Our latest paper on Irish economic meltdown (forthcoming in the refereed economics journal Panoeconomicus) is available on ssrn web page for downloads:
Gurdgiev, Constantin, Lucey, Brian M., Mac an Bhaird, Ciaran and Roche-Kelly, Lorcan, The Irish Economy: Three Strikes and You’Re Out? (March 3, 2011) - download here.
Showing posts with label Exclusive Irish Banks. Show all posts
Showing posts with label Exclusive Irish Banks. Show all posts
Saturday, March 5, 2011
Tuesday, June 1, 2010
Economics 1/6/2010: Numbers game at Anglo
Last night, I sat down to run through possible scenarios for the Anglo's 'The Bad and the Ugly' Banks division. You see, something was telling me right off the start that the idea of a 'Good' Bank just doesn't really square off with our knowledge of the bank's operations to date.
So I posited to myself the following question: given Nama transfers and rumored split off of €12-15bn worth of loans into a 'good' bank, can the resulting entity be viable? Like a scientist in a lab, I donned on a white coat (well, really my favorite UofChicago sweatshirt), pulled out a Petri dish (my Excel) and started observing the split of that outright not-so-beautiful and very toxic (to the taxpayers) bacteria, called Anglo...
Here are the results, first in numbers and then in plain English:
Step 1: recall we have pumped €10.3 billion worth of promisory notes into the bank alone. Relying on my yesterday's analysis (see details here), I reproduced the demand that a 'Good' Anglo will generate for funding these promisory notes. Now, a reminder - these numbers (penultimate column) correspond to interest only charge on Anglo from the promisory notes. They exclude principal repayment and other recapitalization funding already in the bank.
Bah, I said, the thing in the Petri dish of mine looks pretty ugly. Ugly as in unable to cover the taxpayers-due interest on capital it receives at the first glance.
Ok, I said to myself, but may be were the new 'Good' bank to grow over time, it will become relatively viable with time? Suppose the 'Good' bank generates no impairments going forward (unrealistic assumption, but suppose it does), suppose that 'Good' Anglo grows its book at 5% (generating no new impairments). Further suppose that there's some value in the 'Bad' bank - so assume 20% of the loans transferred to it perform in the future (an extremely optimistic assumption, but what the h***ll, not much out of line with the general assumptions the Government has been making all through its management of the crisis).
The question I asked then was: with all these rosy assumptions in place, what amount of interest payments annually can Anglo afford?
To compute this, I took several scenarios:
All of this is fine, I said to myself next, but before the interest requirement is first met on the annual basis, there are years of the bank not covering the interest bills. These will cumulate.
My next question, therefore was: How soon can the bank break into the 'black' vis-a-vis interest repayment alone?
Table above shows the cumulated interest arrears from the €10.3 billion in promisory notes. It clearly shows that under all scenarios, save one (the most optimistic scenario) the entire Anglo operation cannot be expected to generate enough cash to cover even the portion of its interest bill. In fact, under the more realistic scenario (last two columns), Anglo - 'Bad' and 'Good' combined - will continue to accumulate interest arrears on the taxpayers funds (ex €4 billion in direct capital it received) through 2020.
There is no principal repayment charge in the above, nor is there a chance of receiving anything close to the interest bill, even assuming that we do not roll up interest on the cash we put in. In simple words - the entire Anglo operation is so fundamentally bust, that the taxpayer is likely to never receive even a few cents on the euro of the money we've put into it.
The only thing that grew in my Petri dish was a voracious bacteria capable of hoovering taxpayers money at a speed unimaginable to any other bank.
One wonders if that is what Mr Alan Dukes and our Government mean when they are saying that proceeding with keeping Anglo on a respirator amounts to minimizing the cost to the taxpayers.
So I posited to myself the following question: given Nama transfers and rumored split off of €12-15bn worth of loans into a 'good' bank, can the resulting entity be viable? Like a scientist in a lab, I donned on a white coat (well, really my favorite UofChicago sweatshirt), pulled out a Petri dish (my Excel) and started observing the split of that outright not-so-beautiful and very toxic (to the taxpayers) bacteria, called Anglo...
Here are the results, first in numbers and then in plain English:
Step 1: recall we have pumped €10.3 billion worth of promisory notes into the bank alone. Relying on my yesterday's analysis (see details here), I reproduced the demand that a 'Good' Anglo will generate for funding these promisory notes. Now, a reminder - these numbers (penultimate column) correspond to interest only charge on Anglo from the promisory notes. They exclude principal repayment and other recapitalization funding already in the bank.
Bah, I said, the thing in the Petri dish of mine looks pretty ugly. Ugly as in unable to cover the taxpayers-due interest on capital it receives at the first glance.Ok, I said to myself, but may be were the new 'Good' bank to grow over time, it will become relatively viable with time? Suppose the 'Good' bank generates no impairments going forward (unrealistic assumption, but suppose it does), suppose that 'Good' Anglo grows its book at 5% (generating no new impairments). Further suppose that there's some value in the 'Bad' bank - so assume 20% of the loans transferred to it perform in the future (an extremely optimistic assumption, but what the h***ll, not much out of line with the general assumptions the Government has been making all through its management of the crisis).
The question I asked then was: with all these rosy assumptions in place, what amount of interest payments annually can Anglo afford?
To compute this, I took several scenarios:
- I allowed 'Good' Anglo to take €12 or €15 billion in loans on board;
- I assumed that it generates 2% of the loan book annually (another optimistic assumption - as it corresponds to an efficiently operating bank in terms of costs, book of business and funding costs - all of which are not exactly characteristic of the Anglo)
- I then assumed three different potential burden levels on interest (recall, no principal) repayment at 30% of the total annual return by the bank, 25% and 20%. Let me explain here that a 30% number is utterly unrealistic, implying that almost a third of the entire operating revenue of the bank will be used to pay interest on a small share of its capital funding. This will, in effect, leave no surplus to pay bonuses (of any kind) and dividends (of any kind) as well as to finance bank's insurance etc. 25% mark is also unrealistic, while 20% is back-breaking for a bank, but can be probably sustained over a couple of years.
All of this is fine, I said to myself next, but before the interest requirement is first met on the annual basis, there are years of the bank not covering the interest bills. These will cumulate.My next question, therefore was: How soon can the bank break into the 'black' vis-a-vis interest repayment alone?
Table above shows the cumulated interest arrears from the €10.3 billion in promisory notes. It clearly shows that under all scenarios, save one (the most optimistic scenario) the entire Anglo operation cannot be expected to generate enough cash to cover even the portion of its interest bill. In fact, under the more realistic scenario (last two columns), Anglo - 'Bad' and 'Good' combined - will continue to accumulate interest arrears on the taxpayers funds (ex €4 billion in direct capital it received) through 2020.There is no principal repayment charge in the above, nor is there a chance of receiving anything close to the interest bill, even assuming that we do not roll up interest on the cash we put in. In simple words - the entire Anglo operation is so fundamentally bust, that the taxpayer is likely to never receive even a few cents on the euro of the money we've put into it.
