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

23/12/2012: Not another cent?.. Irish banks state aid 2011

In the previous post, amidst the excitement of the aggregate figures reporting, I forgot one small, but revealing chart.

Now, recall the FG/LP election campaign promise of 'not another cent' for the banks?..

23/12/2012: State Aid in EU27 & Ireland

Yesterday, the EU Commission released updated analysis of state aid expenditures, covering 2012 data. The document, titled "State aid Scoreboard 2012 Update Report on State aid granted by the EU Member States - 2012 Update" is available here.

Here are some interesting bits:


"Between 1 October 2008 and 1 October 2012, the Commission approved aid to the financial sector totalling €5,058.9 billion (40.3% of EU GDP). The bulk of the aid was authorised in 2008 when €3,394 billion (27.7% of EU GDP) was approved, mainly comprising guarantees on banks’ bonds and deposits. After 2008, the aid approved focused more on recapitalisation of banks and impaired asset relief rather than on guarantees, while more recently a new wave of guarantee measures was approved mainly by those countries experiencing an increase in their sovereign spreads, such as Spain and Italy.

Between 2008 and 2011,  the overall amount of aid used  amounted to  €1,615.9 billion (12.8% of EU GDP).  Guarantees accounted for the largest part amounting to roughly €1,084.8 billion (8.6% of EU GDP), followed by recapitalisation €322.1 billion (2.5% of EU GDP), impaired assets €119.9 (0.9% of EU GDP) and liquidity measures €89 billion (0.7% of EU GDP)."


In other words, keeping up the pretense of solvency in the legacy banking system of the EU (primarily that of the EA17) has created a cumulated risk exposure of €5.06 trillion (over 40% of the entire EU27 GDP). With such level of supports, is it any wonder there basically no new competition emerging in the sector in Europe.


"In 2011, the Commission  approved aid to the financial sector  amounting to  €274.4 billion (2% of EU GDP). The new aid approved was concentrated in a few countries and involved guarantees for €179.7 billion, liquidity measures for € 50.2 billion, recapitalisations for €38.1 billion and impaired asset relief for € 6.4 billion.

The overall volume of aid used in 2011 amounted to € 714.7 billion, or 5.7% of EU GDP. Outstanding guarantees stood at € 521.8 billion and new guarantees issues amounted to €110.9 billion. Liquidity interventions amounted to € 43.7 billion and new liquidity provided in 2011 stood at €6.5 billion. Recapitalisation amounted to € 31.7 billion. No aid was granted through the authorised impaired assets measures."

Some illustrations of historical trends.

First non-crisis aid:

Amongst the euro area 12 states, Ireland has the fourth highest level of state aid over the period 1992-2011 and this is broken into 5th highest in the period of convergence with the EA12 (1992-1999), 5th highest for the period of the monetary bubble formation (2000-2007) and the second highest for the period of the crisis (2008-2011).

Relative to EU27, Irish state aid was above EU27 average in 1992-1994, 1998-2002, 2007-2011. In other words, Ireland's state aid was in excess of EU27 for 13 out of 20 years. And that despite the fact that our income convergence to the EU standards was completed somewhere around 1998-1999.

In terms of financial sector supports during the crisis, we are in a unique position:

The overall level of supports for financial sector in Ireland is so out of line with reality that our state aid to insolvent financial institutions stood at 365% of our GDP in 2011 or roughly 460% of our GNP. In other words, relative to the size of our economy, the moral hazard created by the Government (and Central Bank / FR) handling of the financial crisis in Ireland is now in excess of measures deployed by the second and third worst-off countries in EU27 (Denmark and Belgium) combined.

The chart above shows that Guarantees amounted to 246.7% of GDP in Ireland, almost identical to 245.7% of GDP in Denmark. Which means that our Guarantees were basically equivalent to those of seven worst-off Euro area countries combined.

However, stripping out the Guarantees, the picture becomes even less palatable for Ireland:

Ex-Guarantees, Irish State supports for the financial sector were more than 10 times the scale of EU27 supports and at 118.4% of GDP amounted to almost the combined supports extended by all EA12 states (123.2% of GDP).

21/10/2012: Overselling & Overhyping

Here's at last a significant recognition from the Irish media that the Government should be held accountable for the claims it makes relating to 'selling' newsflow to the public.

The Irish Government has grossly oversold and mis-interpreted the June 29 EU Summit outcomes, and then subsequently opted to actively undervalue the statements made by the EU states' officials on interpretation of the summit results.

I wrote about this matter here, here, here and here.

02/07/2011: Was banks Guarantee 2008 a subsidy to foreign lenders?

Please note: the figures below are estimates, based on Table A.4.2 data from the Central Bank of Ireland for 6 covered banking institutions liabilities as of September 2008. These charts illustrate the comment I provided to the Quarterly Journal of Central Banking - forthcoming issue for Q3 2011.
First, straight forward composition of liabilities as shown in the chart above.

Next, the same expressed as percentages of total liabilities:
Finally, assumptions and calculations of total implicit subsidy from the Irish taxpayers/Exchequer to foreign liabilities holders:
Click on the chart to enlarge and see assumptions and calculations. Euro area residents accounted for €39.572 billion of our banks' liabilities or 6.42%, while non-Euro area residents accounted for €218.836 billion or 35.5% of total Ireland-6 liabilities at the time the Guarantee was issued. Thus, Euro area residents received an implicit subsidy from the Irish taxpayers to the tune of €5.5-6.7 billion over the time of the Guarantee - well in excess of the life-time cost of 1% reduction in the interest rate on our EU loans.

