Economics 29/09/2009: Nama Trust Full Costs

Full balance sheet for either a 'nationalization option' or my Nama Trust idea is here, now with bonds figures (courtesy of Peter Mathews):

Economics 29/09/2009: Socialism is Bad for Your Health

International health services ratings 2009 Euro Health Consumer Index (EHCI) were published today. These provide comparisons for a number of EU countries, plus Switzerland and Canada. Tables below show Irish performance over 2006-2009 in the rankings and the performance of our closest peers - small European economies.

Summary of overall performance:
Before looking at the tables, here are some facts:

• All leading healthcare systems (top 4 in the table) have separated provider of services (mixed models of private, publicly-owned but independent, locally-owned & non-profit) from payee (state) for services.
• Of top 10 performers, 5 have fully separate functions of service providers and payees for service, 3 others have a mixed system. In contrast, Ireland has not even a mixed system, with all primary, emergency and non-elective medical service providers being captured by the state.
• Ireland is ranked a lowly 14th this year, although it is a marked improvement on the past years performance (see below).
• Fully nationalized system of healthcare practiced in Canada scores marginally worse than Ireland in patients rights and access to information. Only Latvia, Portugal, Romania and Spain score worse or equally poorly as Canada in this area.
• Canada scores worse than Ireland in waiting times for treatment. The only other country that scores as poorly as Canada in this area is Latvia.
• In terms of healthcare system outcomes (designed to gauge basic treatments effectiveness), Canada scores as highly as Ireland, with both countries ranked between the 4th and 8th places.
• In terms of range and reach of health services provided within the system, Canada (100) scores marginally above Ireland (92), with Canada ranked between 12th and 14th places, while Ireland ranks between 15th and 22nd places.
• In terms of access and quality of pharmaceuticals within the system, Canada ranks between 26th and 27th. Ireland ranks between 2nd and 8th.
• Thus, contrary to the noise about 'socialised medicine for Ireland's future' movement within Irish Left, global data shows year after year, that using objective criteria, socialised medicine is bad for your health.

Now more detailed tables compiled by me from previous years' reports:

Economics 28/09/2009: Aggressive pre-Nama re-writing of loans?

Corrected version (hat tips to Adrem for correcting my math and for suggesting a good question to follow up on)


So I was told today, by a senior banker, that banks have been actively re-writing non-performing loans (since at least April this year) under new contracts with extended principal and interest holidays in covenants. These, in preparation for Nama, are priced at higher rates so they can get more on the loans once Nama discount applies.

This makes sense.

Do the math - assume:

• 20% cross-collateralized Euro100mln loan (see explanation of this below), written in 2006
  
• 3 years rolled up interest at 19.1% accumulated at 6% pa - which gives us loan face value at placement on the bank watch list of Euro119mln
  
• New covenants set in April 2009 at 9%pa, with no interest yield or principal repayment required for the next 3 years.
  
• On the date of Nama initiation, then, the loan is performing with expected yield of 9% on Euro119mln.
  
• Now, suppose the LTV ratio of the loan is 75% of principal (meaning the value of the underlying collateral was 133mln in 2006)
  
• Assume that collateral value has fallen 30% (an under-estimate to be palatable to all optimists out there), which means that with 20% cross-collateralization writedown, plus 2% inflation annually since 2006 (cumulative inflation discount of 6.1%) collateral now is valued at 63mln,
  
• By the time new covenants on the loan kick in in 2011, the rolled up interest on the loan and principal will mean total loan value will be roughly Euro 154mln.
  
• Now, to break even on this loan Nama will have to pay 1.5% interest charge on bonds, plus 0.5% management cost (including bank fees), implying that 3 year average mark-to-market writedown (at 2% pa or 6.1% cumulative) plus inflation at 1% pa on average (3% cumulative) is (1-63mln/154mln*0.91)*(100%)=62.7% (assuming no growth in the property market between now and 3 years from now).
  

Remember that figure in the Irish Times article signed by 46 economists, including myself? It stated that the real value of 90bn worth of distressed loans is around 30bn. That implied a mark-to-market writedown of just 67%! When published it caused Garret Fitz to go ballistic and the entire pro-Nama crowd to shout "Extremists are at the gates!" Not that far off from 62.7%.

Of course, this is an illustrative example. But notice that it assumed very modest decline in underlying assets value (30%) to date, plus a very generous (75%) LTV ratio. House prices alone are already down by more than 30% from the peak.

Challenge the rest of my assumptions?

Whether you do or not, one thing is clear - if you are a bank you had no incentive to manage your stressed loans since the very least this April. And you had a massive incentive to push up the face value of the loan without forcing it to become non-performing. The latter can be done by re-writing the loan with new roll up covenants.