The only thing that grew in my Petri dish was a voracious bacteria capable of hoovering taxpayers money at a speed unimaginable to any other bank.
One wonders if that is what Mr Alan Dukes and our Government mean when they are saying that proceeding with keeping Anglo on a respirator amounts to minimizing the cost to the taxpayers.
Monday, May 31, 2010
Economics 31/05/2010: Anglo's latest cash call
This just in - the Government has decided to give Anglo, yes, that very Anglo which is Ireland's real zombie bank with no prospect - even theoretical one - a fresh capital injection of €2 billion (here). This brings taxpayers' capital injected into the bank to €14.3 billion to-date.
The official information by DofF claims that because the injection comes in a form of a promisory note, payable over 10-15 years, there will be lesser impact on the taxpayers today. However, although the official announcement does not say so, this term structure of payments means that our future deficits will be front loaded (pre-committed to the amount announced today), implying that for Ireland to reach required 3% deficit/GDP limit by 2015, we will have to face an increased funding requirement for Anglo over time.
This requirement must be provisioned today, since the notes work in the following way:
Now, let us revert back to the 'bank' called Anglo. The State has now committed €10.3 billion in promisory notes. These carry interest rate of... well, I am not sure... but suppose it is 5% to cover the cost of borrowing for these funds in the market, once the funds are disbursed. Assume that 10% of that (actually below a normal charge for a letter of credit for an insolvent company) is outstanding annually until a drawdown. Make a further assumption: assume that Anglo will draw the entire amount in equal annual installments over 5 years - an assumption that is also extremely conservative.
At 5% per annum, Anglo's liabilities to the taxpayers are:
Let me quickly and briefly explain the last 2 columns above. The penultimate column shows the sum of interest charges (at 5% on drawn funds), plus underwriting charge (at 0.5% for undrawn promisory note funds remaining) that Anglo should be paying over the next 10 years, assuming draw down is evenly spread over 5 years on both tranches. The last column then states the amount of loans that are performing that Anglo needs to have on its books in each year to cover the loans interest, not the principal, but interest, assuming that Anglo uses 0.5% of the loans to cover its interest rate, which would roughly amount to 25-30% of its entire interest income on the loans (note - that is really a severe case of the credit squeeze on a bank, but hey, suppose they manage without breaking the back).
How do I come up with this 25-30% estimate? In a normal year, one can expect a fully efficient bank to make ca 2% of their loans volume in revenue. If it pays 0.5% of that amount to cover costs of promisory note, it will be swallowing 25% of the revenue base.
Now, Anglo is transferring to Nama some €35 bn worth of loans, leaving it with ca €30 billion in remaining loans on its books. Of these, roughly 60% is expected to go into the 'bad' bank - in other words, roughly €18 billion worth of loans won't b performing. This leaves it with roughly 40% of loans or €12 billion on the side available for revenue generation. It needs ca €28 billion to cover the cost of the prmisory notes alone...
Get the picture? Even if you dispute my assumptions and half all the costs of the promisory note carry, you still can't get Anglo balance sheet to cover the cost (not the principal) of what it is borrowing from the taxpayers. This puts into perspective the DofF claim that: "As the Minister stated last March the overriding objective of the Government is to minimise the cost to the taxpayer of the restructuring of Anglo Irish Bank".
The official information by DofF claims that because the injection comes in a form of a promisory note, payable over 10-15 years, there will be lesser impact on the taxpayers today. However, although the official announcement does not say so, this term structure of payments means that our future deficits will be front loaded (pre-committed to the amount announced today), implying that for Ireland to reach required 3% deficit/GDP limit by 2015, we will have to face an increased funding requirement for Anglo over time.
This requirement must be provisioned today, since the notes work in the following way:
- At any point in time between today and 10-15 years from now, Anglo can waltz into DofF's offices and ask for any share - between 0.00001% and 100% of the amount issued on the promisory note.
- At that moment, the Government will have to come up with cash pronto, which means - no time to issue separate bonds.
- Which implies that the very second Mr Dukes asks for cash, our deficit goes up by that exact amount.
Now, let us revert back to the 'bank' called Anglo. The State has now committed €10.3 billion in promisory notes. These carry interest rate of... well, I am not sure... but suppose it is 5% to cover the cost of borrowing for these funds in the market, once the funds are disbursed. Assume that 10% of that (actually below a normal charge for a letter of credit for an insolvent company) is outstanding annually until a drawdown. Make a further assumption: assume that Anglo will draw the entire amount in equal annual installments over 5 years - an assumption that is also extremely conservative.
At 5% per annum, Anglo's liabilities to the taxpayers are:
Let me quickly and briefly explain the last 2 columns above. The penultimate column shows the sum of interest charges (at 5% on drawn funds), plus underwriting charge (at 0.5% for undrawn promisory note funds remaining) that Anglo should be paying over the next 10 years, assuming draw down is evenly spread over 5 years on both tranches. The last column then states the amount of loans that are performing that Anglo needs to have on its books in each year to cover the loans interest, not the principal, but interest, assuming that Anglo uses 0.5% of the loans to cover its interest rate, which would roughly amount to 25-30% of its entire interest income on the loans (note - that is really a severe case of the credit squeeze on a bank, but hey, suppose they manage without breaking the back).How do I come up with this 25-30% estimate? In a normal year, one can expect a fully efficient bank to make ca 2% of their loans volume in revenue. If it pays 0.5% of that amount to cover costs of promisory note, it will be swallowing 25% of the revenue base.
Now, Anglo is transferring to Nama some €35 bn worth of loans, leaving it with ca €30 billion in remaining loans on its books. Of these, roughly 60% is expected to go into the 'bad' bank - in other words, roughly €18 billion worth of loans won't b performing. This leaves it with roughly 40% of loans or €12 billion on the side available for revenue generation. It needs ca €28 billion to cover the cost of the prmisory notes alone...
Get the picture? Even if you dispute my assumptions and half all the costs of the promisory note carry, you still can't get Anglo balance sheet to cover the cost (not the principal) of what it is borrowing from the taxpayers. This puts into perspective the DofF claim that: "As the Minister stated last March the overriding objective of the Government is to minimise the cost to the taxpayer of the restructuring of Anglo Irish Bank".
Friday, April 30, 2010
Economics 30/04/2010: Minister Lenihan's statements in the Dail
Some interesting points on Nama, coming out of Minister Lenihan's answers to Dail questions this Wednesday, April 28 (emphasis is mine):
"The NAMA SPV structure has a subscribed capital of €100m. As explained to the Dail at the time of the legislation, and subsequently agreed with the EU, 49% of this capital was advanced by NAMA and 51% by private investors.
