13/3/2013: IMHO press release on CBofI Mortgages Plan

Here is the IMHO press release on today's Central Bank announcement relating to mortgages arrears resolution. This sums up my views and views I agree with.

Press release

March 13th, 2013

Government and Central Bank mortgage plan throws borrowers to the wolves, says Irish Mortgage Holders Organisation

Today’s announcement that the Central Bank of Ireland will set targets for six major banks in relation to restructuring of mortgages in arrears is a sad extension of the failed policies of the past that have allowed Irish mortgages crisis to spin out of control and have resulted in total mortgages arrears of unprecedented proportions.

The latest plan lacks any prescriptive solutions and allows banks to determine the nature, the extent and the application of all solutions while setting the terms and conditions with out any supervision. The plan delivers no improvement in transparency of solutions to be offered to borrowers by the lenders and provides no protection for borrowers against potential abuses by the lenders of their powers.

While the review of the code of conduct is to be welcomed the review fails to deliver a meaningful improvement to the previous practices and does not allow for an effective protections for borrowers.

Mr Elderfield's statement claiming that the regulator intends to remove the current cap on number of times a bank is allowed to contact or call or visit a borrower ahead of the review of the code of conduct is very concerning. In our view, the central bank is underestimating the extent to which the banks are willing to go to pressure borrowers. It also pre-empts the actual review of the code of conduct for mortgage arrears..

The borrower is exposed and has been afforded no protection in this plan. The lenders are incentivized to maximize the rate of extraction of savings and income from the already distressed borrowers prior to completion of any long-term forbearance or restructuring agreements, thus reducing the effective relief that can be accorded the borrower in the end.

The net effect of this plan will be additional stress on mortgage holders and more power to banks without an appropriate safety net or independent arbitration for mortgage holders.

The Irish mortgages crisis, now into its sixth year, is still raging beyond any control of the authorities. Per latest figures from the Central Bank of Ireland, 186,785 mortgages (including BTL) in Ireland are at risk (in arrears, restructured or in repossession), accounting for an unprecedented 25.3% of all mortgage accounts still outstanding. The balance of mortgages at risk,  relative to the total balance of all mortgages outstanding has reached a catastrophic figure of 31.9%. With some 650,000-750,000 estimated people residing in the households with the principal residence in mortgages difficulties, we are witnessing a wholesale destruction of savings, pensions and wealth of several generations of Irish people.

State response to this crisis to-date has been woefully inadequate and erring on the side of the financial institutions. Today’s announcement offers no hope for any meaningful change in the ways Irish authorities treat ordinary borrowers in distress.

For further information contact:

David Hall

or

Constantin Gurdgiev

IMHO

6/12/2012: 2008 and the Confidence Fairy

An interesting paper on euro area levels of financial stress arising from household debt (here). Do note that data on which this is based refers to 2008 survey, so is pretty dated by all possible means.

Recall that back in 2008 no one in the Official Ireland was even slightly concerned with household debt levels. I recall AIB senior banking team making rounds through the brokerage houses in late 2008 blabbing out mythological stuff like: "Irish people do not default on mortgages" and "Not a single cent from the State".

Yet, the data in the link above clearly shows that Ireland was already building up some serious payments problems:

Figure 1: Proportion of the population in a critical situation with respect to arrears and outstanding amounts by poverty status, 2008 (% of specified population) - Source: Eurostat 2008 ad-hoc module 'Over-indebtedness and financial exclusion'

Note that for the vulnerable population group, Ireland sports the 5th highest rate of stress in the EU.

But the really interesting chart is the following one:

Figure 6: Expectation for the financial situation for the forthcoming 12 months, 2008 (%) (NB: Households could also answer ‘to stay about the same’ or ‘don’t know’)

The above shows the following interesting fact: in 2008, Irish people had a pretty reasonably average ratio of optimism to pessimism. This ratio is roughly consistent with that in France, Belgium, Slovenia and the Netherlands. Our optimism for 12 months ahead was higher than the EU27 average and our pessimism levels were below those for any other bailout country. In other words, that confidence fairy was working our way... and the outcome of that was...

