Economics 03/03/2010: IL&P results FY2009

IL&P – the folks who pushed their mortgages lending to 300% of their deposit base – in the style of Northern Rock – have released their FY 2009 results this morning. Overall operating loss of €196 million for 2009 represents a swing of €537 million against the profit of €341m in 2008 reported in 2008. This takes some doing to achieve for a book of loans valued roughly at €39 billion (and that is widely optimistic – the total lending book declined from €40.1bn in 2008 to €38.6bn in 2009 – a decline that is hardly reflective of the peers).

When considered against the Irish Life division operating profit of €102 million (down from €284 million in 2008) the Permanent bit of IL&P is emerging as a seriously weak link. The bank posted a loss of €270 million with operating loss of €280m – a swing of €310 million on €30 million profit in 2008. Bad debt provisions are set at €376 million – assuming relatively static deterioration in 2010 compared to 2009. Total expected provision for 2009-2011 crisis period is standing around €900-950 million. I am not sure this is realistic, given the fact that mortgages are now starting to show increasing stress – with anticipated lag of legal process and for work-through of savings cushions by distressed households. In contrast with all rational expectations, IL&P management commented that home arrears growth was slowing. Good luck to them.

Capital ratios remain flat over 2009 - Total Tier 1 of 9.2% - hefty, healthy, but… one has to remember that IL&P has a much heavier T1 requirement due to life insurance business side. Translated into banks ratios, this implies effective banking side Tier 1 of roughly 6-6.5% - still better than AIB or BofI, but has some room for improvement. Given the overall reluctance of the Permanent side to take realistic writedowns on mortgages, I would suspect there will be renewed pressure on Tier 1 in months to come.

Economics 03/03/2010: IDA's new campaign

IDA have launched their new long-term strategy document that is worth taking a look. Here are my own observations:

“I am delighted to take up the role of chairman of IDA as we launch a new strategy... There are great challenges before us but there are also great opportunities. The sweeping changes in technology and the world economy outlined in this document promotes [sic] an increased sense of urgency as we change the way IDA performs its mission. I have full confidence that the expertise and energy IDA staff bring to the task will ensure we remain one of the world’s most admired agencies for promoting FDI.” [a bit of self-loving here?]

Liam O’Mahony, Chairperson, IDA Ireland

I must confess, I like IDA guys. They and Enterprise Ireland side are the exceptionally rare parts of the public sector that actually work. One can question them from the point of the return on the euro spent (I have no knowledge of the metric, so this is a rhetoric question) but one cannot question their engagement with their work.

Thus, I actually looked forward to today’s release of the IDA strategy 2020 document. And as before, I loved the core theme of their imagery – signifier (perhaps too optimistic) of what Ireland should look like – modern, expressive and smart (not just in terms of technical brains, but in terms of broader, diversified creativity - alas, the signifiers did not match the strategy exactly).

Now, IDA has two very competent, and professionally admired people at the helm – Liam O’Mahony and Barry O’Leary. This should get IDA moving. Maybe not quite into 2020, but certainly into 2010-2011.

So let me not pour too many accolades, and focus on what I usually do – challenges. And there are some in the 2020 strategy document. These are, as I say, challenges. It would have been nice to see them addressed in greater depth in Horizon 2020 document.

Tax policy - absent

Take the first and foremost policy instrument for IDA and for general economic development in Ireland – tax. IDA is keen to recognize the overarching importance of tax policy to attracting MNCs. But it fails to take stock of the more recent changes in tax regime and the ongoing changes in the business development and corporate investment environments.

“We have a young, highly skilled workforce and easy access to the best young talent across Europe. Our tax regime is compelling,” says strategy document.

Really? At 50%+ marginal tax rate on highly skilled and experienced talent? "Compelling" as in second highest in Europe? And adjusted for benefits what do we, the taxpayers, get in exchange for this rate?

Spatial Pipe Dreams

Oh, and there is another little thingy there – the mandate to “support regional development”. Yes – the Spatial Development Plan (or rather our Spatial Development Pipe Dream) is still there, folks. Hasn’t gone away along with all those empty country-side estates that were supposed to be ‘Gateways to Excellence”.

Of course, this is not IDA’s fault - both tax policy and spatial development illusion are domain of policymakers, but still – couldn’t internationally-aware guys like Barry O’Leary and Liam O’Mahony quietly slip this ‘regional development’ schlock into an addendum to an appendix of sorts?

