Economics 14/05/2010: IMF on fiscal stability I

So the IMF analysis of changes in global fiscal positions is out today and makes an interesting reading. Here are some high level observations, pertaining to Ireland.

In relation to the EU and Irish Government consistent attacks on so called ‘bond speculators’, IMF states: “Net CDS positions amount to only about 5 percent of outstanding government debt in Portugal (the country with the highest share), 4 percent in Ireland, and 2 percent in Greece and Spain. In other countries, including Italy, the ratio is even lower, and it is extremely small for Japan, the United Kingdom, and the United States.”

In other words, CDS markets are shallow and cannot be expected to have a significant effect on sovereign bond spreads or yields.

However, per IMF: “The analysis uses 5-year CDS and 10-year bonds, as they are the most liquid maturities. Granger causality tests over the period January 2008–April 2010 show that the CDS spreads anticipated bond spreads (measured by the Relative Asset Swap spreads), while the reverse is not true.” In other words, as I’ve stated on many occasions before – CDS markets are a good predictor of sovereign yields.

Another interesting analysis from the IMF. I am adding to it adjustment for Ireland to GNP figures, per usual argument that GDP is largely irrelevant for our country real income metrics. I also added rankings columns for two main parameters of fiscal sustainability.
One should be concerned with the figures provided above. While international comparisons call for GDP as a benchmark for national income, in Irish case, this metric is best captured by GNP. And of course, GDP/GNP gap is growing rather dramatically...

I will be posting more on IMF analysis over the next couple of days, so stay tuned.

Economics 12/05/2010: Irish Nationwide - an expensive delay

I have gone through the Irish Nationwide balance sheet, as summarized in the table below (all values are in millions of euro):
All scenarios are explained above and all assumptions are in there as well.

So the conclusions are:

• If we continue injecting cash into INBS, the total cost of winding down the bank will be the loss of all cash already put into it, plus the expected post-Nama injection of ca €1,148 million. The grand total bill for shutting INBS via Minister Lenihan's preferred option will be €7,234 million;
• Shutting down INBS back in 2009 would have cost between €2,030 million and €3,078 million, were the Government to listen to people like Peter Mathews, Brian Lucey, Karl Whelan and myself. The bond holders (senior ones) would have been paid 50 cents on the euro.
• Shutting it down now, without going Nama route will cost €1,575-2,659 million, plus the money we already dumped into it to date, i.e €2,700 million. Which is still cheaper than what Minister Lenihan's plan would deliver.
  

Either way, the DofF and Minister Lenihan really must come clean on the issue of bondholders at this stage. How much more can this economy carry on throwing good money after bad?

Economics 13/05/2010: AIB's IMS blues

AIB released its Q1 2010 IMS statement:

• It will issue 198m shares to the Government in lieu of a €280m preference coupon it will not be paying (remember the stockbrokers and the Government argued that this coupon payment will be a handsome return on our ‘investment’ in AIB?).
• AIB, subsequently will be in for an 18.6% Government stake in the bank.
• Some analysts are saying that the lack of dividend is due to AIB being precluded from paying cash dividends on debt instruments while its business case was under review at the EU.
• I would say that this represents a convenient excuse. In reality, AIB simply cannot afford a €280 million pay out, given its funding conditions and given its capital requirements.
  

There is more farcical stuff in the IMS. AIB claims that while trading conditions remain challenging in Ireland, its UK (ex Northern Ireland), Polish and Capital Markets operations are booming. Ooops, the very family silver that AIB is going to sell to cover its bad loans in the Republic is still the only set of assets that have any positive value in AIB.

IMS confirmed that AIB will need €7.4bn in new capital, and that this based on Nama discount expected to average 45%. As AIB is shifting €23bn of the bad and the outright ugly loans to Nama, this discount might change. So no speculation here…

Aside from speculation, if AIB is hoping to get some dosh for its 22% stake in the US M&T, worth estimated $2.3bn. If this target is achieved (a big if, given that large placements like these would probably attract some discount) the sale can deliver new capital of €900mln. The target for capital raising then moves to €6.5bn. Selling Polish holdings will provide maximum of €2.4-2.6bn, assuming euro holds against zloty and assuming a discount of no more of 10% on block sales, inclusive of commissions. Of course, this means that AIB will have to write down its book value on the asset side, so that the net gain is likely to be around €1.2-1.4bn to capital side.

Which leaves us with a hole of €5.1-5.4bn to plug. The UK side of business is a sick puppy, unlikely to yield any net gain on risk-weighted assets side, but let’s be generous and give it €500mln of value. On the other hand, AIB investors are raking the dosh in… well, not really. I would expect the bank to be able to sell something to the tune of €1.2bn worth of equity at the most (its current market cap is €1.22bn as of yesterday close price). Suppose this is the net (although discounts might imply much shallower rate of capital raising). Will the Exchequer be required to pump in another €3.4-3.7bn into AIB?