27/10/2012: UBS on Irish banking debt restructuring

UBS' European Weekly Economic Focus is dealing in detail with the prospects of Ireland getting a deal out of the EU Summits promises to break the links between the banks liabilities and sovereign liabilities. Comments are mine.

"Taking the June 29th statement at face value, there is a strong case for supporting Ireland by breaking the link between the government and the financial system." 

[I wholeheartedly agree - the case can be made across a number of points: (1) Ireland de facto underwritten the euro system in the early stage of the crisis; (2) the cost of (1) to Irish taxpayers is unprecedented in modern history; (3) Irish banking fallout is partially based on absolutely mis-shaped monetary policy pursued by the ECB; (4) Ireland is the only country in the euro periphery, in my view, that has potential to organically grow out of the current Great Recession, assuming the country gets a significant (€40-45 billion) writedown on the banks debts; and more]

"There are two potential routes for euro zone support to the Irish state. The direct route involves the ESM acquiring all or a part of the government’s stake in the banks, thereby assuming responsibility of the Irish lenders and absolving that liability of the Irish state. The alternative, less generous, approach is a relief on the promissory note/ELA commitments by the ECB."

[I disagree - the impact from both of these measures taken individually will be minor. What is needed is a combination of the two measures, with ELA commitments writedown of at least €30 billion. The reason for this is simple: the ESM will not be able to take on IBRC liabilities even in theory as IBRC is not a functional bank. Hence, route 1 outlined by UBS can amount to ca €5-6 billion in maximum potential recovery to the Irish state. Route 2 take by itself alone will simply see marginal relief on the net present value of promo notes liabilities, something close to €3 billion yield. Hence, even combined, such measures are unlikely to generate more than €10 billion, or roughly 1/8th of the assumed current and future liabilities.]

"In our view, there is very little chance that the ESM will acquire a stake in Irish lenders any time soon, for the simple reason that a direct ESM intervention requires the establishment of a euro area bank regulator and that would take a long time, in our view." [I agree. And worse, not only ESM has to be fully established, it also has to be fully operational and, potentially, have a track record of sorts before it can be used to underwrite banking sector directly.]

"What’s more, Ireland will need to remain a programme country for longer. Depending on the potential scale of the intervention, the first argument is likely more important that the second, but either way this route is not likely to be available for a long time." [I fully agree and this is the reason why I argued earlier this week that the Irish Government push to 'exit' the programme is rushed and unwise.]

"How about a recapitalisation via the sovereign? To start with, this approach does not help sever the link between the sovereign and the banks, one key driver for euro area intervention. More importantly though, it is not clear to us that Ireland will qualify for that sort of intervention even if it tried, for the simple reason that ESM funds can only be provided to limit ‘the contagion of financial stress’. The financial sector in Ireland is no longer a threat to the rest of the euro area and, as such, it would not qualify for ESM intervention. 

[I spoke about this factor for a number of years now. As long as Ireland continued replacing private liabilities to bondholders and inter-bank funding sources with sovereign obligations, it continued to dilute its own power in the bargaining game. I warned years ago that once we complete this process, we will be left alone. No tramp cards in our hands. Fully exposed to carrying the weight of banking debts on taxpayers shoulders. This Government and the previous one have failed to listen. Now, its a payback time.]

"The only way around this is if the ESM facility is made available retrospectively, but that is unlikely if the statement from the Dutch, Finnish and the German finance ministers where they rejected ESM assistance for ‘legacy assets’ is true." 

[At the time of June 29th summit I wrote about the cumulative potential exposures that such retrospectively can yield. It was clear then, as it is clear now, that ESM will not be able to absorb all potential calls on such a measure. Hence, Fin Mins statement breaking retrospectively clause is fully rational and expected.]

The rest of the note is based on a superb and must-read analysis by Karl Whelan of the promo notes.

