30/10/15: Repaired Irish Banking: Betting Your House on Corporate Deleveraging

I have not been tracking more recent changes in Irish banking sector aggregate balance sheets for quite some time now. However, preparing for a brief presentation on Irish banking crisis earlier this week, I had to update some of my charts on the topic. Here is some catching up on these.

Take a look at Central Bank’s data on credit and deposits in Irish banking system. These figures incorporate declines in both due to sales of loan books by Irish banks, so step-changes down on credit lines reflect primarily these considerations. As superficial as the numbers become (in this case, the aggregate numbers no longer fully reflect the true quantum of debt held against Irish households and companies), there are some positive trends in the figures.

1. Over the 3 months through August 2015 Irish households have reduced the level of outstanding debt by some 7.1% compared to the same 3mo period in 2014. Total level of household debt now stands at the average of December 2004-January 2005. This is a massive reduction in debt burden, achieved by a combination of repayments, defaults and sales of loans to non-banking entities (e.g. vulture funds). However, loans for house purchases have declined by a more moderate 4.5% over 3mo through August 2015 compared to the same period in 2014. This brings current pile of house mortgages outstanding to the average level of February-March 2005. Which is impressive, but, once again factoring in the fact that quite a bit of these reductions was down to defaults and sales of loans, the overall organic deleveraging has been much slower than the chart above indicates. Over the last 3 months (though August 2015), total volume of household debt declined, driven down by deleveraging in mortgages debt and ‘other debt’ against a modest increase in consumer credit. It is interesting to note that over the last 12 months (based on 3mo average), volume of ‘other loans’ has dropped by a massive 38%, suggesting that this category of credit is now also subject to superficial debt reductions, for example originating from insolvencies and bankruptcies. For the record, there are at least three highly questionable reductions in recorded household debt on record: November-December 2010 drop of EUR7.5 billion, September-October 2011 drop of EUR17.2 billion, and May-June 2014 decline of EUR4.1 billion. This suggests that the official accounts of household deleveraging may be overstating actual degree of deleveraging by upwards of EUR28 billion which could bring our debt levels back to September-October 2011 and signify little material reduction in total debt over recent years.
2. Over the 3 months through August 2015, loans outstanding to the Non-financial corporations in Ireland fell 19.4% compared to the same period average in 2014. Most of this decline was driven by the 19.5% drop in loans, with debt securities outstanding declining by only 5.7%. This marks 12th consecutive month of m/m declines in credit outstanding to the corporate sector. Current level of corporate credit brings us back to the levels last seen in 3Q 2003. Just as with households there are at least 3 episodes of significant declines in credit volumes since the start of the Global Financial Crisis, although the path for corporate loans has been more smooth overall than for household debt. This suggests that banks have prioritised resolving corporate arrears over household arrears, as consistent with 2011 PCAR strategy that also prioritised corporate loans problems. 

Total credit outstanding to the real economy (excluding Government and financial intermediaries) has fallen 12% y/y in the three months through August 2015. The official register now stands at EUR145.3 billion, a level comparable to the average for June-July 2004.The truly miraculous thing is that, given these levels of deleveraging, there is no indication of severe demand pressures or significant willingness to supply new credit.

As shown in the chart below, Irish banking sector overall has been enjoying steadily improving loans to deposits ratios.

Over the July-August, household loans to deposit ratios dropped to 99% - dipping below 100% for the first time since the Central Bank records began in January 2003. Loans to deposit ratio for non-financial corporates declined to 120% also the lowest on record. However, this indicator is of doubtful value to assessing the overall health of the financial sector in Ireland. To see this, consider the following two facts: household loans/deposit ratios have been below pre-crisis lows since October 2011, while corporate loans/deposits ratios have been below pre-crisis lows since July 2014. Reaching these objectives took some creative accounting (as noted above in relation to loan book sales), but reaching them also delivered practically no impetus for new credit creation. In other words, deleveraging to-date has had no apparent significant effect on banks willingness to lend or companies and households willingness to borrow.

By standards set in PCAR 2011, Irish banks have been largely ‘repaired’ some months ago. By standards set in PCAR 2011, Irish banks are yet to start their ‘participation in the economy’.

Meanwhile, take a look at the last chart:

As the above clearly shows, Irish banking system is nothing, but a glorified Credit Union, with credit outstanding ratio for household relative to corporates at a whooping 177%. This, again, highlights the simple fact that during this crisis, banks prioritised deleveraging of corporate debt and lagged in deleveraging household debt. Irish economic debt burden, thus, has shifted decisively against households.

Someone (you and me - aka, households) will have to pay for the loans write downs granted to companies over the years. And the banks are betting the house (our houses) on us being able to shoulder that burden. 

1/12/2012: Irish banking Reforms: are things getting better?

In the previous post, I discussed changes in irish banking system systemic stability in 2012 (January-November). But here's a longer range view - from September 2010 on through November 2012.

Now, keep in mind: since September 2010, Irish banks had

1. Massive recaps (2011-2012)
2. Full reform and deleveraging programmes, approved by the EU and Irish authorities
3. Rounds of increases in charges on customers to beef their own interest margins
4. Vast subsidies from the ECB and CBofI
5. Subsidies from the Government via deposits (see here)
6. According to the Government, BofI (largest bank) has completed its deleveraging programme, while AIB (second largest bank) is ahead of target
7. Massive sales of riskiest assets to Nama that crystalized losses and led to recaps, which are now completed
8. According to the Government have bee operating in more benign environment of property prices stabilization
9. Benefited from a 88% rally in Government bonds which they stuffed onto their balancesheet over 2010-present like there is no tomorrow

and so on. In other words, there are tomes and tomes of Government sponsored propaganda to suggest that things are going honky-dory in the banking sector in Ireland. Here's what Head of the Department of Finance had to say this week about the banking sector 'progress' (emphasis is mine):

"With PCAR capital investments and the Bank of Ireland sale, confidence started to return to the banking sector. [this refers to 2011]"

"In 2012 we have witnessed further tangible signs of stability. …Even though non-performing loans continue to grow; here again there are tentative signs that in the mortgage arrears area the growth in new arrears has been arrested. 

