15/7/2014: Covenant-lite Debt Mountain & the Great Unwinding...

Recently, I wrote about IMF findings that the corporate and household debt mountains in the euro area remain unaddressed. Here is the World Gold Council chart on issuance of new covenant-lite corporate debt in the US:

The new age of complacency is emerging, defined by the ease of debt raising and low volatility:

Which, of course, can mean only two things:

1. There will be reversals out of status quo.
2. Low volatility implies reduced returns on investment and capital. This, in turn, implies lower investment and capital, which means lower growth and higher inflation into the future

With a caveat that we do not know the timing of the above changes, one has to keep in mind that the longer the status quo pre-1&2 remains in place, the worse 1&2 will be.

So there it is, a set up for gradual, painfully stagnant and prolonged unwinding of the extraordinarily accommodative monetary policies of the recent past...

14/7/2014: Some Facts on Web-Enabled Russian Consumers

Some interesting data from Google on internet-enabled consumers in Russia:

14/7/2014: As Far As Debtor Nations Go… All That FDI

There are more interesting revelations in the IMF survey of the Euro Area when it comes to Ireland. Let's imagine what we think of the Emerald Isle… no, not Guinness and not music or the Temple Bar… let's think of FDI. 

• It is huge, right? Right. 
• It is a marker of huge source of our success, right? Right-ish. 
• It is making us richer as a nation, right? Err…

Ok, IMF provides a neat table summarising euro area economies as net creditors (the ones for which Net Foreign Assets held in the economy - private and public - are positive, so the world 'owes' them and associated with this, they have a positive, with exception of Malta, current account, averaging over 1999-2013) and debtors (the ones for which Net Foreign Assets are negative and so they owe, net, to the world, with their current account balances being negative on average over long period of time).

So Ireland is FDI-rich - we have lots of foreign assets that we can call upon as ours, right? Hmm… judge by the table:

And now notice two things:

1. Our Net Foreign Assets position is a whooping -105% of GDP, less disastrous than that of only two other countries: hugely indebted Greece and heavily indebted and less open Portugal;
2. Our current account averages at a deficit, of -0.6% of GDP which is benign compared to all other debtor economies, but that said, even at the best performance (maximum) we have generated a current account surplus of just 3.1% of GDP which is… no, not spectacular… it is ranked tenth in the euro area.

Do tell me if this consistent somehow with the evidence that Ireland's external balances are strong indicators of our economy's structural successes, as Irish and Brussels analysts are keen claiming?

But IMF soldiers on. In the following table in the same report it shows us the Average Real Return Difference between Foreign Assets and Liabilities Euro Area Economies. Now, what should we expect from our successes with FDI? That returns to assets inside Ireland should be in excess of returns on Irish assets held abroad. We are, after all, more successful in using investment (FDI) than other countries. What do we get? Exactly the opposite:

Note per above, our real return difference is a whooping 2.8 percentage points - largest after Greece and Slovak Republic. We know what is happening in Greece's case, but what on earth is happening with Slovak Republic case? Why, the same thing that is happening with Ireland: exports of returns via FDI.

So the above simply means we pay more on our liabilities than we get from our assets. In household finances sense... we are going broke...

Is this a problem? Why yes, it is. Here's IMF: "On average, many creditor economies saw negative real return differences between their foreign assets and liabilities, acting as a drag on their net foreign asset positions and also suggesting possible gains from portfolio rebalancing, either by shifting away from foreign towards domestic assets, or by changing the composition of their foreign assets and liabilities, away from euro area debtor economies. At the same time, many debtor economies had large negative real return differences on average, reinforcing their large net foreign liability positions and making adjustment more of an uphill climb."

That said, things are improving - our current account is now in stronger position than in the 2002-2007, but that is largely because of our consumption of imported goods dropping. Still, things are improving...

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

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

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

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

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

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

13/7/2014: Up, Down the Current Account Ladder

For quite some years now, Irish Governments have been keen promoting Ireland's 'unique' external balances performance that, allegedly, made us so distinct from other 'peripheral' countries. Our external balances were booming, we were told by the Government. Ireland's external surpluses are its unique strength, said the boffins at the Brussels think tanks. We are not like Portugal or Greece or Spain when it comes to the 'real' 'competitive' economy.