In summary - and this is my view - Irish policymakers have carelessly forced the country into a corner: we worked hard to assure some stabilization in fiscal space, which in turn undermined our ability to get meaningful relief. Congratulations to our policy makers who seemingly traded the interests of the longer term debt crisis resolution for friendly pats on the back from Europe.

10/9/2012: Corporate debt iceberg

Another topic, much ignored by the Irish media and the Government and covered by the IMF in today's releases is the corporate debt.

The chart below shows the extent of debt overhang in Ireland:

Here's what IMF has to say on that (emphasis mine):
"Despite an overall decline in corporate debt, an increasing number of firms are facing difficulties covering interest payments on debt. Interest coverage ratios [ratio of earnings before interest and taxes (EBIT) to interest expenses] have declined, with the interest coverage for the median firm having decreased from 6.9 in 2002 to 0.8 in 2009, and with an increasing number of firms not generating sufficient income to cover interest payments on outstanding debt. ... Moreover, the interest coverage is markedly lower for SMEs, with a median of 0.8 compared to 1.9 for large firms. The decline in firm profitability associated with depressed demand is playing an important role in the reduction in interest coverage ratio. This suggests that financing constraints are particularly important among SMEs and in property-related sectors."

In other words, whatever supply of credit is doing, demand for credit is severely constrained by deterioration in firms' financial sustainability.

Although "Leverage for the median firm (which is a small firm) has fallen to 46 percent of equity, with the usage of bank debt showing a similar decline. The data also indicate that trade credit and other non-debt liabilities play an important role in the financing of SMEs, together with internal financing from retained earnings." Although leverage overall has dropped, debt affordability has fallen off the cliff:

Why? "The decline in firm profitability associated with depressed demand is playing an important role in the reduction in interest coverage ratio. This suggests that financing constraints are particularly important among SMEs and in property-related sectors."


So what can be done? Here's the list of IMF outlined options:


"Credit guarantees or subsidies on SME loans can in principle stimulate SME financing. ... Until recently, Ireland was one of the few OECD countries without some form of loan guarantee scheme. ...However, the international experience with SME lending schemes is mixed. ...Moreover, the historical experience shows that credit guarantee schemes can only be effective when there are competent, financially sound banks, with adequate staff to effectively screen and monitor SME loans. ...

Government support for SMEs will need to be complemented with progress in improving the operational capacity of banks to work out loans. The restructuring of SMEs on a case-by-case basis is resource intensive yet important to ensure that where a viable core business exists, that it has the possibility to invest and grow, and contribute to broader economic recovery.

Considering the number of SMEs, it would not be appropriate to rely principally on court-based bankruptcy procedures. Rather, banks will need to build their capacity to design and implement work outs though out-of-court workout processes. Drawing on international expertise may well be needed to help major banks build capacity in this area.

The government could also explore ways to facilitate the securitization of SME loans. However, liquidity premia currently demanded by market participants even on senior
tranches, plus the inability of the Irish government to offer substantial credit enhancements
on such securitizations given the low sovereign credit rating, imply that, at least for the
moment, the market for securitization of SME loans is limited."

So, in other words: NOTHING can be done on the scale required. We are boxed into the corner with SMEs debt overhang too. All state resources and economy's resources wasted on rescuing the banks bondholdres, folks. No powder left for the rest of the economy. Sit tight and pray for a miracle.



Aside: An interesting observation via the IMF concerning the links between the negative equity and property values and firms formation: "With depressed home prices it has become more difficult to finance a new firm using home equity, which has hampered job creation."

10/9/2012: Irish Households Debt Overhang: IMF note

IMF published today three papers relating to Ireland's economy. Each of interest on its own merit and I intend to blog about them.

However, here's a chart that actually summarizes pretty well both the extent of the Irish crisis and the sorry state of affairs expected as we exit it:

Here's IMF's explanation for the household deleveraging process out of what is - by the standards of the chart above - a historically unprecedented debt overhang.


