10/6/2015: A Bombshell Goes Off on Anglo, IBRC & Nama

Here are the excerpts from the very important speech delivered today in the Dail by Deputy Peter Mathews. And I urge you – the public and professional readers of this blog – to read through the length of this.

My focus here is one core aspect of the IBRC scandal that remains largely ignored by the Government and the media and that Deputy Mathews raises. For those inclined, full official transcript is available here. In the quotes below, bold and italics are emphasising points of major importance and are added by me.

“… I want to talk about how the so-called profits of IBRC were inflated for a period starting in 1993 and travelling forward to the present date. There were two ways this was done.”

Note, the word ‘inflated’ in relation to reported profits. If such inflation indeed take place, it would imply that Anglo reported profits were fraudulent. And this covers years from the early 1990s through 2003. That is a lot of years of potential major corporate fraud – fraud that (if proven such) would involve deliberate overcharging of clients, concealment of such overcharging and reporting this overcharging on the revenue and profits side of the company accounts.

The Act

“First was the direct manipulation of interest charges and the concealment of loaded interest, which happened in the majority of cases. An extensive exercise carried out by Bank Check revealed this. … Some 494 separate DIBOR-EURIBOR rates were reconciled and found to be loaded to a degree ranging from 0.5% in the early 1990s to between 0.03% and 0.05% in 2002 and 2003. Some 80% of all the loans examined, relating to many clients, were found to have this loading.” So the [alleged] fraud was systemic, not sporadic.

The Concealment

And it was actively concealed from the clients: “The statements which clients received never showed the breakdown of the base rate and the DIBOR 3-month rate plus a margin, which had been agreed by loan agreements, plus the reserve asset cost, RAC, if and when it applied.” Does this show an intent? For one has to ask if not intent, then how could this ‘error’ or ‘omission’ be perpetuated across 80% of examined cases?

The Size

The [alleged] fraud was also on a large enough scale to makes it material. “The quantum of the loaded overcharging was in the order of 0.3%. A margin of 1.5% would comprise two elements, namely, the amount that goes to cover overheads, which is usually about 0.9% of the 1.5%, and the remainder, 0.6%, which is the profit of the bank. A loaded secret dark pool profit of 0.3% would represent one third of the overall profits, including that dark pool profit.”

The letter from Mr. Morrissey’s solicitors that Deputy Mathews cites states the following: “Bankcheck has advised Mr. Morrissey that, in total, approximately EUR1 billion has been overcharged by you, the Special Liquidators, Nama, private equity and institutional buyers of former IBRC loans, IBRC and its predecessors. This is very material sum and represents a most material proportion of the bank’s declared profits over the past 25 years. You have been made aware of this on several occasions.” Note: “you” references in the above quote joint special liquidators of IBRC. And further note Nama mentioning in the above.

Boom! Remember the case against the Anglo directors that alleges wrongdoing relating to manipulations of the company accounts by means of loans and interbank deposits? Well, that is chips compared to the juicy chunk of meat contained in the above statements: thanks to over-billing of the customers, Anglo might have been over-inflating its margin by a third! Year, after year, after year. 

And, even more importantly, this information was known and is known to the current authorities and liquidators. Who did nothing with it.

Should former shareholders, current investors in ex-IBRC debt, former borrowers from Anglo, and possibly even auditors who were not given pertinent information by the Anglo and IBRC call in the legals now, the hit will be on the state.

Deputy Mathews went on: “That means the market valuation of Anglo Irish Bank in the 14 years up to 2002 when this was going on was overstated by one third. If it had been discovered by proper auditing the market would react with a collapse, …of at least one third of the value of the bank and this would affect the shareholders, creditors and depositors. That would happen irrespective of whether there was an international credit bust and a freeze of credit.”

Systemic Failure that Continues Today

“This has been brought to the attention of the NTMA, NAMA and others but it has been ignored to date. I have the evidence here and it is shocking.” Let us stress the fact that Irish authorities were and are aware of this.

• An Irish court ruled on the matter in favour of Mr. Morrissey.
• Mr Morrissey notified this to the bank.
• Mr. Morrissey also notified this to Nama and the Department of Finance in early January 2015. It was notified to the Central Bank in late January 2015, and to the Minister for Finance in early March 2015, and subsequently again to the Central Bank in early March 2015. And the case is being ignored. Per Mr. Morrissey, he received no reply to his notifications from any official body.
• Per Mr. Morrissey letter cited by deputy Mathews today, Mr. Morrissey notified the then Chairman of IBRC, Mr. Alan Dukes of overcharging as far back as in mid-January 2013. Simultaneously, he notified of the same matter the Department of Finance, the Central Bank and the Financial Regulator. 

Mr Morrissey has been ignored since then, according to the record set forth by his solicitors.

It gets worse. Recall that the liquidation of IBRC was undertaken under the procedure that all claims against IBRC were to be notified before the end of 1Q 2015. And again, the notifications in the case of Mr. Morrissey were filed on time. We are at the end of 2Q 2015 and he received no response on these notifications. So the deadline established by the IBRC liquidation procedures has now expired. And the IBRC and by extension the State have not replied to Mr. Morrissey before the expiration of that deadline, effectively undermining the very process of liquidation they themselves set out.