The banks still have a lot of work to do to roll out sustainable mortgage solutions, but this process is underway.

Importantly, confidence is returning to our banking system following its recapitalisation.  Deposits across the Irish system are up 2.5% with stronger growth recorded by AIB, BOI and PTSB (which are up 5.3%).

We are in a situation now where the domestic banking system is getting stronger, albeit from a very weak starting point.

• The large scale balance sheet restructuring has been completed;
• BOI have completed the disposal of non-core portfolios
• AIB have substantially completed their disposals. 
• The funding gap has been significantly reduced and the drawing on Eurosystem funding by our government supported going-concern banks continues to decline, and is now less than €60 billion (excluding IBRC).
• Importantly, as I said earlier deposits are growing and the banks are back in the funding markets."

So, in other words, we should expect Ireland's banking system to have performed well in progressing since 2009-2010 lows?

Here's the chart:

In reality, courtesy of Euromoney surveys, we know that Irish banking system stability has deteriorated, not improved, between September 2010 and November 2012, and this deterioration was the second largest amongst 37 European countries.

1/12/2012: Ireland - still the second worst banking sector in EA

Another Euromoney risk survey on and the results for the banking sector are out:

Ireland's banking sector zombies are ranked as 4th least safe in the entire Europe of 37 countries. Next to Greece (3rd least safe), and Macedonia (1 place ahead of Ireland - 5th least safe). Iceland, having defaulted and demolished its banks, ranks 7th least safe. Note, Ireland remains the second weakest banking sector in the EA17.

Of course, our 'leaders' would say that yes, things are bad, but they are improving... hmm...

Are they? Well, sort of. Ireland's score (higher score, greater systemic stability) have risen in 11 months of 2012, but the rise was far from spectacular. Ireland's improvement in the score is 7th largest in the sample, behind that for Iceland.

Ireland's gap to the peers (Advanced Small Open Economies) in overall score is about 4.4 points. 11 months of heroic Government reforms have yielded a gain of 0.2 points in Irish position, and the deterioration in the overall euro area climate has resulted in a decline in the average ASOE score of 0.07 points. This means the spread improved in favour of Ireland by less than 0.3 points in 11 months - a rate of 'reforms' that can close the current gap, assuming continued deterioration in ASOE average, over  161 months. In other words, unless the 'reforms' in Ireland's banks start bearing fruit much faster than they have done in 11 months of 2012 so far, it will take us 13.4 years to reach ASOE average levels of banking system stability.

1/12/2012: Much Hype on Little Signs: Private Sector Deposits in October

Much hoopla is doing rounds these days about the 'rise in October deposits' in irish banking system. Head of the Department of Finance has referenced the 'welcome news' in his most recent speech and the Central Bank has cheerfully noted as much in the release published last night. Alas, as usual, the reality is not as encouraging as the 'Green Jerseys' crowd might suggest it is.

Let's cut some fog of numbers here.

First, Domestic Group of banks:

• Total Deposits in Domestic Group of banks (covering all banks registered to operate in Ireland) rose from €206,363mln in September to €208,633mln in October. In other words, deposits rose 1.1% m/m (reversing a -0.19% contraction m/m in September 2012).
• However, total deposits in Domestic Group are down 16.6% y/y in October 2012, oops... volatility in m/m figures seems to be clouding the minds at the 'Green Jerseys' clubhouse. And worse:
• More worrying: 3mo average deposits through October 2012 are down 7.9% on 3mo average deposits through July 2012, and are down 16.8% on 3mo average through October 2011. 
• Likewise, 6mo average through October 2012 is down 10.0% on 6mo average through April 2012 and is down 15.4% on 6mo average through October 2011.
• Some might say that these averages are down because of some exits of banking institutions from Ireland, but that is simply false, as data for Covered Banks (see below) shows an even more disastrous trend.
• Now, October 2012 levels of total deposits from Irish Residents are down 16.6% on October 2011, down 31.2% on October 2010 and down 32.8% on October 2009. Only Borat would cheer these trends with a 'Good news' headline.

Much of the above data trends is driven by the Monetary & Financial Institutions deposits changes. Much, but not all. 

• Government deposits with Domestic Banks rose 25.9% m/m in October having posted a 6.0% rise in September 2012. Year on year, Government deposits are up 44.8% in October 2012 and they were up 2.4% in September 2012. Virtually all trends on Government deposits are up.
• In contrast, Private Sector deposits with Domestic banks grew only 1.16% m/m in October 2012 and 2.2% in September 2012. 
• In longer term trends, Private Sector deposits didn't fare that well: 3mo average through October 2012 rose 0.06% on 3mo through July 2012, while it was up 0.73% y/y. 6mo average was up 1.2% in October 2012, compared to 6mo average through April 2012, but down 1.25% in y/y terms.
• Now, for dysmal science analysis of the Private Sector deposits: in october 2012, Private Sector Deposits in Domestic Group of banks were up 2.2% on October 2011, down 13.0% on October 2010 and down 18.0% on October 2009.
• Borat back, please.