But wait, this is hardly a final number. Remember, so far AIB has been assuming (in its impairments provisions) that the 2009 performance will continue into 2010. It sounds conservative, until you actually pause and think. There are serious lags on some assets deterioration and on recognition of impairments. These lags are driven by two major factors:

1. On households and corporate loans side, impairments take time to build up. For example, an average unemployed person with job tenure of 6 years would have gotten around 36-42 weeks of redundancy (factoring in tax relief) when they lost their jobs back in the H1 2009. They might have had savings. At an average rate of saving of 5% of annual income over 6 years, that would add up to 30% annual income or another 16 weeks worth of income cushion. Again, net of tax the cushion rises to ca 19 weeks. This means that any serious distress on their mortgages will show up around 55-61 weeks after the layoffs. Guess that pushes the dateline for major stress on mortgages only starting to manifest itself to around May-July 2010.
2. Much of the non-Nama book of commercial and development lending that will remain with AIB has been rolled up, redrawn across covenants and so on. How long will it take for these to come up for another appraisal? I’d say on average 12-24 months. So look back at 2008-2009 loans that were non-performing then and were rolled over for 12-24 months. These will start flashing red once again sometime around 2010-2011.
   

Neither (1) nor (2) is provided for (as far as risk capital goes) under the current €7.4bn new capital requirement. By the time the demand on these hits, AIB will have no assets left to sell. Then what?

How I know that AIB is once again has its head stuck in the sand on future impairments? Well, this morning’s IMS tells me as much. For its non-NAMA loans, AIB is expecting bad debt charges to be matching 2009 rates. IMS says that bank’s €27bn residential loans book is continuing to perform “better” than the sector averages (as if there is any meaningful average here to be had). And significantly it says that residential bad debt charges are currently not significantly different from 2009. The non-NAMA exposure to property in Ireland will be €12bn of which €9 is investment and €3bn land and development. These are still material at this stage, as any further writedowns on this part of the book are going to hit capital base again.

On the macro side of its balancesheet, AIB is still going to be a sick bank with loan to deposit ratio declining from a severely unhealthy 146% to a still unhealthy 124% post-Nama. And this is really rosy, folks. And the cost base and margins are unlikely to improve. Take for example deposits costs – AIB’s IMS highlighted the reality of high cost of attracting new deposits. Wait till Government starts hovering dosh from the punters through the new Post Office bonds. Supply of deposits will drop. And then, wait for the ECB to cut its discount window operations again, should things improve in the euro area funding markets. AIB, alongside BofI, is heavily dependent on being able to roll the collateralized borrowings from ECB. AIB’s term funding as a percentage of wholesale funding is massively up from 30% in December 2009 to 41% by end Q1 2010, reflecting a €6bn of issuance.

So can anyone explain just how on earth can AIB escape a de facto nationalization?

Economics 12/05/2010: How not to do austerity...

How not to do austerity? Well, Ireland is a good example.

For all the tough talk about reforms and changes to spending habits of the public sector, the new employment in civil service document released two weeks ago, drawn up by the Department of Finance envisions that staffing levels will fall from 37,376 estimated for the end of 2010 to 36,594 at the end of 2012. That’s a whooping (or in terms of SIPTU/ICTU savage) drop of 782 workers, or less than 2.1%. The resultant savings, assuming jobs cut will be at the media level of pay for the civil service, will total a massive €39.41 million per annum. Translated into our public sector’s spending habits, that’s about 16 hours and 20 minutes of our deficit financing for the first 4 months of this year. Not counting the banks costs.

The Government has told the nation before that the new public service pay and reform deal negotiated with unions at Croke Park last month will "substantially" reduce the number of State employees over the coming years. Hmm... guess 2.1% is philosophically ‘substantial’, even if not economically substantive.

But wait, these are gross savings, pathetic as they might be. To get to the net figure, we must factor in early retirement incentives doled out to civil servants by Brian Cowen in Supplementary Budget 2009 and golden handshakes for voluntarily leaving staff.

So take a rule of thumb - the cost of laying off civil service workers ranges around 15-20% of their total annual salary per year of service – once the value of pensions and redundancy payments are factored in. This is very, very much conservative, given the one-off payments and other perks accruing to retiring public sector workers and given that their tax liabilities collapse upon the retirement, especially over the first year. Take 15% on the lower end and assume that average tenure of the workers leaving the service is around 15 years (lower-end assumption as those taking early retirement would more likely to be more senior than that).

What do you have? The cost – and not all of this obviously will hit the taxpayers at one single shot, but most will – will be around €133,400 per worker reduced. And that’s at the lower end.

Savings of €50,294 per annum, at a cost of €133,400 means that given our Government’s innate inability to manage its own workforce, the first time we, the taxpayers, will see positive net savings on the deal (assuming opportunity cost of funds at 5% and automatic stabilizers on the salary payments to public sector workers at 30% - income tax, levies, etc - none of which are going to apply under voluntary retirement) September 2015!

I am not kidding you – September 2015! By which time, of course, the Unions would have forced the Government to get a new Benchmarking going…

Folks, we are now truly turning the corner!