Is this a collusive behaviour? In economics, such actions would be viewed as potentially collusive: all parties responsible and empowered knew, none responded, the wrong remains unaddressed.

The Legal Bits

Mr Morrissey solicitors letter cited by Deputy Mathews has this to say on the matter: “It appears numerous illegalities have been carried out by Anglo Irish Bank and its successors over these 25 years [from 1990 through today]. You, Mr. Wallace, have acknowledged under oath in the US Court proceedings the overcharging of interest by the bank. As the overcharging has continued under your watch, you are jointly and severally liable for same, together with the Minister and Department of Finance, the Central Bank of Ireland and the Financial Regulator.”

And per official behaviour in response to the evidence presented: “we most strongly object to this glib attempt to absolve yourselves from responsibility and liability both for historic and current interest overcharging, or the consequences thereof, including the sustained misstatement of the bank’s publicly released annual accounts since 1990.”

The IBRC Inquiry

Deputy Mathews spoke in the context of the upcoming IBRC inquiry. But what he said is more important than an inquiry itself. Here is why. The inquiry is supposed to provide and independent and objective view of alleged, potential, possible wrongdoing at the IBRC. Deputy Mathews statement shows that in an actual, tangible, established and courts-confirmed case of misdeeds by the Anglo and IBRC, the State is unwilling to do anything to address these misdeeds. Thus, one has to ask a simple question: what’s the point of an inquiry into alleged wrongdoings, when actual wrongdoings are not being dealt with.

Now, take a trip through theory. An inquiry can come back with two possible outcomes: One: nothing found. Two: something worng is identified. In outcome One, under the above revelations about the Anglo overcharging case, one can be pretty certain that no one will believe the inquiry findings. There is no trust in our systems, there is no trust in our processes. No matter how well the inquiry works, its findings, were they to deliver inconclusive verdict, will always be subject to mistrust. In outcome Two, nothing will happen. Just as nothing is happening in the overcharging case. The outcome will be ignored. And so the inquiry, given the context of the cases such as cited by Deputy Mathews is hardly an exercise in building trust. For all its possible merits in design and execution, it is more likely going to be an exercise in further chipping at the little trust still left in this system.

Other Players in the Penalty Box

Deputy Mathews quotes from the letter from the Black solicitors, “following the John Morrissey case: “It appears numerous illegalities have been carried out by Anglo Irish Bank and its successors over these 25 years. You, Mr. [Kieran] Wallace, have acknowledged under oath in US Court proceedings the overcharging of interest by the bank. As the overcharging has continued under your watch, you are jointly and severally liable for same, together with the Minister and Department of Finance, the Central Bank of Ireland and the Financial Regulator.””

But remember, there are other players beyond Mr. Morrissey who might want to ask few questions from the Government now that the word is getting out. As Deputy Mathews notes: “This is serious stuff. There are loans that are being operationally processed by the originators of those loans. Now those loans are owned by third parties, including hedge funds, and they are calculating interest on an unlawful basis, even though it has been brought to their attention. This is shocking.”

Yes, we have on the line now:

1.  Borrowers who were [potentially] defrauded of billions in false charges;
2.  Investors in Anglo shares who were potentially defrauded by over-valuations of the bank;
3. Investors in distressed loans purchased off Anglo-IBRC who are holding hot paper with [potential] fraud written all over it – the loans of the borrowers potentially defrauded;
4. Potentially, the auditors of Anglo/IBRC who were possibly misled by non-disclosure of overcharging;
5. And on top of all of them are the underwriters of the IBRC liquidation: taxpayers, who are facing huge bills for this.

And Another Bombshell

Deputy Mathews did not end just there. 

Here is another bombshell that exploded loud and clear in the Dail today, even through the repeated interruptions: “There is other evidence that NAMA knowingly----- allowed the information memorandum ----- -----for the Chicago Spire ----- to be negligently misleading, which has resulted in unnecessary huge losses for both the Irish people and the developer. I have the evidence for that.” That’s right – you’ve read it here. There are now allegations that Nama – not subject to the inquiry – has ‘mislead’ the markets participants to the tune of [potentially] hundreds of millions on just one, repeat, just one, asset sale.

Conclusion

These are mind-blowing revelations that expose more than just a systemic fraud [potentially] being perpetrated by a rogue bank. These are the revelations that show the current system wanting in respect of acting on the established legal case judgement in addressing the systemic [potential] fraud. And the worst bit is that even that is a tip of an iceberg, for Deputy Mathews statement about potential misrepresentation of the Chicago Spire case by Nama opens up the EUR77 billion can of worms over the Grand Canal. In this context, the current planned inquiry into 2009-2013 IBRC dealings is nothing more than a fig leaf of fake decorum on a rotten corpse of the Irish Solution to an Irish Crisis.

