Economics 6/8/10: Anglo's plans & systemic risks

Updated

Here are some interesting questions (note - just questions for now, on the foot of comments made by Prof Brian Lucey earlier today) regarding the 'Good' v 'Bad' Anglo plans.

Take it from the top: we started with a bank with €71bn on the books valued at valuations of the peak markets. This is now allegedly going to:

• €25bn of the face value of loans pre-writedowns - to the 'Bad' bank, implying that these loans are so poor in quality, even Nama, with an average 50%+ (LTEV-inclusive) haircut is not touching it. This implies that even in the long run, these loans are not going to generate more than, say, 30% recovery rate (a generous 30% that is, but let's take it as such. Note: that is across the entire loan book of the 'Bad' bank);
• €10bn of the face value of loans pre-writedowns - to the 'Good' bank, implying that these loans are better than Nama average, so the LTEV on these loans is above 50%. Assume that the LTEV on them is 60% (which makes them better than Ulster Bank's Irish book, per today's results for Ulster - again a generous allowance, but let's entertain it);
• the remainder is going to Nama.

Now, another little factoid: Central Bank of Ireland has lent Anglo €11.5bn under a MLRA repo agreement secured against the non-Nama loans.

Per Anglo last published results: "Sale and repurchase agreements with central banks include €12.2bn (30 September 2008: €7.6bn) borrowed under open market operations from central banks and €11.5bn (30 September 2008: €nil) borrowed under a Master Loan Repurchase Agreement (’MLRA’) with the Central Bank and Financial Services Authority of Ireland."

Let's do some simple math.

Value (recall - I am factoring referencing to Long Term Economic Value, not the current mark-to-market value, which is even lower):

• €10bn in 'Good' Anglo can be (optimistically) expected to yield €6bn valuation using LTEV;
• €25bn in 'Bad' Anglo can be (again, optimistically) expected to yield €7.5bn valuation using LTEV.
• Allow for 1.5% margin of costs on both sides, to €525mln pa, or over 5 years - i.e. much shorter than Nama horizon - €2.6bn (note: current bank cost structure, which one can expect to be preserved as both banks go about conducting impaired assets recovery - a higher cost activity)
  
• Total non-Nama book value is, inclusive of LTEV net of expected management costs, therefore could be already around €10.9bn.

Against this value of €10.9-13.5bn, CB of Ireland holds €11.5bn worth of loans to the Anglo.

Now to the question: Does this mean that CB might be facing a potentially significant loss on the repos?

This possibility raises two issues:

1. If the repos are spread across 'Good' and 'Bad' bank, then the 'Good' bank is hardly a feasible undertaking, as repos alone already exceed the value of the 'Good' bank even absent impairment charges, while 'Bad' bank has clearly no ability to repay any fraction of these;
2. If the repos are inherited by the 'Bad' bank, then, either CB has to declare a loss (and I am not sure how it can do this), or the taxpayer is on the hook for the repos by having to pay them down through the 'Bad' Anglo.
   

Now, alternatively, let's ask the following question: to recover CBs repos from non-Nama assets, we need to have a combined 'Good' & 'Bad' banks recovery rate of 33% (not covering the costs of operating both banks, funding, bond holders etc). And this, once again, refers to the valuations done on the face value of the loans before any recent impairments - before the bubble burst. To recover all other CBs' funds, plus our own - we need a recovery rate of ca 68% (again ex all costs etc). That's really highly unlikely, folks.


Quite a dilemma, then, especially since ECB (see here) didn't approved the repos in the first place... and since Anglo also owes the other Eurozone Central Banks some €12.2bn more.

What could Mr Trichet say about Anglo's priorities in repaying the loans? Would he be (a) so kind as allow CB of Ireland to recoup its repos, which ECB thought were dodgy enough to refuse to take them itself? or (b) insist that other CBs be repaid first before our own repos are covered? If (a) - I'd say Mrs Merkel would have a few kind words to say to Mr Trichet, given her electorate's feelings about having to bailout Greece. If (b) - the above potential negative valuation of the repos will have to be multiples larger...