Of course, this is a crude estimate based on official provided and expected default rates on assets held by the Irish banks - excluding Anglo and INBS. Which means it is likely to be an under-estimate. Expected losses at INBS and Anglo are multiples of those assumed for the Ireland-4 covered in the main PCARs. With Anglo & INBS thrown into the mix, subsidy to Euro area residents rises to ca €8 billion.

Another issue here is that I am using estimates through 2013 only. This means that, like the CBofI I am assuming (ad hoc) that post-2013 IRL-6 will be able to cover their own losses without resorting to taxpayers capital injections. This assumption, in my view, is absolutely unrealistic.

Finally, no allowance is made here for the Irish Government underwriting of the funding debts incurred by the banks vis-a-vis ECB and CBofI - the debts which, at least in the case of Anglo & INBS, should be treated as largely reckless lending to insolvent institutions and which should not be a liability of the taxpayers.

In the end, in my opinion, Irish Government had no business underwriting a Guarantee for any of the liabilities in excess of €130.2 billion of domestic deposits and €2.813 billion of its own deposits with the IRL-6.

Note - another issue not addressed in these estimates, but also likely to increase the implicit subsidy extended to Euro area residents is that Monetary & Financial Institutions deposits figures cover IRL-20 banks regulated here, which include a large number of deposits from Euro area banks that are within IRL-20.

13/05/11: CBofI accounts

Update: Namawinelake blog has an excellent post on the lunacy of Government treasury management exposed by the CBofI's latest accounts - read it here.


On April 7, 1775, Samuel Johnson made his famous pronouncement: "Patriotism is the last refuge of the scoundrel". This statement caught the chord with many other illustrious thinkers. Ambrose Bierce's The Devils Dictionary: “In Dr. Johnson’s famous dictionary patriotism is defined as the last resort of a scoundrel. ...I beg to submit that it is the first." In 1926, H. L. Mencken added that patriotism "...is the first, last, and middle range of fools.”

Whether one can separate a scoundrel from a fool or the first refuge from the last, in recent years we have seen Government officials who have exhibited all four attributes of false 'patriotism'.

No doubt, the decision by the Irish Minister for Finance to instruct NTMA to deposit €10.6 billion of state money with the Irish banks were not supposed to be amongst one of them. However, motivated by a 'patriotic' desire to provide a temporary support for the zombie institutions, artificially increasing their deposits base, this was a significant mistake from the risk management point of view.


Irish banks are experiencing a severe liquidity crisis, as the latest figures from the CBofI clearly show (Table A.2, column E). Lending to Euro area credit institutions has risen from 30 April 2010 levels of €81.25 billion to the peak of €136.44 billion by the end of October 2010 and now stands at a still hefty €106.13 billion (April 29, 2011), down €8.37 billion on the end of March. That's folks - our banks debts to the ECB. As far as banks debts to the CBofI itself are concerned, these have declined by some €12.64 billion to €54.15 billion March to April 2011. Chart below plots combined ECB and CBofI 'assets' that are loans to the Irish banks.
So the banks are still under immense pressure on the liquidity front.

As far as their solvency is concerned, BalckRock advisers estimated back in March 2011 the through-cycle expected losses in excess of €40 billion for just 4 out of 6 Irish 'banks'. Although these relate to 'potential' losses, the likelihood of these occurring is high enough for the CBofI to provision for €24 billion of these.

Either way, Irish banks are not really the counterparties that can be deemed safe.

There is an added component to this transaction - under the deposits guarantee, the Irish Exchequer holds simultaneously a liability (a Guarantee) and the asset (the deposit) when Mr Noonan approved the transaction. Before that, the Exchequer only had an asset. In effect, balance-sheet risk of this transaction was to reduce the risk-adjusted value of the asset it had.

Lastly, the entire undertaking smacks of the Minister directly interfering in the ordinary operations of NTMA which is supposed to be independent of exactly such interference.

So whether Minister's 'patriotism' of supporting Irish banks was the first or the last resort or the first and the last range, the outcome of his decision to prop up banks balance sheets with artificial short-term deposits was an example of a risky move that has cost NTMA its independence and reputation. The move achieved preciously little other than destroy risk-adjusted value of Government assets. Not exactly a winning combo...

Economics 21/12/10: BofI & Irish derivatives warning from the IMF

How wonderful is the world of international banks linkages? And especially, how wonderful it can get when regulators are so soundly asleep at the wheel, a firecracker from the IMF can be shoved in their faces and popped, and the snoring still went on.

A 2007 working paper from the IMF, republished earlier this year in an IMF journal, has warned Irish regulators that (referring to the data through 2005):

“BofI had launched a new venture with a leading Spanish bank, La Caixa to provide extra mortgage options for Irish people buying property in Spain, which included equity release from existing BofI mortgages” (IMF WP/07/44: External Linkages and Contagion Risk in Irish Banks, by Elena Duggar and Srobona Mitra).

Now, think of those La Caixa/BofI borrowers leveraging levels. But here’s the bit that relates directly to securitisation threats I hypothesize about in the previous post (here): on page 8 of the report, IMF folks state: “Irish banks could be indirectly exposed to property markets by selling risk protection (buying of covered bonds, credit default swaps, and mortgage backed securities) to other banks which are exposed to foreign property markets. From anecdotal evidence, some small IFSC banks, exposed to international property markets, are selling CDS to other domestic-oriented banks, making the latter indirectly exposed to these property markets even though their loan books are not.”