Still feel like the IBRC inquiry over 2009-2013 deals is going to be enough? Or should we not start systemically reviewing all post-crisis dealings and pre-crisis wrong still unaddressed by all agencies involved?

7/5/15: Europe's Non-Performing Loans: Still Rising & Getting More Toxic

In the world of scary stats, there's no place like Europe.

Even the perennial optimists at the IMF - that place where any debt is sustainable as long as there are structural reforms underway - agrees. This is why the IMF published this handy chapter as a part of its Global Financial Stability Report for Q1 2015 (http://www.imf.org/External/Pubs/FT/GFSR/2015/01/pdf/c1.pdf).

In this report it said that [italics are mine]: "Asset quality continued to deteriorate in the euro area as a whole in 2014, although at a slowing pace, with total nonperforming loans now standing at more than €900 billion. Furthermore, the stock of nonperforming loans in the euro area is unevenly distributed, with about two-thirds located in six euro area countries. [The stock of nonperforming loans in Cyprus, Greece, Ireland, Italy, Portugal, and Spain in total amounts to more than €600 billion]. In Cyprus, Greece, Ireland, Italy, Portugal, and Slovenia, a majority, if not all, of the banks involved in the ECB’s Asset Quality Review were found to have nonperforming assets of 10 percent or more of total exposure."

Roll in two super scary charts:

So far so bad… But it gets worse. "These bad assets are large relative to the size of the economy, even net of provisions. Euro area banks have lagged the United States and Japan in the early 2000s in their write-offs of these bad assets, suggesting less active bad debt management and more limited improvement in corporate indebtedness."

And another spooky illustration in order here:

Now, let's sum this up: after 6 years of 'reforms', deleveraging, special bad loans vehicles set ups, extraordinary legislative and regulatory measures aimed at dealing with loans arrears, waves of corporate and household bankruptcies, a minestrone worth of alphabet soups of various 'Unions' etc etc etc…

• Bad debts pile in Euro area is rising;
• Bad debts pile in Euro area is not matching dynamics in other countries, specifically the economic wasteland of Japan; and 
• The best performing country in the group - Ireland - has the second worst performing banking balance sheet in the group (even after Nama and IBRC are netted out).

Clearly, successful resolution of the crisis is at hand.

1/2/15: Oh, those largely repaired Irish banks...

What do foreign 'experts' like BofE Mark Carney forget to tell you when they say that Ireland's banking system has been [largely] repaired?

Oh a lot. But here are just two most important things:

Both, in level terms and in growth terms, Irish banks remain zombified. 'Repaired' into continuously shrinking credit supply and stagnant household deposits base, the banks have been flatlining ever since the beginning of the crisis. In the last 6 consecutive quarters, household deposits posted negative rates of growth - a run of 'improvement' that is twice longer than the 'recovery period' of Q3 2012 - Q1 2013 when the deposits rose (albeit barely perceptibly).  Meanwhile, credit continues to shrink in the system with not a single quarter of positive growth (y/y) since Q4 2009. In four quarters through Q3 2014, credit for house purchases shrunk at just around 3.05% on average - the steepest rate of decline since the start of the crisis.

"Yep, [largely] repaired, Mr. Carney", said undertaker firming up the dirt on top of the grave...

13/11/2014: Irish Banks: In a Bad League of Their Own

Standard & Poor's report published yesterday (link here) offers a dark view on the French banks, arguing that their capitalisation, based on S&P own metric, puts them into a "weaker position against their European and international peers than according to regulatory ratios".

The S&P looked at the rank order of national banking systems, "resulting from the capital measure that Standard & Poor's Ratings Services uses in its ratings analysis, the risk-adjusted capital (RAC) ratio… According to the latest available comparative data on Dec. 31, 2013, the five French banks (the four mentioned above plus Groupe Crédit Mutuel) had an average RAC ratio of 7.0% versus 7.7% for our top 100 rated banks. …The gap between our in-house measure and the regulatory one (the fully loaded ratio) mostly stems from the banks' internal models for credit risk that we view as less stringent on some asset classes than for some peers. It also results from our stricter treatment than under Basel III of French banks' large insurance subsidiaries."

So in basic terms, S&P used higher quality test of capital buffers. And here are the results for the select sample of European banking systems:

One thing is clear from the above: Ireland's banking system is faring the worst - by a mile - in the sample. In fact, by S&P measure, it is in the league of its own.

27/9/2014: Growth... just not in Irish deposits...

Here's an interesting question: when economy grows, what happens with the household deposits? The right answer is: it depends on a couple of factors:

1. How long has economy been growing: if we have growth over a month or two, one can safely assume that households are using up cash to cover their short term debts accumulated over the course of the downturn. Indeed, Irish debts have been shrinking, not growing over the downturn - on aggregate - and growth has been ongoing for a long time now, at least in official accounts.
2. What type of growth we are seeing: if economy grows outside the household sector, e.g. via corporate profits that do not 'trickle down' into the real economy in higher wages, etc, then deposits will not follow growth, although this effect too should be short-lived.

