Economics 11/8/10: Anglo saga continues

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

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

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

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

Third consider Irish media and 'analysts' response to the Anglo call for cash. Of all stockbrokers, only NCB managed to comment on the Anglo call, despite the fact that Anglo's capital demands are indicative of the sector-wide problems. NCB guys actually did a good job in their morning note, saying that:

• "We had added €23bn to our General Government Debt to GDP ratio as a result of Anglo to leave it at 98.1% at year end 2011. This additional €1.4bn now needs to be added and will add approximately 0.7% to our debt to GDP figure at year end 2011." Yeps, with Anglo latest request for funding, Ireland Inc sovereign debt is set to be 99% by the end of 2011.
  
• The NCB guys are also aware, unlike, it appears Davy and Goodies, that Anglo can end up costing us (taxpayers) of sovereign bonds side as well: "The NTMA announced that its next auction on Tuesday August 17th it will tap the 4.0% 15 January 2014 bond and the 5.0% 18 October 2020 bond. The NTMA will be hoping that the Anglo issue is cleared up sooner rather than later and that clarity is given on the final requirement by the State. The uncertainty surrounding the exact amount of the transfer into Anglo is weighing on the Irish sovereign. The Irish 10 year is currently at 5.16% which is 274bps over the equivalent German bond and wider than the benchmark Portuguese 10 year which is yielding 5.079%."

Of course, most of the media have missed the two points of Anglo contagion to the broader markets:

1. Sovereign risk rising due to Anglo uncertainty, and
2. Corporate risk is also rising due to spillover from sovereign uncertainty to corporate assets valuations.

Finally, the whole circus around Anglo's 'news' missed the core point - Anglo started into the present mess with €71bn of 'assets' (aka loans). The total amount earmarked to date for the bank amounts to €24.354bn.

If Nama were to be believed in its LTEV estimates, Anglo's book is roughly 55% under water. This means that its post-Nama book is somewhere closer to being:

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

Translated to the full pre-crisis book, this implies the average recovery rate on Anglo loans of ca 43-47% across the whole book.

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

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

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

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

Economics 6/8/10: Anglo's plans & systemic risks

Updated

Here are some interesting questions (note - just questions for now, on the foot of comments made by Prof Brian Lucey earlier today) regarding the 'Good' v 'Bad' Anglo plans.

Take it from the top: we started with a bank with €71bn on the books valued at valuations of the peak markets. This is now allegedly going to:

• €25bn of the face value of loans pre-writedowns - to the 'Bad' bank, implying that these loans are so poor in quality, even Nama, with an average 50%+ (LTEV-inclusive) haircut is not touching it. This implies that even in the long run, these loans are not going to generate more than, say, 30% recovery rate (a generous 30% that is, but let's take it as such. Note: that is across the entire loan book of the 'Bad' bank);
• €10bn of the face value of loans pre-writedowns - to the 'Good' bank, implying that these loans are better than Nama average, so the LTEV on these loans is above 50%. Assume that the LTEV on them is 60% (which makes them better than Ulster Bank's Irish book, per today's results for Ulster - again a generous allowance, but let's entertain it);
• the remainder is going to Nama.

Now, another little factoid: Central Bank of Ireland has lent Anglo €11.5bn under a MLRA repo agreement secured against the non-Nama loans.

Per Anglo last published results: "Sale and repurchase agreements with central banks include €12.2bn (30 September 2008: €7.6bn) borrowed under open market operations from central banks and €11.5bn (30 September 2008: €nil) borrowed under a Master Loan Repurchase Agreement (’MLRA’) with the Central Bank and Financial Services Authority of Ireland."

Let's do some simple math.

