Newspapers today are reporting that banks may be pressuring Irish developers to sell their UK assets to write down the loans that are bound for NAMA. This is an interesting development. As UK market has shown some signs of revival (although these signs are tenuous at best), prime properties with less recent vintage can be sold off to generate cash to pay down some loans. Now, the problem for Nama is that of selection bias.
On one side of this equation, developers willing to do this will be disposing of the more liquid and better properties, depleting their own risk-weighted assets base.
They will be using cash to pay down the loans that are marginally at the boundary of being transferred to Nama. Why? Elementary, Watson!
Suppose Nama imposes a discount of 30% on your loans. You have two loans. One is recoverable at 80%, another at 0%. You have a choice – pay down one loan and let the other go Nama. If you take loan A with 80% recovery, you get 70cents on the euro from Nama. If you hold it to maturity you get 80 cents. If you take loan B with 0% recovery, you get 70 cents on the loan from Nama and zilch from the market. Guess which loan will be repaid and which will be heading for Nama?
In the mean time, naïve and inexperienced in collection and recovery business Nama is still sticking to 30% average discount claims, thus further incentivising this adverse selection process against itself. NAMA chief executive Brendan McDonagh few days ago repeated this much.
So the end game here is that, if the banks are successful, even poorer quality loans will be transferred to Nama, while Nama’s CEO is running around town committing himself to valuations before any valuations are even done.
Lovely.
Showing posts with label Allied Irish Banks. Show all posts
Showing posts with label Allied Irish Banks. Show all posts
Tuesday, January 19, 2010
Monday, December 28, 2009
Economics 28/12/2009: Investment Funds in Ireland & other
Two recent datasets: CB's Investment Funds in Ireland and ECB's Financial Stability Review for December 2009.
Central Bank of Ireland has published new data series on Investment Funds in Ireland in December 2009. The data is reproduced in the table below with my analysis added:
This data, of course, covers IFSC-based funds which dominate (vastly) the entire sample. Overall funds issuance is up robust 16.6% (although activity on transactions side is falling - we cannot tell anything about seasonality here, as the CB just started collecting data). Real estate funds are out of fashion. Clearly so. Mixed funds and hedge funds are relatively flat and judging by the collapse in transactions are still in batten-the-hatches mode. Equity funds are in long-only mode, on a buying spree. Nice sign of renewed confidence in the global markets. Bonds funds are steady rising, albeit not at spectacular rates, which, of course, is a sign on IFSC missing on bonds over-buying activity going on worldwide.
Chart below shows how the market shares evolved over time.
ECB's latest (December 2009) financial stability report throws some interesting comparisons for Ireland. Focusing on the charts: first consider the extent of deleveraging going on in the financial systems:
So the US leads, as per IMF GFSR, with most writedowns in quantity and relative to the system. The UK comes second. Emergent markets are catching up. Japan has much smaller problem, unless yen carry trades unwind dramatically. These are on track to complete writedowns in 2010. But EU states are lagging. Ireland's figures are skewed by IFSC institutions taking serious writedowns. But overall, we still have some distance to travel on domestic banks front.
Next chart shows just how advantageous our low profit margins on the lending side have been in terms of yielding lower burden of debt servicing. This can change very fast in the New Year as retail interest rates are bound to rise. No top-up mortgages here or car loans and personal loans secured against house assets, etc. And also note that these refer to the 2005 benchmark, plus, of course, these are percentages of gross income. Given our households are now faced with some of the highest income taxes in the Euro area, good luck sustaining this low burden into 2010.
And another issue - notice how significant is the rise in burden for lower income households. Guess which households are also facing higher rates of unemployment?
Table above shows the deterioration in house prices in Ireland relative to other countries. We are now 21.1% down on 2007 figures, or at 90.9% of 2005 level of nominal prices. The worst performance of all countries, including such bubble-lovelies as Spain.
And on the commercial real estate side, we are an outlier by all measures (remember, unlike Spain, our total banking sector includes non-domestic banks as well). That is another mountain yet to be scaled in this crisis.
Central Bank of Ireland has published new data series on Investment Funds in Ireland in December 2009. The data is reproduced in the table below with my analysis added:
This data, of course, covers IFSC-based funds which dominate (vastly) the entire sample. Overall funds issuance is up robust 16.6% (although activity on transactions side is falling - we cannot tell anything about seasonality here, as the CB just started collecting data). Real estate funds are out of fashion. Clearly so. Mixed funds and hedge funds are relatively flat and judging by the collapse in transactions are still in batten-the-hatches mode. Equity funds are in long-only mode, on a buying spree. Nice sign of renewed confidence in the global markets. Bonds funds are steady rising, albeit not at spectacular rates, which, of course, is a sign on IFSC missing on bonds over-buying activity going on worldwide.Chart below shows how the market shares evolved over time.
ECB's latest (December 2009) financial stability report throws some interesting comparisons for Ireland. Focusing on the charts: first consider the extent of deleveraging going on in the financial systems:
So the US leads, as per IMF GFSR, with most writedowns in quantity and relative to the system. The UK comes second. Emergent markets are catching up. Japan has much smaller problem, unless yen carry trades unwind dramatically. These are on track to complete writedowns in 2010. But EU states are lagging. Ireland's figures are skewed by IFSC institutions taking serious writedowns. But overall, we still have some distance to travel on domestic banks front.Next chart shows just how advantageous our low profit margins on the lending side have been in terms of yielding lower burden of debt servicing. This can change very fast in the New Year as retail interest rates are bound to rise. No top-up mortgages here or car loans and personal loans secured against house assets, etc. And also note that these refer to the 2005 benchmark, plus, of course, these are percentages of gross income. Given our households are now faced with some of the highest income taxes in the Euro area, good luck sustaining this low burden into 2010.
And another issue - notice how significant is the rise in burden for lower income households. Guess which households are also facing higher rates of unemployment?
Table above shows the deterioration in house prices in Ireland relative to other countries. We are now 21.1% down on 2007 figures, or at 90.9% of 2005 level of nominal prices. The worst performance of all countries, including such bubble-lovelies as Spain.
And on the commercial real estate side, we are an outlier by all measures (remember, unlike Spain, our total banking sector includes non-domestic banks as well). That is another mountain yet to be scaled in this crisis.
Friday, October 30, 2009
Economics 30/10/2009: Reliance or dependency
Quick points on post-Nama recapitalisation, credit flows from ECB to Ireland and Frank Fahey encounter with an egg...
I have done some sums on demand for equity capital by Irish banks post-Nama. Assuming underlying conditions for loans purchases as outlined in Nama business plan, using 6% core equity ratio as a target (remember, this is a lower target by international standards) and assuming no further deterioration in the loans books quality post-Nama:
Our agriculture is the heaviest subsidised in the EU (and indeed in the world). This fact has never troubled our policymakers, as if subsidies are a sign of industry viability and strength, as long as they are being paid by other countries taxpayers (as in the case of CAP).
Now, we have become the biggest ECB liquidity junkie by far. Table below from RBS research note shows the dramatic level of financial life support our economy requires.
Note that the above list of countries includes heavily crisis-impacted Spain, the Netherlands, Belgium, APIIGS (less Ireland), aggregated in the 'Other' grouping. And yet... they all have larger economies than Ireland and smaller demand for liquidity injections.
Does anyone still believe that Nama can add liquidity to our economy? Or that such an addition can improve lending conditions? Apparently, ECB-own lending operations were not able to do so to date...
And on related note, there is an interesting quote from Dr Alan Ahearne in a recent article in the Southern Star newspaper (here):
"As one economist warned last year, ‘buying the assets at inflated prices would amount to a back-door recapitalisation of the banks’. Best practice ‘is for the banks to recognise the losses on these loans up front and sell the assets at fair market value’. Whose words? Dr. Alan Ahearne – now economic advisor to Brian Lenihan and one of the chief advocates for NAMA. Go figure."
Well, not much to figure, really - call this miraculous conversion a '€100K effect' triggered by new employment...
Oh, and while we are on Nama, here is an excellent 'Public Anger at Nama' account of the latest Leviathan encounter by Peter Mathews. I wonder if Senator Boyle and Frank Fahey get the point - people are angry at the way the country is mismanaged, but they are even angrier at being pushed into Nama.
I have done some sums on demand for equity capital by Irish banks post-Nama. Assuming underlying conditions for loans purchases as outlined in Nama business plan, using 6% core equity ratio as a target (remember, this is a lower target by international standards) and assuming no further deterioration in the loans books quality post-Nama:
- AIB will require €3.2-3.5bn in equity capital post-Nama;
- BofI will need €2.0-2.6bn;
- Anglo will need €4.5-5.7bn;
- INBS/EBS & IL&P will require total of €1.1-1.2bn.
- Total system demand for equity will be in the range of €9.7-12.4bn.
- €54bn in direct purchases;
- €5bn in completion 'investments' with estimated further €3-5bn in future completion additional funds;
- €1bn in legal, advisory and management costs;
- €9.7-12.4bn in equity injections;
- Past measures €11bn.
Our agriculture is the heaviest subsidised in the EU (and indeed in the world). This fact has never troubled our policymakers, as if subsidies are a sign of industry viability and strength, as long as they are being paid by other countries taxpayers (as in the case of CAP).
Now, we have become the biggest ECB liquidity junkie by far. Table below from RBS research note shows the dramatic level of financial life support our economy requires.
Note that the above list of countries includes heavily crisis-impacted Spain, the Netherlands, Belgium, APIIGS (less Ireland), aggregated in the 'Other' grouping. And yet... they all have larger economies than Ireland and smaller demand for liquidity injections.Does anyone still believe that Nama can add liquidity to our economy? Or that such an addition can improve lending conditions? Apparently, ECB-own lending operations were not able to do so to date...
And on related note, there is an interesting quote from Dr Alan Ahearne in a recent article in the Southern Star newspaper (here):
"As one economist warned last year, ‘buying the assets at inflated prices would amount to a back-door recapitalisation of the banks’. Best practice ‘is for the banks to recognise the losses on these loans up front and sell the assets at fair market value’. Whose words? Dr. Alan Ahearne – now economic advisor to Brian Lenihan and one of the chief advocates for NAMA. Go figure."
Well, not much to figure, really - call this miraculous conversion a '€100K effect' triggered by new employment...
Oh, and while we are on Nama, here is an excellent 'Public Anger at Nama' account of the latest Leviathan encounter by Peter Mathews. I wonder if Senator Boyle and Frank Fahey get the point - people are angry at the way the country is mismanaged, but they are even angrier at being pushed into Nama.
Saturday, October 17, 2009
Economics 17/10/2009: WalMart/IKEA Effect, Bull Markets in Stocks
Scroll for IKEA Effect discussion and Retail Sales Data below...
A superb note on the current markets from Robert Lenzner on the links between the Bull run we are experiencing and economic fundamentals is available from Forbes (here). To sum it up: that which can't go on usually doesn't.