Human capital? Whoa?!

Another interesting omission – also relating to the tax on human capital – is the lack of analysis of the threat to our demographic base from foreign competition for talent.

“With a comparatively younger population, with just 14% of Irish people over 65, Ireland will have a relatively larger proportion of highly skilled and educated workers from which to draw. [Well, that is actually not a foregone conclusion – having younger population does not mean one automatically ends up with a relatively larger proportion of highly skilled and educated workers] Ireland also remains a vibrant and attractive place for younger workers from within the EU, making it easier for multinationals locating here to attract young talent from the whole of the 500 million-strong European Economic Area.”

Really? Are we sure this will be the case? Even when Germany, France, and the rest of ageing EU starts paying higher wages to younger workers to attract them from abroad and to keep their own? Even when other locations worldwide start offering better quality of life and higher wages to younger workers? No, folks, to get that ‘demographic dividend’ we need to work hard to compete for talent globally. And this means putting in place things that IDA strategy does not mention:

• lower tax on higher skilled and better educated workers;
• greater quality of public services for lower price to the taxpayers;
• greater quality of goods and services delivered within domestic economy (competition and market liberalization agendas come to mind here),

and so on.

BRICs: back to the future

I liked IDA’s specific focus on BRICs, but the section on these countries is too thin on details as to how the agency plans to make serious in-roads in these markets. And there are deeper questions here:

• By 2010, BRICs are hardly a new frontier - these are middle income (in case of Russia, officially a developed country) economies with steep competition from other locations for their investment. Shouldn't IDA aspire to broader geographies?
• BRICs are heterogeneous and lumping them into one section is a difficult task - more definition is needed to understand what exactly is the strategy that IDA is planning to pursue here

Regulation - spot on

I liked that IDA is pragmatic – in this age of regulatory hype, this is an achievement – when it comes to recognizing the need for flexible, functional and not-too-burdensome regulation: “Ireland must ensure that it remains at the forefront of creating a regulatory environment that is robust, credible and ‘fit for purpose’ – one that does not place undue burdens on business.”

Creativity mark - C

In a departure with the past, IDA strategy does attempt to deal with the issue of business processes innovation and even strays into business model innovation. This is a fitting change from traditionally 'hard' innovation-driven agency. And it might, just might, sound like a warning shot to domestic sectors - 'Shape up, or lose out'.

But I thought a major weakness of the strategy can be found in the fact that in the entire document, words

• ‘creative’ – as in creative industries/sectors, and as in the business-operative word relating to creative innovation;
• ‘design’ –as in the driver of new products and markets;
• ‘management innovation’ – as in a major driver of systems productivity;
• ‘traded services’ – as in the areas that account for more than 50% of global trade already (note, ‘manufacturing’ is featured in 8 instances in the report),
• 'urban' - as in ca 80% of our economic activity will be by 2015

are not mentioned even once and

• 'high value' - as in high value added sectors

is mentioned only once.

In the age of Twitter, technology is a direct outcome of creativity, not the other way around. In fact, the failure to more comprehensively deal with non-ICT, non-biotech, non-labcoat innovation and sectors puts a massive dent into the entire document. It makes me wonder – does IDA realize that Google, Twitter, Facebook, Apple, IBM, Microsoft – you name a success story in today’s IT & ICT world – are driven more by ‘soft’ innovation and only as a corollary – by technological platforms? I think they don’t – and this mutes that wonderfully designed, creative and aesthetically sophisticated advertising campaign that they feature on the inside cover of their report.

Again, to be fair to IDA - good effort is made to move from previously undefined 'Financial Services' objective toward more specific services-related areas. A bit of an eye-catching is the focus on Financial Analytics - an area where much needs to be done before we can attract into the country leading financial analysis firms. Perhaps, more realistic here would be to develop capabilities by using Ireland as a platform for attracting start-ups and early-stage companies in this area. Bary O'Leary does mention the latter (although not specific to the Fin An sector) in his key note, but again, the document could have had this specified in more detail.

So overall, a slight sense of disappointment, but also some hope that next time (and before 2019) IDA strategy will reflect deeper and more real change in the way the organization is actually starting to see the future. Encouraging signs are present in today’s document.

