20/2/2012: Irish Banks - Zombies Running the Town - Sunday Times 19/02/2012

This is an unedited version of my article for Sunday Times 19/02/2011.

This week’s announcement by the Government that the Irish banks will be issuing loans to small and medium sized enterprises (the SMEs) under the cover of a sovereign guarantee has raised some eyebrows.

Throughout the persistent lobbying to underwrite credit supply to the struggling SMEs, it was generally resisted by the majority of economists and analysts, who argued that the Irish state is in no financial or fiscal position to provide such a measure. Having backed banks’ debts via the original 2008 State guarantee and emergency loans from the Central Bank of Ireland by the letter of comfort, the Irish state had also underwritten the risks associated with the commercial real estate development and investment assets through Nama. In addition, via rent supplements and mortgage interest supports, the government is propping up a small share of other banks assets and the rental markets.

Now, it’s the SMEs turn.

Per Central Bank’s own stress tests, estimated worst-case scenario defaults on all assets in the core Guaranteed banking institutions are expected to run at around 14.6%. SMEs loans had the worst-case scenario default rate estimate of 19%. We can argue as to the validity of the above estimates, but much of the international evidence on lending risks suggest that SMEs loans are some of the riskiest assets a bank can have. Add to this that we are in the depth of the gravest recession faced by any euro area country to-date, including Greece and you get the picture. Without state backing, there will be no lending to smaller firms. With the state guarantee, there will be none, still.

Subsidizing risker loans in the banks that are scrambling to deleverage their balancesheets, struggling with negative margins on their tracker mortgages and facing continued massive losses on loans might be a politically expedients short-term thing to do. Financially, it is hard to see how the Irish banking system crippled by the crisis and facing bleak ‘recovery’ prospects in years ahead can sustain any new lending to the SMEs.

Eleven months after the stress tests and seven months after the recapitalization by the taxpayers, Irish banking sector remains as dysfunctional in terms of its operations and strategies as ever.

Top level data on Government Guaranteed banks, provided by the Central Bank of Ireland, shows that in 2011, loans to Irish residents have fallen by €63.25 billion on 19% with €30.3 billion of this decline coming from the non-financial private sector – corporate, SME and household – loans. Loans to non-residents are down €40.9 billion or 29%.

Over the same period of time, deposits from Irish residents contracted €42.5 billion or 18%, with Irish private sector deposits down €11.2 billion or 10% on 2010. Non-resident deposits have shrunk 35% or €36.1 billion at the end of 2011 compared to the end of 2010.

The Government spokespeople are keen on pushing forward an argument that in recent months the numbers are starting to show stabilization. Alas, loans to Irish residents outstanding on the books of the guaranteed banks are down 7% for the last three months of 2011 compared to the third quarter of the same year. All of this deterioration is accounted for by losses in private sector loans which have fallen €21.7 billion or 12% in Q4 2011 compared to Q3 2011. Deposits from Irish residents are up €2.04 billion or 1% over the same period, due to inter-banks deposits rising €2.3 billion, while private sector deposits are down €384 million.

The ‘best capitalized banks in Europe’ – as our Government describes them – are not getting any healthier when it comes to core financial system performance parameters. Instead, they are simply getting worse at a slower pace.

The outlook is bleaker yet when one considers top-level risk metrics for the domestic banking sector. On the books of the Covered Banks, domestic private non-financial sector deposits are currently one and a half times greater than all foreign deposits combined. On the other side of the balancesheet, ratio of assets issued against domestic residents to assets issued against foreign residents now stands at 159% - the highest since December 2004. Again, this means that banks balancesheets are becoming more, not less, dependent on domestic deposits and assets, which in turn means more, not less risk concentration.

This absurdity passes for the State banking sector reforms strategy that force Irish banks to unload often better performing and more financially sound overseas investments in a misguided desire to pigeonhole our Pillar Banks into becoming sub-regional players in the internal domestic economy. In time, this will act to reduce banks ability to raise external funding and, thus, their future lending capacity.

