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Showing posts with label Irish Government bonds. Show all posts
Showing posts with label Irish Government bonds. Show all posts
The Central Bank of Ireland released the data for holdings of Irish Government bonds for May 2013. Alas, these are not well-defined, as one category, MFIs & Central Bank, pools together two distinct groups of investors.
Here is the data analysis.
The numbers below reference, in addition to those reported by the CBofI, the holdings ex-Promissory Notes. recall that in February we have converted Anglo Promo Notes (EUR26bn worth of the stuff net) into Government bonds. These are held by the CBofI and have nothing to do (for now) with the private demand for Government bonds.
In May 2013, there were EUR115.441 billion worth of Irish Government Long-term Bonds (GLBs) outstanding, with 3mo average through May 2013 up 42.7% on 3mo average through May 2012.
Resident holdings overall amounted to EUR51.236 billion in May 2013. 3mo average through May 2013 is up 143.3% on 3mo average through May 2012, but once we correct for Promo Notes, this increase drops to 'just' 20.9%.
Resident MFIs and CBofI holdings of Government bonds rose from EUR16.671 billion in May 2012 to EUR48.943 billion in May 2013 or controlling for Promo Notes - to ca EUR23.04 billion. 3mo average through May 2013, adjusting for Promo Notes, rose 37.15% y/y. In other words, if contagion conduit between banks and sovereign can be identified with the extent of the banks holdings of Government bonds (and it can be, in part and among other things and with some caveats), then clearly that conduit has gotten larger over the last 12 months, not smaller. I wrote about similar effect in the case of Spain and Italy here: http://trueeconomics.blogspot.ie/2013/06/2962013-banks-sovereign-contagion-its.html
Meanwhile, holdings of Irish Government Long-Dated Bonds by the real resident investors, such as Households and Non-Financial Corporations, have fallen from EUR197 million in May 2012 to EUR193 million in May 2013. 3mo average through May 2013 was down 4.6% y/y. All in, real investors - as opposed to financial institutions, central bank, government and financial intermediaries - held just 0.17% of all Irish Government bonds outstanding in May 2013, down from 0.24% in May 2012.
Non-resident holdings of Irish Government bonds in May 2013 stood at EUR64.206 billion, up on EUR 60.795 billion in May 2012. 3mo average holdings through May 2013 were only 7.8% or EUR4.721 billion ahead of the 3mo average through May 2012.
I am not usually prone on updating my past posts, but the Promissory Notes 'deal' announced last week by Minister Noonan just keeps on giving more and more backlash and analysis. So:
FT Alphaville view here which is broadly in agreement with my view and with links I posted in the original post updates.
Interesting information coming out of ECB on Minister Noonan's claims that the 'deal' is a part of some 'broader plan' - via the Irish Times, here.
Reiterating my view:
Promo Notes have been paid, not deferred
Payment of Promo Notes was originally to be based on Government borrowing cash from the Troika. Under the 'deal' it has been replaced by the Government borrowing cash from BofI
Payment of Notes under the 'deal' cost us more in new debt and increased deficit in 2012, but will decrease interest payment in 2013 compared to original arrangement. Net effect on interest cost - nearly a wash.
The 'deal' is NOT (see ECB official statement) a part of any 'broader deal'.
The ECB are now clearly on a defensive - which means they will be unlikely to support any further 'deals'.
Having gone out with a brave claim to spot a bald eagle soaring in the sky and get a feather for his war bonnet, Chief Noonan came back with a smudgy mud-print of a dodo, a bill for €400mln+, and a promise to go hunting again. Next stop, trading gold for glass beads... oh, they sparkle so nice.
(Obviously - an allegorical analogy. For those rare readers lacking in humor department.)
On a serious note - I find it discomforting and sad that an excellent seasoned politician and a very promising Minister for Finance has been forced into this position of defending the failure. Let's hope his luck (and progress) change in the nearest future.
Trying to sort out the convoluted 'deal' announced by the Minister today and juggle two kids, plus struggle against the computer on a strike from too many files open is a challenge. I might be missing something, but here's my understanding of the thing.
€3.06bn will be delivered not i cash, but in a long-term Government bond of the equivalent fair value
We do not know maturity, but 2025 was mentioned before. Ditto for coupon rate, though Prof Honohan mentioned 5.4% coupon.
Current pricing in around 88% of the FV, so €3.06*0.88=€3.47bn issuance to deliver fair value. If average over longer term horizon is taken - that would go up. If yield is higher - that will go up. It is unclear what fees will be involved as the transaction is complicated (see following).
As is - at current market pricing, there will be an increase in Government debt of roughly €410 million, plus the cost of transactions.
As described above, and as indicated by Minister Noonan, Government deficit will increase by €90mln (approximately: 5.40%*410mln=€22mln plus margin on Government bond yield over interest rate holiday under Promo Notes in 2012).
IBRC will receive the bonds and will repo them to Bank of Ireland on a 1 year deal. In other words, Bank of Ireland will buy the bond from IBRC then put it into ECB repo operations. LTRO being now closed, this will have to be normal repo with ECB. Bank of Ireland will repo IBRC-owned Government bond at ECB Repo rate (1%) + 1.35% margin. In effect, margin is the gross profit to the Bank of Ireland on this transaction.
Before Bank of Ireland formally approves the transaction, bond will be financed by NAMA against IBRC collateral (now, imagine that - NAMA holds IBRC's assets and has a working relationship with IBRC. IBRC has no collateral that is equivalent to Government bonds - hence it cannot repo anything at ECB. So by definition, the collateralized pool backing NAMA-IBRC repo will have to be stretched). A year later, BofI might reconsider and roll the deal, but one has to assume that the margin will remain either fixed or go up, plus whatever the repo rate will be then?
NAMA, as far as I understand, has no mandate to carry any of these operations, thus potentially acting outside its legal mandate.
Minister for Finance will guarantee the entire set of transactions, including Bank of Ireland exposure. In effect, Minister will guarantee Government bonds (which is silly), collateral from IBRC, NAMA exposure, Bank of Ireland exposure and so on.
NAMA will use own cash to finance the bridging transaction.
Having received the funds from the repo, IBRC will remit these to (€3.06bn) to the CBofI to cancel corresponding amount in ELA.
