Economics 10/01/2010: A desperate state of economic analysis

This week has been marked by some remarkable statements on the prospects for Irish economy in 2010 that simply cannot be ignored.

Firstly, yesterday, Irish Times (here) decided to devote substantial space to the musing of one of the stock brokerage houses. Bloxham's chief came out to tell us that things are going to be brilliant in 2010: 10% growth in house prices and commercial real estate valuation, and ca 100% increase in banks shares prices to €3 per share for BofI and AIB. So:

1. Pramit Ghose thinks that there is little to Irish economy other than demand for property and banks shares. The implication of this is that the only way that prosperity and growth will be achieved once again in Ireland is through another construction and lending boom. Have our stockbrokers learned anything new from the crisis? Doesn't look like it.
   
2. Mr Ghose also seem to have little time for the fundamentals of Irish consumers and domestic economy. Massively heavy debts loaded onto Ireland Inc don't matter for growth to him. Neither are sky-high marginal taxation and the prospect for more tax hikes in Budget 2011, nor even high unemployment mar his optimism.
   

Banks shares will rise, you see, because investors will become optimistic. Optimistic about what, Mr Ghose? Low profitability of our zombie banks? Their over-stretched customers who cannot be squeezed for higher margins without triggering massive defaults? High default rates on already stressed loans and high proportion of negative equity mortgages on the books? Exporting sectors suffering from the lack of credit and overvalued currency? The reversion of the interest rate curve upward due to expected ECB policy changes and margins rebuilding efforts by the banks? Double-digit deficits on the Exchequer side?

All in, Mr Ghose thinks that the banks shares might reach €3 per share sometime in 2010. He might be wrong, he might be right. I have no prediction on a specific price target. But here is a thought:

The two banks need some €5-6 billion in capital post Nama. At €3 per share two banks market cap will be around €4.5 billion. So with recapitalization - whether by the state or by the international dupes (oh, sorry - investors) - the market value of the two banks will be €9.5-10.5 billion or close to their 2006-2007 valuations. What sort of expectations curve does Mr Ghose have to get there?

A glimpse into his thinking can be provided by his July 22, 2008 note reproduced below:
You judge the merits of this prediction for yourself, but here are the facts
85-142% wrong?

Oh, and do note that in his July 2008 note, Mr Ghose doesn't do any better in historical analysis either. He completely failed to take into the account real (as in inflation-adjusted) returns to equities. If that little inconvenient fact is considered, the '2/3rds of the 1996 price offer' paid on Mr Ghose's family house 8 years after the crisis would represent just 33-40% of the 1996 offer real price. Markets did come back for Thailand, but once inflation (see IMF) is factored in, Mr Ghose's analysis yields a real loss on the 1996 offer of 50%! Ouch...

Mr Ghose's Chief Economist seems to have little time for Mr Ghose's optimism for 2010. Writing an intro to Daft Report this week he states (here): "in overall terms, I would expect house prices to drop another 10-15% on average this year, with Dublin again seeing the biggest decline [now, Mr Ghose thinks prime real estate will lead in growth, which means Dublin]. ...Looking further ahead, I expect house prices to be higher on average in 2011 than in 2010, and should rise on a five-year view as the labour market returns to normal. That said, the level of any increase in house prices over the next few years is likely to be only in single digits, with three factors - the banks' adoption of a more cautious stance to lending than in the 'Celtic Tiger' era, the return of interest rates to 'normal' and the possible introduction of a property tax for 'principal' homes of residence - all weighing negatively on the market."


The second comment, courtesy of today's Sunday Tribune (page 1, Business), comes from Prof John Fitzgerald of ESRI. After largely staying off the topic of Nama and banks recapitalization for the entire duration of the public debate, Prof Fitzgerald decided to offer an opinion on Ireland's 'financial rescue'.

Now that the stakes in the game are low, credit must be claimed for the future 'I too was critical' position, should things go spectacularly wrong on the Nama side.

Prof Fitzgerald thinks that state-injected funds into INBS and Anglo are totally worthless and will be lost. Who could have thought such a radical thingy!?

