Economics 28/05/2010: Welfare fun in the Credit Unions land

There are three things one must wonder about when it comes to the Credit Unions in Ireland:

1. Why aren't we hearing more about the going-ons in these fine credit institutions that play a significant role in this economy? After all, credit unions have assets of ca €14.5bn per end of 2009 figures. €6.8bn of this is in loans and €7.3bn in investments. And they act as, in effect, second tier lenders (correcting per a tip from a reader: not in terms of quality of borrowers but in terms of types of loans), with most loans going to unsecured lending on cars, home improvements, personal spending, etc. Could they have miraculously escaped the fate of the banks in the current crisis? Highly unlikely.
   
2. Why do we have a separate regulatory regime for these organizations, if their basic business model is virtually identical to prudentially justified banking?
   

Well, folks - in the land of endless quangoes (aka, Ireland) we have a financial regulator and a separate credit union regulator. The latter, James O Brien, now reportedly wants new additional provisions to be made by the 20 unions (out of 414 - a whooping 5%) operating in Ireland that face “serious solvency issues”. Oops. That was a sudden one. In effect, back in 2008 the Irish League of Credit Unions (yeah, I know, sounds like a Klingon gathering) issued annual report full of concerns for the Credit Unions' state of health on their investment side. Then there was a report into the impairments charges. Which promptly followed by a dramatic decline in the surprise spot inspections of the Credit Unions - the only real tool for assessing just how bad the loan books might be.

Now, we are being told that there are Credit Unions out there which have 'serious solvency issues' - or translated into common language 'might be trading in insolvent conditions'.
Apparently, arrears levels in the Irish credit unions rose from 6% in 2008 to 13.5% in 2009. The Credit Unions Klingon-styled response to this was to lobby Brian Lenihan to allow them continue lending for holidays in the sun to households, some of which can easily be on the verge of running into trouble with the banks. You see, credit unions provide credit after the banks provide secured loans to the punters (again, correcting per a tip from a reader: this does not mean that credit unions lend to a less worthy client than the banks, it means that they supply lower priority - in household budget terms - and largely unsecured loans. Neither does it mean that credit unions provide loans to people who were turned down by the banks. However, it is known that credit unions did provide top up loans for house purchasers who have exceeded mortgage allocation and borrowed to either supply a deposit or cover closing costs on property from the credit unions).

Credit unions do so by taking deposits from the same punters in exchange for the promise of a dividend - an annual payment that is there to replicate deposit rates paid by the banks. Alas, when a company runs into red, unless the company is AIB, the normal practice is to withhold the dividend and use the company earnings to replenish capital base. The credit union movement in Ireland disagrees, arguing that a dividends withdrawal for funding of higher reserves and offsetting losses on loans would damage their 'competitiveness' vis-a-vis the banks.

There is, of course, one major issue with the Unions operations - in effect, absent restoration of the proper functional business banking in this country, Credit Unions are now becoming more actively involved in small businesses operating capital management. This is a risky undertaking for all parties involved and we do not have much data on the matter. Small businesses - sole proprietorships in particular - can blend business cash flow management with personal banking, inducing risk spill-overs from business side to household finances. Increasing reserves requirements on Credit Unions will be likely to put the boot into this, rather atavistic, practice, made necessary by the lack of functional business financing in the core banking sector.


But one must be concerned about the end game here. If the regulator were to listen to the unions, what alternative ways can be found to cover the losses then? None other than a direct injection of cash from the taxpayers. So here we have it - welfare junkies in Ireland have reached a new high. We are being indirectly told that Credit Unions should be allowed to pay dividends out by keeping reserves low, even as they face mounting losses. Surely the taxpayers can provide a cover for these, should the trading environment continue to deteriorate into the future. Happy times, folks!

