold on to your seats for a wild ride into the land of bizarre logic: “A falling Irish debt cost is largely unappreciated domestically but is a very hansom reward for the pain taken in Ireland thus far.”

I am now thoroughly confused, folks – if the spreads stayed the same, what falling Irish debt costs do the Bloxham folks have in mind? Am I missing something in their vernacular? Or are they missing in the faculty of trivial maths – falling costs mean declining spreads, yet the spreads ‘remained static’ and debt costs did the same.


A real pearl of the note is in its conclusions: “We would expect that the wider Irish stock market will also benefit strongly over the next 6 months, as re-cap plans proceed and the export sector resilience is maintained. Ireland could be finally coming back on the international investor map.”

Indeed it might. Or it might not. I wouldn’t venture a prediction here, but Bloxham guys – having been so right on so many occasions in the past (including that brilliant note from them back in July 2008 (see the note here) surely would know better. Except, hmmm, what does Ireland’s exporting performance have to do with Irish stock prices? Not much – more than 80% of our goods exports and over 90% of our services exports are accounted for by the MNCs – none of which are listed on Irish Stock Exchange. So unless Bloxham guys know something about Fortune 500 companies plans to relocate their listings to Dublin…

Economics 08/04/2010: AIB first Nama loans

Earlier this week, Nama had completed the first transfer of loans from AIB. Per official report, Nama bought loans with a nominal value of €3.29bn for €1.9bn in NAMA bonds, implying a discount of 42.2%. This was below the discount of 43% announced by the Minister for Finance last week.

But what do these figures mean? Without knowing exact nature of the loans, it is hard to tell just how much did Nama over pay for the loans. Here is an averages-based estimate, however.

First, let us reproduce the original claimed discount of 42.2% using averages. Table below does exactly this:
In the above, I assume:

1. Vintages of loans transfer running between 2005 and 2007;
2. 2 year roll up on interest maximum allowed in the loan covenants;
3. Roll up of interest commencing at a new rate in year 2008 and running through 2009;
4. 2 scenarios of average interest rates applied (Scenario 1: 5% pa, Scenario 2: 6% pa) – as you shall see below, these are optimistic rates;
5. Declines in values affecting different vintages as follows: loans of 2007 vintage – decline of 50% in value of the loan; loans of 2006 vintage – 40% and loans of 205 vintage – 35%.

As the last row shows, taking a simple average across all scenarios and vintages yields a discount on the loan face value of 41.7%, which, factoring in 0.5% Nama-reported risk margin yields the effective rate of 42.2% - bang on with the desired.

Having matched Nama numbers, let’s examine the assumptions and bring them closer to reality:

1. Let us use the actual average annual lending rates for non-financial corporations reported by the Central Bank Table B2 (here)
2. Let us also adjust the loans for security of collateral claims – remember, per official statements from Nama many loans (in the Anglo case up to 20%) are non-secured, with effective claims against the underlying assets of nil) – to do this, we induce the following security risk adjustments to value: 6% for vintages of 2005, 9% for vintages of 2006 and 12% for vintages of 2007. So the average is 9.9%. Although these are significant, remember – reports of 20% for Anglo loans are based on untested cases. It remains to be seen how higher these will go should other lenders contest Nama take over of the claims.
3. Since Nama valuations were carried out through November 2009, we must factor in further declines in value, so let us push up value discounts to 35% of 2005 vintages, 45% on 2006 vintages and 55% on 2007 vintages. Again, these are conservative, given evidence presented in the commercial courts.
4. Instead of running alternative interest rates scenarios (remember – I am taking actual rates reported by the Central Bank), take two different scenarios on vintages compositions: Scenario A assumes uniform distribution of loans across three vintages, Scenario B assumes a 20% for 2005 vintage, 30% for 2006 vintage and 50% for 2007 vintage split.
5. Finally, let us estimate two other alternative scenarios: Scenario 1 has no mark ups charged on average lending rates, Scenario 2 has a set of mark up reflective of higher risk perception of loans, especially in 2008-2009 period. Remember, lenders became unwilling to provide funding for property investments in 2008-2009, which means they would be expected to charge a higher interest rate (risk premium) on loans related to property than those reflected in the average corporate lending rates.