Economics 12/05/2010: How to do fiscal austerity... 2

Ireland, Spain and Portugal currently represent a major threat to the credibility of the euro, according to a number of observers, ranging from the FT to RBS. Not because of their public debts, but because of their deficits. Spanish and Portuguese deficits are expected to hit 11.4% and 9.2% respectively this year. Irish - anywhere between 11% and 18%, depending on how much of the banking liabilities will be covered by the Government. These levels are more than double Italy's deficits and almost double those of the Eurozone as a whole.

Moody’s are now talking about downgrading Portugal and Greece to junk status.

If you look at the countries that are really getting it right - Ireland is not at the races. So far we have seen largely cosmetic reductions in the deficit. As of April 2010 results, the deficit is down 4.86% year on year and up 86% still on the same period of 2008. Worse than that - most of this undramatic cut between 2009 and 2010 was achieved by reducing capital spending. Which means the cuts are not structural and we are rapidly running out of room for any future improvements.

I wrote yesterday about Bulgaria (with 1/4 the size of Irish deficit levels) slashing its public spending by 20% and hitting hard pensions and wages in the public sector (here). I forgot to mention Latvia - assisted by the IMF loan back in 2009 (USD10 billion) - cut public sector jobs by 20% and the remaining public servants took a minimum of 25% pay cut.

Replicating these cuts in Ireland, however, would only be a beginning of the process of restoring public purse to health - we need to shave off 39.5% of our ongoing spending (as of April 2010) figures to bring our finances into balance. The cuts will have to add up to 36% in order to get us down to the Growth & Stability Pact level of acceptable deficit.

At this stage, with Croke Park deal done, and with economy unable to pay much more in added taxes, and the banks still begging for money, the Government has simply run out of any options.

Economics 11/05/2010: Exchequer figures - no real relief in sight

You have to feel for some of our desperate cheerleading squad of ‘analysts’ who toil for some of our banks and stock brokers. These folks are clutching at the straws trying to find something to cheer about. Case in point – latest data from the Irish Exchequer, which was heralded as showing ‘stabilisation’ and even ‘improvement’ in ‘funding conditions’ and ‘headline deficit’.

Putting aside the fact that most of these analysts have no real idea what these terms really mean (and in some cases, neither do I, for they mean preciously nothing in the real world of economics), the fault in their logic is an apparent one:

They say: ‘Irish exchequer receipts are finally coming closer to the Budget 2010 projections. Therefore, things are improving or stabilising.’

I say: ‘Statements like this are pure bollocks, folks. Just because DofF has finally caught up (somewhat) in its forecasts with reality, does not mean reality is getting any rosier.’

Here is the evidence that I am correct. Forget the Exchequer forecasts, and look at the actual data.
Chart above shows that:

• Irish Exchequer tax revenue in April came in below the downward linear trend established since January 2008, which means that we are still returning tax receipts at below 2008-present average rates. Long term, things are still sliding down.
• Irish Exchequer total receipts fared better than tax revenue, but that’s because the Exchequer has managed to squeeze more out of the likes of the semistates. Don’t be fooled – the semistates do not create their own money. This is just a hidden tax on us all.
• Total expenditure, despite all the fanfare from the ‘analysts’ is heading up, and is now above the trend line again. Which (the trend line) is upward sloping. This means that long term trend is still rising for our public spending, and that we are on a seasonal upper push in public spending.
• Thus, our Exchequer deficit has gone up in April, and it did so at a rate virtually identical to April 2009. Long term deficit is still upward moving and we are now above the long term trend once again.

Translated into cardiology, the patient now has an accelerating erratic pulse reaching beyond the norm, and continuously falling blood pressure. Just as Good Doctors Brian & Brian are talking about discharging...

To see if things are indeed improving (or stabilizing) as our ‘analysts’ suggest, let’s put back to back receipts and expenditures for the last three years in one chart:
Clearly, our total Exchequer receipts (and recall, these are boosted by abnormally higher non-tax revenue) are now below those for April 2008 and April 2009. Indeed, only once so far in 2010 have receipts rose to above corresponding monthly levels for 2008 and 2009 – back in March, when the Exchequer booked some of the backed receipts on VAT, VRT and Excise.
Chart above shows that the Exchequer did indeed achieve some reduction in spending in April 2010. But,

1. Good ¾ of these savings came from reduced capital investment cuts
2. Cumulative savings for the first 4 months of 2010 are so far €1.346 billion, implying an annualized rate of savings of €4.035 billion. Over the same time, cumulative losses in revenue were €990 million, implying an annualized loss in revenue of €2.969 billion.
3. So we are looking at (omitting timing consideration) net savings on 2009 of €1.1 billion. This would be a reduction of just 4.3% out of an annual deficit for 2009, or related to GDP – a reduction of roughly 0.6% of GDP. In other words, all the ‘right decisions’ taken by this Government are currently looking like being able to reduce or 14.3% 2009 deficit to a massively ‘improved’ 13.7% deficit? And that’s assuming that the Anglo support this year will only impact the deficit by the same €1.5 billion as last year…
   

This miserably low level of achievement in our battle to restore Ireland to solvency is, of course, fully visible in the above chart, once one considers the Exchequer surplus performance.