Economics 28/05/2010: Euro area leading indicators

I have not updated my forecasts for the euro zone growth in some time now, and it is on the 'to do' list. However, as predicted, euro area leading indicator from Eurocoin came in today at a disappointing 0.55% down from 0.67% a month ago and marking a second consecutive monthly decline. The indicator hit 0.79% in March 2010, marking a 3-year high.
This time around, declines in the indicator were driven by the adverse movements in the stock markets valuations. However, decline is absolutely in line with PMIs, despite the industrial production indicator showing sustained growth. Also worryingly, consumer confidence remains below waterline and is trending down again:Exports are on a tear up, rising at a faster rate in May relative to April. This might be the good news for overall growth, but it is clear that domestic investment and demand sides are still recessionary. Of course, there's a popular theory out there - in Brussels, and even here at home in Dublin - that exports will lift us out of the recession. If you think so - look no further than Japan. Japan has managed to maintain booming export activity, amidst shrinking overall economy for two decades now.

Economics 27/05/2010: Mortgages arrears

RTE reports on the CB data on mortgage arrears, stating that:
"New figures from the Central Bank show a 13% increase in the number of mortgages [90-days or more] in arrears [relative to December 2009]. However, the figures also show a fall in the number of legal actions taken by financial institutions to enforce outstanding mortgage debt."

At the end of Q1 2010, over 4% of all private residential mortgage accounts in Ireland were in arrears - the total of over 32,000 of 791,000 mortgages worth €118bn. Median duration of arrears was in excess of 180 days.

"The Central Bank notes a drop of 4.8% in the number of arrears cases in which legal proceedings have been issued. There are just over 3,000 such cases. During the first quarter of this year, 91 properties were repossessed by banks, 26 on foot of court orders and 65 by voluntary agreement of the borrowers or by abandonment. At the end of March mortgage lenders held 456 repossessed residential properties."

The issues not raised by either the CB or RTE are:

1. Have the banks willingness to pursue cases in court been impacted in any way by Nama operations? Nama is a political entity, with potential to influence banks internal decisions.
2. With median duration of mortgages arrears of 180 days, can we expect the number of cases heard in courts to dramatically accelerate in H1 2011?
3. Mortgages reported in arrears do not include mortgages where lender and borrower have renegotiated mortgage covenants, avoiding arrears by switching to interest-only mortgages and/or changing maturity profile of the mortgage, and/or extending a payment holiday.
   
4. What is the median/average size of the mortgage in arrears. It is likely that mortgages currently under stress are larger and cover properties with much more significant extent of the negative equity.
5. What is the sensitivity of arrears to interest rate changes. The statistical eagles in the CB - we do have some there, right? - can easily compute the sensitivity of mortgages default to changes in retail interest rates. All they need for this is longer-run data on mortgages defaults, retail rates, macroeconomic parameters, housing prices etc. Shouldn't take much of time or effort for the CB to get this useful estimate. We can then see just how damaging the ongoing increases in mortgage rates by the banks will be to this society and economy.
   

In effect, we are only seeing the tip of an iceberg here.

Now, one interesting revelation that comes on the foot of these figures is the spread of mortgage debt burden in the country. 791,000 mortgages are outstanding, involving on average more roughly 2 individuals, majority of whom are in employment. This implies that mortgages debt cover in the workforce accounts for roughly 1,580,000 individuals, or 73% of the entire labor force.

Another thing - with 73% of working (or able to work in theory) households already carrying a mortgage (or two), and defaults on mortgages rising 13% per quarter, I guess two natural questions to ask are:

• In the short run: What stabilization in the property markets can one discern here?
• In the long run: what hope can the Government have to collect any sort of serious wealth tax, when most of our wealth has been tied up in, by now, largely devalued property?
  

Economics 25/05/2010: Here's one for the Budget 2011

Just a chart - from IMF Fiscal Stability report:
Now, as noted - this excludes housing, medical cards, child supports etc. Given that in Austria, Belgium and Denmark rental values are lower, while healthcare is universal for all, where does it put the combined value of long term unemployment benefits in Ireland compared to these two countries? And given our wage deflation since 2008, relative to Austria, Belgium and Denmark?..