Let's take a look at the levels of change in Domestic Group deposits:

• Cheerful increase in total Irish residents' deposits in Domestic Group of banks amounted to €2,270mln in October compared to September 2012, with only €923mln of that - less than half - accumulating in Covered Banks. Looks like foreign banks are beating Irish zombies in the deposits gathering game.
• There was a rise of €1,663 million in Private Sector deposits in the Domestic Group of banks in October, compared to September. Of this, only €574mln - roughly one third - landed in Irish banks, with 2/3rds going to foreign banks.
• Borat would say that the above shows success in restructuring Irish banking system. More even-headed analysis suggests success in foreign banking system operating in Ireland.

Now, Covered Banks (aka Irish Banking Zombies):

• Total Residents' deposits in Covered Banks were up €923 million in October 2012 (+0.59%) m/m, reversing a -0.01% decline in September. Y/y deposits are down 19.63% - worse performance than in September 2012 (-19.26%).
• Let's put things into perspective: in a year to October 2012, Irish Residents' deposits in Covered Banks shrunk €38.5 billion. In the 'cheers inducing' month of October 2012 they rose €923mln. Simple math suggests that it will take us 48 months of these 'improvements' to get back to where Irish Residents' deposits were back in October 2011.
• But there's more: Total Residents' deposits in Covered Banks in October 2012 were -19.63% below October 2011, -36.35% below October 2010, -37.64% lower than in October 2009. You get my point - Covered Banks (which were supposedly reformed, repaired, recaped per Department of Finance & CBofI, ages ago) are still performing woefully worse than foreign banks operating in Ireland.
• Government deposits with Government-owned banks rose €695 million m/m in October (+27.2% m/m and +45.92% y/y), outstripping increases in private deposits of €574mln (+0.55% m/m and +3.3% y/y).
• Private Sector Irish Residents' deposits with Covered Banks fell -0.75% on 3mo average basis through October 2012 compared to 3mo average through July 2012, although these are up 2.80% y/y. On another positive note, 6mo average for Irish Residents' Private Sector deposits with Covered Banks rose 1.8% on 6mo average through April 2012.
• Nonetheless, Irish Residents' Private Sector deposits with Covered Banks in October 2012 were still down 15.8% on same period of 2010 and down 20.7% on same period 2009.
• Switching back to more positive bit of news: Private Sector deposits with Domestic Banks were up €3.121bn in October 2012 y/y, and up €3.379bn for deposits with Covered Banks, which means that y/y Irish Covered Banks are generating stronger activity in attracting Private Sector Residents' deposits than foreign banks.

Here are some charts illustrating the above trends:

14/4/2012: Sunday Times 8/4/2012 - Irish banks: The Crunch is Getting Crunchier

This is an unedited version of my Sunday Times article from 08/04/2012.

A year has lapsed since the much-lauded publication of the first set of the Prudential Capital Assessment Review results – the stress tests – by the Central Bank of Ireland.

Covering the four core banking institutions subject to the State Guarantee, AIB, Bank of Ireland, Irish Life & Permanent and EBS, the tests were designed to be definitive. Once recapitalized by the Exchequer in-line with the PCAR, Irish banks were supposed to be returned to health – recommencing lending to the SMEs and households, returning to normal funding markets around 2013, while continuing to shed loans to improve their balance sheets.

The PCAR made some major predictions with respect to the banking sector performance over 2011-2013 that were not subject to Nama-imposed losses and, as such, are expected to continue into the future. Chiefly, the Central Bank allowed in its stress scenario for the lifetime losses of €17.2 billion on the residential mortgages books of the four institutions. Only €9.5 billion of these were forecast to hit in 2011-2013. Owner-occupier mortgages losses provided for 2011-2013 amounted to just 60% of the above. Post-2013, it was envisaged that the Irish banking system will be able to fund remaining losses out of its own operations with no recourse to the Exchequer assistance.

Having published the PCARs, the Irish Government proceeded to take a break from the banking crisis. Throughout the second half of 2011 there was a noticeable ‘We’ve sorted the banks’ mood permeating the refined halls of power.

Fast-forward twelve months. Annual results for the four domestic State-guaranteed banks for 2011 are, put frankly, alarming. Set aside for the moment the entire media spin about ‘lower 2011 losses compared to 2010 records’. Once controlled for Nama effects on 2010 figures, the data shows acceleration, not an amelioration of the crisis on the mortgages side.

Excluding IBRC, total amount of owner occupied mortgages that remain outstanding on the books of AIB and EBS, Bank of Ireland and PTSB comes to €71.8 billion or 63% of all such loans held by the banks operating in Ireland. According to the Central Bank of Ireland, 12.3% of all mortgages held in Ireland were 90 days or more in arrears – some €13.9 billion. Of these, the four State-guaranteed banks had €7.7 billion owner-occupier mortgages in arrears, representing 10.8% of their combined holdings. Given banks’ provisions, by the end of 2012, the expected combined losses on mortgages, can add up to 60% of the total 2011-2013 losses allowed under PCAR.

And this is before we recognise the risks contained in a number of mortgages restructured in 2009-2010 that will come off the forbearance arrangements. Many are likely to go into arrears once again in 2012 and 2013. Recall that the entire Government strategy for dealing with mortgages defaults rests on the extend-and-pretend principle of delaying the recognition of the loss by giving borrowers some relief from repayments, e.g. via interest-only periods. This approach is patently not working.