So what happened so far with irish households? Here's a chart:

Since Q1 2011, when the current Government came to office and promptly declared yet another economic turnaround miracle, Irish household deposits are down EUR2.08 billion or 2.23%. Worse, household deposits have been running at a flat trend since mid-2011. 

Total private sector (excluding financial firms) deposits are currently only EUR1.289 billion ahead of Q1 2011 average - a miserly increase of just 1.13%. Given Irish firms and households are still pretty much abstaining from investing in the economy, this shows the current recovery to be almost entirely concentrated in the sectors that ship profits out of Ireland with the balance of domestic growth being fully consumed by the debt servicing and repayments. 

Ah, and do note that any talk about 'rising deposits' in Irish banks that we occasionally hear from our politicians is down to one thing: inclusion of the credit unions' deposits into Central Bank statistics. As shown above, absent that, deposits still remain near crisis-period lows: household deposits today are only 1.1% above their crisis period lows, while non-financial corporates deposits are 1.22% above their crisis period lows. And as of July 2014, Irish household deposits fell in 3 months in a row. Just as growth 'accelerated'. 

9/8/2014: Europe's bank risks back under the spotlight: ECR

Euromoney Country Risk report this week is covering rising risks in the European banking systems, with a brief comment from myself:

And unloved European banks chart, showing risk scores (higher score, lower risk):

28/7/2014: Of Savings, Cash and Hedge Funds...

The current crisis, on monetary aggregates side, can be characterised by the rising prevalence of cash over savings. In other words: shrinking stock of credit and deposits relative to cash.

The current crisis, on media commentary side, can be characterised by the endless talk about high savings rates in the private sector.

Here is the problem: savings = inflows into stock of savings (aka, deposits) or investment or divestment out of loans (including forced restructurings, bankruptcies, insolvencies and foreclosures). We know that Irish investment is not growing at the rates worth even mentioning. Which means that Either deposits should be growing to reflect 'high savings' or debt should be shrinking.

Take a look at the difference between M3 money supply and M1 money supply.

By definition:

• "Money Supply (M1) to euro area -M1 is the sum of overnight deposits and currency issued (this comprises the Central Bank's share of euro banknotes issued in the Eurosystem, in proportion to its paid-up shares in the capital of the ECB, plus coin issued by the Bank less holdings of issued euro banknotes and coin by the MFI sector). " 
• "Money Supply (M2) to the euro area -M2 is the sum of M1 plus deposits (with agreed maturity of up to 2 years; redeemable at notice of up to 3 months and Post Office savings bank deposits)."
• M3 is M2 plus deposits with maturity over 2 years.

So the gap between M1 and M3 is deposits.

The M3-M1 gap has fallen since the onset of the crisis. It has fallen along the steady trend line, with some volatility around the dates of banks recapitalisations. And it continues to fall. In fact, between December 2013 and May 2014 we have the longest uninterrupted decline in deposits in history of the series. Current level of the gap is sitting only EUR7 billion above the all-time historical record low. In fact, during this 'historically high savings rates' period, Irish monetary system has managed to reduce the stock of deposits, compared to pre-crisis levels, by EUR85.91 billion.

But while savings (deposits) are falling, 'savings' (debt deleveraging) is all the rage:

You can see what has been happening in the Money Supply territory and private credit here:

With all of these 'high savings' promoted by the official statistics and 'new lending' promoted by the Banking Federation, the Central Bank is now officially giving up on getting those 'repaired and recapitlaised banks' to lend into the real economy (something they were supposed to do since early 2009 - based on the promise of the October 2008 Guarantee, then since early 2010 - based on the various Government programmes, then since first half 2011 - based on the banks recaps and PCARs, then since 2012, based on Government programme agreed with the Troika, then since early 2013, based on Government spin of a turnaround in the economy...). Instead of hoping for the Pillar Banking System to miraculously come back to life, the Central Bank is opening up the floodgates for the hedge funds (here courtesy of fire sales of assets by Nama) to lend into economy, despite the fact that such lending is considered to be a high-risk activity. Nothing like selling pennies on the euro and then celebrating euros on pennies debt reload...

26/7/2014: Of Germans Bearing the Ugly Truth?..

German experts and analysts have an un-Irish capability of speaking their own mind... and when they do (and they do it anywhere, including when visiting this country of ours), they don't mince words. Behold the latest 'visitor' from the land of 'Nein!': Dr. Joachim Pfeiffer, the economic policy spokesman for the parliamentary group of the ruling Christian Democrats. Dr. Pfeiffer was in Dublin this week. Somewhere between a nice dinners and customary ritual of witnessing the Irish 'craic' in a pub, the learned Doktor sneaked a few minutes to tell us that "Ireland has “no chance” of securing a deal on its legacy bank debt" and that "the euro zone’s new bailout fund had not been established for nor would be it used for retroactive bank recapitalisation."