What are the implications for Ireland?
Ikea Effect: I wrote before on many occasions about the WalMart effect: give consumers better value for money (through more efficient purchasing, logistics, distribution, marketing and retailing) and they will vote for you in tens of thousands. Now we have a small glimpse at it in the form of IKEA.
Here it is - in this week's CSO data on retail sales: August retail sales down a massive 1.0% overall, after six months of shallow increases. Worse than that - core retail sales (ex-motors) down 1.8% on July breaking three months improvements pattern. Food sales were down 2.8% despite decent weather and more families staying at home instead of leaving for a vacation. But, Furniture & Lighting was up 26% - thanks to IKEA.
Few charts to illustrate trends.
So broader trends are dire. But look at what's happening in Furniture Sector (IKEA Effect):
Self-explanatory.
Now, per CSO CPI data: Furniture and Furnishings, plus Carpets & Floor Covering account for 1.0812% of total Household Expenditure in 2006, Household Textiles - for additional 0.2424%, Glassware, tableware & household utensils 0.2577%, so roughly 1.6% of household spending goes to items sold by IKEA. Per CSO data, 2008 personal consumption expenditure in Ireland was €93,863bn, so roughly speaking €1,500mln of this went to goods of the types sold by IKEA. If IKEA offers average savings on Irish-domestics in the sector of some 25-40% (and my own experience suggests it is actually greater than that, but let us be conservative), the savings potential due to IKEA Effect add up to some €375-600mln or some €133 per every person in this country.
Now, IKEA has been trying to get a store into Ireland since at least 2000, which implies that an average Irish household has lost up to €4,000 in savings that could have been achieved were the IKEA (or WalMart) effect present in this economy. All due to the corporatist and politicised nature of our planning and retail regulations. Some price to pay!
Of course, these savings would have been even greater as:
A quick note on the WalMart effect in broader terms. Ireland is aiming to get its R&D spending (public and private) contribution up to 3% of GDP or in 2009 terms - roughly €5.1bn per annum. Now, assuming WalMart-type retail efficiencies can deliver a 10-15% savings on our retail spending, the gains from the WalMart effect will mean an addition to our GDP to the tune of €9-14bn per annum. Of these, some 30% will be accruing to the Exchequer in form of various taxes, so the second order increase in GDP will be €2.7-4.2bn. Total increase in GDP will, therefore exceed €11-18bn or 6.5-10.5% of GDP. (These are back of the envelope calculations, but you can see where it is going)...
A superb note on the current markets from Robert Lenzner on the links between the Bull run we are experiencing and economic fundamentals is available from Forbes (here). To sum it up: that which can't go on usually doesn't.
What are the implications for Ireland?
- Our exports are likely to suffer significant downward pressure in years to come - a combination of Obama Administration Healthcare Reform (driving down long-term returns to pharma sector and re-orienting US purchasing to more centralized and, more likely, heavily domestic-industry oriented purchasing will undermine majour pharma players - the dominant force in Irish exports) plus cyclical effects of patents expiration (Pfizer - Ireland's largest singular exporter - is facing tough times in coming up with new blockbusters as its existent ones are running out of patent protection) will act to depress future exports growth in the pharma and bio-phrama sector.
- Our indigenous exports will remain uncompetitive for years to come as a combination of strong euro (especially if the ECB continues to move toward 'exit strategies' and higher interest rates) and the legacy of the crisis (high debt levels and severe maturity mismatch in Irish sectors) will continue to weigh on future growth.
- Our domestic consumption will remain in doldrums for years to come under combined weight of higher taxation and stronger euro, with a resultant shift to imported substitutes (see IKEA effect below).
- Our trading and investment block - the EEC - will remain anaemic growth partner.
- Our internal investment will stay flat at low levels as a combination of higher investment costs (banks raising margins and engaging in wholesale capital destruction by re-drawing terms and conditions of existent loans to companies and households post-Nama) and precautionary savings (our households and corporates holding excessive cash reserves with demand-style access covenants on these holdings) will imply low returns to domestic investment, high cost of such investment all in the environment of subdued growth.
Ikea Effect: I wrote before on many occasions about the WalMart effect: give consumers better value for money (through more efficient purchasing, logistics, distribution, marketing and retailing) and they will vote for you in tens of thousands. Now we have a small glimpse at it in the form of IKEA.
Here it is - in this week's CSO data on retail sales: August retail sales down a massive 1.0% overall, after six months of shallow increases. Worse than that - core retail sales (ex-motors) down 1.8% on July breaking three months improvements pattern. Food sales were down 2.8% despite decent weather and more families staying at home instead of leaving for a vacation. But, Furniture & Lighting was up 26% - thanks to IKEA.
Few charts to illustrate trends.
So broader trends are dire. But look at what's happening in Furniture Sector (IKEA Effect):
Self-explanatory.Now, per CSO CPI data: Furniture and Furnishings, plus Carpets & Floor Covering account for 1.0812% of total Household Expenditure in 2006, Household Textiles - for additional 0.2424%, Glassware, tableware & household utensils 0.2577%, so roughly 1.6% of household spending goes to items sold by IKEA. Per CSO data, 2008 personal consumption expenditure in Ireland was €93,863bn, so roughly speaking €1,500mln of this went to goods of the types sold by IKEA. If IKEA offers average savings on Irish-domestics in the sector of some 25-40% (and my own experience suggests it is actually greater than that, but let us be conservative), the savings potential due to IKEA Effect add up to some €375-600mln or some €133 per every person in this country.
Now, IKEA has been trying to get a store into Ireland since at least 2000, which implies that an average Irish household has lost up to €4,000 in savings that could have been achieved were the IKEA (or WalMart) effect present in this economy. All due to the corporatist and politicised nature of our planning and retail regulations. Some price to pay!
Of course, these savings would have been even greater as:
- IKEA (WalMart) effect could have had spillover effects to other sectors of Irish economy were our policymakers not engaged in actively restricting competition in retail sector;
- IKEA (WalMart) effect would have coincided with heavier purchasing of durable goods during the boom years of 2003-2007, thus offering greater level savings on more expensive items.
A quick note on the WalMart effect in broader terms. Ireland is aiming to get its R&D spending (public and private) contribution up to 3% of GDP or in 2009 terms - roughly €5.1bn per annum. Now, assuming WalMart-type retail efficiencies can deliver a 10-15% savings on our retail spending, the gains from the WalMart effect will mean an addition to our GDP to the tune of €9-14bn per annum. Of these, some 30% will be accruing to the Exchequer in form of various taxes, so the second order increase in GDP will be €2.7-4.2bn. Total increase in GDP will, therefore exceed €11-18bn or 6.5-10.5% of GDP. (These are back of the envelope calculations, but you can see where it is going)...
Tuesday, July 28, 2009
Economics 28/07/09: NAMA & Liam Carroll's Case
Of course, the news is in - NAMA got Cabinet approval around 7 pm tonight. This does not change much - we still have a battle to wage to ensure that proper taxpayer protection and risk management, as well as investment strategies and stop-loss rules are put in place, but we are now one step further away from seeing it done.
Per RTE report (here), the High Court has delayed its decision to Friday afternoon on an application by six companies controlled by property developer Liam Carroll to have an examiner appointed to them. There are several significant implications of this for NAMA.
First: it is now clear that any decision will hang over the weekend, providing for increased uncertainty in the banks shares valuations in the days before Monday. Irish banks shares are currently valued as a call option on success of NAMA. If Carroll is not granted an examinership, this will open up a floodgate for the banks to race to force the receivership on other developers in a hope of salvaging whatever value they can under the prospect that NAMA will distort the seniority structure of debts. This, in turn will act to reduce the scope of assets left for NAMA to pick off the banks balancesheets and will force the banks to write down the loans under receivership. The resulting decrease in the future valuation of the big 3 Irish banks will translate in the fall of the value of a call option, thereby reducing the price of the banks shares. Forcing the Carroll decision to Friday afternoon leaves the markets in a serious uncertainty for the next 3 trading days – an uncertainty where anyone staying long in Irish banks shares has a 50:50 chance of not coming out alive, comes the opening bell on Monday.
Second: about that 50:50 chance. Reading into RTE report, one gets a serious sense that examinership might be denied to Carroll. “Senior Counsel Michael Cush said the companies, and the wider Zoe group of which they are a part, had historically been very successful property development businesses. But he said more recently they had experienced difficulty due to credit problems, the downturn in the property market, and problems with investments. In particular, he said difficulties arising from the development of a new headquarters for Anglo Irish Bank at North Wall Quay in Dublin had created significant difficulties. He said Vantive Holdings is now clearly insolvent, as are three other companies related to it. If liquidated, he said, the estimated deficiency of the group as a whole would be over €1 billion.”
This indicates that indeed, aside from historical record, there is no chance for a recovery of the business and that receivership, not examinership should be applied.
Mr Cush also said that “following the drawing up of a business plan in 2008, seven of the companies' eight banks had supported the continuation of the businesses. He said this had required huge forbearance from the banks. Part of the plan, he said, had seen AIB and Bank of Scotland Ireland make available additional finance to pay back third party unsecured creditors, which had since been done. Another feature of the plan saw seven of the banks agree to a moratorium on repayment of the loans and the rolling up of interest. But he said ACCBank, which is owed €136m, or 10% of the six companies' bank debts, had taken a different view, and its intention to have the companies wound up had prompted the application for examinership.”
This is also significant not only because it is showing the scale of banks’ willingness to roll over for large developers – itself hardly a laudable practice – but because it shows clearly that currently insolvent businesses continue to accumulate liabilities (rolled up interest and fresh demands for continuity funding) that are simply cannot be repaid, ever. Again, examinership is not warranted here, since loss minimizations should require an immediate appointment of a receiver to wind down the companies. In fact, this claim invalidates the ‘hardship’ argument about receivership resulting in €1bn loss on current obligations, as it shows that this loss is only going to increase under the case of examinership that will not be able to introduce any chance of reducing the probability of such a loss.
Mr Cush “said that given time, forbearance of the banks (none of which is opposing the examinership application) and the orderly disposal of assets, there has to be a prospect of survival for the companies. He also pointed out that the companies are not envisaging having to write off any of the money they owe the banks, and intend repaying in full.” This is simply impossible under the conditions outlined by Mr Cush in previous paragraphs.
“The court also heard that since the new business plan was put in place [in 2008], the companies had sold 39 residential units, worth €11.7 million.” Which, of course puts these companies cash flow at maximum €23mln pa, with expected loss of €1bn and the combined debt of companies of ca €1.4bn. Now, at 11% yield, the cost of servicing this debt will be around €154mln pa – hardly a sign of ‘survivability’ of the companies.