Tables below show the results of model estimation:
Alternative scenario 1: Nama overpayment over the current market value ranges between 42% and 51% or €561-638 million.
Alternative scenario 2: Nama overpayment over the current market value ranges between 48% and 57% or €617-688 million.

So averaging across two tables: Nama overpayment on AIB tranche 1 loans is estimated at between 42% and 57% or between €561 million and €688 million. At a lower estimate range, this suggests that Nama is at a risk of overpaying some €26 billion for the loans it purchases, should this type of valuations proceed.


Of course, some would say this overpayment reflects the expected long term economic valuation of these loans. Fine. Suppose it does – how long can it take for the LTEV to be realised to break even (real terms) on Nama assets then?

Let’s make two assumptions:

• suppose that Irish property markets see price increases of 150% of expected economic growth,
• suppose that expected long term economic growth will average in real terms between 2% and 3% per annum.

If Nama overpays 48% on the current value of the assets (lower range of my estimate), Nama will break even – absent its own costs of operations and funding – and assuming full recovery of the loans per their value – by the end of 2027 if the growth rate average 3% pa or by the end of 2035 if the growth rate averages 2% pa in real terms.

If Nama overpays at the top of the estimates range – 57%, then real recovery will take up to the end of 2039 if the average annual growth rate is 3% or up to 2053 is the average growth rate is 2% per annum.

Again – notice that these figures do not include:

• Legal costs of running Nama;
• Losses that might occur on the loans since November 30, 2009 valuation cut off date;
• 3 years long roll up interest holiday built into Nama;
• Operating costs of running Nama (inclusive of very costly advisers it contracts);
• Cost of Nama bonds financing
• Cost of actual working through the bad loans

Still thinking Anglo is the worst case scenario for us?

Economics 31/03/2010: Nama funding scheme - Maddoffian Risk Pyramid

The saga of Nama continues, folks. Ah, and no, I do not mean the dumping of €8.3 billion to the Anglo which miraculously declared losses of €12bn = €4bn injected by taxpayer in 2009 + €8.3bn injected today. Had the Exchequer given Anglo €15bn last night, the bank would have declared losses of €19bn. And not even the admission on the public airways, by our illustrious 'public interest' director soon-to-be-chief of Anglo, Alan Dukes, that Anglo will most likely need more than additional €10bn promised to it by overly-generous-with-other-people-money Mr Lenihan.

Oh no - the really worrying thing is contained in the notes from March 26th issued by Nama (available here) that detail the financing arrangements that Nama will undertake to cover the purchases of the loans from Irish banks.

Some time ago it was rumored that the Government was setting on the following scheme:

• Nama will issue 12 month bonds
• With interest rate rest at Euribor-Libor plus a margin every 6 months
• Which are to be fully unconditionally and irrevocably guaranteed by the state as ranking pari passu with the Nama other unsecured and unsubordinated debts.

At the time, myself and other analysts said that such a scheme would be a disaster. Now, per latest documentation from Nama - this is exactly the scheme chosen to finance Nama acquisitions.

Let me remind you what the problem with this scheme is.

Nama is buying long-term loans with work-out period stretched over 10-15 years. It will use short term financing to get these through. Problem 1: borrowing short to lend long is what got out banks into this mess in the first place. Now, Nama will have exactly the same risk-loaded funding structure as the worst of our banks. For example, at the peak of risk-loading, Anglo carried about 50% of its funding in short-term inter-banks loans. Nama will do the same for 100% of its funding requirement. Scared yet?

Nama will be loading up with short term debt as the yield curve for Libor and Euribor is pointing up. In other words, every progressive reset (6 months) and roll-over of the debt (12 months) will be more expensive to the State. My third year UCD undergrads last Fall knew that this is a bad risk. Nama, having paid millions to advisers and 'experienced' staff couldn't get it right! Trembling yet?

Nama will be rolling over bonds on an annual basis. This means annual transactions costs (making the entire borrowing much more expensive) and reliance on the ECB to re-collateralize the bonds (putting Frank Fahey's 'free lunch' funding out to new tender annually). Is anyone actually thinking about any of these risks out in the Treasury Building on Grand Canal Street?

