Economics 21/12/2009: Nama - perpetuum mobile of ethics and objectives

For those of you who missed my Sunday Times article yesterday - here is the unedited version of the text.

But before we begin on Nama - here is a superb article on the prospects of potential sovereign defaults in Europe (read: Baltics, Greece and Ireland) from the FT today.

And here is a fantastic compendium of Brussels-imposed costs to the UK economy as estimated by the UK Government own assessments studies. One wonders if Irish Government bothered to do the same exercise and what its outcome might be. In the UK, the cumulative present value cost of these measures is ca £184 billion through 2020. If the same apply to Ireland, proportional to the overall size of the Irish economy, the combined cost of these Brussels directives could be around €18.6 billion - more than 77% of our annual deficit.



In the real world economics there is one Newtonian-level certainty: what can’t go on, doesn’t. We should have learned this some years ago, following the 1980s economic debacle and the 2001 collapse of the tech bubble. We had another opportunity to understand it last year. But in Ireland, real economics is reduced to the domain of an eccentric hobby. The real business of the nation leadership is preservation of the status quo – first at the state level, then political, and now – in banking.

Nama is a focus of all three. Through it, even in the midst of the current historic crisis, our political and executive elites continue to inhabit a parallel universe where responsibility and accountability are for the commoners, and transparency and governance are decorations for EU summits.

Aptly, in its current form, Nama reigns supreme as the most non-transparent financial institution in the developed world. Its ‘independent’ directors are being selected behind the closed doors by those who presided over the systemic failures of our regulatory and supervisory regimes. Its risk, audit and strategy functions will be fully contained within the secretive and unaccountable structure of the organization itself.

Nama will not publish a register of properties against which it will hold the right of seizure. This, we are being told, is done to protect privacy of the developers involved. But a register does not have to declare the names of the borrowers – property location, purchase price, vintage, LTV ratio and valuation by Nama would do just fine.

Nama accounting and audit functions will not comply with the requirements imposed by our regulators on public companies. Its directors, management and consultants will enjoy a blanket indemnity that is unparalleled by the standards of any public office or company law. Their remuneration will not face even the farcical constraints that senior banks executives face.

Nama owner – the SPV – is a bogus shell entity with ghost investors and a minority shareholder (the state) in charge. That this scheme has been concocted not in a distant off-shore location, but by our own state in our name and with our money adds insult to the injury.

As if the existent shortfalls of the legislation establishing Nama were not enough, even after the entity approval by the Dail, the goalposts for its operational performance continue to shift. Just weeks after the TDs voted to approve it Nama is now a different beast altogether.

Take the issue of discounts. Throughout the approval process, the Government doggedly refused to accept the need for realistic writedowns on the loans. Hence, all official estimates for Nama were incorporating an extremely optimistic 20-23% average discount. A handful of independent analysts, including myself, Professors Karl Whelan (UCD) and Brian Lucey (TCD), and an independent banking expert Peter Mathews, kept on showing analytically and factually that the final discount must be closer to 35-40% if Nama were to become anything but the skinning of the taxpayer.

The latest revelations from the banks and our stockbrokers, who insisted earlier this year that a 12-15% discount would be just fine, put an average Nama discount at over 30%. Nama cheerleaders now admit that applying a low discount is simply bonkers. This week, international agencies – Fitch and Moody – also waded back to the shores of reality. Both highlighted the fact that going forward Irish banks will remain in their current insolvent state. Nama won’t repair their balancesheets and it will not change their ability to raise capital privately.

With this change in direction, Nama became an exercise in racing to the top of recapitalization heap, as banks scrambled to issue new estimates of their expected demand for additional capital.

Two months ago I estimated in a public note that Bank of Ireland will require up to €2.6bn in capital after Nama loans are transferred, AIB will demand close to €3.5bn, Anglo €5.7bn and the rest of the pack will need approximately €1.2bn. The total demand for recapitalization costs post-Nama – none of which is factored into that work of fiction known as Nama Business Plan – will be €10-13 billion.

All of these figures could have been glimpsed from the banks balancesheets, but the Department of Finance, NTMA, and an army of advisers have opted for creative accountancy in place of realistic estimates.

Over the recent months, virtually every vested analyst in the country has confirmed the above figures for the banks. In one case – that of INBS – the analysts actually exceeded my worst case scenario projections. The result of this delayed admission is the current bear run on Irish banks stocks.

Now, recall that consensus estimates prepared by the independent analysts show that in the end of its operations, the ‘bad bank’ is likely to yield net losses to the taxpayers of between €11 billion and €17 billion. Not a single estimate, short of the fictionalized official Nama accounts, shows the entity breaking even on the loans.

Do the maths: expected losses of €11-17 billion, plus recapitalization costs to date of €11 billion, plus expected post-Nama recapitalization costs of €10-13 billion (only partially reflected in the expected losses estimates). The total bill for this bogus ‘rescuing’ of the Irish banking system is likely to be in the neighbourhood of €29-40 billion.