Quoted in the Irish Times: “There is no chance Ireland’s legacy assets will be paid by the European Stability Mechanism (ESM). This instrument is only an instrument for emergency.”

R. Pfeiffer was in Dublin to speak at the German-Irish Chamber of Industry and Commerce, the same Chamber that recently sponsored a cheerful book on Ireland & Germany being the best pals in economic and policy terms. The best pals, alas, do not help each other all too much, and one of them has no problem telling the other that 'your mess is your mess': "Dr Pfeiffer said the financial meltdown in Ireland “did not fall from heaven . . . there were bubbles in the real estate sector, there were bubbles in the banking sector and all of this was home-made”."

As to the reasons why ESM cannot be used for retroactive assistance to the Irish state, Dr Pfeiffer evoked the same logic that I advanced for some years now: "If the ESM was to be used retroactively to compensate Ireland, he said other countries such as Greece, Spain, Portugal and potentially Italy would want similar compensation."

Needless to say, Department of Finance immediately chipped in with a denial of denial that denial is possible as a denial. I am certain Dr. Merkel in Berlin was all ears...

14/7/2014: Irish Banks are Open for Lending... when no one is looking?

Remember all the Irish banks advertorials in the media about the lending easing they engaged in when it comes to SMEs? The story, as it is being told by the banks, is that our banking system is approving credit to SMEs and that the SMEs just don't apply or don't draw down the loans approved.

Here is IMF chart from today's Euro area survey on the reasons for adverse outcomes of loans applications:

So we have: Irish banks are refusing loans to SMEs at rates second only to Greece. And applications fall short of business expectations at a rate that exceeds that of Greece, so overall, tightness of credit supply to SMEs in Ireland is just as abad as it is in Greece, and worse than in any other 'peripheral' economy.

But never mind, real cost of capital is now back rising in Ireland, so we can expect some additions of grey bars to the above chart too...

All with the blessing of our policymakers who keep talking about higher and higher margins for the banks...

13/7/2014: A Miracle of Reformed Banks Operating Costs Performance

We are all familiar with the fact that Irish banks are aggressively deleveraging and beefing up their profit margins. This much has been set out in regulatory and policy provisions (e.g. PCARs) and lauded by the Irish policymakers as a sign of improvements in the banking sector. Alas, the same cannot be said about operating costs in Irish banks. This metric, in fact, has not been given much attention in Irish media and by Irish politicians. So in their place, here's the latest from the IMF (special note on Spain published this week):

Wait... what?! Irish banks cost-to-income ratio is hanging around 80%, well ahead of all other 'peripherals'. Is the Irish economy (borrowers) sustaining excessive costs and employment levels in Irish banks? Why, yes, it appears so... 

11/7/2014: Notes on German ESM vote

Here are some of my briefing notes on last night's programme on TV3 covering the latest 'seismic' news on retroactive banks recapitalisations and ESM.


Eurogroup meeting on 20th June 2013 agreed on the main features of the European Stability Mechanism's (ESM) Direct Recapitalisation Instrument (DRI).  I covered the fallout from that meeting here  and here  and here.

Note in the first post above, there is a link to Irish Government-set target of 17% of GDP for retroactive recapitalisation.

• The objective of the ESM's DRI will be to preserve the financial stability of the euro area as a whole and of its Member States in line with Article 3 of the ESM Treaty, and to help remove the risk of contagion from the financial sector to the sovereign by allowing the recapitalisation of institutions directly.
• This does not decouple banking sector from the sovereign, but weakens the links.
• There is a specific provision included in the main features of the DRI, which states: "The potential retroactive application of the instrument should be decided on a case-by-case basis and by mutual agreement."

So do note: it is 'potential' (not assured access) and it is to be decided on case-by-case basis (so no 'symmetric' or 'equal' treatment) and it is 'mutual agreement' (allowing states to block any potential case-by-case deal). There is so much conditionality around this statement, one has to view it as being aspiration rather than prescriptive.

But, on a positive side, June 2013 agreement kept open the possibility to apply to the ESM for a retrospective direct recapitalisation of the Irish banks. I covered this here and the fallout from the second round deal here. The last link covers persistent opposition from Germany to retroactive recapitalisations. And if you thought this has gone away, here's the latest on that.

On June 10, 2014 the euro area member states reached a preliminary agreement on the operational framework for the ESM's direct recapitalisation instrument, DRI.

• This framework does not guarantee that we will get our case approved.
• It does not stipulate how retrospective recapitalization can take place (crucial detail).
• It requires unanimous vote of ESM board of governors (which is basically Council of Ministers).

All of this was forthcoming. See my article from March 2014 on this here.

The above is also confirmed by Minister Noonan on July 3 in the Dail. Minister further stated that: "However, it will not be possible to make a formal application to the ESM for retrospective recapitalisation before the instrument is in place. It would, therefore, be premature to make any submission, be it a technical paper or otherwise, in advance of the instrument being in place."

Incidentally, Minister Noonan's pronouncements on the topic have by now converged to repeating the same statement on every occasion. compare this and this.