Has Net Present Value of the debt been altered? We do not know. We need to have exact data on bond maturity and the coupon rate, plus on overall profile of the rest of the notes to make any judgement here. Any change in the NPV under the above outline (1-5) is immaterial.
The positive factor of so-called 'more flexible fiscal buffer' is a red herring, in my view. The idea is that we are 'saving' cash allocation of €3.06bn this year, making it 'available' for borrowing in 2013. This is rather stretching the reality - the 'cushion' has been pre-provided to us by the Troika deal and is specific to the Promissory Notes. There is no indication that it can be used for any other purposes. Even if it were to be used for any other purpose, it would be an addition to the bond issued, so our debt will increase by the amount we use from the 'cushion'. Furthermore, the deal runs out in 2013 and thereafter no 'cushion' is available. So on the net, we have just paid 400mln increase in debt, plus 90mln in deficit to buy ourselves an 'insurance' policy that should we need 3bn in 2013, we will be able to ask for it from the kindness of the EU and have it for no longer than a year. That's pretty damn expensive insurance policy.
The negative factor is that we now have almost 3.5bn worth of extra debt that is senior to the promissory notes it replaced and once it is repoed at the ECB it will be senior to ELA exposure.
Furthermore, this debt is in the form of Government bonds. So suppose we want to return to the debt markets in 2014. We have higher stock / supply of Government bonds (albeit 3.47bn isn't much - just a few percentage points increase) that markets will price in. Higher supply, ceteris paribus, means lower price, higher yield on bonds we are to issue in 2014.
Minister Noonan and a number of other Government parties' members have mentioned 'jobs creation' capacity expansion as the result of this deal. The only way, in theory, this deal can lead any jobs creation is if the Government were to use €3.1bn allocation available for Promo Notes under the Troika deal for some sort of public spending programme. Which, of course, means our debt will increase by the very same amount used.
Brian Hayes on Today FM described the 'deal' (H/T to Prof Karl Whelan) as 'A creative piece of financial engineering.' Presume safely that Brian Hayes has a firm idea that this description is a 'net positive' for the Government.
Following the announcement by the Minister, there were no questions allowed by Dail members and the Minister moved on to the really important stuff - straight to press briefing in the Department of Finance. He might have opted for the right move, however, since the Dail, without any interrruption vigorously engaged in a debate on this important topic:
On that note, the last word (for now) goes to Prof Whelan: "Ok, after exchanges with very wise @OwenCallan I have decided that this deal defers the 3.1bn payment by only one year. Worse than hoped for" (quoting a tweet).
Welcome to the wonderland of wonderlenders.
Updates:
Adding to the above, it is worth postulating directly - as I have argued consistently, ELA is the only debt we can - at least in theory - restructure and promo notes are a perfect candidate for such a restructuring. By converting a part of these into Government debt we are now de fact increasing probability of a sovereign default or restructuring.
Karl Whelan has an excellent post on the 'deal' - here.
ECB statement on Ireland's 'deal' is here. This clearly states that there is no deferral of any payment on Promo Notes and that the Noonan's 'deal' is a one-off. Thank gods it is - because at a cost of €400mln in added debt, plus €90mln in deficit, repeating this exercise in PR spin would be pretty expensive.
"Minister for Finance Michael Noonan said the big benefit was the money would not have to be borrowed to pay this year’s instalment on the promissory notes, the State IOUs paying for the bailouts."
A truly extraordinary statement, given the state will borrow the money (some €410mln more in principal and €90 mln more in interest than actually it had to borrow) using a Government bond to pay said IOU!
The Irish Times headline reads: "Government wins backing on €3.06bn payment". Yet there is no any 'backing' from anyone on this deal, because the deal does not change the payment itself. Read the above-linked ECB statement on the 'deal'.
In another extraordinary statement, the Irish Times (this is their own claim) says: "Further talks on a long-term deal on the remaining repayments as part
of a wider restructuring of the banks will continue between the
Government and the troika of the EU Commission, the ECB and the
International Monetary Fund." Is there ANY evidence that any such negotiations are ongoing? Where is this evidence? Please, produce!
And an excellent piece from Namawinelake on the above: here.
The CSO issued today updated - revised - figures for General Government Debt for Ireland. here's the core changes:
As you can see, the error due to the DofF double counting has been now rectified and the adjusted 2010 GGD now stands at €144,269 million. This, to remind you, does not include Nama liabilities, but it does include the promissory notes issued to Anglo & INBS. Table below details holdings of the Irish Government debt (as of May 2011):
Updated probabilities of default and spreads on Irish bonds. As usual, a preventative disclaimer - this is just simple mathematical estimate - what the numbers say. No comment to be added. Cumulative spreads tell us how much more we are expected to pay for our borrowings over Germany's cost of fiscal deficit financing, over the period of bond maturity. 85% more for 10 years borrowing currently.
let me ask the following question: if Ireland is nearing (or already in - see here) a bailout from the EFSF, what does this imply to the overall Euro area stability? Funny thing - it turns out that a little old Ireland can give a big young Euro quite a headache because of the way EFSF is structured.
Let’s step back and take a look at the promise EFSF attempts to deliver.
The fund, set up back in May this year, was supposed to provide an emergency funding backstop to countries finding themselves in a liquidity squeeze (unable to borrow in the markets).
There two basic problems with this idea from the point of view contagion from Ireland
Ireland’s crisis is that of insolvency, not of a liquidity squeeze 9although it is increasingly looking like the latter will come in the end). If EFSF were to be explicitly used to address Ireland crisis, then Irish Government will be de facto borrowing from the fund with no hope of repaying it ever back (recall – the lending rates under EFSF should be set close to the market rates, which means, say 7-8% currently, which in turn automatically means we can’t be expected to repay this). If so, then any borrower, I repeat – any borrower – from EFSF will not repay the funds borrowed. And this means EFSF borrowings will have to be covered collectively out of the joint funds of the entire Eurozone. You can pretty much count PIIGS out of funding it – they’ll be the very same borrowers. Which leaves it to France and Germany (Belgium hardly can pay much and Austria has it’s own problems etc) to cover the entire fund.