The hiccup of course, is that this rhetoric was ignoring few little pesky facts, such as the source of our external trade 'competitiveness' or the shifting composition of our trade. Nonetheless, it had some teeth: we started with a much higher base of exports in the economy and stronger external balances than other 'peripheral' states.

Still, in the world of crisis-related 'adjustments', the rate of change matters as much as the starting levels. And judging by IMF data, our rate of improvement in external balances is not that unique:

Per chart above, trade-attributed current account adjustments (the pink bar) for Ireland are higher than for any other peripheral economy. But net adjustments (accounting for income and transfers) are only third highest. This, in part, is due to the fact that vast majority of our exports are supplied by companies that increasingly ship more profits out of Ireland (and this is even worse if we are to account for profits temporarily retained in Ireland by the MNCs).

Still, good news: our trade balance is doing well. Better than any other 'peripheral' in the sample...

13/7/2014: Household Debt Mountains

In the earlier post (here) I covered IMF data on Non-Financial Corporations debt, comparing Spain and other 'peripherals' with Ireland. And here is one other comparative: for household debt

I know, I know... it doesn't matter, really, that households are being tasked with funding Government debt first, their own debt later. All is sustainable...

One caveat: per my understanding, the above does not include household debts transferred to investment funds, as data for Ireland comes from ECB, which does not include data not covered by the CBofI, which does not include household mortgages and other debt sold to institutions not covered by the banking licenses in Ireland. So there, keep raising taxes and reporting higher revenues as a 'success' or 'recovery'... because household debt does not matter... until it matters...

13/7/2014: Ireland v Spain: Property Markets Signal Fundamentals-Linked Growth Potential

Two charts showing why Ireland can expect more robust correction in the property prices post-crisis trough:

First, investment in new construction:

The above shows that Irish construction investment dropped more significantly than in the case of (relatively comparable) Spain. This implies that we have been facing longer and deeper reductions in new stock additions than Spain, implying greater pressures on new supply.

Second, House Price to Income ratios (ignore caption):

Irish property prices have fallen more relative to income than Spanish prices. Which implies that penned up demand is greater in Ireland.

So there you have it, two (not all, of course) fundamentals driving prices recovery up in Ireland and both have little to do with the potential bubble dynamics.

Note: above charts are from IMF's Article IV Consultation Paper for Spain.

13/7/2014: Deflating That Corporate Debt Deflation Myth

This week, the IMF sketched out priorities for getting Spanish economy back onto some sort of a growth path. These, as in previous documents addressed to Irish and Portuguese policymakers, included dealing with restructuring of the corporate debts. IMF, to their credit, have been at the forefront of recognising that the Government debt is not the only crisis we are facing and that household debt and corporate debt also matter. As a reminder, Irish Government did diddly-nothing on both of these until IMF waltzed into Dublin.

But just how severe is the crisis we face (alongside with Spanish and Portuguese economies) when it comes to the size of the pre-crisis non-financial corporate debt pile, and how much of this debt pile has been deflated since the bottom of the crisis?

A handy chart from the IMF:

The right hand side of the chart compares current crisis to previous historical crises: Japan 1989-97; UK 1990-96; Austria 1988-96; Finland 1993-96; Norway 1999-05; Sweden 1991-1994.

So:

• Irish corporate debt crisis is off-the-scale compared to other 'peripherals' in the current crisis and compared to all recent historical debt crises;
• Irish deflation of debt through Q3 2013 is far from remarkable (although more dramatic than in Spain and Portugal) despite Nama taking a lion's share of the development & property investment debts off the banks.

Now, remember the popular tosh about 'debt doesn't matter for growth' that floated around the media last year in the wake of the Reinhart-Rogoff errors controversy? Sure, it does not... yes... except... IMF shows growth experience in two of the above historical episodes:

First the 'bad' case of Japan:

 So no, Japan has not recovered...