Of course, the Irish banks were also selling protection to the SPVs they were managing as well. And now, lets jump to IMF’s conclusions:

“Some tentative policy lessons could be drawn from the results of this exercise. The Central Bank and Financial Services Authority of Ireland (CBFSAI) may want to stress test specific categories of exposures of Irish banks to both the U.S. and the U.K. Even though linkages with the U.S. do not come out strongly from aggregate consolidated balance sheet exposures, there might be derivatives or other off-balance sheet exposures that the bank supervisors may need to be vigilant of. The Irish authorities may need to collect more information about types and counterparties of derivative positions and risk transfers through structured products of Irish banks, as the use of these is likely to grow rapidly in the future. This would especially be necessary if Irish banks are buying CRT products from foreign banks (that is selling risk protection) that are in turn exposed to property markets or other loan products in the U.S. or the U.K., thus exposing the Irish banks to these markets even though there is no direct loan exposure.”

Sounds like a warning against Irish banks exposures to lending against the US-based property? Oh, no – not at all. In fact recall a basic stylized fact of mortgages finance – in the long run (equilibrium) long term yields on Government debt and long term mortgage rates converge. Which means that if an Irish bank was underwriting an interest rate swap for the US SPV that purchased Irish bank’s securitised loans, then Irish bank was taking a position in providing insurance into the US interest rates environment.

The article – based on 2005 data – couldn’t have imagined what followed in 2007 and 2008. But, needless to say - judging by their staunch silence on the issue of derivatives and securitisation - our regulators didn't bother with the IMF warnings back then... and still are not bothered by them...


Update: It is worth noting that today the EU Commission approved measures for AIB, Anglo and INBS (details here) that include "a guarantee covering certain off-balance sheet transactions" - a code name for things like securitisations and derivatives...

Economics 21/12/10: Derivatives hole?

Updated (end of post)

The following post is attempting to put some numbers behind a highly uncertain, opaque and completely under-reported side of the Irish banks operations - the side relating to securitisations and derivatives exposures. My numbers below are pure estimates and their objective is to at least start raising the questions as to the depth of our (taxpayers) exposure to this murky world of banks' securitised assets.

Before we begin, I must also relay my thanks to Brian Lucey and 3 anonymous experts for providing advice and comments on the earlier draft and to LorcanRK who was involved in trying to scope the problem earlier.


Years ago, before our sick puppies (banks) became sick, in the golden days when the Anglopup, AIBickey, permo, INBiSquit, EBSsie and BofIpooch were still wagging their happy tails around the streets of Dublin, securitisation was all the rage.

The basic idea behind this transaction runs innocuously enough as follows: a bank holds a bunch of loans, say mortgages. These yield an annual revenue stream, but hold up capital, restricting new lending. To help unlock this capital, a bank can package these loans together and sell them to an SPV which will issue a paper security against these loans that entitles the owner to a share of the total package of loans as they yield returns over time. An SPV, of course, doesn’t manage the mortgages but leaves them in the custody of the bank which acts as a manager/custodian, responsible for collecting the moneys due and paying out to the SPV.

Now, for a bit relevant to us: an agreement between the SPV and the custodian has two key covenants:

1. loans are held by the custodian in trust, so that the custodian is obliged, upon either the termination of the management contract or should other covenants be breached, to deliver the actual loans/mortgages to the SPV owner;
2. ability of the custodian/manager to hold on to the loans is subject to a minimum credit rating, usually - investment grade.
   

The first point means that should an SPV ask an Irish bank for its loans (due to a breach in its covenants), the banks must deliver these loans.

The second point means that if the covenants are breached, by, say for the sake of argument, Irish banks rating sinking to junk, the banks can be found in a breach of covenants and face:

• a margin call – according to my sources, of up to a whooping 20% face value of the securitized loans in some cases; and/or
• a call on the actual loans to be transferred to a different manager/custodian nominated by the SPV

Every securitized contract runs alongside it a derivative security designed to protect against the risk exposures relating to the loans.

These derivatives can be

• symmetric – covering both sides of the potential exposure – e.g. interest rates swaps going both ways or
  
• asymmetric or uni-directional, covering only one side of the risk exposure (e.g. an interest rate swap insuring against a future rise in the interest rates).
  

The derivatives can be written by an independent entity or by the bank, but for the reasons of good risk management (maturity mismatch risk and direct exposure to underwriter risk) these derivatives should really be underwritten by the third parties, not the custodians.

Now, let’s go back to the history. Earlier this year, I wrote about our ‘national derivatives accounts’:

• AIB held the total derivative exposure to the notional value of €261bn in 2008 which fell to €197bn in 2009 (here)
• BOI held €360.5bn (here) in 2009
• Anglo held some €268.3bn worth of notional value derivatives in 2008 (here), falling to €184.5bn in 2010 (here)
  

The above is very close to the gross notional exposure amounts of €640 billion (for two banks ex-Anglo) reported in 2008 by the employee of the Financial Regulator - Grellan O'Kelly (here).

So now, suppose that the notional value reflects symmetric hedges, and even there, let's assume that directionality is such that benign risk is weighted by twice the weight assigned to maximum loss-linked risk, so that the underlying value of these derivatives is around 1/3rd of the €742.3 billion of notional value, or €245 billion.

Here is the beefy problem. Since these derivatives are written against real loans contracts, what happens if the covenants of the SPVs behind them are breached?