And, judging by the public pronouncements from the top bankers of AIB, Bank of Ireland, Anglo, permanent TSB and EBS – there is not a snowballs’ chance in hell Nama will repair lending to Irish companies or households. Instead, as the US experience with TARP shows – a liquidity trap is awaiting our economy. Put in simple terms, no rational banker would forego an opportunity of borrowing from the ECB and lending at ca 5% to the state instead of providing capital to SMEs and households.

Contrary to the hopes of restarting the lending cycle, what we have to look forward to in 2010 is the strengthening of the margins by the banks. A combination of the ‘risk sharing’ scheme built into Nama legislation, costlier interbank funding markets (courtesy of reduced liquidity supply from the ECB), falling corporate deposits base and the deterioration in the capital reserves of the banks will mean that the cost of existent loans and future borrowing will rise. And it will rise dramatically.

The first taste of this was the implementation by permanent TSB of a rate hike on adjustable rate mortgages. ESB preannounced the same move some months ago. Bank of Ireland, AIB and the rest of the pack will follow. When this happens, even absent ECB rates hikes (anticipated by the market in mid-to-late 2010), the retail lending rates will rise, triggering a wave of defaults by households on credit cards debt, consumer loans, car loans and ultimately home loans.

Short term lending facilities for businesses and export supports will also come under pressure as banks address the twin problems created by Nama – the deficit of capital and the uncertain nature of risk sharing scheme. The lack of exports supports either in the form of state-backed export credit insurance for indigenous exporters or the currency risk offset scheme in the Budget 2010 will further exacerbate the problem.

All of this is fuelling the current run on the banks shares. Even with their wings clipped, stock markets investors are indirectly ‘shorting’ Irish banks by withdrawing their cash from the AIB, Bank of Ireland and Irish Life & Permanent valuations. The markets are shouting: ‘We are not buying your story that Nama will work for Irish economy!’ The Government is not listening.

Box out:
A study based on the Standard & Poor’s data released this week shows that over the last 5 years, active funds managers have managed to under-perform broader market indices in four out of four asset categories. Thus, only 37% of active funds managers with large cap strategy orientation beat S&P500 large cap index to July 1, 2009. Only 32% of funds specializing on small cap equities outperformed S&P Small Cap 600 index, and abysmal 13% of funds with international (as opposed to US) orientation have managed higher returns than S&P700 index of global equities. Just 20% of bonds funds beat Barclays Intermediate Government/Credit index. And that is before we factor in cost differentials between actively managed funds and plain vanilla index-linked ETFs. Ouch…

Economics 01/12/2009: Irish Banks - something stirring in the dark

An interesting, but at this stage purely theoretical conjecture that can play out in the next couple of days.

I will posit it after I go over the facts that led me to this conjecture:

1. Today's reporting on BofI and the banks in general has been focusing on the possible conversion of preference shares into ordinary shares to plug in capital holes. Considering that (a) such a conversion will de facto spell near nationalization of the banks; (b) it will destroy Government's case (supported by the stockbrokers and the banks) that preference shares represent significant cash flow positive back to the taxpayers in exchange for recapitalizations to date; and (c) such a conversion will amount to a swap of a guaranteed asset (preference share dividend) in exchange for of a falling asset (as ordinary shares are tanking and are bound to continue to tank if conversion takes place), the statement is alarming. In fact, the statement is extraordinary in nature, similar to the Banks Guarantee Scheme announcement back in September 2008;
   
2. The RTE has completely failed to explore the very core idea of what effect the conversion will have on both capital reserves at the banks and the value of taxpayers' shareholdings in the banks. This might suggest that the story was potentially heavily 'managed' as a staged release as RTE business editors and correspondents should have been aware of such consequences;
3. The extent of demand for capital post-Nama has been approximately estimable from the sheer size of impairments faced by the banks against banks balancesheets (loans to deposits ratios) and did not come as surprise for, say Anglo earlier this month. Why such a hype then all of a sudden? Did Nama haircut change dramatically? Not, Bloxham note today in the morning explicitly worked its estimates from the assumed Nama-signalled haircut of 30%. No change spotted here, then.
4. Core tier 1 capital already includes preference shares, so conversion will only aid the banks balancesheets if and only if it will allow the banks to keep the preference shares dividend. This means that taxpayers get nothing from these shares. And it also means that things are getting so desperate in the banks that they are having trouble (potentially?) repaying these dividends to the state. What can the impetus for such deterioration be, given both banks already guided recently on expected impairments? Why did RTE reporters never bothered to ask about this issue.
5. The whole mess of demand for post-Nama recapitalizations was predicted by some, and publicly aired in the media. In fact, my estimates from one month ago (here) accurately predicted the numbers involved. While some 'experts' from stock brokerages interviewed today by RTE's flagship News at Nine programme might have been unaware of such estimates back then, their arriving at the same numbers one month later is not really that much of a market-making news. So, again, why the hype today?
   