“Summing up, Mr Cush said it was a most unusual application for examinership as it was not being opposed by any creditors, no debts were being written down, and 90% of creditors were co-operating, all of which must satisfy the requirement for there to be a reasonable prospect of survival.” What Mr Cush neglected to mention is that the lack of opposition by the debtors is simply a jostling for seniority between Irish banks, not a reflection on survivability of the firm.
Carroll’s case shows conclusively that NAMA will transfer liability of the banks and developers onto the taxpayers that is well in excess of the original borrowings. Rolled up interest, operating capital injections and other soft budget constraints for insolvent businesses, like Carroll’s empire were accepted by the banks solely on the anticipation of a state bailout (otherwise these banks actively engaged in destroying their shareholders’ wealth by undertaking knowingly reckless decisions). Once again, the markets have neglected this risk. They might have to reprice that call on Irish banks shares now, or risk being repriced by the more proactive traders comes Monday.
Per RTE report (here), the High Court has delayed its decision to Friday afternoon on an application by six companies controlled by property developer Liam Carroll to have an examiner appointed to them. There are several significant implications of this for NAMA.
First: it is now clear that any decision will hang over the weekend, providing for increased uncertainty in the banks shares valuations in the days before Monday. Irish banks shares are currently valued as a call option on success of NAMA. If Carroll is not granted an examinership, this will open up a floodgate for the banks to race to force the receivership on other developers in a hope of salvaging whatever value they can under the prospect that NAMA will distort the seniority structure of debts. This, in turn will act to reduce the scope of assets left for NAMA to pick off the banks balancesheets and will force the banks to write down the loans under receivership. The resulting decrease in the future valuation of the big 3 Irish banks will translate in the fall of the value of a call option, thereby reducing the price of the banks shares. Forcing the Carroll decision to Friday afternoon leaves the markets in a serious uncertainty for the next 3 trading days – an uncertainty where anyone staying long in Irish banks shares has a 50:50 chance of not coming out alive, comes the opening bell on Monday.
Second: about that 50:50 chance. Reading into RTE report, one gets a serious sense that examinership might be denied to Carroll. “Senior Counsel Michael Cush said the companies, and the wider Zoe group of which they are a part, had historically been very successful property development businesses. But he said more recently they had experienced difficulty due to credit problems, the downturn in the property market, and problems with investments. In particular, he said difficulties arising from the development of a new headquarters for Anglo Irish Bank at North Wall Quay in Dublin had created significant difficulties. He said Vantive Holdings is now clearly insolvent, as are three other companies related to it. If liquidated, he said, the estimated deficiency of the group as a whole would be over €1 billion.”
This indicates that indeed, aside from historical record, there is no chance for a recovery of the business and that receivership, not examinership should be applied.
Mr Cush also said that “following the drawing up of a business plan in 2008, seven of the companies' eight banks had supported the continuation of the businesses. He said this had required huge forbearance from the banks. Part of the plan, he said, had seen AIB and Bank of Scotland Ireland make available additional finance to pay back third party unsecured creditors, which had since been done. Another feature of the plan saw seven of the banks agree to a moratorium on repayment of the loans and the rolling up of interest. But he said ACCBank, which is owed €136m, or 10% of the six companies' bank debts, had taken a different view, and its intention to have the companies wound up had prompted the application for examinership.”
This is also significant not only because it is showing the scale of banks’ willingness to roll over for large developers – itself hardly a laudable practice – but because it shows clearly that currently insolvent businesses continue to accumulate liabilities (rolled up interest and fresh demands for continuity funding) that are simply cannot be repaid, ever. Again, examinership is not warranted here, since loss minimizations should require an immediate appointment of a receiver to wind down the companies. In fact, this claim invalidates the ‘hardship’ argument about receivership resulting in €1bn loss on current obligations, as it shows that this loss is only going to increase under the case of examinership that will not be able to introduce any chance of reducing the probability of such a loss.
Mr Cush “said that given time, forbearance of the banks (none of which is opposing the examinership application) and the orderly disposal of assets, there has to be a prospect of survival for the companies. He also pointed out that the companies are not envisaging having to write off any of the money they owe the banks, and intend repaying in full.” This is simply impossible under the conditions outlined by Mr Cush in previous paragraphs.
“The court also heard that since the new business plan was put in place [in 2008], the companies had sold 39 residential units, worth €11.7 million.” Which, of course puts these companies cash flow at maximum €23mln pa, with expected loss of €1bn and the combined debt of companies of ca €1.4bn. Now, at 11% yield, the cost of servicing this debt will be around €154mln pa – hardly a sign of ‘survivability’ of the companies.
“Summing up, Mr Cush said it was a most unusual application for examinership as it was not being opposed by any creditors, no debts were being written down, and 90% of creditors were co-operating, all of which must satisfy the requirement for there to be a reasonable prospect of survival.” What Mr Cush neglected to mention is that the lack of opposition by the debtors is simply a jostling for seniority between Irish banks, not a reflection on survivability of the firm.
Carroll’s case shows conclusively that NAMA will transfer liability of the banks and developers onto the taxpayers that is well in excess of the original borrowings. Rolled up interest, operating capital injections and other soft budget constraints for insolvent businesses, like Carroll’s empire were accepted by the banks solely on the anticipation of a state bailout (otherwise these banks actively engaged in destroying their shareholders’ wealth by undertaking knowingly reckless decisions). Once again, the markets have neglected this risk. They might have to reprice that call on Irish banks shares now, or risk being repriced by the more proactive traders comes Monday.
Saturday, July 25, 2009
Economics 25/07/2009: NAMA Presentation
So NAMA... where can it lead us? This is a question I tried to answer for today's very engaging event. I would like to thank all the participants in it for having such tremendous patience to sit through my presentation.
Those of you who attended would remember a comment from the audience that Ireland has a debt overhang on the private economy side and that NAMA is justified as a form of correcting it. This is, in my view, the singular most problematic issue raised for five reasons:
So here are the slides...
Those of you who attended would remember a comment from the audience that Ireland has a debt overhang on the private economy side and that NAMA is justified as a form of correcting it. This is, in my view, the singular most problematic issue raised for five reasons:
- Logic commands us to look at a problem to determine whether or not it requires a solution. Once we deem the problem to be grave enough to require a solution, it commands us to devise an appropriate solution. I agree - debt overhang is a severe problem and it requires a solution. However, no logic requires us to undertake a wrong solution to a rightly identified problem.
- Economic efficiency argument tells us that we need to solve the problems relating to the most productive sectors of the economy first so as to rescue our productive capacity. Once that is done, only then can we have a luxury to use limited resources to address problems in less productive sectors. NAMA will concentrate solely on the problem of debt overhang on the developers' side. It will not address debt overhang on consumers' side or on the side of our businesses. Yet, while developers who are in trouble are not a part of the productive sector of our economy (they are, by and large in trouble because of highly speculative re-zoning and building projects they undertook) or at the very least not the most productive part of our economy, households and companies are the productive components of this economy. NAMA will do two things to Irish companies and consumers. It will retain their debts and magnify them by forcing banks to increase their existent loans' profit margins (as we are already seeing with variable rate mortgages and accelerated loans revisions for performing customers on the business lending side). And it will saddle companies and consumers with the debts of developers via NAMA bonds. Which part of this economic policy is economically literate?
- Financial efficiency requires us to undertake a form of solution that minimises economic and financial costs to the taxpayers. NAMA is the least economically efficient means for doing so, for an alternative - buying out the main banks or forcing a restructuring of their debts (possibly via an debt-for-equity swap) will be cheaper and will offer more control and upside potential to the taxpayers.
- Any Government policy must apply, without discriminating against or in favour of any particular group of people. And yet, NAMA will create a discriminatory structure whereby the failures in pricing risk by the banks and developers will be dumped unceremoniously onto the shoulders of the ordinary taxpayers. As a taxpayer, I face no chance of doing the same to the banks. In fact, even more egregiously, Minister Lenihan - a lawyer by training has announced recently that he cannot interfere in the 'markets' on behalf of the variable rate mortgage holders who are being fleeced by the banks hiking their rates to push up profit margins. This is the same Minister Lenihan who has no problem interfering with the 'markets' by dumping some €60bn in banks' liabilities on to the taxpayers. This is discriminatory, in so far as both actions are one way streets - the banks cannot be made accountable to the taxpayers, and the taxpayers cannot be allowed to renege on transferring their wealth to the banks.
- Political and ethical legitimacy requires that any solution that uses collective resources must address first the needs of those who provide resources. In the case of NAMA that means the ordinary people. Not of companies (they come second in the tier as employers and creators of added value) and certainly not of the developers (who come in third in the picking order). Which part of NAMA will address the needs of an ordinary family that is going to:
- Pay taxes Messrs Cowen and Lenihan levy on us, while
- Also paying for NAMA, while
- Facing a risk of financial ruin from unemployment and
- Possible home repossession should the default on a mortgage payment because their savings will be wiped out by NAMA debt burden; whilst
- Having the bleak future with no pension provision as
- The banks and Messrs Cowen and Lenihan enjoy a nice tidy rescue package paid for by the aforementioned 21st century Irish Government serfs?
So here are the slides...
Sunday, June 28, 2009
Economics: 28/06/2009: Consumer spending and ECB rescue
Two things worth noticing this week: both relating to longer running developments in the economy, and both not discussed widely enough in the past.
First, the issue of consumer spending in light of unemployment data from QNHS. As I highlighted earlier, it is the younger workers who are being laid off in droves. This, of course, puts pressure on spending power, as highlighted by several other economists and commentators. Doh! Younger workers save less and spend more out of their income. Layoffs are an immediate hit to their consumption. More ominously - and less discussed in the media and by analysts - young workers save for two reasons: car purchases and home purchases. That is when they are not scared sock-less with the prospect of unemployment (traditional precautionary savings motive) and by the threat of the older generations ripping them off via higher taxation (unorthodox exclusionary savings motive - piling up of savings to offset future loss of voting power and access to career growth due to unfair competition from established and entrenched older generations: this is my own theory of savings contribution, by the way).
In Ireland's case, precautionary savings motive will always be stronger for younger workers - courtesy of the bearded men of SIPTU/ICTU crowd who routinely betray younger workers in their quest for tenure-based job security and pay awards. Public sector leads here too, as many more temporary and fixed-term contract employees in the public sector are the younger one. Guess who will lose their jobs once Minister Lenihan takes to cuts in the public sector?
But the exclusionary savings motive is a new one for Ireland and it is the most venal of them all. Up until recently, Irish younger workers were virtually outside the effective tax net, courtesy of larger transfers and smaller wages. Next Budget will see their incomes decimated in order to pay lavish public sector wages. In the society that is much younger demographically than our fellow Eurozone travellers, our younger workers will, therefore, lose not only money, but also political power. This process is fully a result of perverse Social Partnership arrangement that has predominant concentration of power in the hands of the ageing public sector employees representatives and business groups aligned with public sector monopolies (also dominated by older workforce).