Three private investors, namely, Irish Life Investment Managers, New Ireland Assurance and a group of clients of Allied Irish Banks Investment Managers, have each invested €17m in the vehicle. It is important to note that in each case the beneficial owners of the investment are pension funds or other clients of these investment companies and not the parent credit institution. [It is equally important to note that in each case the full owner of each one of these entities is an institution directly involved either in Nama or in Banks Guarantee scheme, which, of course, under normal rules of engagement would imply potential conflict of interest]
The SPV has been established in accordance with Eurostat rules. The Board of the SPV is chaired by the CEO of NAMA and has three NAMA nominated directors with the private investors retaining the right to nominate a further three directors. Thus the SPV is structured in such a manner that NAMA representatives will maintain an effective veto over decisions of the SPV Board. [Thus the so-called 'veto' is a de facto, not de jure. Should one of the Nama representatives on the board fall ill, be delayed in travel or be absent on some state-sponsored junket, in absence of the said member, it is quite possible - even if only in theory - that the veto power can pass over to the 'private' owners of SPV.]
Further:
"In line with my statement to the House on 30 March on the banking situation, I subsequently issued Promissory Notes on 31 March to Anglo Irish Bank and Irish Nationwide Building Society. These Notes will ensure that both institutions continue to meet their regulatory capital requirements. The initial principal amount of the Note that issued to Anglo Irish Bank is €8.3bn and to INBS it is €2.6bn. As I indicated in my recent statement, it is likely that Anglo will need further capital in due course but the extent and timing of such further support remains to be determined.
The terms of the Promissory Notes that issued to both institutions on 31 March are substantively the same and, inter alia, provide that 10% of the principal amount will, if demanded by the institution, be paid each year and that the first such payment will fall due for payment from the Central Fund on 31 March 2011. An annual interest coupon, related to Government bond yields, is also payable on the Promissory Notes which the Minister has absolute discretion to pay on the due date or to add to the principal amount. [So, in contradiction to the deeply-informed Dara O'Brien TD, it is the state who will be paying interest to the banks. Not the other way around]
This ensures that the Note meets accounting requirements to be “fair valued” at the principal amount in the annual accounts of each institution, consistent with the regulatory capital requirements. [This sentence is an example of Minister's habitual abuse of financial terminology, in so far as it makes absolutely no rational sense to anyone even vaguely familiar with finance. 'Fair valued' must refer to a benchmark, being a comparative/relative term. 'Fair valued at the principal amount' is gobbledygook as principal amount - the face value of the bond/note can only be valued in relation to the price of the bond or yield on the bond, none of which are referenced in Minister's statement. Furthermore, fair value concept does not refer to the regulator capital requirements. It refers only - I repeat, only - to the market value of the bond/note.]
In the event of a winding-up of either institution, the aggregate of the outstanding principal amount and any unpaid interest that has accrued on the institution’s Note falls due for immediate payment. [So, at least in theory, the Exchequer might face an immediate call for billions of euros in cash... what provisions have been made to ensure we will have this covered? How will Minister Lenihan be able to raise such funding even if the economy is not in crisis? What will be the additional cost of having to raise such funding in a fire-issue of a new state bond? Has the Minister established adequate pricing scheme to charge the banks for the taxpayers assuming such a risk or has he 'gifted' this risk premium away, thereby potentially exposing taxpayers to added hundreds of millions in new costs of such emergency issuance?]
The Deputy may also wish to note that, as indicated in my banking statement of 30 March, the use of Promissory Notes means that the institution’s capital requirements are met in a way which spreads the cash payments over a number of years and thereby reduces the funding burden on the Exchequer that would otherwise arise in the current year. [This statement clearly shows that Minister Lenihan does not understand the basics of interest rate/yield curve relationships. He implicitly assumes that in the future, the state borrowing costs will be lower than they are today. There is absolutely no reason for such an assumption.]
"The NAMA SPV structure has a subscribed capital of €100m. As explained to the Dail at the time of the legislation, and subsequently agreed with the EU, 49% of this capital was advanced by NAMA and 51% by private investors.
Three private investors, namely, Irish Life Investment Managers, New Ireland Assurance and a group of clients of Allied Irish Banks Investment Managers, have each invested €17m in the vehicle. It is important to note that in each case the beneficial owners of the investment are pension funds or other clients of these investment companies and not the parent credit institution. [It is equally important to note that in each case the full owner of each one of these entities is an institution directly involved either in Nama or in Banks Guarantee scheme, which, of course, under normal rules of engagement would imply potential conflict of interest]
The SPV has been established in accordance with Eurostat rules. The Board of the SPV is chaired by the CEO of NAMA and has three NAMA nominated directors with the private investors retaining the right to nominate a further three directors. Thus the SPV is structured in such a manner that NAMA representatives will maintain an effective veto over decisions of the SPV Board. [Thus the so-called 'veto' is a de facto, not de jure. Should one of the Nama representatives on the board fall ill, be delayed in travel or be absent on some state-sponsored junket, in absence of the said member, it is quite possible - even if only in theory - that the veto power can pass over to the 'private' owners of SPV.]
Further:
"In line with my statement to the House on 30 March on the banking situation, I subsequently issued Promissory Notes on 31 March to Anglo Irish Bank and Irish Nationwide Building Society. These Notes will ensure that both institutions continue to meet their regulatory capital requirements. The initial principal amount of the Note that issued to Anglo Irish Bank is €8.3bn and to INBS it is €2.6bn. As I indicated in my recent statement, it is likely that Anglo will need further capital in due course but the extent and timing of such further support remains to be determined.
The terms of the Promissory Notes that issued to both institutions on 31 March are substantively the same and, inter alia, provide that 10% of the principal amount will, if demanded by the institution, be paid each year and that the first such payment will fall due for payment from the Central Fund on 31 March 2011. An annual interest coupon, related to Government bond yields, is also payable on the Promissory Notes which the Minister has absolute discretion to pay on the due date or to add to the principal amount. [So, in contradiction to the deeply-informed Dara O'Brien TD, it is the state who will be paying interest to the banks. Not the other way around]
This ensures that the Note meets accounting requirements to be “fair valued” at the principal amount in the annual accounts of each institution, consistent with the regulatory capital requirements. [This sentence is an example of Minister's habitual abuse of financial terminology, in so far as it makes absolutely no rational sense to anyone even vaguely familiar with finance. 'Fair valued' must refer to a benchmark, being a comparative/relative term. 'Fair valued at the principal amount' is gobbledygook as principal amount - the face value of the bond/note can only be valued in relation to the price of the bond or yield on the bond, none of which are referenced in Minister's statement. Furthermore, fair value concept does not refer to the regulator capital requirements. It refers only - I repeat, only - to the market value of the bond/note.]
In the event of a winding-up of either institution, the aggregate of the outstanding principal amount and any unpaid interest that has accrued on the institution’s Note falls due for immediate payment. [So, at least in theory, the Exchequer might face an immediate call for billions of euros in cash... what provisions have been made to ensure we will have this covered? How will Minister Lenihan be able to raise such funding even if the economy is not in crisis? What will be the additional cost of having to raise such funding in a fire-issue of a new state bond? Has the Minister established adequate pricing scheme to charge the banks for the taxpayers assuming such a risk or has he 'gifted' this risk premium away, thereby potentially exposing taxpayers to added hundreds of millions in new costs of such emergency issuance?]
