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

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

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

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

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

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

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

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

Meanwhile, take a look at the last chart:

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

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

16/7/15: Ah Shure, matey, de Banks were Solvent... and Still Are...

You know the meme... "Banks are/were solvent"... It replays itself over and over again, most recently - well, just now - in the Banking Inquiry hearings in Ireland.

Ok, so they are:

Source: http://www.valuewalk.com/2015/03/non-performing-loans-europe/

Yes, that is 4 years after Irish banks were recapitalised, more than 3 years after they passed 'stringent' stress-tests and over 2 years of 'rigourous' work-outs (with 'strict' targets being met) of NPLs.

31/10/2011: IRL5 banks - no signs of real improvements in September

Few posts back I looked at the latest data for Irish banking system stability from the CBofI. Here, I complete my analysis by focusing on 5 covered institutions or IRL 5 (previously known as IRL 6 before the merger of Anglo & INBS into IBRC).

Here's the data:

• Borrowing from the euro system by IRL5 has risen from €68,430mln in August to €70,340mln in September. Year on year, this is still down 4.73% or €3,489mln, but at that rate of unwinding IRL6 liabilities to euro system will take, oh, some 20 years (!)... Mom, the increase in borrowing from the euro system was €1,910mln or more than 50% of the reductions achieved yoy.
• Deposits from Irish residents in IRL6 were up from €192,431mln in August to €193,929mln in September, prompting cheers from the Irish Times and Department of Finance, among others. Mom rise of 0.78% or €1,498mln contrasts a 22.22% decline yoy in very same deposits or €55,393mln loss. In other words, to get us back to September 2010 levels (not exactly healthy ones) at current rate of mom increase would take 37 months. In the last three months, on average, deposits were down €26,337mln compared to 3 months through June 2011 (-12.05%).
• The mystery of rising deposits is explained easily by looking at their composition: Monetary and financial institutions (aka other banks) have seen their deposits in IRL5 rising €1,298mln in September (+1.47%) mom, although these deposits are down €32,308mln or -26.53% yoy. This explains 87% of the entire increase in the overall deposits.
• In addition, General government deposits also rose €333mln in September (+16.28%) mom, explaining the remainder of the rise in overall deposits, heralded by our Green Jerseys as 'signs of improvement/stabilization' in Irish banks.
• In contrast to the above two sub-categories, private sector deposits in Irish banks (IRL 5) have shrunk in September by €133mln (-0.13%) mom and are down 18.12% (-€22,589mln) yoy. September marked 5th consecutive month of declines in private sector deposits, which have shrunk by €6,135mln since April 2011.

As mentioned above, borrowings from the euro system have gone up in September. In contrast, as shown in the chart below, total borrowing from the ECB & CBofI have declined slightly in September to €123,596mln from €124,379mln in August (a mom drop of 0.63%). Year on year, the borrowings are still up massive €28,572mln or 30.7%. Over the last 3 months (July-September), average borrowings from the euro system and CBofI declined 1.39% or €1,748mln compared to 3 months from April through June.

Loans to irish residents have contracted once again in September, reaching €294,224mln against August levels of €294,503. The declines were accounted by drops in loans to MFIs and increases in loans to the General Government (+€58mln) and Private Sector (+€95mln). hardly anything spectacular.

Now to the last bit - recall that the comprehensive reforms of the Irish banking sector envision deleveraging Irish banks to loans-deposits ratio of 125.5%. These targets were set in PCARs at the end of March 2011. back in march 2011, LTD ratios stood at 143.25% for all of the IRL6/IRL5 and 173.71% for private sector LTD ratio only. Since then, if anything was going up to the CBofI / Government plans, we should have seen at least some reductions in LTDs.

As chart above illustrates:

• Overall LTD ratio for IRL5 at the end of September 2011 stood at 151.72% - below August reading of 153.04%, but well ahead of March 2011 reading of 143.25% and certainly much ahead of the target of 125.5%.
• For private sector loans and deposits, LTD ratio was 174.61% in September - ahead of 174.29% in August and still above 173.71% back in March.

And the summary is: there's no real stabilization or improvement I can spot in the above for IRL5.

Time to dump some bad risk? and ESB's rip-off 'investments'

EXCLUSIVE: Is it time to let Nationwide sink?
Here is an opportunity to show the financial world that we are serious about cleaning up the mess. It is also a good opportunity to show the world that we understand, as a country, that finance is about controlling the downside as much as exploiting the upside - in other words, that risky trades must be closed off. Nationwide is one of the riskiest plays in town - so the Government should let the stronger ones - including international banks - bid for the pieces. In other words, the Government should not mix Nationwide in with the systemic banks for nationalization or future re-capitalisations, or indeed NAMA cover.