While precautionary savings effects are themselves long-lasting - hard to reverse and 'sticky' over time, the effects of exclusionary savings motive are even longer-term, depressing consumption and investment over much longer time horizon, as loss of power in the society cannot be rectified over business cycles and will have to wait for political cycles to play out. Ireland is going to pay for this 'socialism for the geezers' of our Labour Party, FF, ICTU/SIPTU/TGWU/CPSU etc for many years to come through:
Second, there is an interesting issue of ECB rescue for Ireland. My IMF sources told me that they fully anticipate to put in place an IMF team to monitor developments in Ireland as they expect, over the course of 2009-2010 a serious deterioration in Ireland's fiscal position and a renewed risks to the bond market. But the more interesting comment came on the foot of my questions concerning ongoing ECB rescue of Ireland Inc.
The fact: chart below (courtesy of Davy) shows the ECB lending to Irish institutions.
Irish retail clearing banks (AIB, BofI and the rest of the zombie pack) have raked up €39bn worth of ECB lending, up from around €2bn a year ago. Non-clearing foreign banks have declined in their demand for ECB dosh. Mortgage lenders (ca €66bn) and non-clearing domestic financial institutions (€72bn) are by far the biggest ECB junkies.
Here is Davy take on this: "Headline private sector credit is off about 3% from its November peak and, if you extrapolate the trend forward to the end of the year, the year-on-year (yoy) rate could be -6% (+2.4% yoy in April). However, the economy is likely to contract by maybe 8-10% this year in nominal terms, which means credit is going to have to shrink by a lot more if de-gearing is to take place in Ireland. Otherwise, we are really borrowing from future consumption and investment."
All I can add is that we borrow from future growth and investment in order to pay wages to the public sector and welfare bills.
"On the deposit side, the resident number was running at -2.5% yoy in April – an improvement on January’s -4.5%. Our discussions with the banks would suggest that current account balances, which are a great barometer of economic activity, are still declining but not at the rate that they were – so another positive second derivative for us to consider."
I do not care for second derivatives, for, as I pointed out many times before, mathematics imply that as we fall toward zero economic activity, we are approaching the point of total destruction with a decreasing speed. Which is neither important, nor significant of any upcoming upturn. It is simple compounding past falls with smaller rates of decline acceleration.
"Finally, we will also be watching the ECB funding number, particularly the clearing bank figure, to see if it stabilises (see chart) at around €39bn. Dependence on ECB funding shot up in Q1 when Ireland Inc was under funding pressure, but the banks would say that conditions have improved since then albeit the market remains tough. Moreover, some banks are still paying up to get money, so there is a margin impact to be considered. However, the new one-year ECB facility will help ease this a little and give some much-needed duration."
Sure, good news, according to analysts is that we are getting deeper into short-term maturity debt with ECB, then? What's next? Calling on banks executives to replenish banks capital using credit cards? Let's consider this Davy-style 'positive'. Suppose bank A used to take 2-year loans from ECB at a rate R, so borrowing €1 today implied that it had to repay (1+R)^2 in 2011, with associated transactions cost of, say X per issue, the total cost of €1 today to bank A was €(1+R)^2+X. Now, the ECB forces bank A to split the borrowing into 50% into 2-year tranche and 50% into 1-year tranche at rates R1, R2, R3 corresponding to years 1 and 2 one-year rates, plus R3 being an annualized rate of borrowing for 2-year tranche. The issuance cost remains at €X. You have the cost of borrowing €1 now standing at 0.5*[€(1+R3)^2+X]+0.5*[€(1+R1)*(1+R2)+2X]=1.5*X+0.5*[(1+R3)^2+(1+R1)*(1+R2)].
Compare the two costs:
"The next big development on the funding side is the issue of guaranteed senior notes beyond the September 2010 deadline, the legislation for which has just gone through the Dáil. With the likes of Bank of Ireland having 75% of its funding under one year, this will help slow down the
liability churn, although it will come with a cost. We might be looking at 350-375bps all in, which will not help margins either. As we discussed in our recent Bank of Ireland research note ("When September comes: autumn rights issue can be a big catalyst", issued June 19th), we do not need credit growth over the next two to three years to make an investment case for the banks. That is just as well as frankly we are going to get the opposite. Margin expansion would be helpful though, and margins will expand eventually. However, with the ECB likely to sit on its hands for a while and the NAMA benefit likely to come through over time rather than in one big bang, we can expect margins to go down before they come back up again."
This talk about extending the guarantee is a mambo-jumbo that is designed to get the banks off the hook of defaulting loans for just a while longer. In reality, there is only one 'investment case' for Irish banks - NAMA transfer of bad debts to the taxpayers. This is precisely why the banks will need no new lending to extract value. Once they dump their non-performing loans into NAMA and get recapitalization money from the Exchequer, the Great White Hold-up of Irish taxpayers will be complete. Any growth upside for the banks shares will, thus, come solely from impoverishing Irish taxpayers.
A strong investment case, indeed, thanks to the ECB turning chicken when it comes to forcing Irish Government and Banks to obey market discipline.
First, the issue of consumer spending in light of unemployment data from QNHS. As I highlighted earlier, it is the younger workers who are being laid off in droves. This, of course, puts pressure on spending power, as highlighted by several other economists and commentators. Doh! Younger workers save less and spend more out of their income. Layoffs are an immediate hit to their consumption. More ominously - and less discussed in the media and by analysts - young workers save for two reasons: car purchases and home purchases. That is when they are not scared sock-less with the prospect of unemployment (traditional precautionary savings motive) and by the threat of the older generations ripping them off via higher taxation (unorthodox exclusionary savings motive - piling up of savings to offset future loss of voting power and access to career growth due to unfair competition from established and entrenched older generations: this is my own theory of savings contribution, by the way).
In Ireland's case, precautionary savings motive will always be stronger for younger workers - courtesy of the bearded men of SIPTU/ICTU crowd who routinely betray younger workers in their quest for tenure-based job security and pay awards. Public sector leads here too, as many more temporary and fixed-term contract employees in the public sector are the younger one. Guess who will lose their jobs once Minister Lenihan takes to cuts in the public sector?
But the exclusionary savings motive is a new one for Ireland and it is the most venal of them all. Up until recently, Irish younger workers were virtually outside the effective tax net, courtesy of larger transfers and smaller wages. Next Budget will see their incomes decimated in order to pay lavish public sector wages. In the society that is much younger demographically than our fellow Eurozone travellers, our younger workers will, therefore, lose not only money, but also political power. This process is fully a result of perverse Social Partnership arrangement that has predominant concentration of power in the hands of the ageing public sector employees representatives and business groups aligned with public sector monopolies (also dominated by older workforce).
While precautionary savings effects are themselves long-lasting - hard to reverse and 'sticky' over time, the effects of exclusionary savings motive are even longer-term, depressing consumption and investment over much longer time horizon, as loss of power in the society cannot be rectified over business cycles and will have to wait for political cycles to play out. Ireland is going to pay for this 'socialism for the geezers' of our Labour Party, FF, ICTU/SIPTU/TGWU/CPSU etc for many years to come through:
- lower innovation in consumption (with young people withdrawing from actively leading the new products/services adoption process);
- lower general consumption (with young people and their families clawing back on consumption);
- lower investment in productive capital (with younger people looking increasingly abroad for jobs and life-cycle investments);
- lower entrepreneurial activity in traded sectors (with younger people preferring the perceived safety of the public sector to risky business of entrepreneurship);
- lower overall career-cycle risk-taking (with less on the job innovation drive);
- lower rates of growth both in domestic sectors and exporting sectors;
- net emigration of the most skilled young in search of societies that politically and socially empower their youth, instead of turning them into taxation milk cows for the elderly bureaucrats;
- lower rates of economic growth (per bullet points above).
Second, there is an interesting issue of ECB rescue for Ireland. My IMF sources told me that they fully anticipate to put in place an IMF team to monitor developments in Ireland as they expect, over the course of 2009-2010 a serious deterioration in Ireland's fiscal position and a renewed risks to the bond market. But the more interesting comment came on the foot of my questions concerning ongoing ECB rescue of Ireland Inc.
The fact: chart below (courtesy of Davy) shows the ECB lending to Irish institutions.
Irish retail clearing banks (AIB, BofI and the rest of the zombie pack) have raked up €39bn worth of ECB lending, up from around €2bn a year ago. Non-clearing foreign banks have declined in their demand for ECB dosh. Mortgage lenders (ca €66bn) and non-clearing domestic financial institutions (€72bn) are by far the biggest ECB junkies.Here is Davy take on this: "Headline private sector credit is off about 3% from its November peak and, if you extrapolate the trend forward to the end of the year, the year-on-year (yoy) rate could be -6% (+2.4% yoy in April). However, the economy is likely to contract by maybe 8-10% this year in nominal terms, which means credit is going to have to shrink by a lot more if de-gearing is to take place in Ireland. Otherwise, we are really borrowing from future consumption and investment."
All I can add is that we borrow from future growth and investment in order to pay wages to the public sector and welfare bills.
"On the deposit side, the resident number was running at -2.5% yoy in April – an improvement on January’s -4.5%. Our discussions with the banks would suggest that current account balances, which are a great barometer of economic activity, are still declining but not at the rate that they were – so another positive second derivative for us to consider."
I do not care for second derivatives, for, as I pointed out many times before, mathematics imply that as we fall toward zero economic activity, we are approaching the point of total destruction with a decreasing speed. Which is neither important, nor significant of any upcoming upturn. It is simple compounding past falls with smaller rates of decline acceleration.
"Finally, we will also be watching the ECB funding number, particularly the clearing bank figure, to see if it stabilises (see chart) at around €39bn. Dependence on ECB funding shot up in Q1 when Ireland Inc was under funding pressure, but the banks would say that conditions have improved since then albeit the market remains tough. Moreover, some banks are still paying up to get money, so there is a margin impact to be considered. However, the new one-year ECB facility will help ease this a little and give some much-needed duration."
Sure, good news, according to analysts is that we are getting deeper into short-term maturity debt with ECB, then? What's next? Calling on banks executives to replenish banks capital using credit cards? Let's consider this Davy-style 'positive'. Suppose bank A used to take 2-year loans from ECB at a rate R, so borrowing €1 today implied that it had to repay (1+R)^2 in 2011, with associated transactions cost of, say X per issue, the total cost of €1 today to bank A was €(1+R)^2+X. Now, the ECB forces bank A to split the borrowing into 50% into 2-year tranche and 50% into 1-year tranche at rates R1, R2, R3 corresponding to years 1 and 2 one-year rates, plus R3 being an annualized rate of borrowing for 2-year tranche. The issuance cost remains at €X. You have the cost of borrowing €1 now standing at 0.5*[€(1+R3)^2+X]+0.5*[€(1+R1)*(1+R2)+2X]=1.5*X+0.5*[(1+R3)^2+(1+R1)*(1+R2)].