The Deputy may also wish to note that, as indicated in my banking statement of 30 March, the use of Promissory Notes means that the institution’s capital requirements are met in a way which spreads the cash payments over a number of years and thereby reduces the funding burden on the Exchequer that would otherwise arise in the current year. [This statement clearly shows that Minister Lenihan does not understand the basics of interest rate/yield curve relationships. He implicitly assumes that in the future, the state borrowing costs will be lower than they are today. There is absolutely no reason for such an assumption.]
Economics 30/04/2010: Anglo Irish Bank shutdown costs
We are once again swamped with the 'new numbers' from the DofF and Minister Lenihan. This time the latest 'facts' relate to the potential cost of shutting down Anglo. Yesterday, Mary Coughlan stated in the Dail that the cost of an immediate liquidation of the bank had been prohibitive (per Irish times - here). Today, the unquestioning media squad is reporting that the cost of shutting down Anglo will be "more than €100 billion" (The Irish Independent, page 17). This figure has been floated out by the Anglo's paid-public-'experts'-turn-paid-executives, like Mr Dukes, and by the DofF talk-heads.
In reality this number is simply plain wrong, representing, simultaneously, a combination of
Assets of €72 billion:
Liabilities to customers and the ECB of €60 billion
You might ask me 2 questions at this junction:
In reality this number is simply plain wrong, representing, simultaneously, a combination of
- bad arithmetic, and
- poor understanding of finance
Assets of €72 billion:
- Loans to customers of €65 billion (with €35 billion earmarked for Nama)
- Loans in the interbank markets (loans to other banks) of €7 billion
- Risk-adjusting loans to customers to reflect an impairment charge of 60% implies recoverable loans of €26 billion (without a need to call in Nama at all).
Liabilities to customers and the ECB of €60 billion
- Customers' deposits of €27 billion
- Banks and ECB deposits of €33 billion
You might ask me 2 questions at this junction:
- "What about bond holders?" Ok, there are €15 billion worth of senior bond holders and €2.3 billion of subordinated bond holders. These bondholders - all institutional - have been begging the State for years to keep banking sector lightly regulated. And I agree with them on this, in principle (omitting details here). As a part of their pleas, we've been repeatedly told that markets are able to price risks better than any regulator can. And I agree with them on this as well. So, as a consequence of their own stated desires and claimed powers, the bond holders should be made to bear the responsibility for their own errors in pricing risks. In other words, the Government should tell them to count their losses. This is what the market is all about and this, not the rescue by taxpayers, is what the real market participants expect from Ireland Inc. Lastly, on this point, there is not a single financial instrument or contract that legally requires the Irish taxpayers to foot the bill for non-sovereign investment undertaking. Full stop. Cut the guarantee on all Anglo bondholders and send them packing. Note: even if we are to cover bondholders in full, Anglo wind down will cost no more than €39 billion. Not €70 billion, nor €100 billion.
- "How can the winding down take place?" Simple - we proceed to gradually, over the next 5 years, to sell assets. Depositors remain guaranteed, so we can rest assured they will not call in their deposits all at the same time. As we realize the value of the assets, we gradually close off the liabilities. To do this, bank staff can be reduced by over 50% and their wages (currently averaging €110,515 per annum per employee) can be cut by the same proportion. This is it, folks - simple.
- Why are Messrs Dukes, Lenihan etc are claiming that the winding down Anglo will cost €70-100 billion? Is it because (a) they have no idea and are 'inventing' numbers as they go? or (b) they have an ulterior motive to claim improbably high figures to continue dragging out this Anglo saga over 20 years?
- Why have the Irish taxpayers paid hundreds of thousands of euros to 'consultants' who cannot come up with a simple, straight forward plan for dealing with Anglo to date, despite the fact that people like Peter Mathews (to whom I am obliged for much of the figures quoted above), Brian Lucey, Karl Whelan and myself have provided viable alternatives for dealing with the 'bank' free of charge?
Wednesday, April 21, 2010
Economics 21/04/2010: De-capitalizing Credit Unions
Per latest leaks from the financial regulators: In order to allow credit unions greater flexibility in re-scheduling loans, Section 35 of the Credit Union Act 1997 is amended to increase the proportion of the loan book of individual credit unions comprising loans of greater than five years duration, subject to appropriate liquidity provision and accounting transparency.
This, in effect, is the plan for de-shoring up capital reserves at the Credit Unions, which so far have the lowest level of financial transparency in operations amongst all financial institutions licensed to conduct retail business in the country. Whatever hides underneath that iceberg, one can only wonder. However, it is now clear that our regulators are concerned with the unions' ability to re-negotiate non-performing loans and to, thereby, avoid calling in loans on ordinary households.
Credit unions under this provision will be allowed to extend loans maturity, providing relief to the households who cannot repay their debts. However, unless householders' problems leading to delinquency on loans are temporary and short-term in nature, this measure will simply dig a deeper debt hole for already financially distressed families.
And the news have implications for the banks. Recall that in theory credit unions should have been the most conservative lenders in the nation. If they are now experiencing significant pressures on their consumer loans, what can be said about the banks who hold jumbo mortgages, top-up mortgages and car loans leveraged up to 6-8 times peak 2007 income?
How long can this charade last?
This, in effect, is the plan for de-shoring up capital reserves at the Credit Unions, which so far have the lowest level of financial transparency in operations amongst all financial institutions licensed to conduct retail business in the country. Whatever hides underneath that iceberg, one can only wonder. However, it is now clear that our regulators are concerned with the unions' ability to re-negotiate non-performing loans and to, thereby, avoid calling in loans on ordinary households.
Credit unions under this provision will be allowed to extend loans maturity, providing relief to the households who cannot repay their debts. However, unless householders' problems leading to delinquency on loans are temporary and short-term in nature, this measure will simply dig a deeper debt hole for already financially distressed families.
And the news have implications for the banks. Recall that in theory credit unions should have been the most conservative lenders in the nation. If they are now experiencing significant pressures on their consumer loans, what can be said about the banks who hold jumbo mortgages, top-up mortgages and car loans leveraged up to 6-8 times peak 2007 income?
How long can this charade last?
Saturday, March 27, 2010
Economics 27/03/2010: Breaking News: AIB and FF/Government
Major news breaking in the media rooms:
AIB (the first story below)
RedC Poll (the second story below)
Story 1:
The first story is about the leaks reported by Newstalk (see here) that AIB will announce before opening of trading on Monday that the state will be taking a 65% stake in the bank.
Per senior source in the Dail (hat tip to B) - the reason for AIB guiding 65% ownership now is that in addition to Nama haircuts, they are, allegedly, seeing significant deterioration in the sub-€5mln loans (the loans below Nama-eligible threshold).