EFSF own structure implies high risk of contagion from Ireland.
That second point is slightly technical and requires some explaining to do.
One can make an argument that Ireland, if it borrows from EFSF, will trigger an increase in the Euro zone systemic risk. EFSF is set up similar to Collateralized Debt Obligation (CDO) with a "credit enhancement" that allows the senior debt tranche to retain higher risk rating because junior tranches are the ones that will carry the first hit on the whole package in the case of default.
The lags in the disbursement of funding and the capped nature, plus ‘enhancement’ bit of the CDO implies that countries in trouble will have to get into the funding stream as early as possible – as there is quick exhaustion of drawdown funds in the EFSF due to the knock on effect on CDO rating. This is known as an accelerated negative feedback mechanism – as sovereign comes under pressure, sovereigns are encouraged to race into EFSF, which removes their own bonds and capacity to carry debt out of the senior CDO tranche and increases their presence in the junior tranches.
So the guaranteed pool of liabilities increases by the amount country borrows from the fund, but the senior pool decreases by the contribution of this country to the fund. This means that as Ireland joint EFSF, it’s past ‘good credit’ rating falls to zero in the senior CDO tranche, its ‘bad debt’ risk contributes to the reduced quality of the liabilities held by the EFSF. Pressure rises on AAA rating of EFSF, unless EFSF draws more of AAA-rated countries debt into its senior tranche to offset this. EFSF will have to expand to be able to do both: lend out to Ireland and maintain AAA rating. Which, of course means that other EFSF contributors will need to issue more debt to recapitalize EFSF. Which means their own AAA ratings are becoming threatened as well.
You see where it all leads, now, don’t you?
The greater is the number of countries seeking help and/or the greater is the overall demand for EFSF funds, the greater the required buffer funding increases from the remaining EFSF-lending AAA-rated sovereigns. All of which, in plain English means that the EFSF will run into its own lending limits quicker if Ireland were to go into borrowing from it. Much quicker than a simple level of our borrowing would suggest.
Now, any sovereign with an once of sense now will know that a race to tap EFSF is on. The faster you get to it to borrow from it, the more likely you’ll arrive to the borrowing window before the limits are reached. Portugal, Spain and possibly even Italy are in the race.
This is why the markets have never been easy about the entire EFSF – they know that Ireland tapping into EFSF simply does two things:
It delays the inevitable restructuring of the massive debts accumulated on the Irish economy side – either sovereign or banks or households or any two or all three. EFSF does not remove the need for such a restructuring. It simply delays it.
It signifies an exponential increase in the probability of EFSF acting as a conduit for contagion from the PIIGS to the rest of the Euro area.
Another day, two tables courtesy of CMA ... Greece improves, Ireland... well: CPD refers to the priced probability of default. 40.83% for Ireland within 5 years on 40% loss at recovery.
Good morning, folks. As a day starter, please take a note: We are bust! Yesterday’s Exchequer returns are a worthy reading on the theme of the day and hence I am writing a third post on the subject. Let me recap where we are at:
Tax receipts are now under €17.2bn cumulative for the first seven months of the year. As far as our ‘ever optimistic’ official analysts go, things are going on swimmingly. But in reality, we are on track to meet my December 2009 forecast for a shortfall of €500-700mln on the year. And that despite the fact that Ireland has ‘turned the corner’ on growth – highlighting the fact that the read through from GDP to tax revenue is not a straight forward thing. Of course, most of the shortfall is due to our real economic activity – as measured by GNP – is still tanking.
So relative to profile, here’s the picture:Good news on expenditure – overall voted expenditure was 2.6% below anticipated for the period to July. But this ‘achievement’ was driven solely by the cuts to capital spending. Thus, net voted capital expenditure for the first seven months of the year now stands at €2.2bn – full €660mln (-23%) below target. Net voted current expenditure is so far on target, while national debt is costing us slightly less (-€213mln) than DofF anticipated.
So overall, we are on track to deliver the Exchequer deficit of ca €19bn in 2010, close to the target €18.78bn, as capital spending accelerates in H2 2010. But we won’t reach the overall target to GDP. Most likely, we are going to see a 12% deficit to GDP ratio.
And this does not include the full extent of funding for Anglo and INBS. Brian Lenihan has already committed the state to supply €22bn to Anglo alone, of which €14.2bn was already allocated, but only ca €4bn went on the Exchequer accounts. Of the still outstanding €7.8bn, the question is how much of this amount is going to be directly shouldered by official deficit figures. The second question is – will €22bn cover Anglo demand for capital post Nama Tranches II and III transfers – recall that Anglo is yet to move loans for Tranche II. The third question now relates to AIB – given its interim result announced yesterday, one has to wonder if the bank will need more capital. What is beyond question now is that the State will be standing buy with a cheque book ready, should AIB ask for cash.
All in, Ireland Inc’s sovereign accounts this year are likely to come out with a 20% plus deficit relative to GDP. That’s a massive number implying that over a quarter of domestic economy will be accounted for by the shortfall in public finances. Our debt can easily reach over 87% of GDP and close to 110% of GNP (and that’s just including the full Anglo amount of €22bn and excluding Nama and the rest of recapitalizations liabilities).
Scary thought. But don’t worry – the Government will come out to say that it was all due to one-off measures. One-off in 2008, 2009, 2010, and one can rationally expect 2011 and even possibly 2012. By which time Nama liabilities will begin to unwind… serializing the one-offs into the future.
A brilliant chart from one of the readers (hat tip to Jonathan): May Toyota forgive me a pun, but is this a stuck (downward) accelerator problem?.. After all the 'right things' done to our economy, why are we still leagues away from even our fellow PIIGS travelers?
For those of you who missed my yesterday's article in the Sunday Times, here it is in un-edited version.SUMMARYNote: updated below for estimated probabilities of default.
In their recent note, Fitch has singled out our massive public deficit and rising debt as the drivers for Irish sovereign bonds downgrade to a lowly AA- rating. This warning was in line with broader international markets concern about the mounting public debt liabilities around the world.