Cross-collateralization:

Banks gave multiple loans on same properties in several forms -

1. most commonly, a property was valued several times consecutively and whatever capital gains accrued on the property, these gains were re-mortgaged under new loans;
2. also commonly, capital gains were priced out of new building permits being extended to the properties. I am aware of several cases of mega deals (hundreds of millions borrowed) where a developer/investor bought a site with the site itself being collateralized for this first round of borrowing at the market value, then rezoned it, taking out a new loan against the site value after rezoning in excess of original loan, then obtained a planning application and re-collateralized the site again;
3. less commonly, the banks simply did not check if a collateral property has already been pledged elsewhere.
   

What happens here then?

Suppose a site was bought for 100mln at 75LTV, so that the developer borrowed 75mln for it. New zoning applied lifting the site value to 200mln, providing another 75mln loan facility at 75%LTV on 200-100mln capital gains. The building permission was then granted that, say lifted the site value to 300mln, and a new loan was taken out at 75LTV. Total value of the site was 300mln. Suppose each step in borrowing and capital gains took 1 year (a very short period of time), suppose interest rate was 5%. This means that:
Loan 1 now totaled Euro83mln
Loan 2 now totaled Euro78.8mln
Loan 3 now totals Euro75mln.
At loan 3 origination, LTV ratio on the entire site was 236.8/300=79%.

I assumed in my calculations on the blog that 20% of loans are written against sites that are cross-collateralized - so that other banks hold claims against the same site.

This assumption is based on a guess. It can be challenged if someone has any evidence on better numbers.

Now, that means in example above that some 20% of the site value was cross-collateralized with another bank. If it was the first loan that was cross-collateralized, LTV rises to (236.8+20% of 75)/300=252/300 or 84%. If all three loans were cross-collateralized at 20%, the resulting LTV is (236.8*1.2)/300=284/300 or 95%.

So here you have the maths on Nama - 75LTVs on each loan in reality can mask a 95% LTV of total loan package.

Economics 28/09/2009: Anglo moving staff & loans to Nama

Ahead of actual establishment of Nama, Anglo Irish Bank has internally been reallocating moving staff and loans to Nama - even before the debates in the Dail and the legislative vote on Nama.

Source close to the bank has informed me that Anglo management have internally established that

• 100 staff members are being transferred to Anglo Nama division to be located in their new offices on Burlington Road. The staff transferred is non-lending personnel and transfers might proceed even before the legislation establishing Nama is voted on.
• Anglo Irish Bank will face an 18 months moratorium on new lending (which begs the question as to what its staff will be doing if a large chunk of its business will be transferred to Nama, while another sizable chunk is expected to be sold in the US).
• Staff at the bank - on selective basis - were given a questionnaire as to their preferences for either staying with the bank, going to Anglo's Nama division or leaving the lender. This process - initiated some weeks ago - has now, allegedly, been completed.
• There has been no signalled decision on what will be the full number of staff transferred to Nama division and what staff cuts will follow at the main bank.
• Top 20 borrowers' loans are also being transferred (ahead of Nama establishment) to Anglo's Nama division, in effect providing for advanced transfer of loans to yet-to-be-approved entity. The source used the words 'unofficial transfer'.

To reiterate - this information comes from sources close to the bank.

If these developments are confirmed, they raise several important questions relevant to Nama:

1. Putting aside the issues of legislative process being pre-emptied by the beneficiaries of Nama transfers, what has been done to assure due attention has been given in the participating banks to managing the loans? If Anglo (and possibly other banks) are ready to unroll the entire infrastructure of managing Nama loans today, how much of their internal resources (that could have been used to properly manage stressed loans) have been diverted to the preparatory stages of Nama processes?
2. The banks cannot set up internal divisions to manage Nama loans unless they have had some certainty on who will pay them for this function in the future and how much they will be paid. Once again, to date, Government has failed to clarify these crucial provisions. A commitment to keep 100 staff in Anglo Nama would be expected to cost the bank around Euro 15-17mln per annum in staff costs, plus additional leasing and administrative costs.
3. Decision to move to a specified office location on new premises should be carefully vetted to avoid any potential conflicts of interest (e.g developer owning the building in which the new Nama-related division will be located should not be amongst those whose loans are being transferred to Nama). Again, has this work been performed already, suggesting that the banks are rushing off the start line before the start signal is actually given?

If I were either a Green member of the Dail or an opposition representative in the Legislature, or indeed a backbencher of FF, I would certainly like to know how commitments of resources, contractual obligations etc can be entered in with respect to Nama ahead of the forthcoming vote...

Economics 27/09/2009: Leverage across Ireland Inc

Crunching through the IMF database on Financial Stability reveals some serious structural problems in Irish Government&Monetary Authorities positions, as well as in Banks and Non-Banking Sectors of economy. These are long-term themes worth considering.

