Economics 1/6/2010: Numbers game at Anglo

Last night, I sat down to run through possible scenarios for the Anglo's 'The Bad and the Ugly' Banks division. You see, something was telling me right off the start that the idea of a 'Good' Bank just doesn't really square off with our knowledge of the bank's operations to date.

So I posited to myself the following question: given Nama transfers and rumored split off of €12-15bn worth of loans into a 'good' bank, can the resulting entity be viable? Like a scientist in a lab, I donned on a white coat (well, really my favorite UofChicago sweatshirt), pulled out a Petri dish (my Excel) and started observing the split of that outright not-so-beautiful and very toxic (to the taxpayers) bacteria, called Anglo...

Here are the results, first in numbers and then in plain English:

Step 1: recall we have pumped €10.3 billion worth of promisory notes into the bank alone. Relying on my yesterday's analysis (see details here), I reproduced the demand that a 'Good' Anglo will generate for funding these promisory notes. Now, a reminder - these numbers (penultimate column) correspond to interest only charge on Anglo from the promisory notes. They exclude principal repayment and other recapitalization funding already in the bank.
Bah, I said, the thing in the Petri dish of mine looks pretty ugly. Ugly as in unable to cover the taxpayers-due interest on capital it receives at the first glance.

Ok, I said to myself, but may be were the new 'Good' bank to grow over time, it will become relatively viable with time? Suppose the 'Good' bank generates no impairments going forward (unrealistic assumption, but suppose it does), suppose that 'Good' Anglo grows its book at 5% (generating no new impairments). Further suppose that there's some value in the 'Bad' bank - so assume 20% of the loans transferred to it perform in the future (an extremely optimistic assumption, but what the h***ll, not much out of line with the general assumptions the Government has been making all through its management of the crisis).

The question I asked then was: with all these rosy assumptions in place, what amount of interest payments annually can Anglo afford?

To compute this, I took several scenarios:

1. I allowed 'Good' Anglo to take €12 or €15 billion in loans on board;
2. I assumed that it generates 2% of the loan book annually (another optimistic assumption - as it corresponds to an efficiently operating bank in terms of costs, book of business and funding costs - all of which are not exactly characteristic of the Anglo)
3. I then assumed three different potential burden levels on interest (recall, no principal) repayment at 30% of the total annual return by the bank, 25% and 20%. Let me explain here that a 30% number is utterly unrealistic, implying that almost a third of the entire operating revenue of the bank will be used to pay interest on a small share of its capital funding. This will, in effect, leave no surplus to pay bonuses (of any kind) and dividends (of any kind) as well as to finance bank's insurance etc. 25% mark is also unrealistic, while 20% is back-breaking for a bank, but can be probably sustained over a couple of years.

Table below shows the results by stating the amount of interest repayment that the bank can generate across both its 'Good' and 'Bad' divisions. Blue-bold numbers mark the first time that the annual interest funding requirement gets met.
All of this is fine, I said to myself next, but before the interest requirement is first met on the annual basis, there are years of the bank not covering the interest bills. These will cumulate.

My next question, therefore was: How soon can the bank break into the 'black' vis-a-vis interest repayment alone?
Table above shows the cumulated interest arrears from the €10.3 billion in promisory notes. It clearly shows that under all scenarios, save one (the most optimistic scenario) the entire Anglo operation cannot be expected to generate enough cash to cover even the portion of its interest bill. In fact, under the more realistic scenario (last two columns), Anglo - 'Bad' and 'Good' combined - will continue to accumulate interest arrears on the taxpayers funds (ex €4 billion in direct capital it received) through 2020.

There is no principal repayment charge in the above, nor is there a chance of receiving anything close to the interest bill, even assuming that we do not roll up interest on the cash we put in. In simple words - the entire Anglo operation is so fundamentally bust, that the taxpayer is likely to never receive even a few cents on the euro of the money we've put into it.

The only thing that grew in my Petri dish was a voracious bacteria capable of hoovering taxpayers money at a speed unimaginable to any other bank.

One wonders if that is what Mr Alan Dukes and our Government mean when they are saying that proceeding with keeping Anglo on a respirator amounts to minimizing the cost to the taxpayers.