Economics 02/03/2010: Exchequer (still) Singing Blues

Exchequer returns are in for February (DON'T PANIC sign on the cover) - and things are going just as poorly as was predicted. Well, slightly worse, actually. Few charts to illustrate the trends:

Monthly receipts and expenditures are showing divergent trends. While receipts are showing some improvement relative to 12 months ago, expenditure is showing deterioration. Worse - January 2010 improvement on January 2009 is now gone and February numbers have fallen below long run trend line.

Similar trend on receipts above, but now also adding tax receipts - a relatively hefty deterioration in seasonally adjusted terms (January 2009 to 2010 and February 2009 to 2010 comparatives).

Total expenditure is improving. But exchequer surplus is deteriorating.

What's going on?

At €1.66 billion, receipts in the month were a modest €64 million or 1.3% behind DofF budget forecast. On annualized basis this means something to the tune of €455 million shortfall… small stuff… but.

February income taxes are tanking – down 11.8% on 2009 (-€246 million).

But wait, this was actually the second best performing tax head of all… Table below illustrates

Now, February, seasonally is a low tax revenue month – accounting for around 5% of annual revenue. But this time around, February total tax receipts were down 17.8% on 2009. In two months of the year, the same figure is 17.7% - not much of a change… certainly not enough to say things are improving. Oh, sorry, no – they are actually deteriorating!

How come DofF can be happy about these dismal results? Well, for the first time in over 2 years of this crisis, DofF estimates are sticking! Even if only for two months so far. Budgetary projections assume tax revenue of €31.05bn in 2010 or 6.02% below 2009 figure. So far, seasonally-speaking, we have seen roughly 15% of annual tax revenue coming in at roughly speaking 18% below 2009. So should the trend continue flat from here on, we have lost 2.7% or almost half of the allotted annual deterioration! Slightly better than Nama spending its entire legal costs allowance for the year in two months of work, but still... not a record to be proud of.

And on the spending side things are a bit bleak and bleaker: most of the spending decline to date has been on the capital side. In fact, capital expenditure – remember, Brian Cowen and Brian Lenihan have both claimed in 2008 that capital spending will be our stimulus – is down 25% in February (annual terms). In January, this decline was 21%, so the drying up of the ‘stimulus’ is accelerating.

Of course, it is current expenditure where most of fiscal waste rests and where the entire structural deficit is hidden. So one would assume that here, there should be some sizeable cuts. In January 2010, in order to, presumably, impress ‘international markets’, DofF cut current spending by 12% in year-on-year terms. Happy times? Not really – in February this figure eased back to 8%. Even at a half this rate of a ‘forward retreat’, we will end 2010 with spending well in excess of 2009 total.

But, so far, through February 2010 total savings on current spending side add up to €567mln. Now, our structural deficit is roughly 8-9 percent after the Budget 2010 measures take place. Which means we need to cut roughly €5.5 billion in annual spending. At the rate of current cut-backs we are achieving €3.4 billion, under very optimistic assumptions that the current rate of cutbacks will be sustained.

Economics 02/03/2010: CBFSAI - in search of Art Consultants

As the country is grappling with the risk of banking sector collapse, lack of direction toward new regulatory environment for the financial services, unemployment, fiscal problems, need for reforming (and also lack of direction for such reforms) public sector, and so on, it is comforting to know that at least some of the policy / public management bottlenecks are being addressed...

The Central Bank of Ireland is looking for an Art Consultant - here - seriously (hat tip to Brian)!

There are precious pearls here (comments are mine):

"The CBFSAI maintains and refreshes its visual art collection, not only as an investment, but to enhance and enrich the working environment of its staff and as a means to encourage creativity and cultural diversity amongst employees and the wider community [apparently Central Bankers really need a working environment that encourages their creativity and cultural diversity].

We believe that our particular support for emerging artists, especially those in the early stages of their career, is a valuable conduit of encouragement, not only of individual artists, but of the artistic community in general [and encouraging artistic community is one of the functions of any Central Bank, one would presume]."

One, of course, is wondering if the new Art Consultant role will also be responsible for:

• managing Nama-led acquisition of art accumulated by our poorly performing banks (with some of poor performance likely attributable to poor regulation by, hmmm, ... would that be the Central Bank?)
• giving recognition to the artistic values of Irish banks creativity in the area of financial engineering (with some of the lending deals done at the height of Celtic Tiger clearly bearing resemblance to the post-Abstract Expressionist decompositions of the Barcelona School of Art), or
• providing advice on writing constructive press releases explaining the collapse of our banking system and subsequent taxpayer rescue of the 'art appreciating' financial sector in this country (after all, some of the PR produced on Nama, for example, borders on the best works of Eugene Ionesco and Luigi Pirandello), and
• commissioning and orchestrating the performance of Stockhausenesque compositions to depict the true extent of disorder in our banking balancesheets?