6. RTE stated tonight that the markets anticipated 20% haircut (here). This is simply not true:

• Per today's Davy note: "This has been reviewed by NAMA and the Department of Finance and on the basis of interaction with both and the minister's estimate of €16bn of eligible bank assets, 'the directors believe that the average discount on disposal applicable to these assets should not be greater than the estimated average discount for all participating institutions of 30%'."
• Bloxham are working off 30% assumption.
  
• Goodbody's note was a bit more volatile on assumptions: "As per BOI’s recent interim results and a November’s IMS from AIB, both banks highlight that a number of uncertainties exist as to the specific quantum and timing of loans which may transfer, the price, the fees due and the “fair value” of the consideration. In its statement, AIB refers to the previously highlighted industry average discount of 30% to the gross value of the loans and indicates - as it did at the time of its IMS - that the board’s view is that “there is no reason to believe that the average discount applicable to AIB’s NAMA assets will fall significantly outside of this guidance”. When we wrote on this at the IMS stage, we highlighted that the language here was more vague than previous utterances and note our haircut applied is 28%. Similarly, in the case of BOI, the references in the release today are all based off the generic 30% industry figure referred to be the Minister, though that the discount will vary by institution, with the Court believing this industry figure to be the “maximum loss likely to be incurred on the sale of loans to NAMA”. We are of the view though that BOI’s haircut will be closer to 18%." I'll explain in human language: AIB itself believed that average Nama discount (30%) or something close will apply, while Goody believed 28% will do. For BofI, the management believed before that 30% will apply. But Goody's believed 18% will do (why, beats me). So no evidence on 20% market consensus anywhere here, then.
  
• NCB applied 30% model to both BofI and AIB in today's note. And so on.
  
• Taken over all brokers and banks themselves, AIB assumed discount averages at 29.5%, not 20%, BofI assumed discount averages at 27%. Now, forgive me, but where is RTE taking its 20% market expectation from?
  

So now, let us summarise the evidence:

• Banks announcement today was out of line with ordinary business;
• Banks announcement was never probed or challenged by the official media;
• Banks announcements were not queried by the the brokers to the full extent of conversion implications to the balance sheets;
• Three components can have a dramatic fast impact on bank core tier 1 capital - equity collapse (not the case - banks shares are down by less than 5% today, plus the statements were released in the morning before market prices were revealed); loans collapse on a massive scale (unlikely, given that both banks guided very recently on new impairments and also unlikely given that both banks appear to be impacted simultaneously); or deposits falling off dramatically (there is no way of confirming this unless banks publish their data, but do recall September-December 2008 when deposits flight exposed Anglo to nationalization).
  

So something really strange is happening around the BofI and AIB in the last few days. I do not know what this might be, but some fast moving deterioration in hitting banks balancesheets.

Watch tomorrow's ticker.

Economics 30/11/2009: Nama estimates confirmed

Scroll for a couple of interesting topics (other than Nama) below...

Per Bloxham’s note today (emphasis is mine):

“Bank of Ireland this morning officially announced its intention to participate in the National Asset Management Agency ... The bank sees the first assets as moving from January 20th 2010, and on a phased basis from there on until mid 2010. The group does not know the discount to be applied to the assets on transfer to NAMA. However, the bank expects to receive €11.2 billion for the assets currently shown with a worth of €16 billion in the balance sheet, based on the 30% discount guided by NAMA. Total provisions set aside on the assets to move to NAMA are €1.4 billion resulting in a €3.4 billion loss. The Risk Weighted Assets will be adjusted down by €15.2 billion as a results of the transfer. The bank shows a loan book of €116.7 billion (down from €131.3 billion pre NAMA) after the movement in assets, while Risk Weighed Assets fall from €100.7 billion to €85.5 billion. Core Equity will fall to €3.5 billion from €6.6 billion. Therefore, the reduction in Core Equity Tier 1 would be from 6.65% in September 30th to 4.2% as a result of the transfer to NAMA, and subsequent write down.”

So to restore the bank balancesheet to internationally acceptable risk-core equity balance of over 6% will require some €2.55bn in capital injection post-Nama, not accounting for any additional deterioration in the remaining book. In a note published exactly a month ago (here) I predicted that BofI will need €2.0-2.6bn in fresh capital – bang on with today’s statement.

This is the second estimate fully confirmed by the Nama-participating banks that is in line with my projections of October 30, with earlier this month media reports putting Anglo’s demand for fresh post-Nama capital at €5.7bn.