Aptly, the latest trends clearly suggest increasing concentration and lower competition in the sector across Ireland. While ECB only reports a direct measure of market concentration (or monopolization) for the banking sector through 2010, the trends from 1997 reveal several disturbing facts about our domestic banking. Firstly, contrary to the popular perspective, competition in Irish banking did not increase during the bubble years. Herfindahl Index – the measure of the degree of market concentration – for banking sector in Ireland remained static at 0.05 in 1999-2001, rising to 0.06 in 2002-2006, and to 0.09 in 2009-2010. Secondly, back in 2010, our banking services had lower degree of competition than Austria, Germany, Spain, France, UK, Italy, Luxembourg, and Sweden. On average, during the crisis, market concentration across the EU banking sector rose by 8% according to the ECB data. In Ireland, this increase was 29% - the fastest in the euro area. Lastly, the data above does not reflect rapid unwinding of foreign banks operations in Ireland during 2011, or the emerging duopoly structure of the two Pillar banks.

Meanwhile, the banks continue to nurse yet-to-be recognized losses on household, SMEs and corporate loans as recent revision of the personal bankruptcy code induced massive uncertainty on risk pricing for mortgages at risk of default. In addition, Nama constantly changing plans to offer delayed repayment loans and mortgages protection, destabilizing banks risk assessments relating to existent and new mortgages, property-related and secured loans. The promissory notes structure itself pushes the IBRC to postpone as much as possible the winding up process.

To summarize, evidence suggests that seven months after the Exchequer completed a €62.9 billion recapitalization of the Irish banks, our banking system is yet to see the light at the end of the proverbial tunnel. Far from being ready to lend into the real economy, Irish banks continue to shrink their balancesheets and struggle to raise deposits. Their funding profile remains coupled with the ECB and Central Bank of Ireland repo operations – a situation that has improved slightly in the last couple of months, but is likely to deteriorate once again as ECB launches second round of the long term refinancing operations at the end of this month. In short, our banking is still overshadowed by the zombie AIB, IL&P, and IBRC.

Let’s hope Bank of Ireland, reporting next week, provides a ray of hope. Otherwise, the latest Government guarantees scheme can become a risky pipe dream – good for some short-term PR, irrelevant to the long-term health of the private sector and damaging to the Exchequer risk profile.

CHART

Source: Central Bank of Ireland

Box-out:

This week, Minister Richard Bruton, T.D. has made a rather strange claim. Speaking to RTÉ's News, Mr Bruton said that last year's jobs budget had created 6,000 jobs in the hotel and restaurant sector. Alas, per CSO’s Quarterly National Household Survey, the official source of data on sectoral employment levels in Ireland, seasonally adjusted employment in the Accommodation and food service activities sector stood at 119,100 in Q3 2009, falling to 118,200 in Q3 2010 and to 109,700 in Q3 2011. While jobs losses in 12 months through Q3 2011 – the latest for which data is available – were incurred prior to June 2011 when the VAT cuts and PRSI reductions Minister Bruton was referring to were enacted. But even if we were to look at seasonally adjusted quarterly changes in hotel and restaurant sector employment levels, the gains in Q3 2011 were a modest 1,400 not 6,000 claimed by the Minister. In reality, any assessment of the Jobs Programme announced back in May 2010 will require much more data than just one quarter so far reported by the CSO. That, plus a more careful reading of the data by those briefing the Minister.

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. 

Economics 13/04/2010: As bad as Northern Rock back in 2008?

So we have some more clarity on the state of our credit flows, courtesy of the latest monthly report from the Central Bank. And boy are we sick. At the height of the financial crisis, Northern Rock had 303% loans to deposits ratio. Ireland Inc? 269% absent risk adjustments on short-term deposits, and 323% once short term deposits risk of call-in is set at 10%.

Ouch! Irish financial system doesn’t resemble Quinn Insurance – it resembles Anglo!

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.