This is hardly surprising. Since May 2009 I have consistently supplied estimates as to the eventual state ownership in both AIB and BofI. Depending on various scenarios:
Alternative: force banks to acknowledge the full extent of their expected losses (as Swedes did in the 1990s), then force them to take the bondholders and equity holders to the cleaners (as Swedes did in the 1990s), and only then take equity - or in effect, take full equity in the banks. The cost for AIB would be around €10-12 bn, depending on how deep of a haircut on senior bondholders the banks can impose.
Story 2:
Tomorrow's RedC poll
Here is a preview - as was supplied to me by my sources (a disclaimer is due here: these are as provided by the source, so check tomorrow's papers for actually confirmed figures). Parties support:
The poll was conducted on Monday-Tuesday, so it does not reflect change of opinion in the wake of Cabinet reshuffling and the dissident TDs comments. Both factors can be expected to contribute to further decline in FF ratings, speculatively pushing core FF support post-Thursday to 21-22%.
Some specific questions:
“Brian Cowen understands people like me” - 31% agree
“Brian Cowen is a good Taoiseach” - 27% agree
“Brian Cowen is a safe pair of hands” - 31% agree
“Brian Cowen is the man to lead us out of recession” - 29% agree
Hat tip to NN.
I wonder what the same punters would say about our leaders now, after the reshuffle debacle and the open dissent amongst the back-benchers.
AIB (the first story below)
RedC Poll (the second story below)
Story 1:
The first story is about the leaks reported by Newstalk (see here) that AIB will announce before opening of trading on Monday that the state will be taking a 65% stake in the bank.
Per senior source in the Dail (hat tip to B) - the reason for AIB guiding 65% ownership now is that in addition to Nama haircuts, they are, allegedly, seeing significant deterioration in the sub-€5mln loans (the loans below Nama-eligible threshold).
This is hardly surprising. Since May 2009 I have consistently supplied estimates as to the eventual state ownership in both AIB and BofI. Depending on various scenarios:
- assumed Nama haircuts,
- the actual current risk weighting on the loans being transferred,
- share price at the time of announcement and
- the willingness of the banks and the Government to recognize future expected losses on the loans not transferred to Nama
- post-Nama injection of capital (with AIB placing around 60-70% of its equity with the State and BofI placing around 40-45%), plus
- second stage recapitalization to correct for continued deterioration in the books over 2010-2011 (adding another 20-30% of equity for AIB and 10-15% for BofI)
- Having injected €7 bn into two banks at the time when they were worth less than €2.5 bn for the entire lot,
- we are now be left on the hook for some €20 bn worth of largely worthless loans - to be purchased at ca 30-40% discounts (against the real market discount of 65-90%),
- plus €7-8 bn in fresh capital post-Nama
- plus the margin of ca 10-15% for further deterioration in non-Nama loan books (requiring another €7-9 bn of fresh capital).
Alternative: force banks to acknowledge the full extent of their expected losses (as Swedes did in the 1990s), then force them to take the bondholders and equity holders to the cleaners (as Swedes did in the 1990s), and only then take equity - or in effect, take full equity in the banks. The cost for AIB would be around €10-12 bn, depending on how deep of a haircut on senior bondholders the banks can impose.
Story 2:
Tomorrow's RedC poll
Here is a preview - as was supplied to me by my sources (a disclaimer is due here: these are as provided by the source, so check tomorrow's papers for actually confirmed figures). Parties support:
The poll was conducted on Monday-Tuesday, so it does not reflect change of opinion in the wake of Cabinet reshuffling and the dissident TDs comments. Both factors can be expected to contribute to further decline in FF ratings, speculatively pushing core FF support post-Thursday to 21-22%.
Some specific questions:
“Brian Cowen understands people like me” - 31% agree
“Brian Cowen is a good Taoiseach” - 27% agree
“Brian Cowen is a safe pair of hands” - 31% agree
“Brian Cowen is the man to lead us out of recession” - 29% agree
Hat tip to NN.
I wonder what the same punters would say about our leaders now, after the reshuffle debacle and the open dissent amongst the back-benchers.
Sunday, March 21, 2010
Economics 21/03/2010: Reckless expectations, not competition
This is a lengthy post - to reflect the importance of the issue at hand. And it is based largely on data from Professor Brian Lucey, with my added analysis.
The proposition that this post is proving is the following one:
Far from being harmed by competition from foreign lenders, Irish banking sector has suffered from its own disease of reckless lending. In fact, competition in Irish banking remains remarkably close (although below) European average and is acting as a stabilizing force in the markets relative to other factors.
I always found the argument that ‘too much competition in banking was the driver of excessive lending’ to be an economically illiterate one. Even though this view has been professed by some of my most esteemed colleagues in economics.
In theory, competition acts to lower margins in the sector, and since it takes time to build up competitive pressure, the sectors that are facing competition are characterized by stable, established players. In other words, in most cases, sectors with a lot of competition are older, mature ones. This fact is even more pronounced if entry into the sector is associated with significant capital cost requirements. Banking – in particular run of the mill, non-innovative traditional type – is the case in point everywhere in the world.
As competition drives margins down, making quick buck becomes impossible. You can’t hope to write a few high margin, high risk loans and reap huge returns. So firms in highly competitive sectors compete against each other on the basis of longer term strategies that are more stable and prudent. Deploying virtually commoditized services or products to larger numbers of population. Reputation and ever-increasing efficiencies in operations become the driving factors of every surviving firm’s success. And these promote longer term stability of the sector.
Coase’s famous proposition about transaction costs provides a basis for such a corollary.
This means that in the case of Irish banking during the last decade, if competition was indeed driving down the margins in lending (as our stockbrokers, the Government and policy analysts ardently argue today), then the following should have happened
In Ireland, of course, during the alleged period of ‘harmful competition’ exactly the opposite took place. Let me use Prof Brian Lucey’s data (with added analysis from myself) to show you the facts.
Firstly, Irish banks became less prudent in lending – as exemplified by falling loans approvals criteria, and by rising LTVs:
Secondly, banks reduced their assets and liabilities diversification (charts 1-3 below) setting themselves up for a massive rise in asymmetric risk exposures.
On the funding side, out went customers deposits, in came banks deposits, foreign deposits and bonds and Irish bonds.
Capital ratios fell out of the way.
And so there has been a change in the world of Irish banking that no other competitive and mature sector of any economy has ever seen. Why? Was it because foreign banks started pushing the timid boys of BofI and AIB and Anglo and INBS out into reckless competitive lending?
You’ve gotta be mad to believe this sop. In reality, the Irish banks’ assets tell the story.
Business loans collapsed, personal loans (the stuff that allegedly, according to the likes of the Irish Times have fuelled our cars and clothing shopping binge during the Celtic Tiger years) actually declined in importance as well. Financial intermediation – the higher margin, higher risk thingy that so severely impacted the US banks – was down as well. No, competition was not driving Irish banks into the hands of higher margin lending. It was driving them into the hands of our property developers. We didn’t have a derivatives and speculative financial investment crisis here – the one that was allegedly caused by the foreign banks coming in and forcing our good boys to cut margins on run-of-the-mill ordinary lending. No, we had an old fashioned disaster of construction and property lending.