Further per Bloxham:

“Loss on disposal of assets will be tax deductible as we understood previously. Bank of Ireland also highlights that after 10 years, in the event NAMA discloses a loss the Minister of Finance may bring forward legislation to impose a special tax on participating institutions. The bank goes on to confirm that the interest rate Bank of Ireland will receive from the bonds which replace the transferred assets, is still not know. Therefore the impact on income is still not known.”

Oh and per Davy's morning note: using average 30% haircut implies a loss of €3.4bn on top of the €1.4bn impairment already estimated at September 30, 2009. This implies - per Davy's model - €960mln pre-tax hit which, "combined with some other adjustments to RWAs and sub-debt... would increase the capital required to keep core equity at the trough of 5% from €1.3bn to €2.3bn."

Now, Davy's model, therefore suggests demand for €2.8bn in capital to 6% ratio. Both Davy estimates are therefore comfortably within my range of expected capital demand by BofI. And good luck to those who have a hope that BofI can raise new funding with 5% core equity ratio at anything close to reasonable costs.

Anyone who at this stage in the game still holds illusions that Nama will allow for a restart of lending in this economy has to be simply bonkers.

Oh, and on a funny side of things: today's CSO data release is for:

"Census of Industrial Production 2008 - Early estimates". One question begs asking: When will the later estimates arive? December 20, 2011?

Oh, and do see this on Ireland v Dubai - here. The worrying thing is that it is talking about partial default scenario for Ireland and the ECB rescue ahead of Greece! which, of course, goes nicely with my article in The Sunday Times yesterday - which I will post later tonight.

Economics 19/10/2009: A proud member of National Mediocrity

Sunday Sunday Business show on Today FM. Minister Lenihan commenting on the anti-NAMA economists (podcast here):

"What I notice about them is that there’s about forty of them. There is about two hundred economists in the state. Most of the rest of them have approached me privately and said that these gentlemen and ladies are wrong. But of course they are not prepared to say so publicly because in Irish academic class, people don’t criticise other people’s books. That’s part of our national mediocrity. ...If you look at the press in the United Kingdom or the United States, you’ll see robust academic criticism of others works but we’re reluctant to do it."

Karl Whelan has his view on this - read it here.

My view is a simple one. Want to have some criticism - compare publications records of Mnister's advisers to that of, ough, say Karl Whelan or Brian Lucey. Want to have some criticism - compare supporters and critics of Nama:
Supporters:

• Stockbrokers and Irish Banks' economists - all with a major conflict of interest implied in their positions as their respective organizations will be the intended beneficiaries of Nama. In my books, this does not invalidate their points and analysis, but it does raise a question or two;
  
• EU Commissioner who actually negotiated with Minister Lenihan Nama solution;
• Ghosts of other - possibly independent - economists who have spoken to the Minister in private?..
  

Critics:

• 4 Nobel Prize winners, several senior faculty members from the top 5 Finance Departments in the world, and one former SEC Board Member;
• 46 academic and practicing economists and finance specialists;
• 4 authors of comprehensive analysis of Nama proposals (myself, Brian Lucey, Ronan Lyons and Karl Whelan - in alphabetic order) that provided more detailed and more accurate costings of Nama and alternatives than the one supplied by Minister's own staff;
• 1 former banker - Peter Mathews - who has extensive experience in managing bad loans within a special division for such loans set up by ICC bank in the 1980s;
• A range of independent economic commentators some with extensive finance experience in the past;
• A number of top class finance entrepreneurs, including Dermot Desmond;
• Hundreds of people from finance, international finance and economics who comment on this blog and the Irish Economy blog;
• One Governor of the Central Bank who proposed significant changes to Nama that were subsequently taken out of context by His Intellectual Excellence's Government colleagues and reshaped into an unrecognizable watered-down versions to suit original Nama.

Not that excellence is measured in numbers (as Gallileo and Copernicus and many others have proven before), but you get the point.

As far as Minister Lenihan has a stomach to talk about mediocrity, I wonder how he feels sitting at the Cabinet table. Or how he feels about the Nama analysis being pushed forward by his staff - analysis that has been time and again proven as:

• coming after the mediocre Irish economists put forward their figures; and
• turning out to be wrong and proven to be wrong by the mediocre Irish economists.

Hmmm...

One real sign of intelligence and excellence is ability to listen, seek truth and change your views/plans in response to overwhelming evidence that disputes one's original proposition. To date, after months of factual analysis by many of us, this Government has been showing complete lack of ability to do either one of the above.

Let us all be judged, then, alongside Minister Lenihan, as to where the real mediocrity in this country resides.

Economics 17/10/2009: WalMart/IKEA Effect, Bull Markets in Stocks

Scroll for IKEA Effect discussion and Retail Sales Data below...

A superb note on the current markets from Robert Lenzner on the links between the Bull run we are experiencing and economic fundamentals is available from Forbes (here). To sum it up: that which can't go on usually doesn't.