After days of falling prices on Chinese and Greek debts, this Tuesday it was Spain’s turn. October figures from Spain have revealed that the country deficit is now set reaching 9.5% of its GDP. The Spanish Government has gone out of its way to assure the markets that it plans to bring the deficit to 3% Euro zone limit by 2012. The plan involves raising VAT and capital gains tax. But the main measures will deal with public expenditure cut of 12-15%.
Spain, or course, is facing a public deficit that is some 3 percentage points shy of Ireland’s. But, unlike Ireland, Spain is planning to take its medicine in full and swiftly. Take another example. Denmark’s deficit is 7 percentage points below ours. In contrast to us, Danish government passed tax breaks and a major tax reform package encouraging more labour supply. The country also used its pension reserves to boost household income in this recession. To keep things under control – Danes cut public expenditure by up to 20% in some areas.
Latvia, Estonia, Iceland, and Hungary – all have implemented IMF-mandated cuts in public spending with some inflicting cuts up to 30% on public sector wages. All have seen subsequent rounds of upgrades from economic forecasters and bond markets.
But the signs are, after 27 months of severe crises, the Leinster House is still in the denial as to the full realities of our perilous fiscal position. Even after all the tough talk, Minister Lenihan is now appearing to accept Unions’ compromise for a temporary symbolically modest cut to public sector wages. Yet, the depth of our economic crisis requires nothing short of a drastic and permanent reductions in public spending.
Ireland’s promised €4bn cut in the Budget 2010 – contentious as it might seem to us – is pittance compared to what is needed to restore credibility in our economy.
Per latest set of accounts, we are in the need of raising almost a half of our current spending financing through borrowing. The latest forecasts from the EU Commission and the OECD state that Ireland's general government deficit is expected to be 12.2-12.5% of GDP in 2009 and 11.3-14.7% of GDP in 2010-2011.There is no snowball’s chance in hell that Ireland can reach the required 3% target by 2014 or, for that matter 2015, unless we deal with that share of the deficit that is known as structural deficit.
Any deficit arising in real life, therefore, can be decomposed into a cyclical deficit – that share of the deficit that arises due to a temporary recession – and structural deficit. The latter, of course, is the deficit that arises from structural overspending and cannot be expected to disappear when the economy reaches its long run growth potential.
Hence, the extent of our structural deficit is crucially dependent on the assumptions for the natural rate of growth in Irish GDP. So far this year, our Department of Finance forecasters have assumed that the natural rate of growth for Irish economy lies around the simple average for the 2000-2008 levels –close to 3.8% per annum. Their friends in the ESRI are slightly less optimism, predicting that the natural rate of growth is somewhere around 3% of GDP. All of this suggests that the structural component of our deficit is around 8-9% of GDP per annum or under €14bn. The cyclical component is in the region of 3-4% of GDP or up to €7bn. Hence, the current preferred adjustment path to fiscal solvency envisions cuts of €4bn in 2010 and 2011. Thereafter, reckon our mandarins, things will come back to ‘normal’ and Irish economy will miraculously churn out more tax revenue to cover the remaining hole.
But this bet assumes that Ireland is somehow an outsider to the entire Euro area club of smaller open economies. How else can our potential GDP growth be almost 300% above that of Denmark, 250% greater than Belgium’s, 60% above that for the Netherlands and for the Euro area as a whole? Or why should we assume that Irish economy will overshoot potential growth rate in the first year of recovery, when the majority of European economies are expected to reach theirs some 3-5 years after the end of a recession?
If our potential GDP growth is really in line with the small Euro area countries’ average, then our output gap (the difference between the potential and current GDP) is closer to 6% rather than 7.25% that the Department of Finance builds into its forecasts. This in turn implies that our cyclical deficit is around 2.5%, yielding a structural deficit of ca 9.5-10% of our GDP or €16-17bn in 2009 terms.
To get close to a realistically feasible path to solvency, Brian Lenihan should be aiming to cut some €8bn in public deficit in 2010 alone, followed by €3-4bn cuts in 2011 and 2012 each.
This is the real legacy of excessive exuberance with which Bertie Ahearn handed out cash to various Social Partners constituencies. And it is now manifested in purely toxic extent of deficits that cannot be corrected by any means other than savage cuts. The structure of our expenditure – manifested by the fact that some two thirds of it goes to finance wages, pension and social welfare payments – implies that the cuts must happen in exactly these areas.
Painful as this may be, there is simply no alternative. No productivity increases in the public sector will help deflate the actual costs of the sector. The costs that keep on rising. Per CSO’s latest data, 2009 was a bumper crop year for our servants of the state. Average public sector earnings are up 3.2% in a year to the end of Q2 2009, while average private sector wages are down 6.8% over the same time - a swing of 10 percentage points. Survivorship bias – the fact that earnings figures do not reflect the jobs losses and do not net out resulting redundancy payments in the private sector – suggests that the actual earnings growth differential is much wider than that.
Restoration of our economic health at this junction requires swift and significant cut – of the magnitude of 15-20% - in the total pay bill of the public sector. This can only be achieved through a combination of reduced employment and earnings cuts. It should be accompanied by a 10% cut in social welfare and a 30-40% cut in capital spending.
This is an urgent task that cannot be delayed for future Governments to tackle. Since May this year the Government has gone on a PR offensive arguing that the markets have treated Budgets 2009 as serious efforts to correct deficit.
Most of this is political sloganeering. As the chart clearly shows, although markets estimates of our probability of default on sovereign debt have declined in time from a historic peak in February 2009, this decline was far less significant than the overall market gains experienced by other countries with similar budgetary problems. Having peaked well ahead of all other Euro zone countries, Irish CDS spreads have stayed persistently at the top of the common currency area distribution. And there they remain with a significant risk to the upside.
Here are some index pics, all countries CDSs (5-year) set at 100 on 18/07/2008:
And here is an interesting chart for actual CDSs
The markets are now putting estimated probability of our default above that of Peru!
To put these into perspective, using OECD and EU Commission latest forecasts, taking €8bn in deficit financing out this year will save Irish taxpayers some €3-5bn in interest payments alone over the next 5 years.
The costs of our inaction are mounting.
Here are two charts on estimated probabilities of sovereign default for various CDSs, using a linear formula (not a more accurate PV of contingent claim =PV of fixed payment approach and no bootstrapping).