Let’s talk some hypotheticals (since we have no actual clarity on these):

• Scenario 1: Irish Government debt sinks to junk, which automatically means banks debt sinks to junk (while I was writing this, the latest Moody’s downgrade pushed it even deeper...). There’s a margin call on derivatives of say ½ of 20% mentioned above, or 10%. Oops – Irish banks are in a hole for up to 24.5bn off the starting line (10% of the 245bn above)
• Scenario 2: Instead of a call on the derivatives, SPV breaks management agreement with an Irish bank and asks for its loans to be moved out of the bank. Wouldn't be a problem, unless: what if the bank, in the mean time, has leveraged the same loans it held in custody for the SPV at the ECB (or CBofI or both) discount window? Well, should the SPVs insist, the Irish banks will be forced to buy their collateral out of ECB and CB of Ireland to the amount that the banks borrowed against such collateral.

Things are starting to smell rotten… But do not be afraid, those in charge who still have some brains left spotted the dodgy stuff. To our chagrin, however, the smart ones are in Frankfurt, not in Dublin. Back in August 2008, the ECB has pulled the plug on taking Irish banks-securitised loans as collateral. Miraculously, in the end of 2008, CBofI lent Anglo €10.5bn against some mysterious collateral that, several of my sources argued, was previously rejected by the ECB.

Why would the ECB decline to take securitised packages as collateral, while taking the loans? Surely this signals something is amiss with the vehicle of securitisation as carried out by the Irish banks?

Two things can be dodgy with the securitized packages in general:

1. Underlying derivatives, and/or
2. Security over the loans/assets that are securitized.
   

I am not going to speculate what it is – time will tell. Instead, let’s run through some scenarios on potential losses due to the above positions.

Assumptions:

• Assume that the above gross notional amounts of derivatives are 2/3 covering one side of exposure (e.g. expected increases in interest rates, for interest rate swaps) and 1/3 covering less expected opposite direction risk. This means that of the total values of derivatives written by the 3 banks, these derivatives were covering a collateralised pool of loans/assets equal to 1/3 of the gross notional derivatives.
• Now, some of collateralised assets were held by the banks themselves, but we do not know how much. So let’s assume that 25% and 50% are reasonable amounts for these shares, implying that banks sold on some 50% to 75% of the securitised assets
• Next suppose that the banks have written down these securitised assets by 20% (a gross overestimate, but let’s allow it to be conservative) and that the ECB has applied the usual 15% haircut in lending against the above writedowns
• Table below shows the estimates of potential losses

So the downside from the derivatives exposure and securitization can range between €12.25bn and €50.8bn.

Pretty wide.

Let’s take a look at the underlying assumptions. Running through the ‘What if covenants are breached?’ scenarios, one has to remember that many of the securitized loans borrowed against are related to more stable, longer-term mortgages. Since default rates across mortgages are lower it is highly unlikely that SPVs wouldn’t want to claim them out of the hands of the insolvent banks. This means that the 10% margin call on all loans scenario is highly unlikely to materialize. More likely – either the margin calls will be larger, or full call backs will be triggered. Which suggests that the range above more realistically should be expected around €17.15bn and €25.7bn.

Also, recall that Irish banks weren’t really at the races in speculating on financial instruments, preferring instead to speculate on property. This means that my assumption of 50% unidirectional net derivatives relating to property securitization is pretty conservative.

And remember that none of this has been factored by either the IMF or anyone else into the expected losses across the Irish banks. It hasn’t been incorporated into my earlier estimates of

• €67-70 billion total losses on NAMA, recognized losses and post-2010 commercial and investment books’ losses, and
• €9-11 billion total losses on mortgages post-2010, plus
• the lower €17bn figure as an estimate for the derivatives and securitization-related losses.
  

The total expected loss across the entire banking sector, net of recoveries might be as high as €93-98 billion. Or it might go as high as €107bn. And at this point, folks, even an old hawk like myself starts to feel scared.


Note: these are potential estimates. Given that we have been given no clarity as to the depth of securitisations, or the derivative instruments underlying it, nor do we have any idea as to what the banks have been doing with custodial-managed loans that relate to securitised products, one can only guesstimate - or speculate - as to the true extent of losses. I tried my best to be very, very conservative in the above, with my upper limit of factored estimate of €25.7bn in losses being below the average of the most benign scenario (€12.25bn) and the worst case scenario (€50.8bn). I was also very conservative in my assumptions. Note also that in the end, €17-25bn range of losses used in final estimate of the total cost of banks bailouts corresponds to just 2.29-3.37% of the notional value of all derivatives held in 2009 by the three banks.


Update: things are hardly trivial when it comes to potential securitisation-linked derivatives exposure. Back in 2007, the IMF has warned Irish regulators that:

“BoI has transferred the bulk of its domestic residential mortgage assets to a designated mortgage credit institution, which has a banking license to issue mortgage covered securities.—these are used both for hedging interest risk and for generating additional funding. Almost 60 percent of these securities were held by other Euro Area members, while 25 percent was held in USD by other countries. (IMF WP/07/44: External Linkages and Contagion Risk in Irish Banks, by Elena Duggar and Srobona Mitra - here)

Did IMF say 'the bulk'? So as of 2006-2007, the bulk of mortgages were out to securitisation in a 'conservatively' run BofI?

Economics 14/12/10: ECB/CBofI Ponzi schemes

Last week's ECB figures show that the Irish banks have managed to rake up €136bn worth of borrowing from Frankfurt as of November 26th. This is an increase of €6bn on end-October figures. Mysteriously little? Not really - Irish banks have also borrowed some €45bn from the Central Bank of Ireland - a rise of €10bn on October.