So a reminder: After June 2012 summit, Minister Noonan went onto "Today with Seán O'Rourke", and said he expected the retrospective recapitalization agreement to be concluded by November 2012. Now, we are looking at the earliest possible application date or application consideration date of November 2014. But even this application date is uncertain. Methodology for valuation or even structuring recapitalisations is uncertain. In the mean time, we are getting less and less certain if it makes any sense for us to even apply for this measure.

Minister Noonan on the topic again: "When one thinks through the recapitalisation retroactive option, it was always envisaged that there would be some form of exchange of shares in the banks for capital upfront, and that this capital would be used to reduce the debt. While the technical work has been done on it, there is a question of value, price and judgment in all these matters. I certainly do not wish to talk ourselves into a position where just as the banks are becoming valuable, we give them away for the second time." This was stated on July 3 this year in the Dail.

Meanwhile, Bank of Ireland shares we hold have already yielded returns that are EUR1 billion in excess of original recapitalization, excluding the cost of the Bank of Ireland-related measures to the Exchequer via higher borrowing costs in 2009-2013 period.

Value of AIB currently is around EUR11 billion, value of PTSB is virtually nil, which is less than ca EUR23.5 billion we put into the bank and PTSB.

Our borrowing costs are low, and are lower than those of other peripheral states - why would they approve a recapitalization for Ireland? See, for example, most recent pressure points on borrowing costs here.

Another pesky issue: ESM is EUR500 billion fund. But only EUR60 billion is set aside to cover all future and any potential retrospective recapitalisations of banks. Eurostat estimates Irish Government banks stake at EUR16 billion in terms of its future potential value, which means that Ireland's retroactive recapitalization will either have to be so small as to make no difference to us, or so large as to swallow some 20% or so of the entire DRI fund.

Do we seriously expect to get anything substantial from the ESM?

Let us remember that until June 2013, Germany resisted not only retroactive recapitalisations, but even forward recapitalisations. The reason German leadership changed its mind is that EU has substantially reduced any potential exposure of ESM to such recaps in the future and loaded more, not less, burden onto national banks and sovereigns. These are covered here and here.

In short, the latest news from Berlin are not a 'step forward toward retroactive recapitalisations of the Irish banks' - at the very best these are simply re-affirmations of the already taken steps and the muddle they left behind.

Meanwhile, there are 3 major points of pressure relating to Irish banks:

1. Recaps we put in are weighing on our debt levels: 25.3 billion against 13-14bn value. There is little we can hope to get from the ESM in this context.
2. Government bonds from Promo Notes conversion: 25 billion against nothing. There is nothing in the ESM that allows us to swap these bonds for anything that is cheaper. Instead, the real impact can be achieved by significantly delaying sales of these bonds to private markets, which is not related to the ESM but is rather an ECB action.
3. State of banks balance sheets - arrears and tracker mortgages (EUR36 billion in AIB and PTSB). Professor Karl Whelan has an excellent note on trackers here.

18/6/2014: ECB Assessment of Irish Banks: IMF view

In the previous post, I looked at the IMF report on Irish banks from the point of view of ongoing developments and balance sheet repairs (link here). Now, let's take a look at IMF report from the point of view of the ECB stress tests.

Per IMF: "The ECB’s Comprehensive Assessment and corrective actions where needed are important to reinforce confidence in European banks, including in Ireland (see stress tests parameters described below).

"AIB, BoI, and PTSB all reported capital ratios above the regulatory minima at end 2013. Notwithstanding, a finding of a capital need under the Assessment cannot be precluded, with results due to be announced in October." In effect, here's your warning, Ireland - IMF has no confidence as to the outcome of the tests and this is in line with the risks to the sector still working through banks balance sheets, as highlighted in the previous post.

Never mind, though, as per IMF "Private capital is the first line of recourse and it is welcome that market conditions for European bank equity issuance currently appear relatively favorable."

While IMF seems to think there are plenty of crazies out there willing to bet a house on banks stocks valuations, the IMF is still hedging its bets: "Nonetheless, where private capital is insufficient, public support may be needed, including from a common euro area backstop to protect market confidence and financial stability; the possibility of ESM direct recapitalization should not be excluded."

Which begs a question or two:
1) Will ESM come in ahead of irish taxpayers? Answer - unlikely.
2) If ESM were to come in, will it have seniority over previous taxpayers equity in the banks (in other words, will it destroy whatever recoverable value we have achieved so far)? Answer - likely.

IMF is less gung-ho on the idea of immediate state supports in the worst case scenario: "If the supervisory risk element of the assessment identifies other issues, such as profitability or liquidity, staff considers these should be addressed over time in a manner that contains costs while firmly safeguarding financial stability. This is especially important for PTSB, where staff continues to see risks to its return to adequate profitability over a reasonable horizon in its current form, but approval of its European Commission restructuring plan is on hold pending completion of the Assessment."