The above chart shows the cumulative probability of default over 5 year term of life of bonds... we are back in double digits and above Spain and Greece...
And so we now learn than Nama beast has mutated into a high-risk derivative game with ghost investors, imaginary assets and illusionary payoffs. We are, for all intent and purpose, in the BaNama Republic.
Here is the story: per Annex H of the original statement of intent to establish Nama (April Supplementary Budget 2009 : here), the state will set up a Special Purpose Vehicle (SPV) to issue bonds (Nama bonds) that will be guaranteed by the State. Per Eurostat analysis (here) these bonds will not be counted as Irish Government debt.
First point to be made – we are now the first developed country in history that is about to throw the weight of its entire economy behind a private undertaking of extremely risky financial engineering nature.
€54bn worth of Nama Bonds will be issued by this SPV. SPV will be 51% owned by private equity investors who will supply €51mln worth of capital. Total capital base of SPV will be €100mln. This SPV will be borrowing (by issuing bonds) €54bn – which means that on day 1 of its running, the SPV will be 54,000% leveraged or geared. This will imply that Irish Nama-SPV will be leveraged in excess of LTCM – the infamously riskiest of all major investment propositions that anyone saw in financial history before Nama SPV idea came to being.
Point two: the Irish state will be engaged in the riskiest derivative instrument undertaking of all known to man to date.
To cover up the farcical arrangement (with folks with €51mln buying €77bn worth of risky (but recoverable, by Minister Lenihan’s assertions) assets), maximum 10% of SPV value can be distributed in profits. 10% of what you might ask?
CSO submission to Eurostat states that: “The profits earned by the SPV will be distributed to the shareholders according to the following arrangement, which reflects the fact that the debt issued by the Master SPV will be guaranteed by the Irish Government:
The equity investors will receive an annual dividend linked to the performance of the Master SPV.
On winding up of the Master SPV, the equity investors will only be repaid their capital if the Master SPV has the resources; they will receive a further equity bonus of 10% of the capital if the Master SPV makes a profit.
All other profits and gains of the Master SPV will accrue to NAMA.”
Two possibilities: 10% of expected (by DofF) Nama profits or 10% of Nama assets?
In the unlikely event of 10% of assets, the lucky ‘private equity’ folks can get 10%*€54bn*51% share – or €2.754bn – on the original investment of €51mln. They face no downside other than their initial capital injection less whatever dividends they collect prior to default, as bonds are guaranteed by the State. I assume this is a fantasy land. But one cannot make any rational assumptions about Nama anymore.
In a more likely event, it will be 10% of Nama profits. Ok, per DofF, Present Value of Nama profit is €4.7bn * 10% * 51% = €239.7mln. With principal repayment this means they will collect a cool €291mln on day last of Nama existence if DofF projections stack up.
We know nothing about the dividends, but we do know that the dividends will be paid out over 10 years. For some sort of decorum the Irish Government will have to allow SPV to appear to be legitimate and therefore it will allow it to pay a dividend on assets managed. Suppose the dividend will be around ½ of the standard management fee for assets, or roughly 100bps on revenue generating loans or 2.5% on net cash flow. Per DofF Table 5 of Nama business plan, this will add up to €12bn*1%*51%=€61.2mln using the first method or €61mln computed using the second method. In present value terms. Thus €51mln in initial investment will generate:
Scenario 1 – Nama works out per DofF assumptions = €352mln (inclusive of principal) – a handy return over 10 years of 690% or 21.3% annualized. Not bad for a government guaranteed scheme…
Scenario 2 - Nama loses money and is pronounced insolvent. Investors lose €51ml of original investment, but keep €61mln in dividends. 100% security, 0% risk...
Which brings us to the third point: as Irish taxpayers, we are now in a business of paying handsome returns to private equity folks (more on those below) in exchange for them covering up the true nature of our public finances. A good one, really.
Who owns this SPV? This is an open question. 51% will be held by ‘private investors’. 49% by Nama. 100% of liability will be held by you and me. Is this a Government throwing the entire weight of the sovereign state behind a privately held investment scheme? You bet.
But wait. Who are those ‘private investors’? Can Sean Fitzpatrick be one of them? Why not? Of course he can. Can Ireland’s non-resident non-taxpayers be amongst these? Why not? Of course they can. So as taxpayers we will be issuing a guarantee to tax exiles? Possibly. But wait, it gets even better – can the banks themselves be investors in SPV? Well, of course they can. Wouldn’t that be a farce – banks get to unload toxic waste on taxpayers and then make a tidy profit on doing so…
One way or another – parents struggling to put their kids through schools, elderly people struggling to pay medical care costs, single parents trying to balance work and raising family, young folks studying to better their lives – all of them and all of the rest of us will be bearing 95% responsibility of assuring that some ‘private investors’ will make a nice tidy profit, so Minister Lenihan and Taoiseach Cowen can go around the world claiming that Irish bonds that underpinned Nama were not really Irish bonds!
Which brings us to the fourth point: Why is Eurostat assured by this massive deception scheme to accept it?
Globally, G20 summits one after another have been focusing on how we will have to deal with the risks of the traditional SPVs and other ‘alternative investment’ assets classes that spectacularly imploded during the current crisis. Yet here, in a Eurozone country, a Government is actively setting up the most leveraged, highest risk SPV known to humankind. Surely there is a case to be made that the EU authorities should be actively stopping such reckless financial engineering instead of encouraging it?
The entire SPV trickery works because the Government has managed to convince the Eurostat that SPV will be fully operationally independent of the state. So far so good. But, Nama will sit on the board with a right of veto over SPV managerial and operational decisions: “The NAMA representatives on the Board will maintain a veto over all decisions of the Board that could affect the interests of NAMA or of the Irish Government.” Furthermore, Minister Lenihan and his successors will have veto power over Nama decisions and will be the final arbiters of Nama. Is that arms-length getting to finger-length?
At this point, there is only one institution still standing between the madness of the runaway train of Nama and the crash site of the SPV-high leveraged high finance gables with taxpayers money. That institution is ECB. The ECB will have to be concerned with non-transparent (Enron-like) accounting procedures that are being created by the Irish Government when it comes to accounting for Nama bonds. It has to be concerned if only for the sake of the Eurozone stability and its own reputational capital. Will ECB step in and tell this Government that enough is enough?