Economics 31/05/2010: Anglo's latest cash call

This just in - the Government has decided to give Anglo, yes, that very Anglo which is Ireland's real zombie bank with no prospect - even theoretical one - a fresh capital injection of €2 billion (here). This brings taxpayers' capital injected into the bank to €14.3 billion to-date.

The official information by DofF claims that because the injection comes in a form of a promisory note, payable over 10-15 years, there will be lesser impact on the taxpayers today. However, although the official announcement does not say so, this term structure of payments means that our future deficits will be front loaded (pre-committed to the amount announced today), implying that for Ireland to reach required 3% deficit/GDP limit by 2015, we will have to face an increased funding requirement for Anglo over time.

This requirement must be provisioned today, since the notes work in the following way:

• At any point in time between today and 10-15 years from now, Anglo can waltz into DofF's offices and ask for any share - between 0.00001% and 100% of the amount issued on the promisory note.
• At that moment, the Government will have to come up with cash pronto, which means - no time to issue separate bonds.
• Which implies that the very second Mr Dukes asks for cash, our deficit goes up by that exact amount.

Now, prudentially, we should have set an escrow account and provided for this funding. In practice, as is clear from the DofF release, no provisions will be made. The entire, and I repeat, the entire risk of the drawdown therefore is leveled on the shoulders of taxpayers. The DofF in effect is praying to the forces of fortune that Anglo won't come in with a request for funds tomorrow, and/or that any request will not be for the entire sum of the promisiory note.

Now, let us revert back to the 'bank' called Anglo. The State has now committed €10.3 billion in promisory notes. These carry interest rate of... well, I am not sure... but suppose it is 5% to cover the cost of borrowing for these funds in the market, once the funds are disbursed. Assume that 10% of that (actually below a normal charge for a letter of credit for an insolvent company) is outstanding annually until a drawdown. Make a further assumption: assume that Anglo will draw the entire amount in equal annual installments over 5 years - an assumption that is also extremely conservative.

At 5% per annum, Anglo's liabilities to the taxpayers are:
Let me quickly and briefly explain the last 2 columns above. The penultimate column shows the sum of interest charges (at 5% on drawn funds), plus underwriting charge (at 0.5% for undrawn promisory note funds remaining) that Anglo should be paying over the next 10 years, assuming draw down is evenly spread over 5 years on both tranches. The last column then states the amount of loans that are performing that Anglo needs to have on its books in each year to cover the loans interest, not the principal, but interest, assuming that Anglo uses 0.5% of the loans to cover its interest rate, which would roughly amount to 25-30% of its entire interest income on the loans (note - that is really a severe case of the credit squeeze on a bank, but hey, suppose they manage without breaking the back).

How do I come up with this 25-30% estimate? In a normal year, one can expect a fully efficient bank to make ca 2% of their loans volume in revenue. If it pays 0.5% of that amount to cover costs of promisory note, it will be swallowing 25% of the revenue base.

Now, Anglo is transferring to Nama some €35 bn worth of loans, leaving it with ca €30 billion in remaining loans on its books. Of these, roughly 60% is expected to go into the 'bad' bank - in other words, roughly €18 billion worth of loans won't b performing. This leaves it with roughly 40% of loans or €12 billion on the side available for revenue generation. It needs ca €28 billion to cover the cost of the prmisory notes alone...

Get the picture? Even if you dispute my assumptions and half all the costs of the promisory note carry, you still can't get Anglo balance sheet to cover the cost (not the principal) of what it is borrowing from the taxpayers. This puts into perspective the DofF claim that: "As the Minister stated last March the overriding objective of the Government is to minimise the cost to the taxpayer of the restructuring of Anglo Irish Bank".

Economics 31/05/2010: How much more evidence do we need?

In the spirit of my earlier posts on the matter - here is today's press release from Ryanair. Let me add, uncontroversially, that I fully subscribe to Ryanair view that our travel tax (defacto assigned in the Irish Times op ed to Gurdgiev-Ryanair [campaign against the] tax, but since then spreading to include on the opposition side all main airlines based in Dublin) has been hurting tourism in Ireland, while imposing an arbitrary, unnecessary and unjustifiable burden on ordinary families here.