Value (recall - I am factoring referencing to Long Term Economic Value, not the current mark-to-market value, which is even lower):

• €10bn in 'Good' Anglo can be (optimistically) expected to yield €6bn valuation using LTEV;
• €25bn in 'Bad' Anglo can be (again, optimistically) expected to yield €7.5bn valuation using LTEV.
• Allow for 1.5% margin of costs on both sides, to €525mln pa, or over 5 years - i.e. much shorter than Nama horizon - €2.6bn (note: current bank cost structure, which one can expect to be preserved as both banks go about conducting impaired assets recovery - a higher cost activity)
  
• Total non-Nama book value is, inclusive of LTEV net of expected management costs, therefore could be already around €10.9bn.

Against this value of €10.9-13.5bn, CB of Ireland holds €11.5bn worth of loans to the Anglo.

Now to the question: Does this mean that CB might be facing a potentially significant loss on the repos?

This possibility raises two issues:

1. If the repos are spread across 'Good' and 'Bad' bank, then the 'Good' bank is hardly a feasible undertaking, as repos alone already exceed the value of the 'Good' bank even absent impairment charges, while 'Bad' bank has clearly no ability to repay any fraction of these;
2. If the repos are inherited by the 'Bad' bank, then, either CB has to declare a loss (and I am not sure how it can do this), or the taxpayer is on the hook for the repos by having to pay them down through the 'Bad' Anglo.
   

Now, alternatively, let's ask the following question: to recover CBs repos from non-Nama assets, we need to have a combined 'Good' & 'Bad' banks recovery rate of 33% (not covering the costs of operating both banks, funding, bond holders etc). And this, once again, refers to the valuations done on the face value of the loans before any recent impairments - before the bubble burst. To recover all other CBs' funds, plus our own - we need a recovery rate of ca 68% (again ex all costs etc). That's really highly unlikely, folks.


Quite a dilemma, then, especially since ECB (see here) didn't approved the repos in the first place... and since Anglo also owes the other Eurozone Central Banks some €12.2bn more.

What could Mr Trichet say about Anglo's priorities in repaying the loans? Would he be (a) so kind as allow CB of Ireland to recoup its repos, which ECB thought were dodgy enough to refuse to take them itself? or (b) insist that other CBs be repaid first before our own repos are covered? If (a) - I'd say Mrs Merkel would have a few kind words to say to Mr Trichet, given her electorate's feelings about having to bailout Greece. If (b) - the above potential negative valuation of the repos will have to be multiples larger...

Just asking some questions for now... Wonder if there are any answers out there...

Economics 04/05/2010: Why Anglo case is irreparable

A funny way of arguing financial returns that some of our senior 'bankers' have has been highlighted in the latest comments of the Politician-turns-Banker Mr Alan Dukes reported in today's Irish Times (comments and emphasis are mine):

“The [EU] commission came back with a whole series of questions [concerning Anglo's 'business plan' - whether a zombie can have a business plan is a matter for another debate] and we are now rejigging the restructuring plan to deal with the issues the commission has raised. One of the things we are looking at is what would be the situation if we liquidated the bank immediately? Total disaster. A total non-runner. [ Am I the only person concerned with the fact that apparently the 'new plan' will be a re-jigging of the old version or that Mr Dukes has already decided that, while the bank is still looking into liquidation option, he is sure that it will be a total disaster and a non-runner?]

“...The best prospect of getting some value out of it and reducing the total cost to the taxpayer is keeping the good bank of it, because eventually it could be sold on to the benefit of the taxpayer. If you just do a wind-down, it is losses all the way. Whereas if you can make a good bank of it, which should be a quarter of the size of the whole bank, at least you have got something viable and that can be sold off to the private sector in the fullness of time.”

Our senior banker is clearly confusing gross return with net return here. Let me illustrate:

Suppose Anglo separation into two banks - bad and good -

• Yields the value of the 'Good' Anglo at €A at the time of disposal t-years from now
  
• Winding down 'Bad' Anglo costs €B by the time of disposal t-years from now
  
• In the mean time (between now and disposal) the cost of running 'Good' Anglo will be €C
• While the current value of the 'Good' Anglo, without a workout (a fire sale, if you may prefer to call it, or a shorter winding up over 5 years as I would prefer to label it) implies the value of it of €D today.
  