Update: There is an interesting note in one of today's stockbrokers' reports: "AIB is to review its selection process for a successor to Eugene Sheehy, according to reports this morning. The Government will not endorse an internal candidate based on renewed signals according to the article. Separately, Minister Brian Lenihan said it was "inevitable" that further public capital will be required by the country's banks after the NAMA transfers."
Two points:
If Government is so aggressive in staking its control over AIB's selection of a CEO, why can't the same Government commit to firing the entire boards upon initiation of Nama? Governments change overnight, so why banks' boards are so different?
I must confess, I like Minister Lenihan's belated (this blog and other analysts have said months ago that there will be second round demand for funding post-Nama due to RWA changes triggered by Nama, and then due to second wave of defaults within mortgage and corporate loans portfolia) recognition of a simple financial / accounting reality. Strangely enough, the brokers themselves never factored this eventuality in their projections of Nama effect on banks balance sheets.
Oh, another little point: Minister Lenihan was last night explaining on RTE that BofI and IAB both raised circa Euro1bn bonds each with the issues oversubscribed by a healthy margin and that these were 3-3.5 year bonds. we should be impressed, then? Au contraire: those foreign investors (in the case of BofI 92% of the bond issue gone to foreign institutionals and banks) are making a rational bet that Ireland will continue to guarantee depositors through 2014 if not even longer, and that the Exchequer will rather destroy the households than see banks go under. In other words, the markets priced Irish banks now as being effectively fully guaranteed by the state - bondholders, shareholders, unsecured debt holders, furniture and office suppliers, staff - you name a counterparty working with Irish banking sector... they are all now implicitly guaranteed by you, me, ordinary taxpayers in Tallaght and elsewhere across the nation. Some success, then.
News: IMF's Global Financial Stability Report Chapter 1 is out today. This is the main section of the report and it focuses on two themes:
Continuation of the crisis in financial markets - the next wave of (shallower, but nonetheless present) risks to credit supply in globally over-stretched lending institutions; and
Future exist strategies from the virtually self-sustaining cycle of new debt issuance by the sovereigns that goes on to mop up scarce liquidity in the private sector, thus triggering a new round of debt issuance by the sovereigns (irony has it, I wrote about the threat of this merry-go-round link between public finances and private credit supply back in my days at NCB - in August 2008).
The report is a good read, even though it is a voluminous exercise - check it out on IMF's main website (at this hour I am still working with press access copy).
Ireland-specific stuff: Nice chart above - Ireland was pretty heavy into ECB cash window back in 2007, but by 2009 we became number one junkies of cheap funding. Like an addict hanging about the corner shop in hope of a fix, our banks are now borrowing a whooping 7% of their total loans volumes through ECB. This is a sign of balance sheet weakness, but it is also a sign that the banks are doing virtually nothing to aggressively repair their balance sheets themselves. Why? Because Nama looms as a large rescue exercise on the horizon. But, denial of a problem is not a new trait. Per chart above, through 2006, Irish banks were third from the bottom in providing for bad loans despite a massive rate of expansion in lending and concentration of this lending in few high risk areas (buy-to-rent UK markets, speculative land markets in Ireland, UK and US and so on). Now, taking the path the Eurozone average has taken since then, adjusting for the decline in underlying property markets in Ireland relative to the Eurozone, and for the shortfall on provisions prior to 2007, just to match current risk-pricing in the Eurozone banks, Irish banks would have to hike their bad loans provisions to 3-3.75%. And this is before we factor in the extremely high degree of loans concentrations in property markets in Ireland. Again, why are we not seeing such dramatic increases? One word: Nama. Lastly, table above shows the spreads on bonds in the US and Eurozone. Two note worthy features here:
The rates of decline in all grades of bonds and across sovereign and corporate bonds shows that they are comparable to those experienced by Ireland. This debunks the myth that Irish bonds pricing improved on the back of something that Irish Government has done ('correcting' deficit or 'setting a right policy' for our economy). Instead, Irish bond prices moved in-line with global trends, being driven by improved appetite for risk in financial markets and not by our leaders' policies;
Current spreads on Irish bonds over German bunds suggest market pricing of Irish sovereign bonds that is comparable to US and European corporates. In effect, Ireland Inc is not being afforded by the markets the same level of credibility as our major European counterparts. One wonders why...
Moody's downgraded Ireland from top Aaa government-bond ratings one notch to Aa1 (hat tip to PMD) saying that Ireland's policy response to the economic downturn had been decisive and the government had a strong balance sheet before the crisis struck, so there was only a need for a moderate downgrade. The ratings were on watch for possible reduction since April. So the move was widely expected.
"The review process focused on the nature of the policy response and the extent to which the Irish economic model was durably affected by a sudden and brutal economic and financial adjustment," said Moody's Sovereign Risk Group analyst.
Despite politically correct chatter about ‘decisive response’ etc, Moody's still has a negative outlook on Irish ratings. Why? Risk of further deterioration in terms of debt affordability (as measured by the share of government revenue used for interest payments) and financeability (the cost at which the country can raise more debt).
Per WSJ report, the ratings agency said debt dynamics will remain unfavorable for the country for several years, and that downside risks outweigh upside risks in the near to medium term.
First order of business today is to say "Happy Birthday, Jen" to my (much) better half - "I miss you here in Moscow!"
Second order of business is the Exchequer release from yesterday. As my access to data and software is somewhat more restricted here, it is a short analysis:
January-May 2009 tax receipts are in and they are down €3.6bn y-o-y – 21%, slightly better than –24% decline in January-April. Uncork that vintage Dom, Brian? Not yet…
Budget expectations are for 15.6% decline in the entire 2009. Not likely at the current rate. So far we have: 5 months receipts accounting for 39% of the total of projected annual intake of €34.4bn. Annual projection from here suggests that we are going to see around €32-33bn assuming all goes as planned.