RYANAIR BELIEVES IRISH GOVT HAS CAUSED OUR TOURISM COLLAPSE AS GROWTH RETURNS TO OTHER EU COUNTRIES

INDEPENDENT REPORT SHOWS THAT ONLY COUNTRIES WITH TOURIST TAXES CONTINUE TO DECLINE

Ryanair, Ireland’s largest airline, today (31^st May) published irrefutable evidence that the Irish Govt is responsible for the collapse in Irish tourism as new (independent) statistics show traffic growth has returned to those EU countries that do not impose tourist taxes. These statistics disprove Minister Dempsey’s claims that the fall in traffic and tourism is ‘an international phenomenon’ and proves that Irish tourism is being devastated by the Govt’s €10 tourist tax.

The RDC Aviation report (attached) highlights that Irish seat capacity (which drives passenger numbers) collapsed by over 140,000 in April and by over 700,000 so far in 2010. Seat capacity continues to decline in Ireland, the UK and France - the only European countries which continue to impose tourist taxes. By contrast, growth has returned to countries which have scrapped tourist taxes (Belgium and Holland) or reduced airport charges, in some cases to zero, (Spain) to stimulate tourism growth.

Ryanair warned that this downward trend at Irish airports will worsen throughout 2010 as the DAA makes Ireland even more uncompetitive with a 40% increase in the airport charges to pay for its €1.2bn T2 white elephant.

RDC Aviation: Irish Airport Capacity Jan-Apr

Year	Seats
2009	5,021,727
2010	4,321,433
Decline	– 700,294

Ryanair’s Stephen McNamara said:

“The RDC Aviation report shows that those countries, like Ireland, which impose tourist taxes continue to decline and disproves the Dept of Transport’s claims that the continuing record collapse in traffic at Dublin Airport is ‘an international phenomenon’. The Irish Govt’s €10 tourist tax and high charges at the DAA Monopoly have made Dublin an uncompetitive, expensive destination. Growth has returned throughout Europe except in Ireland, the UK and France which are the only major European countries to tax tourists instead of welcoming them.

“Ireland’s traffic and tourism decline will increase when charges at the DAA Monopoly rocket by over 40% in October as the Dept of Transport rewards the DAA for its traffic decline and the €1.2bn white elephant, T2. Unfortunately 2010 will be even worse than 2009 in terms of lost visitors, jobs and tourism revenues in Ireland. It is time to axe this stupid €10 tourist tax and slash the DAA’s high fees”.

Economics 30/05/2010: A gargantuan task ahead

As the Government continues to insist that the worst is over for Ireland Inc, let us consider some headline numbers on the structure of our public spending.

The figures reported below refer to 2008 comparisons, so they omit most of the horrific fall-out from the current economic crisis. as such, these comparisons relate more to the structural imbalances our state is running, not to the recessionary effects. This is worth keeping in mind, for it means that the differences between Ireland and other states reported below, as well as the adjustments required for us to reach sustainable long term equilibrium on spending and taxation sides will have to be put in place no matter what happens to our economy in years to come. It is also worth keeping in mind because the figures reported below underestimate the extent of our post-2008 imbalances compared to other countries that had experienced much less pronounced crisis over 2009.

All data is taken from the publicly available sources - the IMF and CSO - so the Government and our tax-and-spend crowd of Unions-led economists are fully aware of these. Plausible deniability does not apply, therefore, when it comes to our Government pronouncements about its policies and the current position of the Irish economy on international competitiveness scale.

Chart above plots Ireland's position vis-a-vis its peers in the developed world in terms of the overall size of the primary (non-capital) share of public expenditure in the economy. Two facts worth highlighting here:

• Ireland's Government spending as a share of our real economic income (GNP) is the second highest of all countries in the group, and is well in excess of the average for small open market economies (SOME). It is in excess of Germany (Berlin) and well ahead of the US (Boston).
  