What are the implications for Ireland?

• Our exports are likely to suffer significant downward pressure in years to come - a combination of Obama Administration Healthcare Reform (driving down long-term returns to pharma sector and re-orienting US purchasing to more centralized and, more likely, heavily domestic-industry oriented purchasing will undermine majour pharma players - the dominant force in Irish exports) plus cyclical effects of patents expiration (Pfizer - Ireland's largest singular exporter - is facing tough times in coming up with new blockbusters as its existent ones are running out of patent protection) will act to depress future exports growth in the pharma and bio-phrama sector.
• Our indigenous exports will remain uncompetitive for years to come as a combination of strong euro (especially if the ECB continues to move toward 'exit strategies' and higher interest rates) and the legacy of the crisis (high debt levels and severe maturity mismatch in Irish sectors) will continue to weigh on future growth.
• Our domestic consumption will remain in doldrums for years to come under combined weight of higher taxation and stronger euro, with a resultant shift to imported substitutes (see IKEA effect below).
• Our trading and investment block - the EEC - will remain anaemic growth partner.
• Our internal investment will stay flat at low levels as a combination of higher investment costs (banks raising margins and engaging in wholesale capital destruction by re-drawing terms and conditions of existent loans to companies and households post-Nama) and precautionary savings (our households and corporates holding excessive cash reserves with demand-style access covenants on these holdings) will imply low returns to domestic investment, high cost of such investment all in the environment of subdued growth.

Can you see Bank of Ireland or AIB shares trading at Euro4.00-5.00 range with these prospects? I don't...


Ikea Effect: I wrote before on many occasions about the WalMart effect: give consumers better value for money (through more efficient purchasing, logistics, distribution, marketing and retailing) and they will vote for you in tens of thousands. Now we have a small glimpse at it in the form of IKEA.

Here it is - in this week's CSO data on retail sales: August retail sales down a massive 1.0% overall, after six months of shallow increases. Worse than that - core retail sales (ex-motors) down 1.8% on July breaking three months improvements pattern. Food sales were down 2.8% despite decent weather and more families staying at home instead of leaving for a vacation. But, Furniture & Lighting was up 26% - thanks to IKEA.

Few charts to illustrate trends.
So broader trends are dire. But look at what's happening in Furniture Sector (IKEA Effect):
Self-explanatory.

Now, per CSO CPI data: Furniture and Furnishings, plus Carpets & Floor Covering account for 1.0812% of total Household Expenditure in 2006, Household Textiles - for additional 0.2424%, Glassware, tableware & household utensils 0.2577%, so roughly 1.6% of household spending goes to items sold by IKEA. Per CSO data, 2008 personal consumption expenditure in Ireland was €93,863bn, so roughly speaking €1,500mln of this went to goods of the types sold by IKEA. If IKEA offers average savings on Irish-domestics in the sector of some 25-40% (and my own experience suggests it is actually greater than that, but let us be conservative), the savings potential due to IKEA Effect add up to some €375-600mln or some €133 per every person in this country.

Now, IKEA has been trying to get a store into Ireland since at least 2000, which implies that an average Irish household has lost up to €4,000 in savings that could have been achieved were the IKEA (or WalMart) effect present in this economy. All due to the corporatist and politicised nature of our planning and retail regulations. Some price to pay!

Of course, these savings would have been even greater as:

• IKEA (WalMart) effect could have had spillover effects to other sectors of Irish economy were our policymakers not engaged in actively restricting competition in retail sector;
• IKEA (WalMart) effect would have coincided with heavier purchasing of durable goods during the boom years of 2003-2007, thus offering greater level savings on more expensive items.

But let us not count 'small change' - after all, preserving a 'small town' character of retailing (with convenience shops littering every corner of our towns and gas-station shopping outside of Dublin instead of proper multiples retailing) is worth €4,000 per family. Isn't it?

A quick note on the WalMart effect in broader terms. Ireland is aiming to get its R&D spending (public and private) contribution up to 3% of GDP or in 2009 terms - roughly €5.1bn per annum. Now, assuming WalMart-type retail efficiencies can deliver a 10-15% savings on our retail spending, the gains from the WalMart effect will mean an addition to our GDP to the tune of €9-14bn per annum. Of these, some 30% will be accruing to the Exchequer in form of various taxes, so the second order increase in GDP will be €2.7-4.2bn. Total increase in GDP will, therefore exceed €11-18bn or 6.5-10.5% of GDP. (These are back of the envelope calculations, but you can see where it is going)...

Economics 06/10/2009: A stockbrokerage strategist on Nama

And so it comes to my attention that last week in a local Chamber of Commerce hosted a debate on Nama. Per my contacts, “a number of issues arose that may be of interest”.

These issues are important because they largely outline main arguments about Nama made by the proposal supporters out there.