Just asking some questions for now... Wonder if there are any answers out there...

Economics 5/8/10: Russia and wheat prices

Following the worst drought in 130 years, the unprecedented heat wave and subsequent wild fires, Russia stopped exports of wheat, corn, rye, barley and flower from August 15 through December 31, 2010. Russia is the third largest exporter of wheat in the world. It expects 2010 harvest to come at 65-75mln tonnes, a 25% shortfall on 2009. Prior to the latest disasters, which started in April this year and is expected to continue at least through August, Russia expected to post second record breaking export years in wheat in 2010.

Despite the shortfall, Russian Government does not expect significant shortages of wheat for domestic markets. Government holds estimated 9.5 million tonnes of wheat in reserves and has ordered fixed price deliveries of wheat to regions impacted by the fires and drought.

The implications of the Russian exports ban are multiple:

1. There is a direct impact on wheat prices, with short term futures rallying today 8%, while longer term deliveries contracts being on an exponential uplift curve (see chart below for December deliveries contracts);
2. There is indirect impact on other commodities and food products, such as milk, etc, as wheat and its by-products are used across almost entire production and breeding chain.

Wheat prices on the CBOT were up 42% in July, the biggest monthly gain since at least 1959. Monday prices were up 5%, and are now the highest for 22 months.

Economics 5/8/10: Service PMIs

Time to update my earlier post on PMIs - this time with new data on services PMIs. The original post is here. Once again, the data is from NCB Stockbrokers PMI release and you can read their very good objective analysis on their site.
New business activity in the chat above is the one to worry about going forward. Giving a snapshot of more recent periods:
Here, both, the flattening out of the expansion rate in total business activity and the decline in the growth of new business activity are pretty clearly evident. Nonetheless, both series are above 50, signaling continued expansion.
Underlying macro parameters are a mixed bag. Business expectations are still improving and are pretty robust, though the rate of improvement is slipping. More dramatic is the slippage in the rate of new export business orders expansion. In the mean time, contraction continues across services employment and profitability, though the rate of contraction is slowing and is almost reaching zero.

Unlike in the case of manufacturing PMIs, services-related prices are trending in the right direction:deflation is setting in once again in input prices and deflation is ongoing, but at a slowing rate, in terms of output prices.

Putting services and manufacturing sectors side by side, first consider the employment picture:
Both employment pools are contracting. Manufacturing employment has crossed into negative growth territory, while employment in services sectors is falling at a slower rate than before.

Lastly, putting side by side actual PMIs:
Expansion in manufacturing has been under pressure in Ireland over the last three months. Meanwhile, services sector has been on expansionary path since the beginning of the year.

Of course, PMIs are not a perfect signal for near term future of the overall economic activity. Nonetheless, the series have been signaling weak expansion for almost 7 months now. This is the good news. The bad news is that there is low degree of confidence in the gains made so far, especially in manufacturing. In all likelihood September-November will be the key months when it comes to either stabilizing economy in a growth mode, or triggering a double dip. In my view, the risk of the latter before the end of Q1 20111 is around 40-45% and rising.

Economics 5/8/10: Live Register - up & up, again

Live register is out today with some poor news: the seasonally adjusted LR rose from 444,000 in June to 452,500 in July (+8,500 mom).This year to July 2010 LR rose by the cumulative total of 34,403 (+8%).

The latest increase in LR is marked by women signees leading males signees by 4,600 to 3,900. This suggests that (a) services sectors are more likely to show accelerating contraction in employment, and (b) the trend for jobs destruction in higher value added activities is still running strong.