Compare the two costs:
- if the cost of borrowing does not rise over time, so that R1=R2=R3, then the 1-year lending scheme introduction will cost the banks more than the old 2-year scheme by the amount X;
- if the cost of borrowing - ECB rates - rise in 2010 by, say Z bps, so that R2=(1+Z)*R1, then a two-year trip will be cheaper relative to the two 1-year trips by a grand total of €[X+Z(R1+R1^2)].
"The next big development on the funding side is the issue of guaranteed senior notes beyond the September 2010 deadline, the legislation for which has just gone through the Dáil. With the likes of Bank of Ireland having 75% of its funding under one year, this will help slow down the
liability churn, although it will come with a cost. We might be looking at 350-375bps all in, which will not help margins either. As we discussed in our recent Bank of Ireland research note ("When September comes: autumn rights issue can be a big catalyst", issued June 19th), we do not need credit growth over the next two to three years to make an investment case for the banks. That is just as well as frankly we are going to get the opposite. Margin expansion would be helpful though, and margins will expand eventually. However, with the ECB likely to sit on its hands for a while and the NAMA benefit likely to come through over time rather than in one big bang, we can expect margins to go down before they come back up again."
This talk about extending the guarantee is a mambo-jumbo that is designed to get the banks off the hook of defaulting loans for just a while longer. In reality, there is only one 'investment case' for Irish banks - NAMA transfer of bad debts to the taxpayers. This is precisely why the banks will need no new lending to extract value. Once they dump their non-performing loans into NAMA and get recapitalization money from the Exchequer, the Great White Hold-up of Irish taxpayers will be complete. Any growth upside for the banks shares will, thus, come solely from impoverishing Irish taxpayers.
A strong investment case, indeed, thanks to the ECB turning chicken when it comes to forcing Irish Government and Banks to obey market discipline.
Sunday, June 14, 2009
Economics 15/06/2009: policies for growth
For those of you who missed my Sunday Times article, here it is in an unedited version (scroll below).
Here is a link to my Friday's quote in WSJ editorial.
Our Government keeps droning on about Ireland not having a toxic derivatives problem in the banks… Hmmm… unless you count the banks themselves as derivative instruments. Take a look at our loan-to-deposit ratios (LDRs):
AIB: 153% at end-June 2008; 140% in March 2009;
BOI: 174% in September 2007, 157% March 2008, September 2008: at 160.3%,
ILP: 245% in November 2008, 277.4% in September 2008.
Anglo: 124.2% in September 2008
Nationwide: 154% in April 2009 down from 170% in 2007
Now, according to a UBS survey of bank balance sheets of September 2008, Ireland's average loan-to-deposit ratio was 163.1%.
US average: 51% LDR for pre-1960, rising to 85% between 1960 and 1980; breaching 100% in 1997, then 113% in 2007 at its peak, down to 97% May 2009.
Yes, we don’t need securitized packages of MBS tranches to get ourselves thoroughly poisoned…
On to my Sunday Times article:
Over the last two weeks, just as Brian Cowen was exulting over the prospects for Ireland’s return to economic growth thanks to his visionary policies, Russian Government, also facing a major economic crisis, unveiled a new set of economic programmes aimed at getting the state back on track. The package included a tough realistic Budget for 2009-2010, some tax breaks, a commitment to fiscal conservativism, an ambitious set of policies directed at reducing public sector waste, corruption and improving management practices, measures aimed at stimulating private sector investment and demand, and significant new initiatives in R&D and business and technology innovation.
To-date, Irish government sole responses to the crisis have been to raise taxes on businesses, consumers and income earners, and to cut capital investment. All to preserve excessively high level of current public expenditure. Moscow’s response was to cut wasteful spending, lower some business and personal tax rates and rationalise new investment programmes to focus on future growth priorities.
Hence, an ordinary working person in Ireland is now facing an effective tax rate of over 22% - up from 19% a year ago. Her counterpart in Russia is facing a flat rate income tax of 13%, the same as in 2008. An average Irish self-employed person is looking at surrendering over 32% of her income in income tax, up from 29% a year ago. Russian self-employed workers enjoy a new 6% income tax, down from 13%. In terms of incentives, it is clear that Irish Government’s priority is to skin the small entrepreneurs, while the Russians are taking an approach of encouraging individual risk-taking in business.
While Ireland is facing a double-digit fiscal deficit, our current expenditure continues to rise unchecked since July 2008 Government promise to get it under control. The Government is yet to produce a single forecast that actually projects a decrease in current expenditure at any time between now and 2013. This unambiguously signals that Irish leadership envisions fiscal policies adjustments to be fully financed out of increasing tax burden on the ordinary households and businesses.
In contrast, Moscow is cutting spending outside priority areas and temporarily shifting funding from longer-term investment projects. In effect, the Russians retain ring-fenced commitments to invest significant funds in new technologies and SMEs – areas earmarked for future growth, but the Government is borrowing short-term some of the already allocated funds to finance more immediate crisis-related spending.
For example, a year ago, Russian state allocated some €2.3bn for investment in nanotechnologies to cover its programmes over the period of 2009-2015. Last week, the Government wrote Rusnano – semi-state investment company in charge of the funding – an IOU for almost €500mln of these funds, temporarily withdrawing cash without sacrificing any of its investment programmes.
This reveals a more sustainable funding model for state investment in Russia that is based on pre-funding and ring-fencing long-term investment, than the one we have in Ireland, where current revenue is used to finance public investment irrespective of the length of investment horizon.
Other measures enacted by the Russian government in combating this crisis, such as export credits supports, aid to SMEs and state financing of some enterprises (either via equity stake purchases or preferential loans) would fit well in our own policy arsenal, were we more prudent with our expenditures in the years of economic boom. In just 7 years between 2002 and 2008, Russian fiscal authorities built a war chest of funds to sustain necessary public spending and investment. Even after almost a year of financing growing primary imbalances, Russian reserves currently stand at approximately 21% of 2008 GDP. Ireland’s NPRF never exceeded 12% of Ireland’s 2008 GDP – hardly an impressive record of state ‘savings’ over 17 years of robust growth.
History aside, Russian experience shows that forward policy planning and fiscally conservative approach to current spending are the necessary ingredients in dealing with a crisis. Which brings us to the scope for long-range reforms that present a feasible alternative to the present Government plans.
First and foremost, long-term changes are required in our taxation. This much is admitted even by our policy cheerleaders in the Department of Finance and the ESRI. However, to date, there is no indication that the taxation commission is guided in its decisions by the future growth considerations, rather than by the immediate objective of raising new tax revenue.
If Ireland were to seriously pursue high value-added growth development model, our taxation policy has to be altered dramatically. The burden of financing the Exchequer spending, currently disproportionately falling on the shoulders of the above-average income earners (majority of whom represent the same knowledge economy we are trying to expand) must be shifted away from personal income to less mobile physical capital. This will incentivise investments in education, labour productivity-enhancing R&D, training and other forms of human capital, and reduce the wage-costs pressures on companies that operate in the knowledge-intensive sectors. One of the means for delivering such a change would be to levy a significant tax on land offset by reductions in the upper marginal income tax rate.
Another aspect of the tax reform that can stimulate creation of sustainable long-term economic activity in Ireland is an idea of dramatically reducing self-employment and proprietary income tax in line with the Russian experience. Self-employed individuals assume all the risk of running their own business without gaining any of the tax benefits that accrue to corporations. Lowering personal income tax on self-employment to a flat rate of, say, one half of the effective rate of tax applying to an employee earning €60,000 pa (currently standing at 32%) will go a long way in encouraging shift from unemployment into small entrepreneurship.
A different issue is now resting in the hands of yet another Government commission. Current public sector pay, financing systems, and managerial and work practices are simply out of line with the rest of our economy. Across all sectors of Ireland Inc, public sectors sport the lowest value added per unit of labour inputs. Ditto for comparing Irish public sectors productivity against other small open economies within the OECD. Yet, the cost of financing these services is accelerating even during the current downturn, just as the sector overall output is falling. This is hardly news: since the mid 1990s, the range of services and products supplied by the state has been narrowing, yet the staff levels, especially at the top of the pay scale, remuneration costs and non-pay benefits grew.
Reforms must address this exceptionally poor performance, as well as restore pay and benefits to reflect low levels of productivity and value-added delivered by the public sectors.
However, even more important for the long-term growth is to enact systematic principle of separating service provider from the payee. In effect, Irish public sectors are quasi-regulated near-monopolies in their respective industries. Modern services in a small economy cannot function efficiently if the State employees responsible for these services provision are also responsible for pricing and rationing access to the services, regulating services supply and restricting external competition. Irish public sectors price inflation shows conclusively the overall lack of efficiency in our public services provision (see chart).
The Government should elect to provide payment for public access to services, without any prejudice in the choice of service provider. Thus, for example, in health, once standards for quality and safety are adhered to, any approved and properly regulated provider should be allowed to supply medical services to patients. The Exchequer should ensure that those without sufficient income are given state funds to access necessary services. But the Government should exit the business of actually supplying medical services.
Such reforms promise delivering on several key objectives. Experience in other countries, where services provision and access were effectively separated in the 1990s shows that existent service providers do engage in cost-reducing competition, thereby drawing down the cost to the Exchequer. Second, the range and quality of services supplied are improved. Third, granted critical access to the market, new enterprises and thus new employment grow, with some supporting export of such traditionally domestic-only services abroad. Fourth, services consumers do welcome greater choice of service providers and better quality of services. Separation of service provider and payee is a basic concept of organizing modern public services that is yet to dawn on our allegedly highly enlightened politicians and civil servants.
After some 11 months since the current Government has first acknowledged the existence of the economic and financial crises, it is both surprising and disheartening to observe continued lack of policy responses from our leadership. Yet now is not the time to sit on our hands and wait for the US and global economy upturn to rescue Ireland Inc. Instead, it is time we start putting in place few policies that can underpin the recovery in the short run, but can provide support for future long-term growth as well. Tax reforms and public sector revamp certainly top the priorities list.
Here is a link to my Friday's quote in WSJ editorial.
Our Government keeps droning on about Ireland not having a toxic derivatives problem in the banks… Hmmm… unless you count the banks themselves as derivative instruments. Take a look at our loan-to-deposit ratios (LDRs):
AIB: 153% at end-June 2008; 140% in March 2009;
BOI: 174% in September 2007, 157% March 2008, September 2008: at 160.3%,
ILP: 245% in November 2008, 277.4% in September 2008.
Anglo: 124.2% in September 2008
Nationwide: 154% in April 2009 down from 170% in 2007
Now, according to a UBS survey of bank balance sheets of September 2008, Ireland's average loan-to-deposit ratio was 163.1%.
US average: 51% LDR for pre-1960, rising to 85% between 1960 and 1980; breaching 100% in 1997, then 113% in 2007 at its peak, down to 97% May 2009.