"Under the current forecast, households would reduce debt gradually from about  210 percent of disposable income to 185 percent by 2017. Building on the forecast of the
savings rate, the debt path is calculated based on the IMF desk forecast for a muted recovery
of disposable incomes at below GDP growth. Further, the debt path assumes that households use about half of their savings to retire debt, and new lending growth remains moderate, increasing from 1.6  percent of GDP in 2012 to 5.3 percent by 2017."

Now, give it a thought, folks.

1. Irish crisis in mortgages is well in excess of anything represented in the above chart;
2. Irish deleveraging over 9 years (2009-2017) will yield mortgages debt reduction of just 25 percentage points even if we use half of our entire savings to pay down the debts;
3. This painful deleveraging will still Ireland's mortgages markets in wore shape in 2017 than the second worst peak  of the crisis (the UK) back in 2007.

And here's the chart showing that all the debt paydown to-date has had zero effect on arresting the degree of Irish households leveraging (debt/asset value ratio) as underlying asset values of Irish properties continue to fall:

It is clear from the above that the Irish Government is out to lunch when it comes to dealing with the most pressing crisis we face - the crisis of severe debt overhang on households' balancesheets.

23/6/2012: Sunday Times 10/6/2012

This is an unedited version of my Sunday Times article from June 10, 2012.

Last week, the Irish voters approved the new Euro area Fiscal Compact in a referendum. This week, the Exchequer results coupled with Manufacturing and Services sectors Purchasing Manager Indices have largely confirmed that the ongoing fiscal consolidation has forced the economy into to stall. Irish economy’s gross national product shrunk by over 24% on the pre-crisis levels and unemployment now at 14.8%. The most recent data on manufacturing activity shows a small uptick in volumes of production offset by significant declines in values, with profit margins continuing to shrink. Deflation at the factory gates is continuing to coincide with elevated inflation in input prices. In Services – accounting for 48 percent of our private sector activity – both activity and profitability have tanked in May. The Exchequer performance tracking budgetary targets is fully attributable to declines in capital investment and massive taxation hikes, with current cumulative net voted expenditure up 3.3% year on year in May.

On the domestic front, the hope for any deal on bank debts assumed by the Irish taxpayers, one of the core reasons to vote Yes advocated by the Government in the Referendum, has been dented both by the German officials and by the ECB. Furthermore, on the domestic front, the newsflow has firmly shifted onto highlighting the gargantuan task relating to cutting our deficits in 2013-2015 and the problem of future funding for Ireland.

Per April 2012 Stability Programme Update, Ireland’s fiscal consolidation path will require additional cuts of €5.55 billion over the next three years and tax increases of at least €3.05 billion. Combined, this implies an annual loss of €4,757 per each currently employed worker, equivalent to almost seven weeks of average earnings. This comes on top of €24.5 billion of consolidations delivered from the beginning of the crisis through this year. The total bill for fiscal and banking mess, excluding accumulated debt, to be footed by the working Ireland will be somewhere in the region of €18,309 per annum in lost income.

This has more than a tangential relation to the Government’s main headache – weaselling out of the rhetorical corner they put themselves into when they solemnly promised Ireland’s ‘return to the markets’ in 2013 as the sole indicator for our ‘regained economic sovereignty’.

Even assuming the Exchequer performance remains on-target (a tall assumption, given the headwinds of economic slowdown and lack of real internal reforms), Ireland will need to raise some €36 billion over 2013 and 2014 to finance its 2014-2015 bonds rollovers and day-to-day spending. In January 2014 alone, the state will have to write a cheque for €8.3 billion worth of maturing bonds. The rest of 2014 will require another €7.2 billion of financing. Of €36.5 billion total, €19.3 billion will go to fund re-financing of maturing government bonds and notes, plus €6.9 billion redemptions to Troika. Rest will go to fund government deficits.