This is confirmed by LR new data on occupation breakdown of lost jobs. Per CSO: "All occupational groups showed monthly Live Register increases in July. The largest percentage increase was in the Professional group (+12.3%), while the smallest percentage increase was in the Craft and related group (+0.1%). In the six months to July 2010 all occupational groups showed Live Register increases with the largest percentage increase in Professional (+22.8%), while the next largest increases were in Clerical and secretarial (+15.6%) and Sales (+13.0%). The smallest percentage increase was in the Craft and related group (+0.1%)."

So for the headline impact of the news - take an average weekly earnings (Q4 2009) at €716.09 (€37,237pa), take the average professional grade weekly earnings at €793.35 (€41,254pa), apply tax rates consistent with these earnings at €3,963-5,610 net tax liability, plus €1,225-1,386 PRSI, plus €1,489-1,650 Health Levy and €745-825 Income levy. Net loss to the Exchequer of tax revenue alone is €7,422-9,471. Employer-side taxes lost are ca €1,250-1,400. Now, add to this the cost of unemployment benefits, loss of Vat on private health insurance, provision of public benefits, such as health etc - you have total cost to the Exchequer of €28,040-30,240 per each new signee.

So July figures are signaling a hit on the Exchequer balance of ca €257mln over the year - just like that, one month worth of newly unemployed.


The average net weekly increase in the seasonally adjusted LR was 1,700 in July or virtually identical to June figure of 1,725.
Monthly rate of change accelerated in July to 8,500 up from 4,900 in June and marking the fastest rate of monthly increase in a year to date, and the highest rate of increase since July 2009:
The standardised unemployment rate in July is now at 13.7% up from 13.4% in June. This compares with 12.9% in the first quarter of 2010, the latest seasonally adjusted unemployment rate from QNHS.
Some final comparatives:

• Weekly net increases average from January 2008 through July 2010 were 2,102 - above the July average weekly net rate of increase of 1,700. However, over the last 12 months, average net weekly increases were 386 - well below the figure for July;
• Monthly average rate of increase in LR was: January 2008-July 2010 = 9,100, 12 months to July 2010=2,783. July 2010 monthly increase was 8,500.
  

Economics 5/8/10: Good news - we might be 'one-off' broke?

Good morning, folks. As a day starter, please take a note: We are bust! Yesterday’s Exchequer returns are a worthy reading on the theme of the day and hence I am writing a third post on the subject. Let me recap where we are at:

Tax receipts are now under €17.2bn cumulative for the first seven months of the year. As far as our ‘ever optimistic’ official analysts go, things are going on swimmingly. But in reality, we are on track to meet my December 2009 forecast for a shortfall of €500-700mln on the year. And that despite the fact that Ireland has ‘turned the corner’ on growth – highlighting the fact that the read through from GDP to tax revenue is not a straight forward thing. Of course, most of the shortfall is due to our real economic activity – as measured by GNP – is still tanking.

So relative to profile, here’s the picture:Good news on expenditure – overall voted expenditure was 2.6% below anticipated for the period to July. But this ‘achievement’ was driven solely by the cuts to capital spending. Thus, net voted capital expenditure for the first seven months of the year now stands at €2.2bn – full €660mln (-23%) below target. Net voted current expenditure is so far on target, while national debt is costing us slightly less (-€213mln) than DofF anticipated.

So overall, we are on track to deliver the Exchequer deficit of ca €19bn in 2010, close to the target €18.78bn, as capital spending accelerates in H2 2010. But we won’t reach the overall target to GDP. Most likely, we are going to see a 12% deficit to GDP ratio.

And this does not include the full extent of funding for Anglo and INBS. Brian Lenihan has already committed the state to supply €22bn to Anglo alone, of which €14.2bn was already allocated, but only ca €4bn went on the Exchequer accounts. Of the still outstanding €7.8bn, the question is how much of this amount is going to be directly shouldered by official deficit figures. The second question is – will €22bn cover Anglo demand for capital post Nama Tranches II and III transfers – recall that Anglo is yet to move loans for Tranche II. The third question now relates to AIB – given its interim result announced yesterday, one has to wonder if the bank will need more capital. What is beyond question now is that the State will be standing buy with a cheque book ready, should AIB ask for cash.