Yes, we don’t need securitized packages of MBS tranches to get ourselves thoroughly poisoned…
On to my Sunday Times article:
Over the last two weeks, just as Brian Cowen was exulting over the prospects for Ireland’s return to economic growth thanks to his visionary policies, Russian Government, also facing a major economic crisis, unveiled a new set of economic programmes aimed at getting the state back on track. The package included a tough realistic Budget for 2009-2010, some tax breaks, a commitment to fiscal conservativism, an ambitious set of policies directed at reducing public sector waste, corruption and improving management practices, measures aimed at stimulating private sector investment and demand, and significant new initiatives in R&D and business and technology innovation.
To-date, Irish government sole responses to the crisis have been to raise taxes on businesses, consumers and income earners, and to cut capital investment. All to preserve excessively high level of current public expenditure. Moscow’s response was to cut wasteful spending, lower some business and personal tax rates and rationalise new investment programmes to focus on future growth priorities.
Hence, an ordinary working person in Ireland is now facing an effective tax rate of over 22% - up from 19% a year ago. Her counterpart in Russia is facing a flat rate income tax of 13%, the same as in 2008. An average Irish self-employed person is looking at surrendering over 32% of her income in income tax, up from 29% a year ago. Russian self-employed workers enjoy a new 6% income tax, down from 13%. In terms of incentives, it is clear that Irish Government’s priority is to skin the small entrepreneurs, while the Russians are taking an approach of encouraging individual risk-taking in business.
While Ireland is facing a double-digit fiscal deficit, our current expenditure continues to rise unchecked since July 2008 Government promise to get it under control. The Government is yet to produce a single forecast that actually projects a decrease in current expenditure at any time between now and 2013. This unambiguously signals that Irish leadership envisions fiscal policies adjustments to be fully financed out of increasing tax burden on the ordinary households and businesses.
In contrast, Moscow is cutting spending outside priority areas and temporarily shifting funding from longer-term investment projects. In effect, the Russians retain ring-fenced commitments to invest significant funds in new technologies and SMEs – areas earmarked for future growth, but the Government is borrowing short-term some of the already allocated funds to finance more immediate crisis-related spending.
For example, a year ago, Russian state allocated some €2.3bn for investment in nanotechnologies to cover its programmes over the period of 2009-2015. Last week, the Government wrote Rusnano – semi-state investment company in charge of the funding – an IOU for almost €500mln of these funds, temporarily withdrawing cash without sacrificing any of its investment programmes.
This reveals a more sustainable funding model for state investment in Russia that is based on pre-funding and ring-fencing long-term investment, than the one we have in Ireland, where current revenue is used to finance public investment irrespective of the length of investment horizon.
Other measures enacted by the Russian government in combating this crisis, such as export credits supports, aid to SMEs and state financing of some enterprises (either via equity stake purchases or preferential loans) would fit well in our own policy arsenal, were we more prudent with our expenditures in the years of economic boom. In just 7 years between 2002 and 2008, Russian fiscal authorities built a war chest of funds to sustain necessary public spending and investment. Even after almost a year of financing growing primary imbalances, Russian reserves currently stand at approximately 21% of 2008 GDP. Ireland’s NPRF never exceeded 12% of Ireland’s 2008 GDP – hardly an impressive record of state ‘savings’ over 17 years of robust growth.
History aside, Russian experience shows that forward policy planning and fiscally conservative approach to current spending are the necessary ingredients in dealing with a crisis. Which brings us to the scope for long-range reforms that present a feasible alternative to the present Government plans.
First and foremost, long-term changes are required in our taxation. This much is admitted even by our policy cheerleaders in the Department of Finance and the ESRI. However, to date, there is no indication that the taxation commission is guided in its decisions by the future growth considerations, rather than by the immediate objective of raising new tax revenue.
If Ireland were to seriously pursue high value-added growth development model, our taxation policy has to be altered dramatically. The burden of financing the Exchequer spending, currently disproportionately falling on the shoulders of the above-average income earners (majority of whom represent the same knowledge economy we are trying to expand) must be shifted away from personal income to less mobile physical capital. This will incentivise investments in education, labour productivity-enhancing R&D, training and other forms of human capital, and reduce the wage-costs pressures on companies that operate in the knowledge-intensive sectors. One of the means for delivering such a change would be to levy a significant tax on land offset by reductions in the upper marginal income tax rate.
Another aspect of the tax reform that can stimulate creation of sustainable long-term economic activity in Ireland is an idea of dramatically reducing self-employment and proprietary income tax in line with the Russian experience. Self-employed individuals assume all the risk of running their own business without gaining any of the tax benefits that accrue to corporations. Lowering personal income tax on self-employment to a flat rate of, say, one half of the effective rate of tax applying to an employee earning €60,000 pa (currently standing at 32%) will go a long way in encouraging shift from unemployment into small entrepreneurship.
A different issue is now resting in the hands of yet another Government commission. Current public sector pay, financing systems, and managerial and work practices are simply out of line with the rest of our economy. Across all sectors of Ireland Inc, public sectors sport the lowest value added per unit of labour inputs. Ditto for comparing Irish public sectors productivity against other small open economies within the OECD. Yet, the cost of financing these services is accelerating even during the current downturn, just as the sector overall output is falling. This is hardly news: since the mid 1990s, the range of services and products supplied by the state has been narrowing, yet the staff levels, especially at the top of the pay scale, remuneration costs and non-pay benefits grew.
Reforms must address this exceptionally poor performance, as well as restore pay and benefits to reflect low levels of productivity and value-added delivered by the public sectors.
However, even more important for the long-term growth is to enact systematic principle of separating service provider from the payee. In effect, Irish public sectors are quasi-regulated near-monopolies in their respective industries. Modern services in a small economy cannot function efficiently if the State employees responsible for these services provision are also responsible for pricing and rationing access to the services, regulating services supply and restricting external competition. Irish public sectors price inflation shows conclusively the overall lack of efficiency in our public services provision (see chart).
The Government should elect to provide payment for public access to services, without any prejudice in the choice of service provider. Thus, for example, in health, once standards for quality and safety are adhered to, any approved and properly regulated provider should be allowed to supply medical services to patients. The Exchequer should ensure that those without sufficient income are given state funds to access necessary services. But the Government should exit the business of actually supplying medical services.Such reforms promise delivering on several key objectives. Experience in other countries, where services provision and access were effectively separated in the 1990s shows that existent service providers do engage in cost-reducing competition, thereby drawing down the cost to the Exchequer. Second, the range and quality of services supplied are improved. Third, granted critical access to the market, new enterprises and thus new employment grow, with some supporting export of such traditionally domestic-only services abroad. Fourth, services consumers do welcome greater choice of service providers and better quality of services. Separation of service provider and payee is a basic concept of organizing modern public services that is yet to dawn on our allegedly highly enlightened politicians and civil servants.
After some 11 months since the current Government has first acknowledged the existence of the economic and financial crises, it is both surprising and disheartening to observe continued lack of policy responses from our leadership. Yet now is not the time to sit on our hands and wait for the US and global economy upturn to rescue Ireland Inc. Instead, it is time we start putting in place few policies that can underpin the recovery in the short run, but can provide support for future long-term growth as well. Tax reforms and public sector revamp certainly top the priorities list.
Wednesday, May 6, 2009
Economics 07/05/09: Banks: over-exuberant markets?
Forgive me if I am stating the plain obvious, but Ireland Inc is now insolvent. Full stop. And this means I cannot understand how on earth do the markets think BofI and AIB are a good buy at over €1.00. These prices reflect a peer-pricing comparatives, not the specific banks' fundamentals.
Fundamentals of any regional bank must be tied into two things:
So it is back to Ireland for both banks and thus to points (1) and (2) above.
On point (1), regional economy - Ireland Inc - has no real prospect for growth. If you are in a business of lending you are in for a shock in this country with Ireland's:
Ah, but they do have some value left in them, I hear you say. Ok, sure, they do. Run two scenarios:
Scenario 1: NAMA takes a bite and swallows them in chunks. Equity dilution means existent shareholders will be stuck with, say 10% of the post-NAMA equity pool. In effect, if you are buying these shares now, you will have 1/9th of the value of these claims against current assets post-NAMA. Now, put differently, if you bought today at, say, €1.20 AIB and €1.17 BofI, you actually bought a claim that is worth €0.12 on AIB and €0.117 on BofI in post-NAMA equity. Does this make any sense? I'll get to it in a second.
The only way the above trades make sense is if you expect the Government to nationalize both banks at a spot price on the day of nationalization. In other words - you are in aconfidence game, which can be less-flateringly described as a game of chicken. You run at the Government at an increasing pace, hoping that you can make Cowen and Lenihan blink and pay up on your gamble. That is a hell of a lot of hope. But it is worth entertaining:
Scenario 2: Government nationalizes both banks paying spot price on the close of the day before nationalization. You wake up one day and your shares are just worth what they were last evening at the closing bell, except the state is giving you an IOU for them and the IOU might even bear a discount on the closing price.
This has to be priced as a gamble, or an option. You can get some eggheads in your pricing department to do the maths, but here is a sketch:
You in effect are paying €1.2 today on a put option giving you a right to sel to the Irish Government a share of AIB at some excercise price X to be paid at maturity T, when AIB stock will be worth S(T).
Now,
You expected profit on this put is given by the following:
If you are a sensible investor you have a required rate of return, say r, which in turn determines a strike price required for you option to yield such a return, call it X*:
Of course, your price P is just what you pay today for AIB shares.
The above is still unsolvable and your eggheads are now heading for the windows of their high-rise, high-spec office block. So to save them, lets make another reasonable assumption, namely that when you bought AIB shares at €1.20 you expected them to go up by some factor k which might or might not relate to your required rate of return r. Just for fun, assume that k=r - in other words you were adding AIB to your portoflio on a neutral expectation (we can try it to be aggresive, so k>r, but clearly, no sane person would try to price AIB as a defensive play, unless you've been managing Zimbabwe Soverieign Wealth Fund).
Now, we have required strike price of
Parameterising this for r={5%}, d={0,10%}, we have: X*>{2.5, 2.93}. In other words, for you to make money on this deal, you need the Government to commit to a strike price above €2.5-2.93 per share of AIB range.
And we have not dealt with all layers of uncertainty at all...
Put alternatively - as a bet on nationalization, your purchase of AIB does not really add up. Now, if the price of shares was €0.12 for AIB at the time you bought, then ok, you might have been making a rational bet on nationalization. But not now.
Finally, back to the Option 1: so what does NAMA imply about the fundamentally-justifiable share price for AIB?