Good news, in 2007 we also had 39% collected by the end of May. Bad news is – we had a very robust flow of business for SMEs and self-employed – all of whom force tax payments into the end of the year. Now, recall that we are going to see two things around October-November: (1) tax returns reconciled for 2008, (2) tax returns estimates for 2009. On (1) we can assume that estimates made, say in October 2008 did not fully take in the carnage of November-December, so estimated payments back in October 2008 will be erring on higher side, implying that the actual returns filed in autumn 2009 might be much weaker. On (2), given the current tax measures in place, businesses and self-employed will do everything possible to reduce and delay payments, so estimates will be erring on a lower side and tax deductions will be used to the max. I am not sure that a combination of (1) and (2) will not provide for relatively poor showing in autumn returns.
Current moderating is most likely reflective of the fact that the first half of 2008 was relatively buoyant, so the corresponding period in 2009 is going to register steeper declines. This will moderate into the second half of 2009, naturally, but it will mean preciously little, because any decline on the debacle that we witnessed in H2 2009 is going to be a disaster reinforced.
Another issue to keep in mind: current figures include two rounds of tax increases – Budget 2009 and, partially, Supplementary Budget 2009 – some €230mln added in 5 months. So one can expect further push on tax receipts side. The fact that it is not very impressive is telling me that tax measures are not working and tax substitution and minimization are now working their way through the economy.
To see how bad the new tax measures are at raising revenue – consider the fact that tax receipts in April were 1.7% below the tax profile published on April 28. In other words, within days, the receipts have already slowed down 1.7% relative to what DofF expected. May figures were 1.9% ahead of the profile: Corpo Taxes came in €155mln ahead of profile, Excise and Income taxes were ahead by €48mln and €39mln, respectively. VAT was down €139 million on profile in the month. So, ok – we are now bang on the target when it comes to profile. Note: the source for the above table is Ulster Bank, with minor adjsutments by me.
But Income tax receipts were driven by new taxes, as are Excise duties, and the two will see some new pressure per optimising households and businesses. Corpo tax can surprise on the upside, assuming the US MNCs continue to book profits here – that is the big unknown in my view. CGT is also a candidate for downgrades as investors are shifting out of Ireland, booking losses here. In general, apart from income tax, other revenues were down 27% in May – a moderation of sorts on 32% decline in April, but the flattening out of the tax decreases curve is not anything to cheer about – it is simply the nature of any asymptotic dynamics: the closer you get to absolute zero, the slower the pace.
So back to income tax measures: €48mln monthly gains in May suggest that the income tax measures to date are yielding: 48mln*5/0.39=615mln in revenue, assuming that income tax follows the same path over the year as total tax receipts. A far cry from €1.5-2bn envisioned and very much close to what myself and other observers were expecting back in April.
In the mean time, spending races ahead: current expenditure was up 4.3% (in April it was up 4.5% but the latest ‘moderation’ is still placing current spending at an insolvency levels and the decrease was due to factors other than demand for social welfare and public sector wages). Capital spend continues to fall - down 6.3% year-on-year. Some suggested that there are timing issues delaying capital spending boost, but we are now 5 months into the year and this leaves me wondering – what sort of timing are we talking about?
On the net, therefore, May figures are no real improvement: receipts are flattening at a very slow rate, we might be closer to target here than before, but this only means a difference of €1-2bn on revenue side – a chop-change for our public sector wasters. On expenditure side, we are now 10 months past the July 2008 promises by the Government to introduce real savings, and… zilch, nada, none, nyet, can’t find any no matter how hard I am looking… If a rapidly decaying alcoholic were to be the allegory for the Exchequer balance sheet, we are past the gulp stage and into a burp moment. The hand with a bottle is rising once again, drawing closer and closer to the mouth. How long can this last? Your guess is as good as mine, but a friend today suggested that 6 weeks from now the Government will say, “Whoops, due to international economic conditions (WHICH HAVE NOTHING TO DO WITH THE LAST 12 YEARS OF FIANNA FAIL RULE) our readiness for rebound which was most certainly there when we said so has now disappeared. Not our fault, mate.”
Full text of Oireachtas debate on NAMA is available here. But for some commentary-worthy passages, consider the following:
Deputy Brian Lenihan: …The bad bank solution means that the person with the impaired asset takes a very substantial loss, and a substantial loss is also taken by the bank. Looking at it in terms of this particular approach, the first 35% is the equity value of the developer or the owner of the land, and if he or she is not in a position to pay off the loan, then clearly that is wiped out in this exercise. The key question in valuation is not about the wipeout of the initial landowner’s equity, but about how much of the banks’ equity should in turn be wiped out as well, as we are insisting on the banks taking a loss. Therefore, the taxpayer is third in the queue rather than first. There is a risk and the reason we are focusing so much on valuation is to ensure that this risk is minimised as much as possible. In a frozen or illiquid market, it is not possible to place an exact valuation on the loans, but a long-term commercial valuation can be made. That is what we will have to do... It is a long-term economic valuation…
I am not sure I understand the Minister. Take a loan of Euro65 on a bank balance sheet. Suppose the value of the asset underlying the loan at the time of the loan issuance was Euro100, so 35% of the project was the equity accruing to the developer at the time. Assume that the value of the project has fallen 40% since then, so the market value of the project itself is no Euro60. NAMA buys the loan at, say 20% discount on the face value of the loan – it now has Euro52 loan on hands against the project currently valued at Euro60. What will the balance sheet of NAMA look like?
If NAMA can sell the underlying asset today for Euro60, it makes profit of Euro8, but presumably the bank could have done the same without NAMA. But suppose it does go for NAMA. The bank used to have a loan of Euro65 against an asset with Euro60 value, it got back Euro52 from the Government and has new capital demand of ca Euro6. The bank takes the hit and the developer takes a hit. This is a non-flyer for NAMA politically, but in this case NAMA would make a profit of Euro2 on the entire transaction.
If NAMA cannot sell the project, it has to finance the purchase of the loan at say 5.5% pa on a termed bond issue of, say 5-years and face value of Euro52, so total cost of financing is Euro15.96. It has to plug bank’s capital hole – same Euro6, and it has to incur operating cost for the loan – say 0.5% of the loan value pa for 5 years at Euro1.36. Against this, NAMA will receive income stream on average of ca 3-4% pa, or Euro14.37. Assuming the value of the underlying asset remains the same, we have a net loss to NAMA of Euro0.95.
