Economics 17/05/2010: BofI rights offer - back of an envelope

Update: Tasc have published a very interesting piece of research (here) mapping the real Golden Circle of Ireland's interconnected political and economic elites. Fair play to Tasc for covering semi-state bodies and companies. Well done to the authors! (hat tip to RDelevan)



Back of an envelope calculations for the BofI rights offer - self explanatory stuff:
But what about taxpayers' buy-in into BofI under this deal? Well, if the value of this offer is negative at the buy-in price of 55 cents per share, think what the value is for the taxpayers, who bought at €1.80 per share! Ok, let's do the maths: we have post-rights price of BofI at 81.9 cents, for which we paid 180 cents - the net return is the loss of 98.1 cents per share bought by the Irish Exchequer... Amazingly, there is no reason for this loss whatsoever - as an existent shareholder in the bank, Irish Exchequer is entitled to participate in the same deal offered to all current shareholders. we, therefore, could have limited our losses to 24.75 cents per share from 81.9 cents per share and still done the same deal!


Note: the above estimates are based on straight forward linear model of equity-price relationship. These are, therefore approximations. Based on expected balance sheet model, the returns can be estimated different - with upside growth scenario over the next few years potentially yielding a positive return, while downside growth scenario can yield an even deeper loss. You be the judge, but my figures should be treated as being closer to risk-adjusted (static model) averages.

Disclaimer - I do not hold any shares or any other financial instruments (equity or debt) in any of the Irish banks.

Economics 17/05/2010: Jose Maria Aznar's proposals that ireland should adopt

When Spain beats you in a race of setting out pro-market reforms, can you still claim you are open for business? Well, that's a conundrum Ireland is likely to face. For 'all talk, no action' Messrs Cowen & Lenihan, here's a proposal from Spain's José Marià Aznar - a rather sensible list of reforms Spain needs to adopt in the next few years, published in FT:

1. Large-scale labour reform to transform collective bargaining (equivalent to killing off our own Social Partnership to which Messrs Cowen & Lenihan seem to be totally wedded), deregulate labour recruitment services (which is now out of reach for Ireland since Messrs Cowen & Lenihan subscribed to the Croke Park deal) and, lower taxes on employment (which is, of course, an impossibility for Ireland as we continue destroying our domestic and exporting capacity by saddling workers with the bills for banks and public sector rescues) and encourage the unemployed into work (a possible by-product of the next wave of public spending cuts, but not a concerted effort that pairs both negative and positive incentives and access to training and entrepreneurship resources for the unemployed);
2. a new energy policy to avoid the shutdown of nuclear plants, deregulate markets and cut subsidies on inefficient renewable energy sources (which, of course, would run counter to our Government's insistence on preserving ESB's market power and building windmills to escape modernity. Do note that our refusal to properly deregulate energy distribution rests on the Government continued protection of the ESB trade unions' interests in maintaining their ownership of the national grid);
   
3. a bank shake-up, including authorising the investment of private capital in savings banks (yeah, right, as if we really have a chance of reforming our banks with Nama assuring they will remain zombie lenders for a good part of the next 10 years);
   
4. sweeping reforms to reduce the size of regional administrations and create a viable and efficient state (again, we have no reform agenda on local authorities, and no reform agenda on creating any meaningful efficiency gains in the public services);
   
5. changes to the state pension system to guarantee its mid-term and long-term sustainability (in Ireland's case, this is equivalent to the earlier Government promise to... create a new compulsory quasi-tax on our incomes that would underpin state-controlled, privately supplied pension system, while maintaining the status quo of inefficient, and politically manipulated social security);
   
6. deregulation to increase competition, including reforms to the welfare state and further privatisation of public companies (Messr Cowen & Lenihan have not got this far, and are unlikely to get there in the future. Instead of stimulating private growth by opening state-controlled markets to competition and breaking up Government near-monopolies, our Government is keen on actually providing more cash for semi-states to engage in 'investment' which normally - DAA, anyone, or ESB - yields no real returns to the economy, but always acts to increase market power of these semi-states);
   
7. tax reform to foster competitiveness (again, not a peep on this one from Messrs Cowen & Lenihan. Instead of tax reforms, we have Commission on Taxation report and a promise of pushing tax rates even higher in the next couple of years. Take a wild guess which 'programme' will this Government pursue).
   

That's right, folks. Our ex-politicians now line up to take state jobs at the insolvent banks. Spain's ex-leaders are trying to design new policies. Any idea who's got a better shot at a recovery?

Economics 16/05/2010: IMF on fiscal stability IV

So continuing with the IMF Fiscal Outlook report data, building on the three previous posts: Part 1 (here), Part 2 (here) and Part 3 (here), take a look at another wonderfully ludicrous myth perpetrated by the Irish Left: the Myth of Underinvestment in Public Health in Ireland.

The Myth of Healthcare has two parts to it: Part 1: "Irish Government has under-invested in Irish public health." Part 2: "We need to ramp up Health spending to achieve better services".

Hmmm:
The data above is taken from the paper that formed the background to the IMF report, titled “From Stimulus to Consolidation: Revenue and Expenditure Policies in Advanced and Emerging Economies”, Prepared by Fiscal Affairs Department, Approved by Carlo Cottarelli (30-Apr-10). My calculations cover GNP comparatives and ranked results, plus the change between 1990 and 2007. IMF reports changes between 1960 and 2007 and 1970 and 2007. I find these data problematic, because of a large number of gaps in the data for these years. In addition, I would have trouble comparing Ireland between 1960 and 1970 through 2007 to majority of the countries on the list, as arguably, Ireland was not a developed or advanced economy in the decades prior to 1990.