• By this metric, Ireland simply does not qualify as a 'market' economy, as domestic private sector accounts here for less than 47% of GNP! In the USSR of the 1980's, private economy (black market) accounted for around 40% of the total GNP. Get the comparison?

Chart above shows that Irish public sector is clearly one of the most lavishly paid one in the entire developed world. In fact, our public sector wages and earnings swallow over 14.4% of our national income, making Ireland's PS workers the 5th highest paid (on aggregate) in the advanced world. The gap between Irish public sector earnings bill and that for the average SOME is a massive 4.47% of our GNP. Roughly speaking Irish public sector wages bill contains a roughly speaking 48% premium relative to the PS counterparts in similar economies around the world. Clearly, even the reductions in overall take home pay imposed on PS in Budgets 2009-2010 has not erased this premium, especially when one recognizes that since 2008 our GNP has contracted almost in line with the decline in PS pay.

Chart above maps Ireland relative to the US (Boston) and Germany (Berlin) to show just how absurd the whole notion of Ireland Inc being positioned between Boston and Berlin is in the real world. In reality, just one parameter - Social Benefits as a share of GDP/GNP - marks our relative position as being between Boston and Berlin. In every other parameter, we are a basket case of excessive public spending and taxation relative to both the US and Germany.

With the above data in mind, what adjustments in the budgetary positions will be required to bring Ireland into the exact position of being between US and Germany to reflect our stated competitive benefit of being an economy that can facilitate trade and investment flows between the two giants - the EU and US?
To restore our competitive balance we need:

• A cut of €23 billion in gross annual primary spending by the state (current expenditure) - some 14.7% of our GNP. Not €3bn as Brian Lenihan is doing, or €3.5bn as An Bord Snip Nua was suggesting. A whooping €23 billion, folks!
• The cut above cannot come from the capital budget side - where most of the cuts so far took place. It has to be cut from the current expenditure. The reason for this is simple - capital spending is one-off item of expenditure and it is associated, in theory, with a net positive return on investment. Current spending is permanent and yields no financial return.
  
• The cuts must include at the very least a €9.3bn reduction in the wages and pensions bill in the public sector (5.9% of GNP or almost 44% cut in the total PS wages bill, achievable through both reductions in numbers employed and wages paid and pensions benefits entitlements).
• Social benefits, at least in the long run, actually are in line with us being smack between Boston and Berlin, so no adjustment is needed here in the short term (given further deterioration in the fiscal position in Ireland since 2008, I would actually recommend a temporary cut here. Also, longer term reforms, to change the structure of welfare benefits and state pensions must be enacted, but for the reasons different from the budgetary considerations).
• Instead of raising tax revenue, Irish Government should engage in a dramatic reduction of tax burden on the economy. Generally, total tax take in the Irish economy exceeds the average Boston-Berlin position by 6.5% of GNP, requiring a reduction in overall tax burden of €10.3bn on 2008 numbers.
• This reduction in the tax burden should include a cut in personal income tax, CGT and personal gains/profits taxes of 2.1% of GNP or €3.3bn.

There is absolutely no ground for our Government and policy leaders' claims that Ireland is strongly positioned between the low(er) tax US and high(er) tax Germany as a competitive destination for exports and investment arbitrage. In fact, due to the Government-own policies, fiscal and tax imbalances created in this economy mean that we are, at a macroeconomic level, grossly uncompetitive relative to

• both the EU and the US,
  
• as well as relative to our main competitors world wide - the small open market economies.

Economics 29/05/2010: EBS - taxpayers are on the hook, again

One really has to start worrying about the going-ons at the DofF, the CBFSAI and in the Government. After all, over recent weeks we have been told that:

1. The leadership in this country is finally getting its hand on the pulse of the financial sector and the economy (a tale that emerged back in March when Minister for Finance, the Governor of the CB and the FR made back to back statements concerning the plans for the banking sector stabilization, and subsequently went on to assure the nation that all is now going to be fine);
2. Ireland has turned the corner (we've heard this in its various variants since May 2009);
3. With Nama working overtime, lending is about to be restored across the nation;
4. There are no more nasty surprises (apart from the ever-shifting capital targets in the Anglo);
5. That banks can now sort themselves out and hence there will be no need for a sweeping Guarantee extension comes September;
6. That Ireland is so far ahead of the PIIGS curve, it is reckless and dangerous, and erroneous, to claim otherwise.