Post NAMA, Mr Lenihan will own lions share of AIB. Suppose it will be 90%. Impairment on remaining loans is not going to go away, but it will decline on average. Suppose to 5%, while AIB's book will have shrunk by ca 50%. You are now holding a share covering just 10% of the old total, which means that underlying asset base for you shares is now only 5% of the old share. With 5% impairment, there is no significant asset upside anytime soon, so you are stuck with 5%. Suppose that in the next 5 years you expect AIB to get their act together and rise to the levels of valuation that are 75% of the peak of the 52-weeks range, i.e. old pre-NAMA shares trading at €10.69. In post-NAMA terms, you have a claim to just 5% of this, or €0.53 per share.
Your loss on today's closing price is €1.20-0.53/[(1+i)^5]=€0.72 in today's Euros.
Table below shows some valuation scenarios, assuming 1.5% average annual inflation between now and 2014:
In red - is your bet when buying AIB at €1.20 range: you assume that
Fundamentals of any regional bank must be tied into two things:
- regional growth prospects relative to the bank's market share; and
- bank's ability to open new markets.
So it is back to Ireland for both banks and thus to points (1) and (2) above.
On point (1), regional economy - Ireland Inc - has no real prospect for growth. If you are in a business of lending you are in for a shock in this country with Ireland's:
- rising (and already high) insolvency rates for businesses (see here);
- contracting domestic demand (down 20% already) that, once stabilized, will remain low until households deleverage, which in the case of Irish households means shedding about 50% of their current mortgages and consumer debts to get themselves in line with, say, the US households (in Ireland, household debt per capita stands at about €2 per each Euro of GNP; in the US the figure is about $0.98 per each Dollar of GDP) - do tell me how can this be done if taxes are climbing up while wages are falling down?
- falling external demand and FX shocks - with Irish exporting sector still performing reasonably well, there will be more bad news on the horizon. Even when the global trade turns the corner, Irish banks are hardly significant players in the MNCs game, having no clout, knowledge and global presence of international banks, so exports-led recovery will do little to improve AIB and BofI balancesheets;
- new business start-ups - this area has low potential for growth becasue we are in a big time slowdown, but it also has very high risk attached to it and, again, BofI and AIB simply have no experieince of normal (non-collateralized) business lending;
- housing loans - mortgages lending is going to continue contracting for now and will remain extremely low in years to come because of several factors, including lower incomes, higher income uncertainty, higher taxes (think of us having to actually pay off that NAMA loss over 5-7 years horizon); decimated pension funds, lower disposable savings (just think of people starting to set aside savings for kids college fees and you get the picture), lower cost of housing purchases (smaller transactions volume) and higher costs of house ownership (think of our Greens imposing more and more costs on homeowners while Mr Lenihan & Co are raiding households for more indirect taxation and charges), property tax introduction, etc. etc. etc.;
- competition from other banks - intensifying competition from the foreign-owned banks present here, entering traditionally AIB and BofI territory of personal banking and consumer lending, small business lending and property loans - can BofI and AIB really compete against Barclays, HSBC, or even Rabo, should these banks pursue aggresive growth strategy?
Ah, but they do have some value left in them, I hear you say. Ok, sure, they do. Run two scenarios:
Scenario 1: NAMA takes a bite and swallows them in chunks. Equity dilution means existent shareholders will be stuck with, say 10% of the post-NAMA equity pool. In effect, if you are buying these shares now, you will have 1/9th of the value of these claims against current assets post-NAMA. Now, put differently, if you bought today at, say, €1.20 AIB and €1.17 BofI, you actually bought a claim that is worth €0.12 on AIB and €0.117 on BofI in post-NAMA equity. Does this make any sense? I'll get to it in a second.
The only way the above trades make sense is if you expect the Government to nationalize both banks at a spot price on the day of nationalization. In other words - you are in aconfidence game, which can be less-flateringly described as a game of chicken. You run at the Government at an increasing pace, hoping that you can make Cowen and Lenihan blink and pay up on your gamble. That is a hell of a lot of hope. But it is worth entertaining:
Scenario 2: Government nationalizes both banks paying spot price on the close of the day before nationalization. You wake up one day and your shares are just worth what they were last evening at the closing bell, except the state is giving you an IOU for them and the IOU might even bear a discount on the closing price.
This has to be priced as a gamble, or an option. You can get some eggheads in your pricing department to do the maths, but here is a sketch:
You in effect are paying €1.2 today on a put option giving you a right to sel to the Irish Government a share of AIB at some excercise price X to be paid at maturity T, when AIB stock will be worth S(T).
Now,
- T is uncertain and can be dependent on the S(t) - if Government were to time its nationalization to cheaper price setting;
- S(T) is uncertain, since we do not know T and because the Government can apply a purchase discount d at the day of nationalization, paying you S(T)(1-d) for your shares.
- Discount d can be indepednent of S(T), or it can be increasing in S(T) should the Government decide to extract 'value' out of nationalizing what it might perceive as an overpriced bank.
You expected profit on this put is given by the following:
If you are a sensible investor you have a required rate of return, say r, which in turn determines a strike price required for you option to yield such a return, call it X*:
Of course, your price P is just what you pay today for AIB shares.The above is still unsolvable and your eggheads are now heading for the windows of their high-rise, high-spec office block. So to save them, lets make another reasonable assumption, namely that when you bought AIB shares at €1.20 you expected them to go up by some factor k which might or might not relate to your required rate of return r. Just for fun, assume that k=r - in other words you were adding AIB to your portoflio on a neutral expectation (we can try it to be aggresive, so k>r, but clearly, no sane person would try to price AIB as a defensive play, unless you've been managing Zimbabwe Soverieign Wealth Fund).
Now, we have required strike price of
Parameterising this for r={5%}, d={0,10%}, we have: X*>{2.5, 2.93}. In other words, for you to make money on this deal, you need the Government to commit to a strike price above €2.5-2.93 per share of AIB range.And we have not dealt with all layers of uncertainty at all...
Put alternatively - as a bet on nationalization, your purchase of AIB does not really add up. Now, if the price of shares was €0.12 for AIB at the time you bought, then ok, you might have been making a rational bet on nationalization. But not now.
Finally, back to the Option 1: so what does NAMA imply about the fundamentally-justifiable share price for AIB?
Post NAMA, Mr Lenihan will own lions share of AIB. Suppose it will be 90%. Impairment on remaining loans is not going to go away, but it will decline on average. Suppose to 5%, while AIB's book will have shrunk by ca 50%. You are now holding a share covering just 10% of the old total, which means that underlying asset base for you shares is now only 5% of the old share. With 5% impairment, there is no significant asset upside anytime soon, so you are stuck with 5%. Suppose that in the next 5 years you expect AIB to get their act together and rise to the levels of valuation that are 75% of the peak of the 52-weeks range, i.e. old pre-NAMA shares trading at €10.69. In post-NAMA terms, you have a claim to just 5% of this, or €0.53 per share.
Your loss on today's closing price is €1.20-0.53/[(1+i)^5]=€0.72 in today's Euros.
Table below shows some valuation scenarios, assuming 1.5% average annual inflation between now and 2014:
In red - is your bet when buying AIB at €1.20 range: you assume that- post-Nama Irish Government will hold no more than 75% of equity in the banks, and
- by 2014 - 5 years from now, AIB will be trading at the 75% of its past 52-weeks peak valuation - that is very brisk business conditions indeed, roughly consistent with Ireland's GDP growing at 6-7% pa to get you to such valuations;
- post-Nama Irish Government will hold no more than 90% of equity in the banks, and
- by 2014 - 5 years from now, AIB will be trading at 65% of its past 52-weeks peak valuation;
Tuesday, April 21, 2009
Daily Economics 21/04/09: AIB and getting reality right
AIB is getting reality, courtesy of the Government...
You'd think it was a joke (here), but the Government that can't balance its own books and that prices risk as my two-and-a-half year old prices candies is now pushing an unwilling, reluctant, downright denial-bound AIB into re-considering its capital adequacy. What a fitting beginning of an end to the sorry saga of Irish banking.
CBFSAI or rather the more competent PWC hired to assist them, carried out a stress testing exercise on AIB and then the bank 'concluded' that €1.5bn more capital will be needed to keep the bank capitalized. And not just any capital - Tier 1 stuff, the caviar of the capital world.
The key word here is 'concluded' for it shows that, most likely, some back and forth bargaining between the bank and the Minister for Finance have taken place before arriving at the final figure. Which, of course, leaves me wonder - was the original stress test capital shortfall even bigger than that? We won't know unless PWC report is leaked.
AIB had core equity of €7.7bn (5.8%) and core Tier 1 of €9.9bn (7.4%) in January 2009 before getting €3.5bn in your and my money. Then, government preference shares hiked capital T1 to €13.4bn (10%) while equity remained intact at 5.8%.
Another transfer of wealth from us... to them
To plug the existent hole, AIB is hoping to sell its stakes in the US-based M&T and BZWBK (Poland). The book-value of these assets is questionable, with estimates of €2.2bn being on the higher end (Credit Suisse estimate) with €1.9bn estimated by AIB. But it is largely irrelevant, as sale of M&T will require a goodwill write-back yielding about €480mln in net T1 addition. Sale of BZWBK will require an RWA reduction, implying a net gain of €320mln. From €2.2bn of assets sold, AIB will get 75bps on Tier 1 - €800mln. Should the sale reduce the value of both assets by a modest 20%, you get €640mln boost to tier 1 (+60bps). In other words, someone (you and me) will have to cough up the remaining €700-860bn-odd cash injection for the bank.
There are reports of other accounting acrobatics - e.g repurchasing of various termed debts (tier 2) into perpetual paper (tier 1), but at the very least, the Government will end up putting enough cash into AIB coffers to own 30-50% of the bank outright. Another transfer of wealth will be in the works. From you and me to... ultimately - the public sector. Why? Because even if the Exchequer gets 10cents on a Euro, the Government will never rebate the money back to us. The Government will waste this cash on paying off the unionized public sector workers for 'industrial peace' achieved.
In the long run, the sale of both or either of the assets is going to be also a problem for the bank shareholders. Why? Because apart from having exposure to the US market (first to recover and to benefit from stronger trend growth in years ahead) and Poland (likely to show much stronger rebound than Ireland in years to come), AIB has no strategy as to how it will be making money into the future.
So to summarize: the recapitalization-Redux will be a raw deal for the taxpayers and shareholders, a sweetheart deal for the bank management and a modest payoff to the public sector unions and employees in the longer term.
Exposing NAMA scam
And it is back to NAMA. Recall the €80-90bn in loans that Lenihan is keen on shifting off the banks and into our taxpayer-financed vehicle? Remember the haircut to the loans value that the Davy etc were calling for? 15% that is, or a hit on the taxpayer of €68-76.5bn. Well, this is now getting bigger. If AIB needs €1.5bn in capital, before NAMAzation of its book, the two main banks will be going into NAMA with €22.4bn estimated core equity base and will inevitably lead to the Government as the majority shareholder in both banks even under a minor discount.