Looking at EBS and AIB results tells much of the story behind the forbearance risk factor. In 2010, the two banks had 16,992 restructured residential mortgages amounting to €3.7 billion. Of these, residential mortgages amounting to €3 billion were interest-only. Of all forbearance mortgages, 92% were classed as performing. By 2011, AIB and EBS held 32,266 forbearance residential loans totalling €6.2 billion – almost double the levels of 2010. Total amounts of mortgages in forbearance arrangements that went into impairment or arrears over the course of 2011 jumped more than seven-fold. One third of the forbearance mortgages are now in arrears.

While Bank of Ireland data is not as comprehensive on 2010 and 2011 comparatives, current (end of 2011) levels of restructured mortgages run at €1.25 billion, of which €249 million were impaired or past-due more than 90 days. This means that €999 million worth of restructured mortgages remain at risk of future arrears. PTSB report for 2011 shows restructured mortgages rising from €1.7 billion in 2010 to €2.1 billion, with those in arrears rising three fold to €524 million.

Taken together with the aforementioned 2010-2011 dynamics, changes to the insolvency regime imply that mortgages losses can exceed Central Bank’s forecasts for 2011-2013 period. Of all four banks, Bank of Ireland remains the healthiest, and the likeliest candidate when it comes to mortgages-related losses. Of course, the banks can continue extending recognition of the losses past 2013, but that will mean no access to non-ECB funding at the time when ECB is increasingly concerned about extending more loans to Irish banks. Worse, with the first LTRO maturing in 2014, Irish banks will be staring into a new funding storm, when their healthier competitors all rush into the markets to fund their exits from LTRO.

Which, of course, means that the entire Government exercise of shoving taxpayers cash into insolvent institutions is unlikely to resolve the crisis. The core banks will continue nursing significant losses well into 2014-2015, with capital buffers remaining strained once potential losses are factored in. And this, in turn, will keep restrained their lending capacity.

Recent Central Bank estimates show that Irish economy will require up to €7 billion in SMEs lending and €9 billion in new mortgages in 2012-2014, while banks are to accelerate deleveraging of their loans books to meet lower loans to deposits standards. At the same time, there will be huge demand for Irish banks lending to the Exchequer, once some €28 billion of Government debt come to mature in 2013-2015. As we have seen with the Promissory Notes ‘deal’, so far, the Government has difficulty getting Irish banking system to buy into Government debt in appreciable amounts.

In other words, we are now staring at the basic conflict inherent in running a zombie banking system that continues to face massive losses on core assets. At the very best, the choice is: either the banks’ will lend to the real economy, while foregoing their support for Exchequer post-2013; or the state uses banking sector resources to cover its own bonds cliff, starving the real economy of credit. The first choice means at least a shot at growth, but the requirement for more EFSF/ESM borrowing (Bailout 2). The second choice means extending domestic recession into 2015.

It is also likely that we will see amplifying politicization of the banking system, with credit allocated to ‘connected’ enterprises and politically prioritized sectors, at the expense of overall economy. Reduced competition – from already below European average levels, judging by the ECB data – will continue to constrain credit supply.

The lesson to be learned from the 2011 full-year results for Irish banks is a simple, but painful one. Banks going through a combination of a severe asset bust and a massive debt overhang crisis are simply not going to survive in their current composition. We need to carry out a structured and orderly shutting down of the insolvent institutions, in particular, IBRC, EBS and PTSB. We also need to restructure AIB. At the same time, we should use the process of liquidation of the insolvent banks to incentivise emergence and development of new service providers.

This can be done by using assets base of the insolvent institution to attract new retail banking players into the market. This process can also involve enhancing the mutual and cooperative lenders models.

Given current funding difficulties, it is hard to imagine any significant uptick in lending in the Irish economy from the traditional banking platforms. Thus, we need to create a set of tax and regulatory incentives and enablers to support new types of lending, such as facilitated direct lending from investors to SMEs. Such models already exist outside Ireland and are gaining market shares around the world, in particular in advanced Asian economies.


The State Guaranteed banking model is, as the 2011 results show, firmly bust. Time to rethink the strategy is now.


Charts:

Box-out:

On the positive front, Q1 2012 Exchequer results released this week showed total tax take rising to the levels, not seen since 2009. Total tax revenues came in at €8,722 million, just below €8,792 in 2009. Year on year tax take is up 16.2%. But hold that vintage champagne in the fridge for a moment. Tax revenues for Q1 this year include reclassified USC charges which used to count as departmental receipts instead of tax revenues. The department of Finance does not provide estimates for how much of the income tax receipts is due to this change, but based on 2010 figures it is close to ca €525 mln. They also include €251 million of corporation tax receipts from 2011 that got credited into January 2012 figures. Netting these out, tax revenues are up 8.2% year on year – still appreciable amount, but down 7.6% on 2009. Compared to Q1 2008 – the first year of the crisis, we are still down in terms of tax receipts some 26.2%. Even at the impressive rate of growth, net of one-off changes, achieved in Q1 this year, it will take us through 2017-2018 before we get our tax take to 2007-2008 levels. As the Fianna Fail 2002 election posters used to say “A lot done. More to do.”

17/2/2012: Harmful Competition? Not so fast...

In recent years there has been much said about the dangers of competition in the banking sector across the EU and specifically in Ireland. Unfortunately, for the proponents of the argument that less competition will be a good thing, the facts are simply not stacking up in their favor.

Since 1997 ECB has published what is known as Herfindahl Index for European banking systems. The index is a measure of the size of banks in relation to overall sector, thus indicating the actual amount of competition in the national banking system. At 1.0 Index reading, the national banking system is fully monopolized by a single firm. Closer to zero, the system is characterized by the smaller, more directly competing banks.