Of course, we simply have to omit the petro-dollars fueled economy like Norway from consideration. Notice - this chart reflects comparatives for 2008 data for long term unemployed. Cutting unemployment benefits is a hard target. We will have to face that choice, however. Given this, my view would be to impose more significant cuts on longer term recipients, and lower cuts on short term recipients. This should create stronger incentives to seek employment and skills for those who have the lowest propensity to do so - the long-term unemployed.

Economics 25/05/2010: Looking at the Financial sector

As of now, both BofI and AIB are trading below 52-weeks lows. The financials are continuing to experience pressures. But a look back at the overall sector is warranted. Here are some stats:
Let's start from a far: dramatic or not, but the current market conditions are in line with the long term time trend in Irish financials. If anything, per almost 11 years of data, we are currently above the long run trend line. Guess there's more room for downward pressures, should long run dynamics matter.

Zooming in:
Note the chart above - this shows the totality of value destruction since the beginning of the credit crunch back in July/August 2007.

To see some more dynamics, consider the snapshot from the peak to today:
The chart above shows the entire extent of the crisis, with the medium term (through crisis) trend pointing to consistent positioning of the current market valuations. In other words, per trend, nothing dramatic is happening in the markets right now. I also posted some key dates that mark our policy and opinion makers' ability to track markets and predict the future.

Lastly, chart above shows the dynamics in Irish financials over the span of the 'rebirth of optimism' - the last 12 months during which various Government officials and politicians have made a score of statements to the effect that:

• Ireland has turned the corner on recession
• Irish banks are now in a stronger position than before
• Irish Government has made right decisions and these are now evident in the markets' approval, etc.
  

Revealing, isn't it?

Economics 25/05/2010: Daft rental report

Update below: stabilization or not?

Daft rental report is out today. Some interesting reading of the numbers. As predicted by me on the foot of January data - when the prevailing media song was about 'stabilizing' rental markets - rents are continuing their Southward trajectory.

Relative to peak rent:
So no relief in sight. Remember, in this country we call things 'stabilizing' when the rate of fall slows down... Pardon my foreign language skills, but I'd say things are stabilizing when we reach the bottom. In other words, when the numbers above stop increasing in absolute value.

Let me reproduce for you the seasonality chart I did back on the foot of January data:
You can see what I meant by January rally back then, and you can see that things have fizzled out since then. When one realizes that since 2008 we virtually had no new units coming into the rental market, this figure looks even more depressing. We are experiencing a real decline in demand as jobless families are dropping out not out of the property market, but out of the rental market! Emigration is, no doubt, also playing its part. All of which means that those first time buyers... well, are rapidly becoming first time lodgers in their moms homes.

What about the dynamics going forward?

Well, neither levels of rents, nor rates of change in rents are showing any stabilization. Both series are trending in the negative territory, suggesting that pressure on rents might remain, adjusting for seasonality, for some time. That said, positive monthly territory for now remain in sight, both in moving average terms and in rate of change terms. So expect shallow moves, with a risk to some downside.

Update: Since earlier today, there have been some debates going on as to whether Daft data shows any stabilization in rents. As I asserted earlier, relative to peak, monthly march downward continues (see table above) uninterrupted (once seasonality is factored in for January) and in absolute terms for all 4 months. But what about year on year changes? Table below shows the results:
So per annual changes, 2 conclusions are warranted:

• While the rate of decline has moderated across 2010 relative to 2009, the declines continued in double digits in February, March and April. Only in March and April have the declines been lower than a year ago.
• Probability wise, this was to be expected given seasonal variations, with likelihood of more positive moves in March and April being twice higher than in February.

On the net, I do not see any stabilization so far. Oh, and just in case you wondered - Daft data also shows uptick in properties available for rent... Hmmm...