The reason for such a dramatic increase in borrowing from the CBofI instead of ECB is two-fold:

1. ECB is becoming increasingly reluctant to lend to the Irish banks, and
2. Irish banks have run out of suitable collateral to pawn at the ECB discount window.

Which, in turn, means 2 things.

Firstly, Irish banks demand for borrowing is not abating despite Nama and other measures undertaken by the Government. Injecting quasi-Governmental paper into banks balancesheets has meant that the banks face immediate loss without any real means for covering it (remember, they can't really count on selling Nama bonds in the market without incurring an extremely steep discount on the value of these notes). Swapping nearly worthless paper for almost totally worthless loans is not doing the job and the entire banking system simply sinks deeper into debt.

Secondly, Irish banks have now uploaded some €45 billion worth of useless paper (that even ECB is unwilling to accept) into the Central Bank of Ireland. How much of this paper is loss-generative and are we, the taxpayers, on the hook for these losses, should the whole pyramid scheme go belly up?

Oh, and in case you wonder - ECB's equity funds are €5.8bn. It's lending side is over €200bn (it was €139bn total - banks lending & sovereign bonds inclusive - as of the end of December 2009), so as a bank, ECB's 2009 leverage was 24 times. Now, it is closer to 35 times. Lehman Bros territory, folks.

Economics 6/12/10: IMF stress tests for Irish banks

Here are three things that are worth asking about the latest details of the EU/IMF 'rescue' package released over the weekend. All relate to the issue of banking sector restructuring:

1. According to reports, some €2 billion will be available to enable the banks to sell €20 billion worth of assets (which, of course, implies sales of performing loans, as all other assets, such as foreign divisions, auxiliary services providers, asset management branches etc have already been flogged or put on the market). As reports issued today specify: the funds may come in the form of a loss protection or as a guarantee for asset purchasers. These €2 billion come on top of the €10 billion set aside for the immediate re-capitalization of the banks, and on top of further €25 billion in contingency funding allocated. So it appears that it either comes from the Exchequer side of the EU/IMF deal, reducing deficit financing available to the Government or, alternatively, on top of the €67 billion in lending extended under the whole deal. In effect, the EU/IMF will now engage Irish taxpayers funds (remember - these €2 billion are loans) to sweeten the bitter pill for buyers of Irish banks assets. A small, but lovely morsel of taxpayers income that will be spent on artificially propping Irish assets for sale.
   
2. According to the Irish Times, stress testing scenarios deployed by the IMF in pricing the overall demand for taxpayers funding for the banks involved the following assumptions: losses of 10% on buy to let mortgage books and 6.5% for residential mortgages. These assumptions underwritten the demand for €25 billion in contingency funding, spread as €15 billion in required capital, plus €10 billion additional cushion. This is rather interesting and worrying. Buy-to-let mortgages are most certainly completely under water right now, given collapsed rents and capital values, as well as more recent vintage of these mortgages. If investment and commercial books are facing up to 35-40% losses currently (as consistent with the Government own estimate of €50 billion final cost of banking sector recapitalization), is it safe to assume that buy-to-rent mortgages will tank at 10%? Similar questions arise with respect to 6.5% assumption on mortgages defaults. In fact, we already know that over 100,000 mortgages are either in official distress or under renegotiated repayment holidays or interest rates adjustments. This pushes the effective default and at-risk of default numbers will in excess of 6.5% as of today.
3. If contingency fund of €10 billion were to be taken as covering any losses in excess of 6.5% defaults on mortgages and 10% default on buy-to-rents, then this amount is expected to cover: (1) Haircuts by Nama on additional €14 billion in loans transfers (cost ca €6-7 billion at past haircuts), plus (2) Losses in excess of assumed rates on mortgages and buy-to-rents, plus (3) any further losses on investment and development books, plus (4) any further losses on derivatives exposures. This is hardly realistic of a cushion. So it appears that the IMF was either not given the full realistic picture of the Irish banks balance sheets, or it is seriously underestimating the demand for future losses cover in the banks.
   

Either way, the numbers continue to suggest that the €67 billion package of loans will not be enough to provide simultaneously a cover for Exchequer deficits and the funds required to underwrite losses and capital requirements of the banks. Somehow, the Irish Exchequer will have to make up for this shortfall.

Economics 5/12/10: Reserves requirement ratio

In response to the following tweet:

"A question. You wrote here http://j.mp/eL9QWg that the decision of the Chinese government to raise reserve requirement ratio for the commercial Chinese banks in order to cut down on their lending as "monetary tightening".

According to this article by Phillippe Legrain

http://j.mp/hnSF9w

The Republic of Ireland could have taken similar measures during the past decade to cool down the property bubble but didn't.

I thought after European monetary union, a monetary option wasn't open any more to the Republic of Ireland.

Yet what you described as "monetary tightening" in China was possible in the Republic of Ireland according to Phillippe Legrain."

My view on the topic: Legrain is correct.

As a member of the Euro zone, Ireland retained full control over one of the tools of monetary policy, known as 'reserve requirement ratio' - or capital requirement ratio. Irish regulators (CBFSAI) has a full right to increase requirement on the banks operating in Ireland to hold the proportion of their deposits and/or proportion of their loans in reserves as capital to cover any expected losses.

Such an increase in the ratio would have reduced amount of credit available in the system and would have offset the dramatic increase in lending spurred on by the introduction of higher risk products such as 100% mortgages.