And this lending could not have been driven by foreign banks. It came from the total expansion of credit in the economy, presided over by our Central Bank and Financial Regulator, our Government and ECB.
Just how dramatic this change was? Take a look at the ratio of private sector credit to national income in the chart below.
Even a child could have seen the bust coming. The reason that our Financial Regulator and Central Bank failed to see this, despite publishing all this data in the first place, is that they were simply not looking. The former probably obsessed with the pension perks, the latter – well, may be because all the fine art in the Central Bank’s own collection was just too much of a distraction. Who knows? But judging by the above chart lack of significant correction during the crisis – we know who will pay for this in the end. Us, the taxpayers.
As chart above shows, the fundamentals for the boom – in lending and in construction – were never there, folks. And the banks missed that completely. As did our regulators and our policymakers. Brian Lucey of TCD School of Business provides evidence on what was really going on in the Irish banks (again, note that some of the analysis below is mine).
Chart above, based on the Central Bank Credit Survey, basically shows the impact three major forces: expectations of increased competition by the banks, improved banks outlook on the Irish economy three months ahead, and LTVs expectations had in Irish banks willingness to increase lending. Scores above 3 represent tightening of credit conditions (as in banks expecting to cut lending to households), while scores below 3 show forces driving looser credit to households.
If the proposition that foreign banks competition pressures drove Irish banks into looser credit supply were to be correct, one would expect the blue line above to reach far deeper into ‘below 3’ scores than the other two lines. Alas, it did not dip. In fact, competition from other banks was recognized by Irish Bankers themselves to be the least improtant factor contributing to credit supply expansion. Instead, their over-optimism about economic prospects (red line) and their willingess to give away cash at massively inlfated LTVs (the orange line – also a proxy for Bankers’ optimism regarding future direction of house prices) were the two main drivers of credit boom.
Where’s the evidence on ‘harmful competition’ that so many Central Bank leaders, the stockbrokers and Government spokespersons have decried in recent past?
The delirium of our bankers was actually so out of any proportion that, as the surveys data shows, even amidst the implosion of the housing markets since early 2008 they were still saying “hang on....we expect that changes in LTV and economic prosoects will cause us to loosen in the next 3 months". In other words, they were chasing the deflating bubble, not the imaginary foreign banks competitiors.
Let’s take another look at Brian Lucey’s data. Take the scores for Ireland in the above surveys and take their ratios to the Euro area average scores. If the ratio is in excess of 1, then the said factor has contributed to greater tightening in credit supply in Ireland than in the Euro area. If it is less than 1, then the said factor has contributed more to loosening in lending in Ireland than in the Euro area.
So, really, folks, competition in Ireland was actually more of a stabilizing force, than de-stabilizing one. LTV’s optimism and lack of realism in economic forecasts were the two main driving forces of the boom.
Lastly, ECB Herfindahl Index (ratio of Ireland to “big5” EU states) provides exactly the same conclusions:
Again, what above shows is that on virtually every occasion, Irish reading for Herfindahl Index (measuring degree of concentration in banking sector) is in excess of the average Index reading for top 5 EU countries. In other words, there was no such thing as ‘too much competition’ going on in Irish banking sector. If anything, there was somwhat too little of it, compared to Germany, France, Italy, UK and the Netherlands.
And now, for the test of all of this. The chart below regresses each survey factor on the private sector credit index. The negatively sloped line – for LTV and economic prospect factors combined - shows that when this factor scoring in the survey increased, lending became tighter. Positively sloped line – for competition – shows that when competition pressures rose (factor reading declined), lending actually got tighter.
Let’s just stop talking nonesense about too much competition in Irish banking sector drove unsustainable lending. More likely – an anticiaption by our bankers that no matter what they do, they will never be allowed to fail by the state, plus an absolutely rediculous expectations about opur economy drove our banks to the brink.
The proposition that this post is proving is the following one:
Far from being harmed by competition from foreign lenders, Irish banking sector has suffered from its own disease of reckless lending. In fact, competition in Irish banking remains remarkably close (although below) European average and is acting as a stabilizing force in the markets relative to other factors.
I always found the argument that ‘too much competition in banking was the driver of excessive lending’ to be an economically illiterate one. Even though this view has been professed by some of my most esteemed colleagues in economics.
In theory, competition acts to lower margins in the sector, and since it takes time to build up competitive pressure, the sectors that are facing competition are characterized by stable, established players. In other words, in most cases, sectors with a lot of competition are older, mature ones. This fact is even more pronounced if entry into the sector is associated with significant capital cost requirements. Banking – in particular run of the mill, non-innovative traditional type – is the case in point everywhere in the world.
As competition drives margins down, making quick buck becomes impossible. You can’t hope to write a few high margin, high risk loans and reap huge returns. So firms in highly competitive sectors compete against each other on the basis of longer term strategies that are more stable and prudent. Deploying virtually commoditized services or products to larger numbers of population. Reputation and ever-increasing efficiencies in operations become the driving factors of every surviving firm’s success. And these promote longer term stability of the sector.
Coase’s famous proposition about transaction costs provides a basis for such a corollary.
This means that in the case of Irish banking during the last decade, if competition was indeed driving down the margins in lending (as our stockbrokers, the Government and policy analysts ardently argue today), then the following should have happened
- Banks should have become more prudent over time in lending and risk pricing,
- There should have been broader diversification of the banks lending portfolia, with the bulk of new loans concentrating in the areas relating directly to depositor base – corporate and household lending, and a hefty fringe of higher-margin inter-mediation lending to financial institutions, and
- Banks would be seeking to ‘bundle’ more services to differentiate from competitors and enhance margins.
In Ireland, of course, during the alleged period of ‘harmful competition’ exactly the opposite took place. Let me use Prof Brian Lucey’s data (with added analysis from myself) to show you the facts.
Firstly, Irish banks became less prudent in lending – as exemplified by falling loans approvals criteria, and by rising LTVs:
- Lending to private sector as % of GDP was ca 50% in 1995, reaching 100% in 1998 and rising to 300% in 2009
- Vast increases in lending to developers: in 1997 there were €10bn lent out to developers against €20bn in mortgages; in 2008 these figures were €110bn and €140bn respectively
- Over the time when lending to private sector rose 600%, mortgages lending rose 550%, our GDP rose by 75%
Secondly, banks reduced their assets and liabilities diversification (charts 1-3 below) setting themselves up for a massive rise in asymmetric risk exposures.
On the funding side, out went customers deposits, in came banks deposits, foreign deposits and bonds and Irish bonds.
Capital ratios fell out of the way.
And so there has been a change in the world of Irish banking that no other competitive and mature sector of any economy has ever seen. Why? Was it because foreign banks started pushing the timid boys of BofI and AIB and Anglo and INBS out into reckless competitive lending?
You’ve gotta be mad to believe this sop. In reality, the Irish banks’ assets tell the story.