So applying all pain to developer (example of quick fire sale) will yield profit, going NAMA route and soaking the ‘third in line’ taxpayer as Minister Lenihan puts it will make a loss…
However, regardless of how the numbers come out, Minister Lenihan is confusing two things. The developer has already taken a hit, and guess what – I don’t care if he did. Tough luck, mates. But the banks are yet to take a hit. And in part, they have delayed taking a hit because of NAMA promise of rescue. This does not look like NAMA puts taxpayer third in the firing line. It looks more like the taxpayer is next, right after the developers. Except, personal bankruptcy laws protect the developers, but not the taxpayers. Which means that in real world, taxpayer is the first in the firing line and indeed he is the only one in the entire firing line.
Mr. Brendan McDonagh:…about rolled-up interest. I was a member of the due diligence team that worked on Allied Irish Bank and Bank of Ireland. I have also had access to information in terms of reports compiled by the Financial Regulator in regard to the other institutions. What I have seen in the banks’ loan books is that the land and development book generally included a feature that for two years loans had rolled-up interest. Therefore, a loan of €10 million on which the interest was 10% per annum, effectively became a €12 million loan at the end of the two-year period. If at that stage the asset had metamorphosed from land with rezoning to land with planning permission - once a certain element of risk was gone from the loan - it was refinanced or sold on.
So let us revisit the figures provided above… if NAMA cannot sell the project, it has to finance the purchase of the loan at say 5.5% pa on a termed bond issue of, say 5-years and face value of Euro42, so total cost of financing is Euro15.96. It has to plug bank’s capital hole – Euro8, and it has to incur operating cost for the loan – say 0.5% of the loan value pa for 5 years at Euro1.36. It has a capital loss now instead of gain of Euro10. Against this, NAMA will receive income stream on average of ca 3-4% pa, or Euro7.88. Assuming the value of the underlying asset remains the same, we have a net loss to NAMA of Euro27.44. Ouch…
But this, incidentally, does not cover the cost of outsourced functions – and NAMA plans to have loads of outsourcing if it will run a fund requiring 400 staff with 30-40 employees…
Mr. Brendan McDonagh:Bespoke means something has particular features. Usually a loan document with standard terms and conditions is drawn up by an institution when, to give a simple example, it extends a mortgage... It is not a question of quality. It means that if one wants to value these loans which we will be required to do, the terms and conditions of each loan will have to be examined to ensure account is taken of any particular feature... It will not [take years to work these loans out]...
I am puzzled – it will not take years to price individual bespoke loans even with a staff of 30-40 or is Mr McDonagh implying here that the existent banks staff will do pricing?
Senator Feargal Quinn:It is not easy to keep quiet for two and a half hours without asking questions. I was surprised that Mr. McDonagh spoke about a timeframe of ten to 15 years because I had investigated what had happened in the United States in the establishment of the Resolution Trust Corporation in 1989. This corporation only lasted six years but the figures were considerably different. It took in $465 billion and the cost to the taxpayer when the assets were sold was $90 billion. The equivalent cost for us would be €20 billion. Mr. McDonagh spoke about a staff complement of 30 to 40. The aforementioned operation in the United States involved 9,000 people. This scares me because it seems we are not very good at sticking to budgets and timeframes in Ireland.
Note that Senator Quinn’s estimate of NAMA net loss of Euro20bn based on the US RTC experience is exactly the same as my and Brian Lucey’s estimate in last week’s Sunday Times. We arrived at this figure without a reference to RTC, so the fact that the two estimates coincide does suggest that the figure is about right…
Deputy Burton spoke about transparency. Freedom of information provisions will not apply to NAMA, although they were applied in similar contexts in Sweden and Finland. It would be of considerable help if citizens and taxpayers had access to information.
Spot on!
Deputy Brian Lenihan: …one of the most difficult tasks relating to NAMA will be drawing the line as to where the agency must or where it should not enforce. A spectrum of borrowers will be hopelessly insolvent; receivers and liquidators should be installed and NAMA will become the property management company for them. That is one side of the spectrum. Clearly, on the other side, because the agency will take performing loans, there will be a category of borrowers who will pay their debts, trade and discharge their obligations as they fall due. In the middle, the agency will have the most difficult commercial decisions to make in terms of the potential viability of the middle category of borrowers.
I am again at a loss as to what NAMA can and cannot do, what enforcement actions it can or cannot take and so on… Does the Minister have a clue himself? Is his own staff and that of NAMA have a clue?
Mr. Brendan McDonagh:Unfortunately, part of the problem is that people have given personal guarantees. If the banks are placing values on personal guarantees as partial security, that is a consequence of what NAMA will be about. If NAMA has to pursue personal guarantees it will do so. I am sure all members are aware that a number of major borrowers, because of the multi-bank nature of their loans, have offered personal guarantees to five or six banks. A personal guarantee can cover only one loan. It cannot cover six. When valuing a loan from a particular institution, we will have to take account of the collateral offered to each institution. One cannot look at this matter in the context of an individual bank or in a vacuum. One must take account of the all the circumstances which can be determined.
Indeed, as I mentioned in the earlier post on this debate, this adds an entirely new and at this stage completely unpriceable risk. NAMA will simply spend the next 5 years tied up in courts with other banks and developers dealing with the issue of who gets which guarantees… Good luck to all involved.
Mr. Brendan McDonagh:With regard to the percentage of foreign assets, …based on the analysis of the loan books of the six institutions which was carried out after the guarantee scheme by PWC for the Financial Regulator, the value of foreign assets of the banks’ portfolios was somewhere in the region of about 35% and most of that would be UK assets... That 35% was of the total loan portfolios of the banks, of the six institutions. I do not have the figures analysed yet as I only received the questionnaires last night.
In other words, we are talking about roughly 35% of the Euro386bn in assets of just BofI and AIB, or Euro135.1bn…
This blog represents my personal views and is not reflective of the views or opinions held by any company, contractor, client or employer I work for currently or have worked for in the past. These views are not an endorsement to take any action in the markets or of any political position, figures or parties.
This blog represents my personal views and is not reflective of the views or opinions held by any company, contractor, client or employer I work for currently or have worked for in the past. These views are not an endorsement to take any action in the markets or of any political position, figures or parties.