And then the 'good' case of Sweden:

Err... ok, neither did Sweden fully recover... for a while... for over a decade.

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

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

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

11/7/2014: BlackRock Institute Survey: EMEA, July 2014

BlackRock Investment Institute released its latest Economic Cycle Survey for EMEA region.

Per BII: "With caveat on the depth of country-level responses, which can differ widely, this month’s EMEA Economic Cycle Survey presented a mixed outlook for the region.

The consensus of respondents describe Russia, the Ukraine and Croatia be in a recessionary state, with an even  split of economists gauging Kazakhstan and South Africa to be a in a recessionary or contraction. Over the next two quarters, the consensus shifts toward expansion for Kazakhstan and South Africa.

Note: Red dot represents Czech Republic, Hungary, Romania, Israel, Slovenia, Poland and Slovakia

At the 12 month horizon, the consensus expecting all EMEA countries to strengthen or remain the same with the exception of Russia, Kazakhstan, Turkey, Hungary and the Ukraine.

Globally, respondents remain positive on the global growth cycle with a net 85% of 34 respondents expecting a  strengthening world economy over the next 12 months – an 14% increase from the net 71% figure last month. The consensus of economists project mid-cycle expansion over the next 6 months for the global economy."

Note: these views reflect opinions of survey respondents, not that of the BlackRock Investment Institute. Also note: cover of countries is relatively uneven, with some countries being assessed by a relatively small number of experts.

11/7/2014: Notes on German ESM vote

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


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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

11/7/2014: My comment on Greek and Portuguese bonds pressures

Portugal's Expresso on Greek and Portuguese bond yields with my comment: here.

My full comment in English:

In my view, we are seeing a strong reaction by the markets to adverse news relating to some peripheral euro area countries. 

In the Greek case, much of the rise in bond yields can be attributed first to the persistent uncertainty over the deficit adjustments and the progression of the reforms. The most recent suggestions by some analysts that Greece may require additional EUR2-3 billion over 2015-2016 relating to the news that the country pension fund is now facing an annual EUR2 billion funding gap have triggered some pressure on the country sovereign debt. This was compounded by thin and nervous markets for today's issuance of EUR1.5 billion bond which originally attracted just over 2.0x cover, but saw final demand slump somewhat on generally negative sentiment in the markets. Today's bond was priced at a yield of 3.5% with guidance between 3.5% and 3.625% issued two days ago on Tuesday. This is below the April 2014 5-year bond issue - the issue that attracted EUR20 billion worth of bids and was priced at 4.95%. However, shortly after the issue, secondary markets yields on April bond shot up to 5.10%.

In Portugal's case, the core risk trigger so far has been building up of pressures in the banking sector, and in particular in relation to Espirito Santo International announcement on Tuesday. This pushed Portuguese yields above 4% for 10 year bonds in today's trading. 

Portuguese risks have also put a stop to Banco Popular Espanol contingent convertible bond issue, as well as Spanish construction company ACS plans for an issue.

All in, Greek 10 year bonds closed at 502.0 spread to 10 year German bund up 20.4 bps on yesterday, Portugal's at 276.2 up 22.3 bps, Spanish at 161.8 up 9.2 bps, Italian at 174.1 up 9.3 bps, and Irish at 112.7, up 4.4 bps.

Spreads on 10 year German Bund:

The markets instability is a reminder that while current monetary and investment climates remain supportive of lower yields, markets are starting to show increasing propensity to react strongly to negative newsflows. Investors' view of the 'peripheral' states as being strongly correlated in their performance remains in place, especially for Spanish, Portuguese and Greek sovereigns and corporate issuers. 

The markets are jittery and are getting trigger-happy on sell signals as strong rises in bond prices in recent months have resulted in sovereign and corporate debt being over-bought by the investors. These investors are now staring into the prospect of gradual uplift in US and UK interest rates, weakening of the euro and thus rising cost of carry trades into the European sovereign bonds. At some point in time, these pressures are likely to translate into earlier investors in 'peripheral' bonds starting to exit their positions. 

We are not there yet, but market nervousness suggests that we are getting close to that inflection point.