All in, Ireland Inc’s sovereign accounts this year are likely to come out with a 20% plus deficit relative to GDP. That’s a massive number implying that over a quarter of domestic economy will be accounted for by the shortfall in public finances. Our debt can easily reach over 87% of GDP and close to 110% of GNP (and that’s just including the full Anglo amount of €22bn and excluding Nama and the rest of recapitalizations liabilities).

Scary thought. But don’t worry – the Government will come out to say that it was all due to one-off measures. One-off in 2008, 2009, 2010, and one can rationally expect 2011 and even possibly 2012. By which time Nama liabilities will begin to unwind… serializing the one-offs into the future.

Economics 4/8/10:Exchequer July receipts

Note: Corrected version - hat tip to Seamus Coffey!

As promised in the previous post (which focused on the Exchequer balance, here), the present post will be focusing on actual tax receipts.

I have resisted for some time the idea that Budget 2010 targets are somehow analytically important. Hence, you will not find targets-linked analysis here. But the main tax heads - their comparative dynamics over 2008-2010 to date are below.

First, take a look at the actual cumulative to date levels.Overall tax receipts are now running below 2009 numbers, and are still way off 2008 numbers (off €1,536mln on 2009 and €5,520mln on 2008). This means we are now 8.22% below 2009 and 24.35% on 2008.

Two largest contributors to the receipts are Vat and Income Tax:Vat is now €483mln below 2009, and still €2,453mln behind 2008, which means we are now 6.9% down on 2009 and 27.5% behind 2008. One wonders how much of this Vat intake in 2010 is due to automotive sales increases driven (as I explained in earlier posts) predominantly by the 'vanity plates' with '10' on them. Income tax shows a similar pattern: down €537mln on 2009 (-8.45%) and €1,060 on 2009 (-15.4%).

Corporate tax and Excise are the next largest categories.Cumulative year to date, corporate tax receipts are performing weaker than in 2009 (-€260mln and -13.8%) and ahead of 2008 (+€192mln and 13.4%), but this is due to timing issues and financial markets recoveries in H1 2010. Excise taxes are still under-performing: down €87mln on 2009 (-3.37%) and €773mln (-23.7%) on 2008.

Stamps
Transactions taxes are not faring well. Stamps are down €75mln on 2009 (-18.3%) and down €808mln on 2008 (-70.7%).

Surprise surprise, Capital Gains Tax is singing similar song:
So CGT is down €89mln (-44.3%) on 2009 - despite being beefed up by bull markets in financial assets, and is down €544mln (-83%) on 2008.

Year on year changes show stabilisation around 2009 levels.
Usually, the Exchequer returns publications now days provoke a roaring applause from our banks and other 'independent' analysts and the remarks about 'turning a corner'. This time - no difference. Nope, folks - let me stress - there is not even a stabilization around horrific results for 2009. Exchequer revenues are heading south. We haven't gotten anywhere close to resolving the crisis.

But let me show you what this bottom will look like, once we are there.
It is a horrific place in which personal income and consumption-related taxes bear roughly 75.2% of all tax burden (up from 62.5% in 2008 and 68.6% in 2009). Meanwhile, physical capital taxes contribution to the budget have shrunk from 14.7% in 2008 to 9% in 2009 and 4.2% in 2010. Corporate tax, despite the robust performance now contributes only 9.5% of total tax receipts down from 2009 level of 12.4% and 2008 level of 13.5%.

In other words, those who benefit less of all demographic and economic groups, from public services - the upper middle classes - are now paying more than 50% of the total tax receipts bill. This, in the words of some of our illustrious guardians of social justice is called 'protecting the poor'. In other times, in other lands, it was also called 'taxation without representation'.

I would rather call it a tax on human capital - the very core input into 'knowledge economy' that we need to get us out of the long term economic depression.