1) Nama supporter (NS) was keen to distance himself and Nama supporters from ‘theoreticians’ and ‘academics’ who exclusively populate the Nama critics land. It is important to note that many of the people who signed the letter of 46 economists, as well as other members of the critics camp are actually practitioners of the same fine art of finance as NS. Many.

How many? Well, just a quick run through

• myself – former business editor who brought finance coverage to the most respectable Irish business magazine, former director of research at NCB, currently head of research and strategy with an American brokerage.
  
• Greg Connor – former director of research for Barra, Fed employee.
  
• Karl Whelan – former Fed employee.
  
• Other members of 46 run options desks, have been bond traders, worked in central banks and finance ministries... you get the picture.
• Brian Lucey - former employee of the Central Bank;
• Ronan Lyons - former economist wit one multinational company and also chief economist of Daft.ie; and so on.
  

NS might think we in academia are just performing random walks in various universities’ squares, but no, we actually advise governments, international organizations, businesses and have some relevant experience in the real world.


2) NS contended that the main problem with Irish banking sector was that after 2001 we had "over competition" from (guess who?) the foreign banks. One assumes he means Rabo and KBC, for the British banks were here before 2001 and in addition we had our banks in their countries as well, aggressively lending to… yes, you’ve guessed it again – property developers there. So the foreign banks, thus, caused a property boom in Ireland. And the foreign banks forced our banks to issue 110% mortgages. And the foreign banks assured that most of our lending has gone to finance property deals of one variety or the other. Of course, it was the foreign banks that made sure that IL&P and Nationwide made strange dealings with Anglo. Why wouldn’t NS read Noel Whelan’s treatise on the crisis (see my comment here) – he might find out that in addition to the foreign banks, 46 economists also caused the crisis.


3) NS also allegedly claimed that as foreign banks leave Ireland, Irish banks will take a "more prudent, even oligopolistic approach to rebuilding their balance sheets". Oligopolistic? I hope the Competition Authority is reading this, plus the folks at the EU Commission. But for those of you who wonder what this means, let me explain. In the case of oligopolistic competition, banks would earn near monopoly profits by charging their customers (aha, you and me) excessive near-monopoly rents. Happy times, folks. A stockbroker calling for oligopoly? Surely not. Though it might happen if our regulators continue sleeping at the wheel. What’s next? Markets for shares becoming too efficient, so NS will call for regulated trade in equities? Incidentally, courtesy of Anglo, we already have had bans on shortselling - an activity that actually has been proven to aid price discovery in the markets.


(4) Per NS, the main aim of NAMA is to get credit flowing. If this turns out to be a problem in a recessionary economy, the profit motive of the banks will induce them to lend after NAMA. Ahmmm, ok, I have one question – why would they seek profit opportunities in Ireland?

• Because our margins are so high? Nope, they are low, Bloxham, Davy and other Irish stockbrokers said so. Can banks raise these margins? Yes, but only at the expense of already strained households, which will mean that their loans books will suffer more defaults. Surely NS wouldn’t call that an improvement in financial stability?
  
• Will the banks have an incentive to lend post-Nama because our lending bears lower risks? No, we are among the worst performing economies in Europe.
  
• Because the banks will simply have excess of cheap cash after Nama? Oh, no – they will still face some €130bn in interbank loans to repay (pricey stuff) (here).
  
• Maybe because they can’t get better returns anywhere else than in Ireland? Well, they can get higher returns pretty much anywhere else other than in Ireland, given our domestic economy will be contracting through 2010.

So, the banks won’t be rushing to lend here. And, incidentally, there won’t be many borrowers rushing in to borrow either – the households will be scrambling to deleverage in the next two years, not to borrow more. What is most likely is that the banks will use our taxpayers’ cash to repay some of the interbank loans, plus buy some discounted debt of which they had €103.8bn worth of senior bonds and €17.7bn in subordinated bonds as of June 2009.


5) Per NS, Nama provides asymmetric exposure to risk to the benefit of the taxpayer as the subordinated Nama bonds will take 1/3 of the risk. As far as I recall, the actual plan was to issue 5% of the Nama disbursed funds in the form of these bonds. Even if the risk weighting on them truly reflects the risk of Nama generating an end loss, this translates into just 5% of risk being shared. Of course, since we have no exact legally defined and enforceable criteria as to what constitutes ‘success’ or ‘failure’ of Nama, any future Government can ‘fudge’ whatever outcome achieved to be called ‘success’, so effective risk-sharing under subordinated bonds is NIL.


6) Allegedly, NS claimed that current commercial property yields are at 6% nationwide and are heading UPWARDS. These numbers were presented as facts in contrast to the ‘nonsense’ figures being quoted by some economists. (See Ronan Lyons on this one: here).