So here are two charts:

Both show that

1. Higher Herfindahl Index reading (lower degree of competition) does not coincide with more stable or less crisis-impacted banking systems
2. During the period of bubble formation there was a reduction, not an increase in banking sector competition in Euro Area, so greater competition did not cause or contribute to the bubble inflation. In fact, the evidence is rather suggestive of the opposite effect.
3. In Ireland, competition pressures in the banking sector actually declined significantly in the years preceding the crisis (2001-2007) and it had subsequently dropped even more dramatically during the crisis.
4. Ireland's banking sector, at any time in the data period covered, was characterized by the levels of competition comparable to those found in Austria, Spain, and France, well below those of Germany, Italy, Luxembourg and the UK and relatively comparable to those in Sweden

So no, 'harmful competition' in Irish banking sector did not cause our crisis, nor did it even contribute to it.

14/1/2012: Irish banking crisis - on a road to nowhere

This is an unedited version of my Sunday Times article from January 8, 2012.

In the theoretical world of Irish banking reforms, 2012 is supposed to be the halfway marker for delivering on structural change. Almost a year into the process, banks are yet to meet close to 70% of their total deleveraging targets, SMEs are yet to see any improvements in credit supply, households are yet to be offered any supports to reduce their unsustainable debt burdens, longer-term strategic plans reflective of the banks new business models, now approved by the EU not once, but twice are yet to be operationalized, and funding models are yet to be transitioned off the ECB dependency.

In the period since publication of the banking sector reforms proposals, total banks core and non-core assets disposals are running at some €14 billion of the €70 billion to be achieved by the end of 2013. Even this lacklustre performance was heavily concentrated in the first nine months of 2011, when few of Irish banks competitors were engaging in similar assets sales.

Since then, things have changed. Plans by the euro area banking institutions, already announced in Q4, suggest that some €775 billion worth of euro area banks’ assets will come up for sale in 2012. That is more than 8.5 times the volumes of assets disposals achieved in 2011. And 2012 is just the tip of the proverbial iceberg. According to the Morgan Stanley research, 2012-2013 can see some €1.5-2.5 trillion worth of banks assets hitting the markets. With 2012 starting with clear ‘risk-off’ signals from the sovereign bond markets and banks equities valuations, the near term future for Irish banks deleveraging plans can be described as bleak at best.

Further ahead, the process of rebuilding capital buffers, in both quantity and quality, can take core euro zone banks a good part of current decade to achieve. In this context, Irish banks deleveraging targets are grossly off the mark when it comes to timing and recovery rates expectations.

Progress achieved to-date leaves at least €35-40 billion in new assets disposals to be completed in 2012 – two-and-a-half times the rate of 2011. The two Pillars of Irish banking alongside the IL&P are now facing an impossible dilemma: either the banks meet their regulatory targets by the end of 2013, which will require deeper haircuts on assets and thus higher crystallized losses, or the 2013 deleveraging deadline is bust. In other words, Irish banks have a choice to make between having to potentially go to the Government for more capital or suffer a reputational cost of delaying, if not derailing altogether, the reforms timetable.

This is already reflected in the negative outlook and lower ratings given by S&P to AIB last month. The rating agency stressed their expectation of the slowdown in assets deleveraging in 2012 as one key rationale for the latest downgrades. Post-recapitalization in July, AIB core Tier 1 regulatory capital ratios stood at a massive 22%, the fact much lauded by the Irish authorities. However, per S&P “AIB’s capital ratio… will be between 5.5% ad 6.5% by 2013” due to materially “higher risk weights [on] capital, estimated deleveraging costs, as well as further capital erosion from the core business”.

Bank of Ireland finds itself in a better position, but, unlike AIB, it has much smaller capital reserves to call upon in the case of shortfall on July 2011 recapitalization funds.

Another area of concern for Irish banking sector relates to funding. Central Bank stress tests (PCAR) carried out in March 2011 assumed that by the end of 2013 Irish banking institutions will be funded on commercial terms. This too is subject to significant uncertainty as euro area banks enter a period of rapid bonds roll-overs in 2012-2014. Overall, the sector will face ca €700 billion of bonds maturing in 2012 and total senior debt maturing in 2012-2014 amounts to close to €2.2 trillion once ECB’s latest 3-year long term refinancing facility is factored in. For comparison, in 11 months through November 2011, euro area banks have managed to raise less than €350 billion in capital instruments, and various senior bonds. Again, international environment does not provide any grounds for optimism about Irish banks ability to decouple themselves from the ECB supply of funds.

In the short run, Irish Pillar Banks dependency on central banks’ funding is a net subsidy to their bottom line, as central banks credit lines come at a fraction of the expected cost of raising funds in the marketplace. This makes it possible for the banks to sustain their extend-and-pretend approach toward retail borrowers.

However, in the longer term, reliance on this funding represents major risks of maturity mismatch and sudden liquidity stops. The latest data clearly shows that the major risk of Irish banking sector becoming fully dependent on ECB as the core source of funding is now a reality. Reductions in the emergency liquidity assistance loans extended by the Central Bank of Ireland are now matched by increases in ECB lending to these banks. A recent research paper from the New York Federal Reserve shows that Irish banks continue to account for the largest proportion of all loans extended by the ECB to the banking systems of the euro area ‘periphery’.

Lacking functional banking sector, in turn, puts a boot into Government’s plans to use reforms as the vehicle for reversing credit supply contraction that has been running uninterrupted since 2008.