Here are tomorrow's results from the Nationwide:

1. Loss after tax €243mln on a loan impairment charge of €464m (2007 pre-tax profit of €309mln), Operating profits €260mln
2. Total Capital at 10.2%, Core Tier 1 at 7.2% (not spectacular, but on par with other Irish banks - hardly impressive for internationals)
3. Total assets at €14.43bn - down 10% (unrealistic assessment, given equity and property markets conditions and shut down of land markets - details below)
4. Loan Book at €10.474bn - down 15% (so lending stalled, the patient is dead)
5. Customer accounts €6.785bn, so accounts cover 65% of loans - up from 59% cover in 2007 (but at what cost did Nationwide achieve this gain in cover?)
6. Cost-income ratio at 17% - the lowest among Irish financial institutions (i.e they have no soft-savings left to achieve as a cushion against future losses)
7. Liquid assets stand at €3.26bn - liquidity ratio of 24% - again, good luck to them if they think they can actually sell the stuff they hold against the loans...
8. Society reserves are at €1.2bn

"The Society did a very detailed examination of the loan book with the result that the sum allocated for provisions was a very robust figure of €464m for the year under review in line with market expectations... The Society’s loan book decreased in 2008 to €10,474m from €12,332 at the end of 2007. €1,339 of the reduction was attributable to the decline in the value of sterling; the balance was a reduction in capital balances. The commercial loan book now stands at €8,183m with the residential book at €2,291ml. As a result the total assets of the Society were reduced from €16,099m in 2007 to €14,429m in 2008."

So the impairment charge is of 3.22% of the total asset base and 4.43% of the property book. This is laughable. Also, Nationwide claims that as a part of its strategy it was actively reducing its exposure to commercial loans. But this active reduction took out at most only €331mln (16,099-14,429-1,339) in real assets, or ca 4%. This is in the time when property values fell over 20% and equity values are down more than 80%?

"Because of the reserves built up over the years from cumulative profits the Society was able to absorb the impairment provision. The Society still has total reserves of €1.2 Billion to absorb further impairment charges should they arise."

Well, now, suppose real impairment rises to 15% of the property-related loan book on commercial and 5% on residential. You have a need for €1.34bn in cash right there but you have only €1.2bn... and that is in the form of Tier 1 capital...

So are Nationwide's numbers (especially in the area of impairment) a case of exemplary management? Or of reckless 'ostrich' syndrome? You decide, but it does look to me like something is amiss. Here's what.

In 2008, Nationwide repaid some €750mln plus £500mln in debt securities, and in December 2008 it raised £325mln in new term notes maturing September 2010 (note the date?). But the beast still has €2.23bn in debt maturing in 2009 alone and "the Society plans to finance [this] through reduction of its loan book, the securitization of loans as well as the issue of new loans."

Yes, you did hear this right - securitization of loans (presumably Irish buy-to-let properties in the UK and Irish developers toxic waste in Ireland have strong market with ready buyers?). Of course they have no such hope, so in reality the Society is most likely looking for refinancing.

And here comes the confession: "the ability of the Society to raise wholesale funding on a continuing basis depends on the Government Guarantee. The Government intends in line with its previous indication to put a State guarantee in place for the future issuance of debt securities with a maturity of up to five years... The society's ability to remain a going concern and achieve its Business Plan is dependant on the continuation of Government support. As a systematically important institution Irish Nationwide was included in the guarantee Scheme. The Irish Government is committed to ensuring the continued viability and stability of systemically important credit institutions."

So here is Nationwide's survival strategy in a nutshell: "Give us more tax money! Now!"

In the end, Nationvile has €2.23bn of debt maturing this year alone and needs the extension of the Government guarantee to keep itself going. It also has an acute case of denial when it comes to potential losses it faces on its asset base and its loans, so it will need even more tax money to survive. This looks like they've gone to the markets to raise refinancing, but the markets laughed at them, they've gone to the auditors for a life-line on their NAV and they got that extension, so now its up to rich Uncle Taxpayer to rescue a systemically important private estate. Hmmm...


ESB's 'stimulus'
For shortage of time - more analysis of this is to follow, but in the nutshell, ESB announced new plans to 'create' 3,700 jobs through 2013... The Government & Opposition have welcomed the move that will see a notorious state monopoly

• using consumers' and businesses' cash (remember - it cannot pass cost reductions to its clients because it's out of town subsidiary - CER - doesn't let it)
  
• hire more grossly overpaid (remember, ESB runs a unionized closed shop with highest salaries in the entire public sector and work pracices that allow its employees draw full pay even when are asigned for years to plants producing absolutely nothing)
• to expand its dominance in the market that is so starved of competition, that much of our economy's competitiveness loss can be attributed to the ESB's existence.
  

This is a farce that passes in this country for industrial, fiscal and economic policies. Instead of breaking up a noxious monopoly, the state will allow ESB to piggy-bank the revenue it gains from ripping off its customers into 'developing new infrastructure such as smart metering and a system to allow for the recharging of electric cars'.

You might also notice that the two investment objectives are a red herring. Smart metering is already widely available and does not require any 'infrastructure' - you can install smart meter at your own home. Electric cars are about as widely spread in Ireland (or indeed anywhere else in the world) as dinosaurs. By 2013, this is unlikely to change.

Lastly, the Government has been calling for increasing ESB's and other state monopolies contributions to the Exchequer to compensate for some of the revenue losses incurred in this crisis. Now, the same Government is welcoming ESB chipping into this contribution. Who will make for the shortfall? Well, the same people who will be paying for those 3,700 new jobs to be 'created' by the ESB - you, me and the rest of taxpayers. ESB claims it can raise funding for the investment in private markets. Maybe so, but it can't raise funding for interest charges on the loans and it can't raise funding for paying lavish salaries to its new employees. At over €80,000 per average ESB job, this 'green investment' will cost the consumers some €300mln per annum in wage costs alone. Now that's what I call 'smart' metering.

WSJ today (here) has an excellent parallel story to the ESB circus.