Of course NS explained that higher yields will come about as economy is now in imminent recovery mode and that we will see a positive q-o-q growth in Q2 2010. Thus, Davy’s Rossa White, for example, is a pessimist compared to NS who was not sure what Rossa White forecasted for Irish economy just a day before this event. Hmmm…

Now, Nama is apparently about Irish economy. Which of course is about GNP – in case NS did not know. In this context, I don’t think anyone really expects the yields to go up to 7% or to even 6% any time soon. And, in addition, I presume NS is unaware of such things as lags – it takes time to work through the surplus properties out there in the market, and it takes time before that to get consumers spending again. So Q2 2010? More like Q2 2011 for consumption to uptick significantly enough for yields to start stabilizing.

Suppose NS is right and the yields are heading for North of 6%, say towards 8%. Does he believe that these yields improvements will be driven by rents increases? In the current economic environment, even if there is some nominal growth in 2010 of say 0.5% in GDP, this an unlikely scenario with vacancy rates in commercial sector of 21% plus, and in residential sector with some 200,000+ properties unoccupied. So the only way yields can hit 8% is by price of property dropping further, and dropping by more than 20%. What does this mean for the ‘haircut’ applied under Nama? It means the haircut is too low. Significantly too low. If the yields were to firm up, per NS’s assertion, property prices will have to drop and Nama will instantaneously be overpaying even more than it already does.

And, folks, there is no arguing against this point for the yield is, by definition, a ratio: rent to price movement ratio. Ratio can rise either if the numerator rises (rents) or denominator drops (prices).


7) The good thing is that NS is at least more committed to some sort of accountability in Nama than the Government is. Per NS, allegedly, we will know if NAMA works within months, perhaps as little as three to six, as the restoration of credit would tell us that. And if not? What would NS do if Nama fails to deliver? Surely all stockbrokers have standard stop-loss rules to prevent reckless or rogue trades? Nama does not – and it always was a major part of my criticism of the current legislation. Surely NS would be familiar, therefore, with the need for a strategic Plan B? He is. And…


8) … of course – Plan B is to buy equity in the banks post-Nama – the Government already admitted this much. Which might lead to nationalizing of the banks or at least nationalizing a large chunk of them. But for NS this won’t work, as he said, allegedly, that people who advocate forcing the banks to face up to the losses are in fact advocating that not only should the equity holders bear the losses but also that the depositors should be expropriated. Of course, no one I know of in the debate on Nama has suggested that, not even unreformed socialists did. Furthermore, as far as I am aware, in every country where the banks were forced to face up to their debts – US, UK, Sweden, Denmark, Spain,... you name it – depositors remained intact.

Two more things come to mind here. Even post-Nama NS, taken at the face value of his argument, won’t stand for nationalization no matter what – in other words, should the banks need more capital he would, I presume agree to simply give it to them once again, with asking nothing in return. And also that post-Nama, when the banks ask for more cash we might be expropriating the depositors?

Is this for real? Is he suggesting that fully guaranteed depositors might face loss of their funds? Personally I think this is completely out of line scaremongering.


9) NS, allegedly, also stated, per my contact who noted it down as the meeting concluded for tea and buns, that NAMA will make a profit as the bonds will be euribor+50bps while the loans (apparently all) will be yielding at euribor+200bps. So the 44% of loans that are performing can easily take the strain of those that are not performing. Well, not so quick.

Assume for a second that NS is right. Banks pay the cost of managing the loans, so euribor+200bps is more like euribor+125bps once cost of managing loans is taken out. State pays the cost of issuing bonds, so euribor+50bps in bonds face value is more like euribor+65bps in gross cost to the state. Now, at 44% weighting, the average loans portfolio yield becomes euribor+55bps, which is below euribor+65bps. Nama makes loss even under NS’s rosy assumption of all performing loans paying euribor+200bps on average.

But here are two additional kickers:

(a) If interest rates increase, and NS should know this, more loans will go into non-performing category, plus, as I explained above. If NS’s assertion of 8% yield in near future is correct, again, more loans will go into non-performing category. Thus 44% of performing loans today, might drop to, ough say 35% or 30% tomorrow. This is what is roughly called interest rate sensitivity – as the cost of loans rises, more loans fail.

(b) NS’s assertion on euribor+200bps and on 44% performing loans rests on the assumption that the due diligence on these loans is straightforward, so Nama won’t make mistakes in buying up ‘performing’ loans. Again, any error, driving either 44% down or euribor+200bps margin down will hammer Nama bottom line figures.

10) NS asserted over some answers to specific questions, that there is a ten year property price cycle, in nominal terms. If he really did say this, this now provides yet another bogus ‘benchmark’ for property markets recovery – first there was a 7 year to 80% correction statement from one property specialist in the Dail, then there were 5 year turnaround time estimates from the Government advisers circles, now it is 10 year nominal recovery number from one of the stockbrokers.