Well, as of today we, the taxpayers, own another banking institution - the EBS - which, up until now was regarded as the least sickly of the Irish banks. Per Irish Times report today: "The Government’s move came after the society failed to attract private investors. The State now seems set to invest up to €875 million in total over the next 10 years."

Pardon my French, but what the h***ll is going on in our circles of power? One would naturally expect the Government and the regulators responsible for the banking sector to be in a daily contact with the institution, like EBS, while it is engaged in a major talks with potential buyers. And one would expect the talks to progress over time, with some clear indications as to whether the deal was likely or not. A sudden release of this new information is, therefore,

• either a reflection of the fact that our banking sector authorities did not have a clue as to the progression of the talks - in which case they once again failed to 'keep their hand' on the patient's pulse; or
• they have at the very least did not disclose pertinent information to the markets and the public as to the state of these talks.

Either way, the news that the taxpayers are once again stuck for ca €1 billion in bailout funds (more than the amount of €600mln the Spanish Government had to inject in one of its banks, triggering a massive run on Spanish markets) without any, and I repeat, any public official making the matter public until the deal was done!

Of course, another remarkable thing about the deal is that it comes on foot of Nama being deployed in the market. Last year, myself, Brian Lucey, Peter Mathews, Karl Whelan and others have warned that nationalization of the failing Irish banks was the least costly option for their recapitalization that should be pursued. Nationalization of EBS would have cost no more than €650-800 million and would have led to a 100% ownership of the bank by the State. In return, we could have imposed a speedy reform on the bank's board and management, and actively repaired its balancesheet.

Instead, we have paid countless millions for it through Nama, shelled out almost €1 billion in direct capital commitments, supplied it with a state Guarantee worth well in excess of €200 million in risk-related implicit costs, and still control only 51% of the bank. We are now left with a quasi-state asset that cannot be reformed and is at a risk of being left to linger like a zombie stuck between private markets and the politicos.

One wonders, will anyone, responsible for Nama and the rest of our banks policy ever be held accountable for this waste?

Economics 28/05/2010: Spain's downgrade is a warning for Ireland

In a significant development today, Fitch cut Spain’s credit ratings to AA+ from AAA. This was expected.

What was unexpected and new in this development is the expressed reason for the cut.

Per reports, "Fitch said Spain’s deleveraging of record-high levels of household and corporate debt and growing levels of government debt would drag on economic growth." (Globe & Mail)

This puts pressure not only on the euro and European equities, but also on the rest of the PIIGS' sovereign bonds. Ireland clearly stands out in this crowd.

As I have shown here and more importantly - here, Ireland is by far the most indebted economy in the developed world. While it is true that a large proportion of our total external debt accrues to IFSC, even adjusting for that

• Our General Government Debt held externally is the fifth highest in the developed world;
• Our External Banks Debt is the highest in the world;
• Our Private Sector Debt (Total Debt ex Banks & Government) is the highest in the world; and
• Our Total External Debt is the highest in the world.

In addition, per IMF (see here) our budgetary position is one of the weakest in the world, including for the horizon through 2015 (here).

“The downgrade reflects Fitch’s assessment that the process of adjustment to a lower level of private sector and external indebtedness will materially reduce the rate of growth of the Spanish economy over the medium-term,” Fitch’s analyst Brian Coulton said in a statement.

Fitch said "Spain’s current government debt would likely reach 78 per cent of gross domestic product by 2013 from under 40 per cent before the start of the global financial crisis in 2007." Irish debt is projected to reach 94% of GDP by 2015 (IMF) or 122% of GNP - the real measure of our income. If we factor in the cost of Nama and banks, Irish Government debt will reach 122% of GDP by 2015.

This puts into perspective the real scope for public spending cuts we must enact in this and next year's Budgets. The Government aim to reduce spending by a miserly €3 billion in each year through 2012 will not do the job here. We will have to do at least 2.5 times that much to get our house in order.