Oh… ouch…

A chart to illustrate the pains:

Watch that equity cushion in the above for PTSB and the margin on provisions… No wonder IMF is feeling a bit uneasy. But across all banks, Gross Non-performing Loans are nearly par or in excess of the Provisions + Equity + Sub-Debt.

Now onto stress tests.

Agin per IMF: "Irish banks are currently undergoing the ECB’s Comprehensive Assessment (CA). The five largest banks are included: three Irish headquartered banks (AIB, BoI, PTSB), and the domestic subsidiaries of Merrill Lynch and Royal Bank of Scotland. Based on end 2013 data, the CA comprises:
(i) an Asset Quality Review (AQR);
(ii) a forward looking stress test covering 2014–16; and
(iii) a supervisory assessment of key risks in banks’ balance sheets, including liquidity, leverage, and funding."

First thing to note: the time horizon for tests is exceptionally narrow: 2014-2016, or 36 months, of which (by the time the tests are done, at least 6 months data will be already provided). Does anyone think Irish banks will have full visibility on risks and downsides expiring at 2016 end? Good luck to ye.

"The AQR will audit banks’ banking and trading books. For each bank, at least half of the credit risk weighted assets and at least half of the material portfolios will be covered. For the banking book, the AQR will look at the impairment and loan classification, valuation of collateral, and fair valuation of assets, while core processes, pricing models, and revaluation of Level 3 derivatives will be covered in the trading book review. Compared with the CBI’s BSA in 2013, the AQR for the CA has narrower coverage of the banking book by risk weighted assets (RWA), it does not review banks’ RWA models, but does cover the trading book although such exposures are not large for the domestic retail banks."

What this means is that the forthcoming tests are less robust than the CBI tests, but that assumes CBI tests were robust enough.

IMF provides a handy set of charts summarising stress scenario, baseline scenario for the CA against IMF own projections.

"The CA will apply a common equity tier 1 risk based capital floor of 8 percent for the AQR and the stress test baseline, and 5.5 percent for the adverse scenario, using the relevant transitional definitions. Results will be announced in October. If a capital need is identified, the additional capital will have to be raised within 6 months if the shortfall occurs under the AQR or baseline scenario, or within 9 months if it arises under the stress scenario."

In my view, CET1 at 8% floor is a bit aggressive. The floor should have been around 9-10% for Irish banks (and all other distressed banks), while for stronger banks the floor could be 7-8%. But ECB does not want to differentiate ex ante the banking quality tiers present in the euro area markets. Which is fine, but yields and outcome that strongest banks have implied identical floor as the weakest ones.

So overall, my view is that the IMF is being rightly cautious about the banks prospects under the ECB CA exercise. The Fund is hedging clearly in referencing the possibility for banks failing the tests. Key point is that the IMF - having had access to CBI and Department of Finance data and assessments, cannot rule out the possibility that Irish banks might need additional capital and that this capital may require taxpayers stepping in.

Next up: Households Balance Sheets

18/6/2014: IMF on Irish Banks: Still Sick to the Core, but of course, getting better...

IMF released Staff Report on the First Post-Program Monitoring Discussion for Ireland. Some of the highlights over few posts.

First up: banks.

Per IMF: "Banks’ 2013 financial statements show higher provisions and, although easing funding costs are supporting bank profitability, credit continues to contract." Ugh? Surely not because the banks are lowering rates on existent and new debt? CBI data shows no such moves.

Here is how dramatic was the decline in banks funding costs (all declines down to ECB lower rates, plus Government ratings improving):

"AIB, BoI, and Permanent tsb (PTSB) set aside provisions totaling €2.5 billion in the second half,
reflecting the CBI’s updated guidelines introduced in May 2013 and the CBI’s balance sheet assessment (BSA) finalized at end November, together with allowances for new NPLs."

Coverage ratios of provisions to NPLs increased at all the banks. Which is good for banks balance sheets and forward potential for lending, but bad for current potential. And it is material for the stress tests forthcoming (see next post on this).

"Higher net interest income in  2013 partly offset provisioning to result in a smaller full year overall loss than in 2012. However, new lending remained weak, with credit outstanding to households and non-financial firms contracting 3.7 percent and 6.2 percent y/y, respectively, in April."

Ah, I wrote loads about credit supply problems: here's a note on latest data for credit supply to households http://trueeconomics.blogspot.ie/2014/06/1062014-credit-to-irish-households-q1.html and another one on latest data on credit supply to Irish private sector enterprises: http://trueeconomics.blogspot.ie/2014/06/662014-credit-to-irish-resident.html And the third post coming up today will cover the margins banks charge on loans relative to what they pay on deposits... the margins that act to extract value out of the economy.

And here's IMF's chart summarising the above developments:

All said, banking sector remains one of the core weak points. In assessing downside risks to Fund's forecasts for Ireland, IMF identified 4 key sources of risks. Banks are the fourth: "Bank repair shortfalls. As firms’ internal financing capacity is drawn down, sustaining domestic demand recovery will depend increasingly on a revival of sound lending, where substantial work remains ahead to resolve high NPLs to underpin banks’ lending capacity."