Some 4 months ago I provided my estimates showing the demand for recapitalization post-Nama totaling €9.7-12.4 billion (here and here). Having spent the entire 2009-long debate on Nama on the sidelines, Ireland's ESRI macroeconomics chief is now telling us that €10-12 billion will be required to complete recapitalization of the banks. This, according to the Tribune is news!

I am delighted to know that Prof Fitzgerald belatedly decided to agree with myself, Brian Lucey, Karl Whelan, Peter Mathews and Ronan Lyons. One only wishes that next time a matter of economic urgency, like Nama, comes up for a public discussion, he joins the debate when it matters - not four months after the fact.

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

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

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

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



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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Economics 30/11/2009: Nama estimates confirmed

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

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

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

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

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

Further per Bloxham:

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

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

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

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

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

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

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

Economics 16/11/2009: Notes on Banks post-Nama & Eurozone recovery

There is an excellent issue on Financial Sector Regulation published tonight by The Economists' Voice of BE Press (free link here), it also contains a superb article by Rob Schiller of Yale on housing bubble.

Oh, and per today's Bloxham note: "...media speculation is suggesting that Anglo needs a €5.7bn capital injection if it is to continue lending. Finance Minister Lenihan said on November 13th that a second capital injection won't be needed, but reports now suggest that if Anglo is to form part of a new banking force in Ireland the eventual cost will be in the region of 5.7bn to meet international capital adequacy levels. Finally the report suggests that a wind down option is now believed to be gathering support in the Dept of Finance."

Hmmm, see my blogpost here. Two weeks ago I predicted this same exactly number - 5.7bn as the upper envelope of the capital demand from Anglo... Glad to see media now catching up...

Watch tomorrow's Mail for my comment on why Anglo can be wound up at a lower cost than continuing the sorry saga of the bank...


Now to news:


You all heard the news: five consecutive quarters of economic contraction later, and the euro area's economy finally grew by 0.4% in Q3 2009. Anemic (as in expectations were for 0.5%) but this does mark the region's exit from its worst recession since World War II.

Eurostat has yet to release a breakdown of the third quarter, but it looks like exports were the drivers for growth. Of course, the other side of the economic equation - European consumers - is still stalled in the quick sands and is now gearing up for higher taxes, lower incomes and permanently higher unemployment in years to come. All of this as the Euro area's debt to GDP ratio is now heading for 100% by 2014. For comparison, US National Debt today stands at around $11,996bn or 96.5% of GDP.

Back to Europe: France expanded by 0.3% (0.6% growth was expected by the markets), Germany grew by 0.7%, (against 0.8% expectation).

Now, Ireland's GDP was stagnant per Q2 2009, while GNP fell another 0.5%. Technicality might be that Ireland will post a positive growth in Q3 2009, but that would mean preciously little: Irish GDP is extremely volatile and another negative correction might be easily coming in Q4 2009 / Q1 2010. This volatility is driven by exports' mammoth share of the country GDP.

Lastly, there is a problem of European fiscal and monetary stimuli - both covered by me before. Once unwinding begins, even the stronger economies of Europe are not immune from a sudden growth reversal. what's there to say about Ireland, Spain and Greece?..


And on a separate note couple of thoughts concerning Nama's passage:

There is an excellent article in the October issue of the US version of Vanity Fair magazine about the legacy of TARP. To remind you - TARP is a US programme to help struggling banks that:

• started its life with an idea of purchasing distressed assets off the banks' balancesheets (just like Nama),
• ended up purchasing common and preferred equity in the banks;
• overpaid grossly (to the tune of 30%) for the equity bought (even though unlike in the case of Nama there was a ready and functioning market for these banks' shares); and
• like Nama promised to deliver easing of the credit crunch conditions.

Now, a year from its inception, we know that TARP:

• resulted in banks taking Government cash and parking it in Government bonds, lending out virtually nothing;
• was immediately followed by a severe tightening of existent lending contracts and revisions of performing loans to squeeze more cash out of households;
• has led to multiple defaults by cash-strapped students, homeowners and credit card holders as banks are going on with their business rebuilding profit margins.

Any idea now what we can expect from post-Nama Irish Banking sector? Or with that ESRI estimate of 300,000 households at risk of negative equity?