Another major risk inherent in the Irish banks’ funding and capital dependencies on Central Banks and the Government is the risk that having delayed for years the necessary processes of restructuring household debts, the banks can find themselves in the dire need of calling in the negative equity loans. This can happen if the Irish banking sector were to be left lingering in its quasi-transformed shape when ECB decides to pull the plug on extraordinary liquidity supply measures it deployed. While such a prospect might be 2-3 years away, it is only a matter of time before this threat becomes a reality and the very possibility of such eventuality should breath fear into the ranks of Ireland’s politicians.

As the current reforms stand, the sector will not be able to provide significant protection against the ECB policies reversal, even if the Central Bank-planned reforms are completed on time. The reason for this is simple. Our twin Pillar banks will be facing – over 2013-2018 – a rising tide of mortgages defaults and voluntary property surrenders, as well as continued mounting corporate loans losses as the economy undergoes a lengthy and painful debt overhang correction, consistent with the historical evidence of similar balance sheet recession.

While the capital for writing these assets down might have been at least in part supplied under PCAR 2011, the banks have no means of managing any added risks that might emerge alongside the mortgages defaults, such as, for example, the risk of their cost of funding rising from the current 1 percent under the ECB mandate to, say, 6 or 7 percent that private markets might charge.

For all the plans for banking reforms proclaimed for 2012 by the Central Bank and the Government, in all likelihood, this year is going to see more mounting corporate and household loans writedowns, amidst the continuation of the extend-and-pretend policies by the banks. The longer this process of delaying losses realization continues, the less viable the remaining banks assets become. And with them, the lower will be the credit supplied into the real economy already starved of investment and funding.

Box-out:

Irish banking sector structure envisioned under the Government reforms plans will not be conducive to an orderly deleveraging of the real economy and simultaneous repairing of the banks balance sheets. Sectoral concentration, in part driven directly by the Government dictate, in part by the massive subsidies provided to insolvent domestic banks, will see a colluding AIB & BOFI duopoly running circles around the regulators, supervisors and politicians.

How serious is this threat of the duopoly-induced markets distortions in post-reform Irish banking? Serious enough for the latest EU Commission statement on Bank of Ireland restructuring plans to devote significant space to outlining high-level set of subsidies that the Irish authorities are planning jointly with ECB.

No one as of yet noticed the irony of these latest amendments to the Government plans for the banking sector reforms: to undo the damaging effects of state subsidies to the incumbents, the EU and the Government will offer more subsidies to the potential newcomers. Such approach to policy would be comical, were it not designed explicitly to evade the real solution to the banking sector collapse in this country – a wholesale restructuring of the sector, that would have used insolvent banks’ performing assets as the basis for endowing new banking institutions to serve this economy.

30/10/2011: Irish banking - getting sicker slower in September

Is Irish banking sector getting slowly better - as numerous articles, including in the Irish Times are suggesting on the back of the Central Bank data for September, or is it getting worse slower?

Consider CBofI data for 18 banks, plus numerous credit unions operating in Ireland. In this post we shall cover the entire domestic group of banks, with IRL6 guaranteed domestic banks to be covered in the follow up post.

The first metric by which our banking system is allegedly doing much better now days is deposits. Apparently, in recent month the flight of deposits from Ireland has been reversed. Charts below illustrate:

 Total system-wide liabilities in September 2011 stood at €659,387 mln or €895 mln up on August, but €108,011 mln down on September 2010. So mom we are up 0.14% while yoy we are down 14.07%. Over the 3 months July-September 2011, there were on average €10,704 mln less in liabilities in the system than in the 3 months from April through June. Nothing to conclude about the 'health' of the system yet, before we look at the liabilities breakdown.

So deposits then. Shall we start at private sector deposits?

Total private sector deposits in the system of all banks operating in Ireland have declined from €166,152mln in August to €163,992mln in September (down 1.3% mom), the same deposits are down 6.43% (or -€11,267mln) yoy. July-September average deposits in the system were 1.59% (€2,679mln) below those for 3 months between April and June 2011. So by all metrics here, the system deposits are shrinking.

This shrinking is captured by declines in overnight deposits and deposits with maturity of less than 2 years. Deposits with maturity over 2 years have increased from €10,843mln in August to €10,946mln in September, marking second consecutive monthly increase, this time around - by a whooping 0.12%. Yes, that's right, the first time we discover anything of an increase is in the smallest sub-component of deposits and that is a massive 0.12%.

Yet, we keep hearing about increases in deposits. So let's take a look at all deposits in the system across all banks operating in Ireland:

Chart above provides breakdown of all deposits in the system. This shows:

• Total deposits in the system stood at €248,861mln in September or 18.12% below their levels in September 2010 (-€55,061mln), but a massive 0.09% up on August 2011 (mom increase of overwhelming €225mln). Quarter 3 average deposits were 10.15% below quarter 2 average deposits (of course most of this decline is due to Government deposits being converted into capital by banks)

What explained this miracle of rising deposits in the system? Was it private sector (productive economy) newly discovered riches or restored confidence in Irish banking system by corporations & households? Nope, remember - private deposits are down, so the increases are broken down into:

• MFIs (inter-banks etc) deposits were up in August (celebration time, folks) from €101,780mln in August to €103,293mln in September. Impressed? That was 1.49% mom rise, that is contrasted by a 23.32% decline yoy. So in a year we lost €31,419mln in interbank deposits and gained €1,515mln in a month. 20 months left to go till we are back at September 2010 levels. Or relative to peak - we are now €48,066 mln down - so only 32 more months of celebrated increases to regain the peak.
• Oh, another thing that drove our total system deposits up in September compared to August was an increase in Government deposits from €2,360mln in August to €2,740 in September. 
• Please note that in 2011, unlike in 2010, there are also some new depositors in the private sector that are potentially channeling new dosh through Irish banks - namely, Nama. That's right, the state agency is, of course, a private company and is cash generative for now. This means that the true decline in real economy's private sector deposits was probably even more substantial than the data shows (next point)
• Private sector deposits - the real economy in Ireland - have declined in September to €142,828mln - down 14% or €23,252mln yoy and 1.15% or €1,668mln mom. 3 months through September average private sector deposits were 4.44% or €6,720 mln below the average for 3 months through July 2011.