At a dinner event in 2006 I told, at the time, Governor of the Central Bank of Ireland that this is exactly what he needed to do to cool down the market for mortgages lending in the Republic. His reply was along the lines that this was politically impossible to do.

That this lever of policy is still available to Ireland is best illustrated by the two recent decisions by the new Financial Regulator to hike capital requirement ratios for Irish banks to 8% Tier 1 and most recently to 12%. Unfortunately, this decision came too late.

Were Irish banks required by the CBFSAI to hold, say 12% of their risk-weighted assets in form of capital, the taxpayers would have seen their total exposure to the banking crisis significantly reduced. Instead of ca €16.2 billion in capital available to cover writedowns against the total lending of €360 billion across our banking institutions, our banking system would have had ca €34-35 billion in capital cushion against lending of €280-290 billion. (Note: these are back of the envelope calculations, but they still show the impact of raising reserve requirement ratios).


PS: for those of you who missed an excellent PIMCO note on Irish situation and EU's 'solution', here's a link. (Hat tip to Georg)

Economics 5/12/10: Default, debt and 'Rescue of Ireland' deal

Today's Sunday Independent article on inevitability of default, with comprehensive figures on the impact of the IMF/ECB/EU deal for ordinary Irish households and the levels of our indebtedness. Link here.

Economics 5/12/10: Links to recent articles on irish economy

Here is the link to my article in Saturday Irish Independent on the topic of FG and Labor 'alternative' Budget 2011 proposals: here.

Here is the link to another article from Saturday, this one from the Irish Examiner on the topic of banks debt default as an option for Ireland: here.

Economics 22/10/10: Bailout that is losing steam by an hour

The immediate fallout from the Irish bailout package is:

• short sales closing on Irish sovereign markets means profit booking, yields down (although surprisingly slightly -0.323%)
• Germany gets relief (Irish-German spread is actually up 0.503%) and
  
• short seller moving on to new targets: the rest of the PIIGS:

Makes you wonder if Portugal, Italy and Spain bonds brokers have been pushing their clients into losses as hard as our own did...

Contagion is clearly far from over, which simply exposes the fact that EU's EFSF and IMF short-ending for the insolvent sovereigns is not a solution to the PIIGS problems and that the EU has no plan B.

Economics 21/11/10: How much funding will we need?

I've run through some figures for the expected amount of bailout drawdown for Ireland. Here are the sums:

• 2011-2014 deficit financing: €17bn in 2011 (accounting for expected increase in interest payments), €16bn in 2012-2014 annually (allowing for €15bn adjustment in 2011-2014 framework to be published by the Government) = €65bn
• Banks capital demand: €37bn in residual capital losses including Nama and incorporating expected mortgages defaults of €12bn
• Bonds redemptions forthcoming (hat tip to Brian Lucey): commercial paper =€ 6.4bn in 2011, redeemable out of IMF loan and thus non-replicative over 2012-2014, bond issues €4.4bn in 2011, €5.6bn in 2012 and €6bn in 2013, to the grand total of €22.4bn
• Banks liquidity supply - immediate draw on IMF funds - €28-35bn

Adding these up: total demand for funds in the amount of €152.4-159.4bn

Government has available ca €20bn (nominal) reserves from NTMA and ca €12bn in liquid funds from NPRF that can be accessed, implying net demand on IMF/ECB funding is €120-127bn.

Assuming the expected haircut on all bondholders in Irish 6 covered institutions implies additional savings of ca €10bn not factored in the above. However over the years 2012-onward I expect Nama to start showing losses. In addition, I suspect that the Exchequer will have to cover losses in the Central Bank of Ireland relating to their lending to the Anglo, which can be in excess of €10bn.

Interest charge on the IMF/ECB loan is likely to be around 5%, providing for a demand for €6bn in annual interest repayments.

Economics 2/10/10: Brian Lucey's comment on Minister Lenihan's statement

In rare occasions, I re-print here some comments made available to me by other economists and analysts. This is the full text of Professor Brian Lucey's comment in yesterday's Irish Examiner (not available on the newspaper website):

"THE Government yesterday engaged in a series of interventions, announcements, and actions which in my opinion have brought the prospect of an intervention from the IMF or the European Union significantly closer.

The major announcements were threefold: the announcement of the losses of Anglo, the bombshell in relation to Allied Irish Banks, and the startling admission that the Government was voluntarily withdrawing from international markets. Let us examine all three of these.

In relation to Anglo Irish Bank, we finally begin to see clarity and reality from the Government; for the first time in two and a half years estimates begin to overlap. The worst-case scenario that the Government has put forward is that Anglo will lose €35 billion. This is the average estimate. We must take this government figure with a very large pinch of salt. The Government over the last two years has given us at least four “final” figures for the total cost of Anglo. God be with the days when it was only €4.8bn. It remains highly likely in my view and in the view of independent analysis external and internal to the country, that the Anglo losses could stretch towards €40bn.

That is an eye-watering amount of money, equivalent to nine months’ total government expenditure. While this on its own is bearable, what is unbearable, and should not be borne, is that once again bondholders take precedence over citizens.

The only rationale for having such an extensive guarantee in 2008 was that over the period of time the banks would be cleaned of their bad loans, the banks would be cleaned of their bad management, and the bondholders would be dealt with. Subordinated bondholders should get nothing, senior debt holders should have been faced with a stark choice; either take an offer of perhaps 30 cent on the euro or take their chances on the market place. A debt-for-equity swap should also have been considered.