Hmmm... art consultants to the rescue, might be the CBFSAI's next motto...

Oh, and in case you thought our Central Bank is out of tune with the banks it regulates, here are few links: AIB and BofI are also keen on making sure their employees work in a rewarding atmosphere, surrounded by art and that they support arts in this country... sadly - both forgot to support proper risk pricing and responsible lending.

Then again, what is more important to an Irish (Central) Banker? Art appreciation classes or risk pricing?

Economics 02/03/2010: AIB 2009 results

AIB's bad fortunes:

• Pre-tax loss of €2.656bn for 2009;
• €5.35bn in bad loans provisions - 4.05% of customer loans base
• ROI operations losses of €3.5bn
• Total criticised loans up to €38.2bn (24.9% of customer loans base), compared to €15.5bn (11.7%) at the end of 2008
• Criticised loans increase - 23% outside ROI, 77% within ROI
• Mortgages 91+days overdue are at 1.96% (December 2008 0.7%) and this does not account for re-negotiated mortgages
• Post-Nama, expects ROI loans to fall to €58bn (55% of the total loans held), composed of €27bn mortgages, €6bn in personal loans, €12.8bn of property loans, €12.6bn other loans

But the real beefy stuff is on pages 111 and 15 of the report (here). Hold on to your seats, folks - from the realistic folks who brought you a dividend in 2008 (as the Titanic was gliding along the iceberg's first bump):

Page 11: Loans and receivables held for sale to Nama €23.195bn, with Provisions at €4.165bn

implying an 17.96% net discount on loans transferred to Nama (the second table below).

Aha, not 25%, or 30% or 35%, but 18%. And as far as those 'Good Loans' that Minister Lenihan wanted to buy go? That's categories 1-3 loans above, or a whooping total of €21mln. Impressive risk hedging by Nama is expected. Oh, don't take my word for this - here is how the Nama portfolio from AIB will look like:
So wait a second, folks, AIB will dump 63% of their impaired loans into Nama, but will provision for a haircut of 18% on these? Their own debt is now being settled at 50 cents on the Euro with private bondholders, while the Irish taxpayer is expected to settle at 18 cents?!

And have a laugh - page 15: ROI Nama-bound loans provision is 16.6%, UK Nama-bound loans are 5.1% and overall impairment charge due to Nama (remember, this accounts for risk-weighting changes) of 14.54% (Table at the bottom of page 15).

It's a free lunch -Frank Fahey-style - except for the bank!

Economics 01/03/2010: AIB, Nama & tomorrow's numbers

From the Dolmen guys - today's preview of AIB results announcement tomorrow -

"We expect operating income of €2bn for the year, impacted by lack of demand for credit by Irish consumers and lower Net Interest Margins (NIM). Due to a pre-tax loss of €2.7bn, equity tier 1 of the group will move down to 5%. Overall, the market will be looking for guidance on NAMA, capital raise and credit quality in the non-NAMA loan book. It is also likely the group will announce an exchange offer on its Lower Tier 2 debt."

Note the figure of 5% Tier 1. Internationally (e.g. UK) target is for 8%+ Tier 1, for banks with Loan-to-Deposits (LTD) ratios in excess of 100%. AIB's latest accounts I have access to show LTD ratio of over 150%. This means that the AIB will be on the hook for up to Euro 4 billion in order to plug in the Tier 1 capital gap with its international peers. And this is before the expected loans losses of Euro 5-5.3 billion expected in the tomorrow's announcement. So on the net, H1 2010 demand for funding should be around €3.8-4.5 billion before Nama kicks in and before provisions for a new batch of bad loans...

This is more than 3 times the current market capitalization of the bank!

Also note Dolmen's reference to the lack of demand for credit. Spot on - the problem is that no matter how one spins the current credit crunch, consumers and businesses (burdened by massive debt and facing rising tax curve into the foreseable future, along with high risk of unemployment and huge uncertainty about the future performance of the economy) are simply in no position to borrow. This, along with the crippling expected cost of Nama to the real economy means that there is not a snowball's chance in hell the credit bubble can be relaunched in Ireland... at any level of interest rates...