At this stage, there is not a snowball’s chance in hell this level of funding can be secured from the markets, given the losses in economy’s capacity to pay for the Government debts. Which means Ireland will require a second bailout. And herein lies the second dilemma for the Government. Having secured the Yes vote in the Referendum of the back of scaring the electorate with a prospect of Ireland being left out in the cold without access to the ESM, the Government is now facing a rather real risk that the ESM might not be there to draw upon. In fact, the entire Euro project is now facing the end game, which will either end in a complete surrender of Ireland’s economic and political sovereignty, or in an unhappy collapse of the common currency.

The average cumulative probability of default for the euro area, ex-Greece, has moved from 24% in April to 27.5% by the end of this week. For the peripheral states, again ex-Greece, average cumulative probability of default has risen from 45% to 52%.

Euro peripherals, ex-Greece: 5-year Credit Default Swaps (CDS) and cumulative probability of default (CPD), April 1-June 1

Source: CMA and author own calculations

These realities are now playing out not only in Ireland and Portugal, but also in Spain and Cyprus.

Spain has been at the doorsteps of the Intensive Care Unit of the euro area for some years now. Yet, nothing is being done to foster either the resolution of its banking crisis, nor to alleviate the immense pressures of it jaw-dropping 24.3% official unemployment rate. Deleveraging of the banks overloaded with bad loans has been repeatedly pushed into the indefinite future, while losses continue to accumulate due to on-going collapse of its property markets. At this stage, it is apparent to everyone save the Eurocrats and the ECB, that Spain, just as Greece, Ireland and Portugal, needs not loans from the EFSF/ESM funds, but a direct write-off of some of its debts.

Spain’s problems are immense. On the upper side of estimated demand for European funds, UBS forecasts the need for €370-450 billion to sustain Spanish banking sector and underwrite sovereign financing and bonds roll-overs. Mid-point of the various estimates is within the range of my own forecast that Spanish bailout will require €200-250 billion in funds, a move that would increase country debt/GDP ratio to 109.9% in 2014 from current forecast of 87.4%, were it to be financed out of public debt, as was done in Ireland or via ESM.

Overall, based on CDS-implied cumulative probabilities of default, expected losses on sovereign bonds of the entire EA17 ex-Greece amount to over €800 billion, or well in excess of 160% of the ESM initial lending capacity.

Europe is facing three coincident crises that are identical to those faced by Ireland and reinforce each other: fiscal imbalances, growth collapse, and a banking sector crisis.

Logic demands that Europe first breaks the contagion cycle that is seeing banking sector deleveraging exerting severe pressures and costs onto the real economy. Such a break can be created only by establishing a fully funded and credible EU-wide deposits insurance scheme, plus imposing an EU-wide system of banks debts drawdowns and debt-for-equity swaps, including resolution of liabilities held against national central banks and the ECB.

Alongside the above two measures, the EU must put forward a credible Marshall Plan Fund, to the tune of €1.75-2 trillion capacity spread over 7-10 years, with 2013 allocation of at least €500 billion. This can only be funded by the newly created money, not loans. The Fund should disburse direct monetary aid to finance private sector deleveraging in Spain, Ireland and to a smaller extent, Portugal. It should also provide structural investment funds to Greece, Italy and Spain, as well as to a much lesser extent Ireland and Portugal.

The funds cannot be allocated on the basis of debt issuance – neither in the form of national debts, nor in the form of euro bonds or ESM borrowings. Using debt financing to deal with the current crises is likely to push euro area’s expected 2013 debt to GDP ratio from 91% as projected by the IMF currently, to 115% - well above the sustainability threshold.

The euro area Marshall Plan funding will require severe conditionalities linked to long-term structural reforms. Such reforms should not be focused on delivering policies harmonization, but on addressing countries-specific bottlenecks. In the case of Ireland, the conditionalities should relate to reforming fiscal policy formation and public sector operational and strategic capabilities. Instead of quick-fix cuts and tax increases, the economy must be rebalanced to provide more growth in the private sectors, improved competitiveness in provision of core public services and systemic rebalancing of the overall economy away from dependency on MNCs for investment and exports.