On all three of these issues the Government has failed. We are told that instead of NAMA taking loans in excess of €5 million, it will only take loans in excess of €20m; this leaves a large amount of impaired and toxic loans on the balance sheet of the banks. It is these very toxic loans that imperilled the banks in the first place and which will make it next to impossible for the banks to engage in any meaningful credit creation.

As if Anglo were not enough, we are also told that AIB will require an additional €3bn. The state will end up with 70%+ ownership of AIB; this will rise as AIB will find it difficult to raise the required funds from the markets or from asset disposals and will consequently have to ask the taxpayer to invest further. The ludicrous situation is that the taxpayer will be taking ownership of a much weaker bank than had this been done two years ago. AIB has sold the jewel in its crown, the Polish operation, and is actively selling its US and British operations. We will own a bank which has sold off its profit-making arms and will be left with a carcass.

Finally, it appears, in so far as one can glean from the gnomic and somewhat confused utterances of Eamon Ryan, that the Government were told that the National Treasury Management Agency (NTMA) did not feel they could raise funds in the markets. The Government has therefore locked itself out of the markets until early 2011. Presumably, the hope is that by 2011 a miraculous change in Irish and world economic conditions will have occurred.

What remains absolutely unclear is what plans, if any, the Government has for a situation where in 2011 the NTMA finds it either impossible to raise funds or finds that those funds are prohibitively expensive. There are in excess of 5bn of Irish government bonds maturing in 2011, these will have to be rolled over or repaid. What if we cannot raise these funds?

In that case the Irish Government will have to raise funds from the International Monetary Fund or from European funds, and this of course ignores the tens of billions of debt which the banks have to roll over on a regular basis. In my view we have moved closer to the end game of losing national economic sovereignty.

Brian Lucey is associate professor in finance at Trinity College Dublin. "

Irish Examiner 1/10/2010

Economics 2/10/10: EU Commission official view of Minister Lenihan's plans

Much debate has been thrown around about the EU Commission position on the latest Government announcements concerning banks recapitalizations. Here is the fact (linked here) - note comments and emphasis are mine:

Full quote: MEMO/10/465, Brussels, 30 September 2010 "Statement by Competition Commissioner Almunia on Irish banks"

"European Competition Commissioner Joaquin Almunia welcomes the comprehensive statement issued by the Irish Finance Minister on banking. Commissioner Almunia said:

"I welcome the statement on banking which brings clarity with regard to the remaining transfer of assets to NAMA and the capital needs of some banks and building societies. [Note there is no finality assertion here on the estimates]. Regarding NAMA, the announced changes to the way it manages loans are in line with the Commission's approval of the NAMA scheme.

"Concerning Anglo-Irish Bank, from a competition point of view, it is clear that the foreseen restructuring and resolution of the bank addresses competition distortions created by the large amounts of aid at stake. Once the Commission receives the details of the plan, it will proceed rapidly towards taking a final decision. [The gombeens haven't yet supplied the Anglo Plan to the Commission, despite the claims made today on RTE Radio by Minister Hanafin to the contrary]

"I also welcome the announcement that subordinated debt holders will make a significant contribution towards meeting the costs of Anglo. This is in line with the Commission's principles on burden sharing since it both addresses moral hazard and limits the amount of aid, with benefits to the taxpayers. [So Commission operates under the direct assumption that subbies will be soaked. And that this will correspond to the spirit of the European common markets.]

"I note that Allied Irish Bank will need to receive further capital in the form of State aid, which will have to be notified to the Commission for approval. I will of course follow this process very closely. I have no doubt that, as in all previous cases, the collaboration between the Irish authorities and the European Commission will be satisfactory. [No blanket endorsement of new AIB capital injections]

"I note positively that Bank of Ireland will be able to continue the restructuring process without further recourse to State resources. The Commission in July 2010 approved the aid and the restructuring plan of Bank of Ireland, and is monitoring its implementation."

"With regard to building societies INBS and EBS, the Commission remains in close contact with the Irish authorities. For INBS, the Commission will await the notification of the additional capital as well as the details on the institution's future, and will assess them thoroughly and swiftly. For EBS, the Commission is in the process of finalising its initial assessment of the restructuring plan submitted end May 2010. "

So let's recap Commission's official opinion:

• Anglo subs must be haircut;
• No Anglo plan delivered to the Commission;
• No Anglo recapitalization additions endorsed;
• No AIB recapitalizations (announced by Minister Lenihan) are endorsed
• No INBS and EBS measures endorsed
  

Economics 19/9/10: Irish banks - Government intervention still has no effect

Returning to my old theme - let's take a fresh look at the Government and its policy cheerleaders success rate with repairing our banking sector. Here is a quick snapshot of history and numbers as told through the lens of Irish Financials index.
So clearly, we have some really powerful analysts out there and keen commentariat (actually one and the same in this case) on the future prognosis for our banks.

But what about recent moves in the index itself?
Take a look at the chart above, which maps the Financials Index for two subperiods:
Period 1: from Guarantee to March announcement of the 'final' recapitalization of our banks,
Period 2: from Guarantee to today.
Now notice the difference between two equations. That's right, things are not getting any better, they are getting worse.

Next, let's put some historical markers on the map:
Surely, our financials are getting better, the Government will say, by... err... not getting much, much worse. The reality, of course is, any index has a natural lower bound of zero. In the case of Irish Financials Index, this bound is above zero, as the index contains companies that are not banks. As far as the banks go, there is a natural lower limit for their share values of zero. Our IFIN index is now at 80% loss relative not to its peak, but to its value on the day of Guarantee!