• Also suppose that if we wind down Anglo today (or in the near future), the cost of winding down is €E.
• Assume that present value adjustment (bringing the value of the bank and the level of costs incurred back to today from the date of disposal) is PVadj<1. pvadj="F(Interest">

Mr Dukes says that: since €A>0 then taxpayers win from the option of splitting the bank into 2 parts.

I say that:

• if (€A-€C-€B)*PVAadj>€D-€E then taxpayer loses from the rapid winding down and gains from the breaking up of the bank (Mr Dukes preferred solution)
  
• otherwise, taxpayers gain from the opposite action of completely winding down the bank as soon as possible

Mr Dukes' vision of 'positive return' is also severely skewed by his failure to consider risks (interest rate risk, asset valuation risk, liquidity risk etc) in his assessment. A rather worrying problem since mis-pricing of risks is what got Anglo into trouble in the first place.

In other words, Mr Dukes should really have read up on

1. PDV methodology of computing real returns; and
2. Net Present Value framework for carrying out comparative valuations.

These are really basic building blocks of finance... really!

Economics 28/09/2009: Anglo moving staff & loans to Nama

Ahead of actual establishment of Nama, Anglo Irish Bank has internally been reallocating moving staff and loans to Nama - even before the debates in the Dail and the legislative vote on Nama.

Source close to the bank has informed me that Anglo management have internally established that

• 100 staff members are being transferred to Anglo Nama division to be located in their new offices on Burlington Road. The staff transferred is non-lending personnel and transfers might proceed even before the legislation establishing Nama is voted on.
• Anglo Irish Bank will face an 18 months moratorium on new lending (which begs the question as to what its staff will be doing if a large chunk of its business will be transferred to Nama, while another sizable chunk is expected to be sold in the US).
• Staff at the bank - on selective basis - were given a questionnaire as to their preferences for either staying with the bank, going to Anglo's Nama division or leaving the lender. This process - initiated some weeks ago - has now, allegedly, been completed.
• There has been no signalled decision on what will be the full number of staff transferred to Nama division and what staff cuts will follow at the main bank.
• Top 20 borrowers' loans are also being transferred (ahead of Nama establishment) to Anglo's Nama division, in effect providing for advanced transfer of loans to yet-to-be-approved entity. The source used the words 'unofficial transfer'.

To reiterate - this information comes from sources close to the bank.

If these developments are confirmed, they raise several important questions relevant to Nama:

1. Putting aside the issues of legislative process being pre-emptied by the beneficiaries of Nama transfers, what has been done to assure due attention has been given in the participating banks to managing the loans? If Anglo (and possibly other banks) are ready to unroll the entire infrastructure of managing Nama loans today, how much of their internal resources (that could have been used to properly manage stressed loans) have been diverted to the preparatory stages of Nama processes?
2. The banks cannot set up internal divisions to manage Nama loans unless they have had some certainty on who will pay them for this function in the future and how much they will be paid. Once again, to date, Government has failed to clarify these crucial provisions. A commitment to keep 100 staff in Anglo Nama would be expected to cost the bank around Euro 15-17mln per annum in staff costs, plus additional leasing and administrative costs.
3. Decision to move to a specified office location on new premises should be carefully vetted to avoid any potential conflicts of interest (e.g developer owning the building in which the new Nama-related division will be located should not be amongst those whose loans are being transferred to Nama). Again, has this work been performed already, suggesting that the banks are rushing off the start line before the start signal is actually given?

If I were either a Green member of the Dail or an opposition representative in the Legislature, or indeed a backbencher of FF, I would certainly like to know how commitments of resources, contractual obligations etc can be entered in with respect to Nama ahead of the forthcoming vote...