 Now, recall that the other metric of health of the banking sector is the Loans to Deposits ratio - the metric of solvency of the system. Recall that the Central Bank of Ireland is aiming for 125.5% ratio for IRL6 banks (more on these in the next post). So what's happening in this area? Chart below illustrates:

And, folks, we thus have:

• Overall across the Domestic Banking Sector, LTD ratios have declined from 145.32% to 145.14% between August and September. The rate of decline that would require 182 months to deliver 125.5% benchmark for stability envisioned under CBofI reforms (note: the benchmark of course does not apply to all Domestic Group banks, just to IRL6, but nonetheless, this can be seen as a comparative metric). Year on year the ratio is up 7 percentage points.
• In the private sector, the LTD ratio actually rose in September to 165.2% from 163.06% in August. Year on year the ratio rose 4 percentage points.

So in summary - there are no signs that things are improving or stabilizing in the broader banking sector in Ireland. The following post will look into IRL6 guaranteed institutions, but as the whole banking system goes, no confidence gained, private sector deposits are continuing to contract, LTD ratio is rising for private sector and the only area of improvement is the inter-bank deposits, which means close to diddly nothing to the economy at large. 

17/06/2011: Who's Confidence is it, folks?

Here are few charts to illustrate the fact that some 3 years into the 'Restoring Confidence' strategy of the successive Irish Governments... and things are not exactly working out.

First straight up, the markets 'voting' on Irish banks:
Looks like investors are not really in tune with Irish Government plans for 'repairing' our banking system despite unprecedented guarantees from the Sovereign which have:

• Explicitly underwritten virtually all deposits and most of the bonds held or issued by the IRL6;
• Implicitly underwritten virtually any extent of losses in the IRL6;
• Explicitly purchased some of the worst 'assets' held by the IRL6; and
• Explicitly underwritten all of the IRL6 funding through ECB and CBofI lending facilities

And what about the entire system of domestic financial institutions? Well, the story is pretty much the same:Recall, thus that at the present (and the picture remains stable in this context since around late 2008):

• Financial investors have no confidence in IRL6 (as these charts illustrate)
  
• Fellow peer banks around the world have no confidence in IRL6 (as clearly indicated by the fact that other banks are not willing to lend to IRL6)
• Bond markets have no confidence in IRL6 (since none of IRL6 can issue any debt paper)
• The ECB has no confidence in IRL6 as it desperately tries to shed their borrowings off its balance sheet (including by shifting it onto CBofI balancesheet)
• Private sector have no confidence in IRL6 as they have taken out some €24 billion worth of funds from IRL6 (per April 2011 data from CBofI) or 23% relative to peak
  

So the only ones still showing confidence in IRL6 is... Irish Government itself, with the Sovereing - itself severely strapped for cash - putting some €18.566 billion worth of taxpayers money into Irish banks deposits since April 2010. That's a whooping ca 8-fold increase in Confidence, then.

2/02/2011: Irish interest rates

For the last post on monthly data release from the CBofI, let's take a look at the interest rates environment at the retail level.

First up - lending rates:

As of November 2010 (latest data available):

• House purchases lending floating rate was at 2.95% (up 0.34% mom and 13.03% yoy - note, these are percentages, not percentage points); rates for over 1 year fixed were 4.10% average (up 0.24% mom and 14.53% yoy)
• Consumer credit rate was 6.06% floating (up 1% mom and 30.32%yoy)
• Non-financial corporations faced a floating rate for <€1mln loans of 4.49% (up 10.86%mom and 13.96%yoy) and over 1 year fixed rate for same level of loans of 5.14% (up 4.26%mom and 18.16%yoy)
• The trends are up for all two borrower types year on year
  

Now, deposits:
So for deposit rates:

• Household deposits attracted an average rate of 1.75% (up 6.06% mom and 17.45% yoy)
• Non-financial corporations attracted an average rate of 1.25% (down 0.79% mom and up 39.98% yoy)

Now, consider the difference between deposit rate and borrowing rate:
For households, the gap between earnings on savings and cost of financing mortgages (I used house purchase, floating rate or up to 1 year fixed) has moved in favor of savers until November 2008, and there after switched in the direction of favoring borrowers. The switch is extremely volatile and since August 2010 the direction has changed once again. Thus, since August 2010 the banks are moving into more aggressively charging mortgage holders and rewarding relatively more savers.

Corporate rates differential has been moving in the direction of penalizing corporate deposits holders. This process in now being reinforced since July 2010.

So here we have it - deposit rates are becoming less attractive to the corporates, just as more and more of them abandon Irish banks... who would have thought that charging our customers out existence can be a bad thing?

Finally, using CBofI breakdown on loans by type and maturity, I conducted a simple exercise - what happens if the interest rates on new and ARM mortgages charged by banks go up by 1 percentage point (incidentally - PTSB is doing just that, apparently). By my calculation, added cost of interest finance will translate into roughly additional €1.67bn being taken out of the economy. That's like having another Leni's tax hike over again for Irish households.