Business loans collapsed, personal loans (the stuff that allegedly, according to the likes of the Irish Times have fuelled our cars and clothing shopping binge during the Celtic Tiger years) actually declined in importance as well. Financial intermediation – the higher margin, higher risk thingy that so severely impacted the US banks – was down as well. No, competition was not driving Irish banks into the hands of higher margin lending. It was driving them into the hands of our property developers. We didn’t have a derivatives and speculative financial investment crisis here – the one that was allegedly caused by the foreign banks coming in and forcing our good boys to cut margins on run-of-the-mill ordinary lending. No, we had an old fashioned disaster of construction and property lending.
And this lending could not have been driven by foreign banks. It came from the total expansion of credit in the economy, presided over by our Central Bank and Financial Regulator, our Government and ECB.
Just how dramatic this change was? Take a look at the ratio of private sector credit to national income in the chart below.
Even a child could have seen the bust coming. The reason that our Financial Regulator and Central Bank failed to see this, despite publishing all this data in the first place, is that they were simply not looking. The former probably obsessed with the pension perks, the latter – well, may be because all the fine art in the Central Bank’s own collection was just too much of a distraction. Who knows? But judging by the above chart lack of significant correction during the crisis – we know who will pay for this in the end. Us, the taxpayers.
As chart above shows, the fundamentals for the boom – in lending and in construction – were never there, folks. And the banks missed that completely. As did our regulators and our policymakers. Brian Lucey of TCD School of Business provides evidence on what was really going on in the Irish banks (again, note that some of the analysis below is mine).
Chart above, based on the Central Bank Credit Survey, basically shows the impact three major forces: expectations of increased competition by the banks, improved banks outlook on the Irish economy three months ahead, and LTVs expectations had in Irish banks willingness to increase lending. Scores above 3 represent tightening of credit conditions (as in banks expecting to cut lending to households), while scores below 3 show forces driving looser credit to households.If the proposition that foreign banks competition pressures drove Irish banks into looser credit supply were to be correct, one would expect the blue line above to reach far deeper into ‘below 3’ scores than the other two lines. Alas, it did not dip. In fact, competition from other banks was recognized by Irish Bankers themselves to be the least improtant factor contributing to credit supply expansion. Instead, their over-optimism about economic prospects (red line) and their willingess to give away cash at massively inlfated LTVs (the orange line – also a proxy for Bankers’ optimism regarding future direction of house prices) were the two main drivers of credit boom.
Where’s the evidence on ‘harmful competition’ that so many Central Bank leaders, the stockbrokers and Government spokespersons have decried in recent past?
The delirium of our bankers was actually so out of any proportion that, as the surveys data shows, even amidst the implosion of the housing markets since early 2008 they were still saying “hang on....we expect that changes in LTV and economic prosoects will cause us to loosen in the next 3 months". In other words, they were chasing the deflating bubble, not the imaginary foreign banks competitiors.
Let’s take another look at Brian Lucey’s data. Take the scores for Ireland in the above surveys and take their ratios to the Euro area average scores. If the ratio is in excess of 1, then the said factor has contributed to greater tightening in credit supply in Ireland than in the Euro area. If it is less than 1, then the said factor has contributed more to loosening in lending in Ireland than in the Euro area.
So, really, folks, competition in Ireland was actually more of a stabilizing force, than de-stabilizing one. LTV’s optimism and lack of realism in economic forecasts were the two main driving forces of the boom.Lastly, ECB Herfindahl Index (ratio of Ireland to “big5” EU states) provides exactly the same conclusions:
Again, what above shows is that on virtually every occasion, Irish reading for Herfindahl Index (measuring degree of concentration in banking sector) is in excess of the average Index reading for top 5 EU countries. In other words, there was no such thing as ‘too much competition’ going on in Irish banking sector. If anything, there was somwhat too little of it, compared to Germany, France, Italy, UK and the Netherlands.And now, for the test of all of this. The chart below regresses each survey factor on the private sector credit index. The negatively sloped line – for LTV and economic prospect factors combined - shows that when this factor scoring in the survey increased, lending became tighter. Positively sloped line – for competition – shows that when competition pressures rose (factor reading declined), lending actually got tighter.
Let’s just stop talking nonesense about too much competition in Irish banking sector drove unsustainable lending. More likely – an anticiaption by our bankers that no matter what they do, they will never be allowed to fail by the state, plus an absolutely rediculous expectations about opur economy drove our banks to the brink. Saturday, January 2, 2010
Economics 02/01/2010: Comparing banking systems
Based on the latest available data from ECB (through 2008, unfortunately), the following three tables provide relative performance analysis of Irish banking system against its main peers.
In all three sets of comparisons I have:
The first table above shows indicators for profitability & efficiency. Here performance rank is computed by assigning the best performing country the score of 1 and the worst performing one the score of 10. There 11 scoring categories in line with the main parameters.
Irish banking system overall comes out as the fourth worst performing in the sample of countries, with significant gap to the group average in terms of sources of income (less stable in the case of Ireland) and total income as a share of assets. Note a very poor performance in net interest income and net fees / commissions - both of these indicators of income will have to be increased in the near future, leading to higher interest charges and fees for retail and corporate clients.
On expenditure side, Irish banks performed above the average, clearly showing that even in the end of 2008 there was virtually no room for improving the margins through further spending cuts. (One caveat - the expenditure side is measured relative to the assets base, so further writedowns on assets in 2009 would have pushed the expenditure performance metric deeper into negative territory). Apart from some layoffs and wages cuts, the sector in Ireland has no choice but to go after income side of the profit margin equation in order to rebuild margins.
On profitability side, provisions & impairments figure is below the average reflecting a clear lack of realism on behalf of the banks. This, in turn, translated into artificially inflated profits, that fell insignificantly short of the group average. However, the relative underperformance of the Irish banking sector was clearly visible in the distribution of returns on equity with most of our banks performing in the lower tier of the group.
The next table shows balancesheets comparatives:
Using the same approach as before, I computed rank scores for the countries (note, I omitted countries with no data observations from the sample). Once again, Irish banks come out as below average performers in the group, ranked fourth from the bottom.
Other interesting features of the data:
Last table deals with capital adequacy. Once again, Irish banking sector posted a lackluster performance.
Mid-range solvency ratio and Tier 1 ratio in the environment of artificially depressed / unrealistic writedowns and over-inflated assets base is worrisome as are total own funds. Securitization weighted heavily under standardized approach, but this was not captured under the internal approach. Average risk-weight for credit risk were high and total capital requirements for operational risks were the lowest in the group.
Little insight can be gained from operational exposures, as these are obscured by the non-Irish IFSC operations, but corporate exposure and retail exposures combined to a hefty 105% for risk-weighted assets, compared to 91% for the group average. The last two lines - overall solvency ratios are telling. Group average is 12.36%. For Ireland: 91% of all assets were held by the institutions with less than 12% in terms of solvency ratio.
The main conclusions from the tables are:
The risk, of course, is that before then, the banks will squeeze all domestic liquidity out of the Irish economy, while the ECB begins to restrict inflow of external liquidity to the system. If that happens, Nama losses and budget deficits will take the second seat to the wave of insolvencies that will hit our country.