Chart: Euro Area: debt crisis still raging

Source: IMF WEO, April 2012 and author own calculations

The core problem with Europe today is structural policies psychosis that offers no framework to resolving any of the three crises faced by the common currency area. Breaking this requires neither harmonization nor more debt issuance, but conditional aid to growth coupled with robust resolution mechanism for banking sector restructuring.

Box-out:

This week’s decision by the ECB to retain key rate at 1% - the level that represents historical low for Frankfurt.  However, two significant developments in recent weeks suggest that the ECB is likely to move toward a much lower rate of 0.5% in the near future. Firstly, as signalled by the euro area PMIs, the Eurozone is now facing a strong possibility of posting a recession in the first half of 2012 and for the year as a whole. Secondly, within the ECB governing council there have been clear signs of divergence in voting, with Mario Draghi clearly indicating that whilst previous rates decisions were based on a unanimous vote, this time, decision to stay put on rate reductions was a majority vote. A number of national central banks heads have dissented from previous unanimity and called for aggressive intervention with rate cuts. In addition, monetary dynamics continue to show continued declines in M3 multiplier (which has fallen by approximately 40 percent year on year in May) and the velocity of money (down to just under 1.2 as opposed to the US 1.6). All in, the ECB should engage in a drastic loosening of the monetary policy via unsterilized purchases of sovereign debt and cutting the rates to 0.25-0.5%, with a similar reduction in deposit rate to 0.25% to ease the liquidity trap currently created by the banks’ deposits with Frankfurt. The ECB concerns that lower rates will have adverse impact on tracker mortgages and other central bank rate-linked lending products held by the commercial lenders is misguided. Lower rate will increase banks’ carry trade returns on LTROs funds, compensating, partially, for deeper losses on their household loans.

15/6/2012: IMF Review : Mortgages Arrears & Household Wealth

In the previous post I promised a closer look at the IMF analysis of the household wealth and mortgages in Ireland. Per Article IV consultation paper:

Mortgage arrears continued to rise as some households struggle with high indebtedness. 

• Household’s net wealth peaked in mid-2007, but has since declined by 37 percent largely due to the collapse in housing prices. 
• By 2011, households’ deleveraging efforts have reduced debt by 13 percent from its end 2008 peak. 
• Declining incomes have, however, meant the overall household debt burden has eased by only 3 percentage points to 208 percent of disposable income in 2011, although there has been some relief from lower interest rates. 
• Income declines, especially on account of the rise in unemployment, have also driven the increase in the rate of mortgage arrears on principal private residences to 10.2 percent of mortgage accounts and 13.7 percent of mortgage balances at end March 2012. 
• The share of mortgages that have been restructured—predominantly through payments of only the interest due or somewhat more—rose to 12.6 percent at end March 2012, but more than half of restructured loans are in arrears, indicating that deeper loan modifications are needed in some cases.

 More charts from the IMF:

In IMF news, rental yields are now closer to stabilization levels, but house prices are averaging 10 times average disposable per capita income, implying ca 4 times average disposable per-family income. In my view, prices will need to reach 3-3.5 times before the property market becomes affordable in the current conditions. This, however, is a longer-term target, with intermediate target being most likely even lower at 2.5 times (given credit conditions and general economic conditions). Also note, the above do not account for upcoming property taxes and for future reductions in disposable income due to tax increases.

Meanwhile credit condition remain horrible:

Chart above clearly shows that although interest costs and interest rates have declined, deleveraging did not take place. This stands in sharp contrast to the US and UK, where deleveraging of the households was more aggressively underpinned by bankruptcies and repossessions. Another issue is that declines in interest rate burden apply primarily to tracker mortgages.

Charts below highlight rapidly accelerating problems with mortgages defaults:

Chart above shows the decomposition of restructured mortgages, highlighting the extent of significant changes in the overall mortgages burden under restructuring (interest only 35%, below interest-only payments at 14%, payment moratorium at 4% and hybrid at 5%, implying that at the very least well over 50% of all restructured mortgages are not delivering on capital repayments).