2/02/2011: Irish termed deposits and credit cards

In the previous two posts I updated data on credit and deposits levels and flows. In this post, let's tidy up by taking a look at deposits by maturity and credit cards.

First deposits by maturity:
Clearly, longer term maturity is exiting, medium term maturity deposits are now shrinking as well, while short term maturity deposits remain steady. This suggests that

1. Irish depositors are exiting Irish banks when longer term savings mature;
2. Irish pool of savings available for investment - remember, banks can more safely lend out of longer maturity deposits than out of shorter maturity ones (lower risk of maturity mismatch) - is also shrinking.
3. Overall, overnight deposits have increased 2.11%mom in December 2010, but fell 4.35% yoy
4. Up to 3 months deposits fell 4.33% in December 2010 mom and 2.77% yoy
5. Up to 2 years deposits fell 9.64% mom and 17.32% yoy.
   

Not very good trends.

On credit cards, the picture is What the data suggests is:

• Irish credit cards balances are declining, but this decline is relatively mild - down 0.81% mom in December 2010 (latest data) and -6.28% yoy.
  

1/02/2011: Growth rates in credit and deposits

Having looked at the levels of credit and deposits through December 2010 in the previous post (here) lets take a look at the rates of change.
Credit growth rates above clearly show the following trends:

• Household loans rate of contraction has accelerated from 4.8% yoy in October and November to 5.2% in December. Thus December 2010 marked the worst month in the entire series history since 2004.
• Rate of decline in mortgages lending was also accelerating to 1.9% in December from 1.7% in November and 1.6% in September and October.
• Rate of decline in credit for non-financial corporations eased in December to 1.6% yoy from 2.4% in November.

Next, deposits rates of change:
The chart above shows:

• A dramatic exist from Irish banks by non-financial corporate deposits. This flight is accelerating - having gone from -9.2% yoy fall in July, to -13.1% in August, -14.8% in September, -15.4% in October, -14.9% in November and a whooping -16.1% in December.
• Household deposits are also accelerating in the rate of decline from -2.4% in October to -4.5% in November and -4.7% in December

To highlight these dynamics and to dispel the myth of 'savings are rising' often perpetrated by some banks analysts, let's come back to the data on deposits. In December 2008-January 2009 there was a discrete jump in household deposits to the tune of just over €12.4bn. This jump is never really noticed by the analysts, but it reflects addition of the credit unions to the database. These are not new deposits, but rather the deposits that were held in institutions previously not covered by the dataset.

Now, let' remove this 'hump' and see what the banking sector deposits really look like today:
The chart abvoe does exactly this. And it clearly shows that:

• Over 2010, Irish households have suffered a loss of savings, not a gain, pushing our deposits to the comparable level of December 2007
  
• Over the entire crisis total private sector deposits have fallen to the levels comparable to those in May-June 2006.

And yet, we keep hearing (admittedly whimpered) calls for taxing 'sky-high' deposits/savings to 'release spending into consumption markets'.

1/02/2011: Credit supply and deposits in Ireland

CBofI released monthly data for December 2010 on credit supply and deposits in the Irish financial institutions.

Updated charts and some analysis:
Irish private sector credit continued to contract in December, having fallen 0.98% mom and -10.7% yoy in total. Overall, credit outstanding fell €3.33bn in December mom and €40.23bn yoy.
Credit has fallen across all categories, except one:

• Household credit fell 4.72% (-€6.49bn) mom and 6.41% (-€8.98bn) yoy
• Mortgages credit fell 7.05% (-€7.55bn) mom and 9.65% (-€10.63bn) yoy
• Non-financial corporations credit fell 2.63% (-€2.5bn) mom and 37.08% (-€54.34bn) yoy
• Insurance and pension funds sector credit rose 5.36% (€5.66bn) and was up 26.18% (€23.09bn) yoy
• Combined non-financial sectors and households credit fell a massive €63.32bn in 12 months to the end of December 2010.

Onto deposits next:

Headline figure is that total deposits fell 2.24% (-€3.86bn) mom and 8.41% (-€15.46bn) yoy. This was backed by deposits declines across two out of three core components:
So:

• Household deposits rose 0.71% (€669mln) mom but fell 4.57% (-€4.53bn) yoy
• Non-financial corporate deposits were down 5.18% (-€1.83bn) mom and 17.64% (-€7.17bn) yoy
• Insurance and pension funds sector deposits fell 6.29% (-€2.7bn) mom and 8.57% (-€3.77bn) yoy
• Non-financial sector and household deposits fell €11.693bn in 12 months through December 2010.

The relative changes in deposits and loans outstanding implied changes in the ratio of loans to deposits - an instrument for the leveraging taken on by the economy at large.

Overall, Irish economy achieved a very modest reduction in the ratio in 2010:

• Total private sector credit to deposits ratio fell 2.53% in 12 months to the end of December 2010 reaching 198.81%
• Lowest deleveraging took place in the household sector, where the ratio fell 1.93% in 12 months and currently stands at 138.56%
• Highest degree of deleveraging was achieved in the non-financial corporate sector, where the ratio declined 23.6% yoy in December (though it rose by 2.69% mom) reaching 275.68%
• Insurance and pensions funds sector actually increased overall leverage ratio by 38% in 12 months to the end of December, reaching the ratio of 276.6%

Overall, outstanding loans exceeded domestic deposits by 98.81% in the end of 2010.