But for all the talk, banks remain sick. Per IMF: "Banks’ NPLs remain very high, at 27 percent of loans at end 2013, in a range of 17–35 percent across the three Irish headquartered banks. Such ratios reduce banks’ potential capacity to lend by hurting profitability, including through higher market funding costs, limiting the supply of collateral for funding, and diverting credit skills. With recovery taking root and property markets improving, banks may see further upside from postponing NPL resolution. But such choices at the individual bank level may not sufficiently internalize the macroeconomic impact of banks collectively leaving NPLs at high levels in terms of barriers to new lending and an inefficient allocation of capital, warranting supervisory pressure on banks to accelerate asset clean up. Reducing uncertainties around the value of banks’ loans will also enhance public debt sustainability by supporting valuations for the government’s bank equity holdings, which it intends to dispose."

Here's an interesting bit. We know banks have been slow to deal with Buy-to-Lets, parking bad loans in hope that current debtor will part-fund warehousing of BTL properties (via renting them out) until such time when prices rise and bank can foreclose on these. This strategy clearly maximises banks returns and is happy-times for CBofI, concerned with how good banks look on their 'profitability' side. But it is bad news for the economy, where investors (aka ordinary punters) are bled dry of cash to fund BTLs which will never return any fund they 'invested' in them.

IMF basically tells the CBofI and Irish authorities: you have to force banks deal with these BTLs and smaller CRE loans, i.e. foreclose earlier, not later.

And IMF is onto the task: "In view of improved market conditions, the authorities should press banks to broaden their resolution efforts into impaired CRE loans. Banks hold mostly smaller CRE exposures (below €20 million) that were not transferred to NAMA, yet delinquent CRE loans still account for 40 percent of NPLs. Recent strong IBRC and NAMA deal flow points to potential investor interest—although the nature of the assets differ somewhat—and the banks’ portfolios also have relatively high provisioning cover. Staff therefore recommends that banking supervision press forward the restructuring of these NPLs or their disposal in a manner that achieves sufficient deal flow while avoiding flooding markets. Although one bank is exploring disposal options for its CRE loan portfolio, others prefer loan restructuring to retain potential upside and their customer base."

And a handy chart:

Do notice how weaker provisions cover is delivered on mortgages, while over-provision is a feature of other loans? Priorities… priorities…

SMEs loans are still a huge problem: "SME loan workouts will require ongoing oversight to ensure viability is restored. The two main banks making loans to SMEs report substantial progress in developing workouts for their distressed SME loans, although in practice such workouts will be implemented over some years as restructuring steps by SMEs move forward." Read: the reports are fine, but we won't see full results over some time. Question, unposited by the IMF is: why?

"Recent amendments to the Companies Act facilitating SME less costly examinership procedures are expected to become operational in June, which may be most useful in multi-creditor cases as banks otherwise prefer to conclude workouts outside of the courts."

And finally: mortgages arrears:

"Mortgage resolution should be both timely and durable. …Banks report that by end March they had concluded solutions for over 25 percent of primary dwelling and buy to let loans in arrears for more than 90 days." Never mind the rest?.. Oh, by the way - of 132,217 accounts in arrears in Q1 2014, 39,111 accounts are less than 90 days in arrears. Of all mortgages that were restructured (92,442 accounts) only 53,580 accounts are not in arrears following restructuring. Again, IMF ignores this.

"Targeted audits give the CBI comfort that the solutions underway are durable, but reducing reliance on shortterm modifications paying interest only or less remains important." Interestingly, this is what we - IMHO - have discussed in depth with the IMF team. Irish authorities have seemingly no problem with the banks 'restructuring' mortgages by loading more debt onto households and spreading this debt either over greater duration or offering temporary relief from cash flow pressures of this debt.

How sustainable is this? Well, 'targeted audits' might suggest that a household that owed 100K on a property and was unable to fund it at full rate, can be made sustainable with 110K debt over same property but with 3 years worth of interest-only repayments. I am not so sure. Neither, it appears, is the IMF.

Another thing we discussed with the IMF: "Securing constructive engagement by borrowers remains a key challenge to progress, where extending independent advice to borrowers willing to negotiate with lenders may be helpful."

So far, the CBI has given independent advisers no support whatsoever and given the banks no encouragement to engage with such advisers. IMHO has worked closely with some banks to deliver such advice - and we have a proven track record showing it works. But two 'pillar' banks refuse to engage with us and any other independent advisor on any terms, unless the borrowers pay directly for advice out of their own pockets. Even IMF now sees this to be completely nonsensical.

Last bit: "The Insolvency Service is developing a protocol to standardize loan modifications, which could also help." So IMF now endorses idea of standardised solutions. From 2010 on, when mortgages crisis blew up, I campaigned for the state to impose onto banks standardised resolution products, such as loans modifications parameters, arrears capitalisation and write downs parameters etc. The state refused. We at IMHO briefed the Central Bank on the need for such standardisation. Our submissions were ignored.


Next: ECB Assessment of Irish Banks: IMF view