Now, consider the signals indicating the state of the loan books that the AIB stress-test conclusions suggest.
We do not have an exact split on LTVs for loans held by the banks. Bank of Ireland in November 2008 was reporting low-50% range for probably the most toxic of all loans - development land, but high-70% range for its overall property investment book. AIB reported in summer 2008 residential development book at 77% LTV (65% allocated to undeveloped land), total development book was evaluated at LTV in excess 70%.
So it is safe to assume that LTV on entire 2-banks loans book is averaging around 72-75%, while for development land - at ca 50%. The total development book to be bought up by NAMA will likely reflect a similar split to 35-65% in AIB, which out of €90bn can be ca €60bn (Davy, for example, have a similar number under their assumption). Since last reports, LTVs have gone up, as values dropped faster than loans write-downs reduced the 'L' part of the ratio, so these assumptions are relatively conservative.
For land, 55% LTV is likely to rise even further, as land markets all but ceased to function. How dangerous is this stuff?
Well, take BofI: land loans of €5.4bn, non-land development loans of €7.9bn. If LTV was 55% in November for land, the bank holds loans on the land with initial value of €5.4bn/0.55=€9.82bn. By many accounts, land is now largely valued at agricultural prices, plus a mark-up of say 50% for better locations. This would imply a 'Value' part fall-off of ca 70% for land. Let's be generous and allow for a 65% fall-off, reducing the BofI's land bank valuation to €9.82bn*0.35=€3.44bn. Under this scenario, assuming BofI takes an impressively honest impairment charge on land of 10%, the LTV has risen from 55% to €5.4*0.9/€3.44bn=141%. BofI will have to cover €1.96bn in lost value before NAMA discounts.
AIB's land bank valuation is €7bn*0.35/0.55=€4.45bn on currently-held €7bn in loans, with effective current LTV up from 55% to €7bn*0.9/€4.45bn=142%. AIB will have to cover €2.55bn in lost value before NAMA discounts. Assuming that this loss is taken at 40% knock-back on RWA, with 10% Tier 1 provision against RWA, we have a capital base hit of an odd €425mln due to land banks out of €1.5bn stress-test implied capital requirement.
But wait, this was just land.
Outside land, there is some roughly €48bn in other development stuff to be picked up by NAMA, with current LTVs at over 70% and values falling by over 40% by the time this recession will be over, implying book value adjusted for risk of €25.6bn - a shortfall of €22bn, approximately, which with 30% RWA impact and Tier 1 ratio of 10% assumptions will require €2.8bn in fresh capitalization.
So combined land and ordinary development stuff on the AIB book is roughly adding up to 1/2 of €2.8bn (non-land), plus ca €425mln (land) = €1.8bn in capital... Pretty close to the €1.5bn figure we got from the PWC's stress-testing after AIB 'agreed' with Mr Lenihan...
And the conclusions are:
Now get into the entire development books that NAMA is aiming to buy: at, say, 70% LTV, the €60bn in loans that NAMA will buy originally underwrote €86bn in 'value'. This will be down ca 45-50% by the end of the crisis (a relatively conservative assumption on housing and commercial development values declines), and assuming write-downs on loans at 5%, we have an implied bottom-of-crisis LTV ratios of €60*0.95/(€86*0.55)=121%.
Applying 15% cut on these loans, as Davy suggests, the taxpayers will be paying €51bn on risk-adjusted assets valued at €47bn, financing the purchase at, optimistically, 5.1-5.5% pa. That is equivalent to taking 121% mortgage on a house that has a closing cost of ca 8.5% upfront and is financed at an interest rate that is more than 2.5 times the rate of my current ordinary mortgage. This Government will turn us all into subprime borrowers.
So now we suspect two things:
You'd think it was a joke (here), but the Government that can't balance its own books and that prices risk as my two-and-a-half year old prices candies is now pushing an unwilling, reluctant, downright denial-bound AIB into re-considering its capital adequacy. What a fitting beginning of an end to the sorry saga of Irish banking.
CBFSAI or rather the more competent PWC hired to assist them, carried out a stress testing exercise on AIB and then the bank 'concluded' that €1.5bn more capital will be needed to keep the bank capitalized. And not just any capital - Tier 1 stuff, the caviar of the capital world.
The key word here is 'concluded' for it shows that, most likely, some back and forth bargaining between the bank and the Minister for Finance have taken place before arriving at the final figure. Which, of course, leaves me wonder - was the original stress test capital shortfall even bigger than that? We won't know unless PWC report is leaked.
AIB had core equity of €7.7bn (5.8%) and core Tier 1 of €9.9bn (7.4%) in January 2009 before getting €3.5bn in your and my money. Then, government preference shares hiked capital T1 to €13.4bn (10%) while equity remained intact at 5.8%.
Another transfer of wealth from us... to them
To plug the existent hole, AIB is hoping to sell its stakes in the US-based M&T and BZWBK (Poland). The book-value of these assets is questionable, with estimates of €2.2bn being on the higher end (Credit Suisse estimate) with €1.9bn estimated by AIB. But it is largely irrelevant, as sale of M&T will require a goodwill write-back yielding about €480mln in net T1 addition. Sale of BZWBK will require an RWA reduction, implying a net gain of €320mln. From €2.2bn of assets sold, AIB will get 75bps on Tier 1 - €800mln. Should the sale reduce the value of both assets by a modest 20%, you get €640mln boost to tier 1 (+60bps). In other words, someone (you and me) will have to cough up the remaining €700-860bn-odd cash injection for the bank.
There are reports of other accounting acrobatics - e.g repurchasing of various termed debts (tier 2) into perpetual paper (tier 1), but at the very least, the Government will end up putting enough cash into AIB coffers to own 30-50% of the bank outright. Another transfer of wealth will be in the works. From you and me to... ultimately - the public sector. Why? Because even if the Exchequer gets 10cents on a Euro, the Government will never rebate the money back to us. The Government will waste this cash on paying off the unionized public sector workers for 'industrial peace' achieved.
In the long run, the sale of both or either of the assets is going to be also a problem for the bank shareholders. Why? Because apart from having exposure to the US market (first to recover and to benefit from stronger trend growth in years ahead) and Poland (likely to show much stronger rebound than Ireland in years to come), AIB has no strategy as to how it will be making money into the future.
So to summarize: the recapitalization-Redux will be a raw deal for the taxpayers and shareholders, a sweetheart deal for the bank management and a modest payoff to the public sector unions and employees in the longer term.
Exposing NAMA scam
And it is back to NAMA. Recall the €80-90bn in loans that Lenihan is keen on shifting off the banks and into our taxpayer-financed vehicle? Remember the haircut to the loans value that the Davy etc were calling for? 15% that is, or a hit on the taxpayer of €68-76.5bn. Well, this is now getting bigger. If AIB needs €1.5bn in capital, before NAMAzation of its book, the two main banks will be going into NAMA with €22.4bn estimated core equity base and will inevitably lead to the Government as the majority shareholder in both banks even under a minor discount.
Now, consider the signals indicating the state of the loan books that the AIB stress-test conclusions suggest.
We do not have an exact split on LTVs for loans held by the banks. Bank of Ireland in November 2008 was reporting low-50% range for probably the most toxic of all loans - development land, but high-70% range for its overall property investment book. AIB reported in summer 2008 residential development book at 77% LTV (65% allocated to undeveloped land), total development book was evaluated at LTV in excess 70%.
So it is safe to assume that LTV on entire 2-banks loans book is averaging around 72-75%, while for development land - at ca 50%. The total development book to be bought up by NAMA will likely reflect a similar split to 35-65% in AIB, which out of €90bn can be ca €60bn (Davy, for example, have a similar number under their assumption). Since last reports, LTVs have gone up, as values dropped faster than loans write-downs reduced the 'L' part of the ratio, so these assumptions are relatively conservative.
For land, 55% LTV is likely to rise even further, as land markets all but ceased to function. How dangerous is this stuff?
Well, take BofI: land loans of €5.4bn, non-land development loans of €7.9bn. If LTV was 55% in November for land, the bank holds loans on the land with initial value of €5.4bn/0.55=€9.82bn. By many accounts, land is now largely valued at agricultural prices, plus a mark-up of say 50% for better locations. This would imply a 'Value' part fall-off of ca 70% for land. Let's be generous and allow for a 65% fall-off, reducing the BofI's land bank valuation to €9.82bn*0.35=€3.44bn. Under this scenario, assuming BofI takes an impressively honest impairment charge on land of 10%, the LTV has risen from 55% to €5.4*0.9/€3.44bn=141%. BofI will have to cover €1.96bn in lost value before NAMA discounts.
AIB's land bank valuation is €7bn*0.35/0.55=€4.45bn on currently-held €7bn in loans, with effective current LTV up from 55% to €7bn*0.9/€4.45bn=142%. AIB will have to cover €2.55bn in lost value before NAMA discounts. Assuming that this loss is taken at 40% knock-back on RWA, with 10% Tier 1 provision against RWA, we have a capital base hit of an odd €425mln due to land banks out of €1.5bn stress-test implied capital requirement.
But wait, this was just land.
Outside land, there is some roughly €48bn in other development stuff to be picked up by NAMA, with current LTVs at over 70% and values falling by over 40% by the time this recession will be over, implying book value adjusted for risk of €25.6bn - a shortfall of €22bn, approximately, which with 30% RWA impact and Tier 1 ratio of 10% assumptions will require €2.8bn in fresh capitalization.
So combined land and ordinary development stuff on the AIB book is roughly adding up to 1/2 of €2.8bn (non-land), plus ca €425mln (land) = €1.8bn in capital... Pretty close to the €1.5bn figure we got from the PWC's stress-testing after AIB 'agreed' with Mr Lenihan...
And the conclusions are:
Now get into the entire development books that NAMA is aiming to buy: at, say, 70% LTV, the €60bn in loans that NAMA will buy originally underwrote €86bn in 'value'. This will be down ca 45-50% by the end of the crisis (a relatively conservative assumption on housing and commercial development values declines), and assuming write-downs on loans at 5%, we have an implied bottom-of-crisis LTV ratios of €60*0.95/(€86*0.55)=121%.
Applying 15% cut on these loans, as Davy suggests, the taxpayers will be paying €51bn on risk-adjusted assets valued at €47bn, financing the purchase at, optimistically, 5.1-5.5% pa. That is equivalent to taking 121% mortgage on a house that has a closing cost of ca 8.5% upfront and is financed at an interest rate that is more than 2.5 times the rate of my current ordinary mortgage. This Government will turn us all into subprime borrowers.
So now we suspect two things:
- Just on land alone, the pre-NAMA liability for two banks is ca €4.5bn - this the cash they will need to find before we level the NAMAzing discount of 15% (Davy), 25% (Merrrion) and so on.
- The latest PWC/CBFSAI stress-test was most likely not stressful enough, as it barely covers the expected land & development loans-related capital losses alone.
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