Of course, as usual, we have no road map for addressing such risks. Remember - even despite all banking heads insisting publicly that post-Nama there will be no increase in credit flows to SMEs / corporates / households, our Government continues to claim that Nama will be a 'liquidity event' restoring flow of credit to economy.
I will leave you with the following quote:
"Most of this lending is policy-directed with an implicit government guarantee. Despite ...closed factories in *** resulting from the global financial crisis, and hundreds of empty office buildings, retail centres and hotels that are not meeting their debt service payments, banks are still not foreclosing on these properties nor calling the loans due.
The banks prefer to rollover or extend the loans to avoid having to report an increase in non-performing loans. It is not uncommon for *** banks to extend a loan for as much as one year without interest payments if the lender “believes” the ultimate recovery value of the assets will be greater than the outstanding principal and interest. However, it is nearly impossible for a bank to value an empty office building, in a market with a reported vacancy rate nearing 40 per cent ...and declining rents."
The article goes on to argue that for *** this scenario of banks unwilling to recognize losses is risking a derailment of the country progression to the top of the world economic order. The *** is, of course, China. And the article was published here.
But it might have been written about Ireland, where the banks' belief in the ultimate recovery value is nothing more than a punt on selling the distressed rubbish assets to Nama for the price that even at a 30% haircut will reflect an overpayment on their true value of up to 30-40%.
What will Nama do to these assets and how willing it might be to shut down insolvent operations? More willing than the completely reluctant Irish banks? I doubt it.
So where does this leave us at in the beginning of 2010? A Japanese-styled zombie economy scenario for 2010-2025? I hope I am wrong!
In all three sets of comparisons I have:
- included only countries with some proximity (trade / investment / market structure) to Ireland;
- computed some additional (combined) variables using ECB data (group averages and categories totals etc);
- ranked all countries on subsets of criteria shown in each table, so that increasing scores in each case reflect worsening of the rank position; and
- identified in shaded cells the instances where other countries (and/or group average) show poorer performance than Ireland in specific category.
The first table above shows indicators for profitability & efficiency. Here performance rank is computed by assigning the best performing country the score of 1 and the worst performing one the score of 10. There 11 scoring categories in line with the main parameters.Irish banking system overall comes out as the fourth worst performing in the sample of countries, with significant gap to the group average in terms of sources of income (less stable in the case of Ireland) and total income as a share of assets. Note a very poor performance in net interest income and net fees / commissions - both of these indicators of income will have to be increased in the near future, leading to higher interest charges and fees for retail and corporate clients.
On expenditure side, Irish banks performed above the average, clearly showing that even in the end of 2008 there was virtually no room for improving the margins through further spending cuts. (One caveat - the expenditure side is measured relative to the assets base, so further writedowns on assets in 2009 would have pushed the expenditure performance metric deeper into negative territory). Apart from some layoffs and wages cuts, the sector in Ireland has no choice but to go after income side of the profit margin equation in order to rebuild margins.
On profitability side, provisions & impairments figure is below the average reflecting a clear lack of realism on behalf of the banks. This, in turn, translated into artificially inflated profits, that fell insignificantly short of the group average. However, the relative underperformance of the Irish banking sector was clearly visible in the distribution of returns on equity with most of our banks performing in the lower tier of the group.
The next table shows balancesheets comparatives:
Using the same approach as before, I computed rank scores for the countries (note, I omitted countries with no data observations from the sample). Once again, Irish banks come out as below average performers in the group, ranked fourth from the bottom.Other interesting features of the data:
- On liabilities side - deposits from CBs - or can we call it dependency on CBs liquidity to prop up deposit base is hefty?
- Total equity as share of asset base is low.
- Issued capital was low, while reserves are seemingly ok. Issued capital and reserves combined are below average. Ditto for tangible equity.
- On liquidity side, low dependency on interbank market in 2008 really shows the extent to which Irish banks were not being able to access private liquidity pools. So funding base stability was weak.
Last table deals with capital adequacy. Once again, Irish banking sector posted a lackluster performance.Mid-range solvency ratio and Tier 1 ratio in the environment of artificially depressed / unrealistic writedowns and over-inflated assets base is worrisome as are total own funds. Securitization weighted heavily under standardized approach, but this was not captured under the internal approach. Average risk-weight for credit risk were high and total capital requirements for operational risks were the lowest in the group.
Little insight can be gained from operational exposures, as these are obscured by the non-Irish IFSC operations, but corporate exposure and retail exposures combined to a hefty 105% for risk-weighted assets, compared to 91% for the group average. The last two lines - overall solvency ratios are telling. Group average is 12.36%. For Ireland: 91% of all assets were held by the institutions with less than 12% in terms of solvency ratio.
The main conclusions from the tables are:
- Irish banks were too slow to recognise impairments;
- Irish banks profitability is below par, while efficiency is relative robust (with the risk to the downside due to inflated value of assets);
- Risk reserves and equity are poor in comparison to other countries, although this does not appear to be a function of regulatory-set reserves; and
- Margins rebuilding on the banks side will have to take place at the expense of retail and corporate clients.
The risk, of course, is that before then, the banks will squeeze all domestic liquidity out of the Irish economy, while the ECB begins to restrict inflow of external liquidity to the system. If that happens, Nama losses and budget deficits will take the second seat to the wave of insolvencies that will hit our country.
Of course, as usual, we have no road map for addressing such risks. Remember - even despite all banking heads insisting publicly that post-Nama there will be no increase in credit flows to SMEs / corporates / households, our Government continues to claim that Nama will be a 'liquidity event' restoring flow of credit to economy.
I will leave you with the following quote:
"Most of this lending is policy-directed with an implicit government guarantee. Despite ...closed factories in *** resulting from the global financial crisis, and hundreds of empty office buildings, retail centres and hotels that are not meeting their debt service payments, banks are still not foreclosing on these properties nor calling the loans due.
The banks prefer to rollover or extend the loans to avoid having to report an increase in non-performing loans. It is not uncommon for *** banks to extend a loan for as much as one year without interest payments if the lender “believes” the ultimate recovery value of the assets will be greater than the outstanding principal and interest. However, it is nearly impossible for a bank to value an empty office building, in a market with a reported vacancy rate nearing 40 per cent ...and declining rents."
The article goes on to argue that for *** this scenario of banks unwilling to recognize losses is risking a derailment of the country progression to the top of the world economic order. The *** is, of course, China. And the article was published here.
But it might have been written about Ireland, where the banks' belief in the ultimate recovery value is nothing more than a punt on selling the distressed rubbish assets to Nama for the price that even at a 30% haircut will reflect an overpayment on their true value of up to 30-40%.
What will Nama do to these assets and how willing it might be to shut down insolvent operations? More willing than the completely reluctant Irish banks? I doubt it.
So where does this leave us at in the beginning of 2010? A Japanese-styled zombie economy scenario for 2010-2025? I hope I am wrong!
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