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 27/03/2010: Breaking News: AIB and FF/Government

Major news breaking in the media rooms:
AIB (the first story below)
RedC Poll (the second story below)


Story 1:

The first story is about the leaks reported by Newstalk (see here) that AIB will announce before opening of trading on Monday that the state will be taking a 65% stake in the bank.

Per senior source in the Dail (hat tip to B) - the reason for AIB guiding 65% ownership now is that in addition to Nama haircuts, they are, allegedly, seeing significant deterioration in the sub-€5mln loans (the loans below Nama-eligible threshold).

This is hardly surprising. Since May 2009 I have consistently supplied estimates as to the eventual state ownership in both AIB and BofI. Depending on various scenarios:

• assumed Nama haircuts,
  
• the actual current risk weighting on the loans being transferred,
  
• share price at the time of announcement and
  
• the willingness of the banks and the Government to recognize future expected losses on the loans not transferred to Nama

RVF approach to valuing AIB and BofI balancesheets suggests that at the end of the current crisis, the state will outright own around 85-90% of equity in AIB and 50-60% in BofI. This eventual outcome, for political reasons, will come in two stages:

• post-Nama injection of capital (with AIB placing around 60-70% of its equity with the State and BofI placing around 40-45%), plus
• second stage recapitalization to correct for continued deterioration in the books over 2010-2011 (adding another 20-30% of equity for AIB and 10-15% for BofI)

The problem with this two stage recapitalization is that the taxpayer will end up paying three times for the same equity:

• Having injected €7 bn into two banks at the time when they were worth less than €2.5 bn for the entire lot,
  
• we are now be left on the hook for some €20 bn worth of largely worthless loans - to be purchased at ca 30-40% discounts (against the real market discount of 65-90%),
  
• plus €7-8 bn in fresh capital post-Nama
• plus the margin of ca 10-15% for further deterioration in non-Nama loan books (requiring another €7-9 bn of fresh capital).

Thus the Irish state is now likely to use up to €20 bn to buy up equity and loans from a bank that is currently worth around €1.5 bn... In the world of finance, even the most reckless bankers never managed such margins.

Alternative: force banks to acknowledge the full extent of their expected losses (as Swedes did in the 1990s), then force them to take the bondholders and equity holders to the cleaners (as Swedes did in the 1990s), and only then take equity - or in effect, take full equity in the banks. The cost for AIB would be around €10-12 bn, depending on how deep of a haircut on senior bondholders the banks can impose.

Story 2:

Tomorrow's RedC poll

Here is a preview - as was supplied to me by my sources (a disclaimer is due here: these are as provided by the source, so check tomorrow's papers for actually confirmed figures). Parties support:
The poll was conducted on Monday-Tuesday, so it does not reflect change of opinion in the wake of Cabinet reshuffling and the dissident TDs comments. Both factors can be expected to contribute to further decline in FF ratings, speculatively pushing core FF support post-Thursday to 21-22%.

Some specific questions:
“Brian Cowen understands people like me” - 31% agree
“Brian Cowen is a good Taoiseach” - 27% agree
“Brian Cowen is a safe pair of hands” - 31% agree
“Brian Cowen is the man to lead us out of recession” - 29% agree

Hat tip to NN.

I wonder what the same punters would say about our leaders now, after the reshuffle debacle and the open dissent amongst the back-benchers.