Clearly NS is unaware of the long-term results for property market busts, and he is unaware that combined shocks to property market, plus to broader financial markets yield much deeper contractions than what his statement implies. I did some actual estimates based on OECD and IMF data and found that past busts across the OECD with an average magnitude being lower than that of expected Irish property prices contraction average 18 years in nominal terms. But what is even more surprising is that a stockbroker would care about nominal, not real, returns. Surely that is not what his usual client advices is based on, one hopes.

Economics 30/09/2009: Global Financial Stability Report

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:

1. 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?
2. 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:

1. 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
2. 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:

1. 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;
2. 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...
   

Economics 27/09/2009: Leverage across Ireland Inc

Crunching through the IMF database on Financial Stability reveals some serious structural problems in Irish Government&Monetary Authorities positions, as well as in Banks and Non-Banking Sectors of economy. These are long-term themes worth considering.

First General Government & Monetary Authorities:
Chart below shows how extreme is our recent performance in terms of maturity mismatch risk on our General Government & Monetary Authorities debt, with Ireland now leading the group of comparable economies in terms of overall share of short-term (highest risk) borrowing relative to total borrowing.
Chart below shows that we also lead peer group of countries in terms of issuance of new debt despite the fact that the peer group includes such 'sick puppies' as Latvia, Estonia, Greece, and Hungary (some subject to IMF rescues in the last 18 months). Although IMF database does not contain comprehensive data on Iceland, it is clear that Ireland is fiscally in worse shape than all of the APIIGS and even Latvia, Estonia & Hungary. Furthermore, despite Q2 2008 announcements by the Irish Government that it will undertake significant corrective measures on fiscal insolvency side, chart below shows that our 'corrective measures' to date have been mostly about borrowing more in international markets, while the chart above shows that, increasingly, this borrowing is short-term.
Chart below provides an index of General Government and Monetary Authorities debt, setting Q4 2002 level of debt at 1. This dramatically illustrates the scale of Irish insolvency, with debt accelerating from Q1 2006 at a rate far in excess of all other peer group countries.
Banking Sector:
Looking at our banking sector, total sector debt in Ireland now exceeds all other peer countries debt, despite the fact that many of these countries have bigger economies and populations than Ireland. It is fallacious to attribute this result to the presence of IFSC institutions, as the data above is comparable with Hong Kong and Luxembourg - both of which are major IFS centres themselves.
In line with other borrowing trends, Irish banking sector now runs the second highest proportion of short term debt liabilities relative to all debt liabilities. As expected, our banking sector maturity mismatch risk is only marginally lower than the same risk in the general government and monetary authorities accounts.

Who's more reckless in risk taking, you might ask, the Exchequer or the Bankers? Sadly, when it comes to maturity mismatch risk, it is the Exchequer.The rate of debt accumulation in Irish banking sector, however, is in rude health, with banks in this country deleveraging much faster than the Exchequer (which is leveraging up instead of paying down debts, and this is before Nama), the Corporates (see below) and the Households. In other words, while the entire country is scrambling to help bankers, it is other sectors of economy that are bearing increasing burden of rising debt exposure.

Furthermore, an important footnote to Nama: chart below also indicates that the likely direction of Nama funds once banks receive state transfers will be to further reduce leveraging in the banking sector. As I have predicted earlier, Nama will be used to pay down more expensive interbank loans, with preciously nothing going into economy in the form of new credits.Index of total debt for Banks shows the rate of debt increases (leveraging up) since Q4 2002.

Non-banking Corporate Sector:
Total debt in Irish corporate (non-Banking) sector stands out as an outlier in the reference group of countries. This is an apt illustration of Corporate Ireland's obsession with leveraged buyouts, M&A binges at the top of corporate valuations and other debt-financed 'growth' deals done by Irish companies.

The above chart clearly shows the extent of the risk that is inherent in Irish Corporate Finance structure and the high probability that Nama will be followed by a new wave of banks balance sheets deterioration - this time on Irish corporate side. It also indicates that a restart of 'normal credit cycle' in Ireland will require an actual and drastic deleveraging of Irish companies, not a new lending out by the banks to prop up debt-ridden enterprises.

Chart below reinforces this point, by showing that our corporate debt represents an excessively high proportion of overall debt.
Not surprisingly, growth dynamics in Irish corporate debt were equally extreme as chart below illustrates.
Interestingly, Irish corporate borrowing activities remained relatively static when compared to the growth rate in total debt obligations of the country.Perhaps the only 'good news' is that most of our corporate borrowings were in form of longer term debt - a sign that any crisis in corporate insolvencies due to debt overhang will be delayed in time relative to other sectors (Government, Banks and even households).

Direct Investment decline:
Lastly, a quick look at direct investment flows to Ireland (from debt side). As the country engaged in uncontrolled debt spree, overall role of direct investment in economy has fallen in time from over 15% of total debt stocks to under 12%.