Adding insult to injury - despite being issued by the agent different than the Sovereign, Nama bonds will be tax-exempt. In other words, issued at Euribor of, say 2.75%, the notes will effectively be priced at around 3.44%. Worse, the Guarantee statement obliges the Irish state to cover incidental and other expenses of the bond holders and exempts them from all and any taxes relating to the Guarantee. In other words, should the bond holders resell their Nama bonds at a profit (in part determined by the Guarantee), there will be no tax on such a resale.

In short, it appears that neither Nama, nor an army of its excruciatingly expensive advisers, nor DofF, nor the Government have any knowledge that normal interest yield curves are upward sloping - cost of borrowing, normally rises in time. Or may be they simply do not care. After all, its our money they are gambling with.

Economics 02/03/2010: AIB 2009 results

AIB's bad fortunes:

• Pre-tax loss of €2.656bn for 2009;
• €5.35bn in bad loans provisions - 4.05% of customer loans base
• ROI operations losses of €3.5bn
• Total criticised loans up to €38.2bn (24.9% of customer loans base), compared to €15.5bn (11.7%) at the end of 2008
• Criticised loans increase - 23% outside ROI, 77% within ROI
• Mortgages 91+days overdue are at 1.96% (December 2008 0.7%) and this does not account for re-negotiated mortgages
• Post-Nama, expects ROI loans to fall to €58bn (55% of the total loans held), composed of €27bn mortgages, €6bn in personal loans, €12.8bn of property loans, €12.6bn other loans

But the real beefy stuff is on pages 111 and 15 of the report (here). Hold on to your seats, folks - from the realistic folks who brought you a dividend in 2008 (as the Titanic was gliding along the iceberg's first bump):

Page 11: Loans and receivables held for sale to Nama €23.195bn, with Provisions at €4.165bn

implying an 17.96% net discount on loans transferred to Nama (the second table below).

Aha, not 25%, or 30% or 35%, but 18%. And as far as those 'Good Loans' that Minister Lenihan wanted to buy go? That's categories 1-3 loans above, or a whooping total of €21mln. Impressive risk hedging by Nama is expected. Oh, don't take my word for this - here is how the Nama portfolio from AIB will look like:
So wait a second, folks, AIB will dump 63% of their impaired loans into Nama, but will provision for a haircut of 18% on these? Their own debt is now being settled at 50 cents on the Euro with private bondholders, while the Irish taxpayer is expected to settle at 18 cents?!

And have a laugh - page 15: ROI Nama-bound loans provision is 16.6%, UK Nama-bound loans are 5.1% and overall impairment charge due to Nama (remember, this accounts for risk-weighting changes) of 14.54% (Table at the bottom of page 15).

It's a free lunch -Frank Fahey-style - except for the bank!

Economics 01/03/2010: AIB, Nama & tomorrow's numbers

From the Dolmen guys - today's preview of AIB results announcement tomorrow -

"We expect operating income of €2bn for the year, impacted by lack of demand for credit by Irish consumers and lower Net Interest Margins (NIM). Due to a pre-tax loss of €2.7bn, equity tier 1 of the group will move down to 5%. Overall, the market will be looking for guidance on NAMA, capital raise and credit quality in the non-NAMA loan book. It is also likely the group will announce an exchange offer on its Lower Tier 2 debt."

Note the figure of 5% Tier 1. Internationally (e.g. UK) target is for 8%+ Tier 1, for banks with Loan-to-Deposits (LTD) ratios in excess of 100%. AIB's latest accounts I have access to show LTD ratio of over 150%. This means that the AIB will be on the hook for up to Euro 4 billion in order to plug in the Tier 1 capital gap with its international peers. And this is before the expected loans losses of Euro 5-5.3 billion expected in the tomorrow's announcement. So on the net, H1 2010 demand for funding should be around €3.8-4.5 billion before Nama kicks in and before provisions for a new batch of bad loans...

This is more than 3 times the current market capitalization of the bank!

Also note Dolmen's reference to the lack of demand for credit. Spot on - the problem is that no matter how one spins the current credit crunch, consumers and businesses (burdened by massive debt and facing rising tax curve into the foreseable future, along with high risk of unemployment and huge uncertainty about the future performance of the economy) are simply in no position to borrow. This, along with the crippling expected cost of Nama to the real economy means that there is not a snowball's chance in hell the credit bubble can be relaunched in Ireland... at any level of interest rates...