Having pledged banks supports to the tune of 1/3 of our GDP already, the Government policy still has not achieved any appreciable improvement in the index.

Forget longer term stuff - even relative to Q4 2009, Government policies cannot correct the strategic switchback away from Irish banks shares that took hold:
A picture, is worth a 1000 words. Unless you belong to the upbeat cheerleaders group of the very same analysts who missed the largest market collapse in history, that is.

Economics 13/9/10: FT's belated recognition of Irish realities

In today's FT (here), Wolfgang Munchau clearly states that (emphasis is mine): "...Irish banking sector is insolvent, and there are questions about the capacity of the Irish state to absorb those losses. ...two years have passed [since the crisis acknowledgement by the state] and nothing has been resolved.

…As we saw last week, this strategy [of shoving bad loans under the rug via Nama and quasi-recapitalizations] came badly unstuck in Ireland. The Irish government massively underestimated the scale of the problem in its banking sector. On my own back-of-the-envelope calculations, the cost of a financial sector bail-out may exceed 30 per cent of Irish gross domestic product, if you make realistic assumptions about bad debt write-offs and apply a conservative trajectory for future economic growth.

[Note: this blog has previously (here), on a number of occasions estimated the overall impact of the net losses realized by the banks to Irish taxpayers will be in the region of €62-75 billion, inclusive of Nama. Based on the Department of Finance own figures, this can be expected to amount to 38.5-46.6% of Ireland’s 2010 GDP or 48-58.1% of our GNP. Either range of numbers is significantly in excess of Munchau’s back-of-the-envelope estimate.

However, even at 30% of annual GDP, the expected hit on this economy from the banking sector debacle is simply insurmountable.

No economy on earth can be expected to withstand a 30% contraction in its GDP over two-three years, while still running a 7-8% of GDP structural deficit in every one of these years. The insolvency of Irish banks recognized by Munchau, therefore, automatically implies the insolvency of our economy, unless the banks are isolated from the rest of our economy by a removal of the blanket guarantee on the bondholders, while retaining a guarantee on depositors.]

Munchau goes on to say that: “We know from economic history that countries enter into longish phases of stagnation after a financial crisis.

[My estimates based on the IMF and OECD models of fiscal and financial crisis imply that Ireland can expect at least another 33 quarters of continued crisis pressures in Exchequer finances, house prices and asset markets, as well as a permanent decline in the potential rate of economic growth to below 1.5%]

Ireland suffered an extreme crisis. In the light of what we know, the safe assumption to make for Ireland – and Greece – is that there will not be much nominal growth in the next five years. If you make that assumption, you realise Greece will almost certainly not be in a position to repay its debts. While Ireland’s situation is marginally better, there are justified doubts about the country’s long-term solvency.”

[The above are not some idle words. They are, as I mentioned early, fully in line with the existent econometric models of crises based on historical experiences in the advanced economies in the past.]

Per Munchau: “….In Ireland, the cure would consist of nationalisation and wiping out the bondholders of Irish banks through bond-to-equity conversions.”

[Needless to say, since April 2008 I am on the record – in the press, media, on this blog, in public meetings and private briefings to the policymakers – these are exactly the first steps that need to be taken in order to begin – note, just to begin – the process of restoring order to our banking system. Irony has it – on a number of occasions, I have written to the Financial Times precisely about these issues, raised by Mr Munchau, with, needless to say, not a peep back from the broadsheet offices].

Economics 31/8/10: IL&P reporting

The ‘healthiest of the sick’, IL&P reports its numbers today. Here are the headlines:

• Operating loss is €10mln in H1 2010, down from a loss of €51mln H1 2009 – causes – lack of further deterioration on 2009 figures on the bank side and serious gains on the life insurance side.
• Operating profits on the life side are €92mln (up from €84mln in H1 2009)
• Bank operating loss of €131mln – equivalent to that in H1 2009. Its clear that 'healthy' IL&P is bleeding heavily on ptsb side.
• Ptsb is one of the largest mortgages lenders in the country, so their mortgages book should be – on average – performing above other banks. Here are some data: arrears > 90 days to the end of June 2010 in Irish residential mortgage book increased to 5.2% of the portfolio (H12009 figure was 3.9% so there was a significant jump). Non-performing mortgages are at 6.9% of the total loan book, up on 4.9% at the end of H2 2009. 32% of arrears cases are related to 100% mortgages – a predictable result as (a) 100% interest-only mortgages are of more recent vintage, hence written against younger families with higher probability of unemployment, and (b) these types of mortgages are more likely to involve purchases of buy-to-rent properties .
• Bad debt provisions are at €150mln compared with €189mln in H1 2009, highlighting the fact that more realistic provisioning earlier in cycle usually helps to underpin the book better than the AIB-style denials. Overall provisions balance is up €141mln to €618m.
• Margins are down to 0.81% (2009 full year margin was a poor 0.83%) despite hikes in the mortgage rates.
  
• As IL&P needs to raise ca €1.3-1.8bn more in bonds (good luck to them trying), higher cost of borrowing is going to further depress margins. So expect even more mortgage rates hikes from IL&P in months ahead. The bank has currently a €8 billion reliance on the ECB, unchanged. Hefty for a minnow.
• Bank’s loan to deposit ratio was down to 240% from 246% - far, far away from the prudential banking model that would imply LTDs of 95-100%.