First General Government & Monetary Authorities:
Chart below shows how extreme is our recent performance in terms of maturity mismatch risk on our General Government & Monetary Authorities debt, with Ireland now leading the group of comparable economies in terms of overall share of short-term (highest risk) borrowing relative to total borrowing.
Chart below shows that we also lead peer group of countries in terms of issuance of new debt despite the fact that the peer group includes such 'sick puppies' as Latvia, Estonia, Greece, and Hungary (some subject to IMF rescues in the last 18 months). Although IMF database does not contain comprehensive data on Iceland, it is clear that Ireland is fiscally in worse shape than all of the APIIGS and even Latvia, Estonia & Hungary. Furthermore, despite Q2 2008 announcements by the Irish Government that it will undertake significant corrective measures on fiscal insolvency side, chart below shows that our 'corrective measures' to date have been mostly about borrowing more in international markets, while the chart above shows that, increasingly, this borrowing is short-term.
Chart below provides an index of General Government and Monetary Authorities debt, setting Q4 2002 level of debt at 1. This dramatically illustrates the scale of Irish insolvency, with debt accelerating from Q1 2006 at a rate far in excess of all other peer group countries.
Banking Sector:
Looking at our banking sector, total sector debt in Ireland now exceeds all other peer countries debt, despite the fact that many of these countries have bigger economies and populations than Ireland. It is fallacious to attribute this result to the presence of IFSC institutions, as the data above is comparable with Hong Kong and Luxembourg - both of which are major IFS centres themselves.
In line with other borrowing trends, Irish banking sector now runs the second highest proportion of short term debt liabilities relative to all debt liabilities. As expected, our banking sector maturity mismatch risk is only marginally lower than the same risk in the general government and monetary authorities accounts.

Who's more reckless in risk taking, you might ask, the Exchequer or the Bankers? Sadly, when it comes to maturity mismatch risk, it is the Exchequer.The rate of debt accumulation in Irish banking sector, however, is in rude health, with banks in this country deleveraging much faster than the Exchequer (which is leveraging up instead of paying down debts, and this is before Nama), the Corporates (see below) and the Households. In other words, while the entire country is scrambling to help bankers, it is other sectors of economy that are bearing increasing burden of rising debt exposure.

Furthermore, an important footnote to Nama: chart below also indicates that the likely direction of Nama funds once banks receive state transfers will be to further reduce leveraging in the banking sector. As I have predicted earlier, Nama will be used to pay down more expensive interbank loans, with preciously nothing going into economy in the form of new credits.Index of total debt for Banks shows the rate of debt increases (leveraging up) since Q4 2002.

Non-banking Corporate Sector:
Total debt in Irish corporate (non-Banking) sector stands out as an outlier in the reference group of countries. This is an apt illustration of Corporate Ireland's obsession with leveraged buyouts, M&A binges at the top of corporate valuations and other debt-financed 'growth' deals done by Irish companies.

The above chart clearly shows the extent of the risk that is inherent in Irish Corporate Finance structure and the high probability that Nama will be followed by a new wave of banks balance sheets deterioration - this time on Irish corporate side. It also indicates that a restart of 'normal credit cycle' in Ireland will require an actual and drastic deleveraging of Irish companies, not a new lending out by the banks to prop up debt-ridden enterprises.

Chart below reinforces this point, by showing that our corporate debt represents an excessively high proportion of overall debt.
Not surprisingly, growth dynamics in Irish corporate debt were equally extreme as chart below illustrates.
Interestingly, Irish corporate borrowing activities remained relatively static when compared to the growth rate in total debt obligations of the country.Perhaps the only 'good news' is that most of our corporate borrowings were in form of longer term debt - a sign that any crisis in corporate insolvencies due to debt overhang will be delayed in time relative to other sectors (Government, Banks and even households).

Direct Investment decline:
Lastly, a quick look at direct investment flows to Ireland (from debt side). As the country engaged in uncontrolled debt spree, overall role of direct investment in economy has fallen in time from over 15% of total debt stocks to under 12%.

Economics 25/09/2009: Euroarea improving growth

Eurocoin is out for August and it is showing a positive reading for the first time in 15 months:
So it is time to upgrade a notch my forecasts.

Interesting detail - Eurocoin turn around is under-pinned by rising (though still negative) trend in industrial production, business surveys (both PMI and EU Commission) still staying on the negative side, with Commission survey being particularly gloomy. Consumer surveys are still in dire straits, with exception of Italy (happy summer, folks) and Spain, though Spain is now looking poised for a double-dip consumer recession. Stock prices still are posting poor performance except for Spain and to a lesser extent Germany. Exports are at zero growth rates across the Eurozone, but are modestly positive in Germany, France and Spain.

Net result - a mixed bag of continued weaknesses (abating) and some strengths (very modest).