What the table above clearly shows is that:

• In 2007 Irish Government spending on public healthcare was 8th highest in the group of advanced economies, measured as a share of our income.
• Accounting for the size of the recession in Ireland and a lack of significant fall-off in public spending on health in Budgets 2009-2010, one can relatively safely assume that we at least retained this position in 2010.
• In terms of increases in spending, we are clearly nowhere near the bottom of the league. We recorded 8th highest increase in spending in the last 17 years of all countries in terms of GDP.
  
• We achieved second highest increase in spending as a share of national income in the sample of developed nations.
• Our increase in health expenditure as a share of GDP was 21.4% above the average for the group of countries. It was 107% (more than double) above the average in relation to our GNP.
• A large number of countries - marked in bold red - to my knowledge offer superior health services to their citizens compared to Ireland while spending less, sometimes vastly less, public resources on healthcare provision. This statement does not take into account that many of these countries have much older population than Ireland.
• Have the FF/PD Governments been any worse (or better) than other Governments in financing health expenditure increases (or dumping good money after bad, if you want)? I don't know - the data above cannot tell me quality differentials or efficiency of spend. But what I can tell is that until 200 we were spending less than the group average on health. In 2007 we were spending above the average (based on GNP).

The problem, of course, is that we cannot perfectly measure the output we get for the money we spend on public health. Alas, somehow, I know that any foreigner living in this country runs for the airport the minute they get sick, desperately trying to avoid HSE's kingdom. French, Italians, Germans, Belgians, Spaniards, Czechs, Dutch - you name a country within the EU - all have been dreading the need to face our 'centres of excellence' where medical staff needs to be reminded to wash their hands and lines of sick patients stretch the length of the lines to the infamous Lenin's Tomb's in the hey days of the CPSU.

It looks like, according to hard data, this adverse reaction is not due to the lack of cash in the health system...

Economics 16/05/2010: EU on the brink

Before I begin the post on Euro, let me bring you a piece of really good news I've learned about last night. Although it has been publicly released few weeks ago, I learned about this just last night. Ireland is ranked third in the world as a centre for research in immunology (details here). Interestingly, I was informed by an anonymous source close working in scientific R&D field that the DofF is putting loads of pressure on science funding organizations to provide 'commercial return'-linked 'Irish drugs' products backed by the above-mentioned research. In immunology, like in any other field linked to phrama or biopharma, it takes around 15 years on average and scores of millions of euros in funding before a drug can brought to the market. We are just at the beginning of what is now internationally recognized to be successful undertaking in immunology research. Sometimes, DofF needs to wait patiently for a payoff! Let's hope they do.


Ambrose Evans-Pritchard, in today's piece (link here) has a superb analysis as to why Euro is in the end game, with pat not an option for its fierce opponents. And, incidentally, why it's the markets that are getting things right in nailing Euro zone. Let me quote few passages (as usual, comments are mine):

"Geneva professor Charles Wyplosz said EU leaders made the error of overselling up their shock and awe package [€750 billion rescue package issued two weeks ago] before establishing any political mechanism to mobilise such sums. The fund is an empty shell, he wrote at Vox EU. Worse still, crucial principles have been sacrificed for the sake of unconvincing announcements."

Bingo: Wyplosz is 100% correct, as I wrote here, the package is a bizarre amalgamation of impossible, improbable and outright reckless:

• It contains guarantees that cannot be backed by resources
• It shoves more debt onto the shoulders of already insolvent sovereigns
• It turns Germany - a solvent nation - into an implicitly (as long as guarantees remain implicit) insolvent nation
• It contains no real mechanism for imposing any sort of discipline on Eurozone sovereigns who might continue engaging into reckless deficit financing
• It demolishes any credibility built up by the ECB over the last decade and with it tears the fabric of the Euro
• It represents a massive cost imposition on Eurozone's economies

"Brussels was unwise to talk of smashing the wolf pack speculators and defeat the worldwide organised attack on the Eurozone. As Napoleon said, if you set out to take Vienna, take Vienna. Besides, the language of the EU priesthood ex-ECB board member Tomasso Padoa-Schioppa talks of the advancing battalions of the anti-euro army frightens Chinese and Mid-East investors needed to soak up EU debt. These metaphors are a mental flight from the issue at hand, which is that vast imbalances masked by EMU, indeed made possible only by EMU have been decorked by the Greek crisis and now pose a danger to the entire world."

Bingo again! Since the foundation of the EU in its modern incarnation - in other words since the mid 1990s, Brussels did nothing in terms of economic policies other than issue lofty plans and guidance documents - which promptly went nowhere real, and blame 'others' for its own troubles. At times, this reminded me of the good old Sovietskies whose entire edifice of the state was supported - from the early 1970s through the late 1980s - solely by the threat of 'others' coming to take over the Motherland.

"One can only guess what Mr Trichet meant when he said we are living through the most difficult situation since the Second World War, and perhaps the First. ...was Mr Trichet alluding to something else after witnessing the Brussels tantrum by President Nicolas Sarkozy? According to El Pais, Mr Sarkozy threatened to pull France out of the euro and break the Franco-German axis at the heart of the EU project unless Germany capitulated. To utter such threats is to bring them about. You cannot treat Germany in that fashion."

And herein is where the trouble's brewing. One thing for people to say Germany should exit the troubled Euro to save itself. Another thing for the country like France, which never really bothered to comply with the budgetary restrictions of the Maastricht Criteria or SGP to threaten to pull out, leaving Germany to pick up the pieces...

"The German nation is moving on. I was struck by a piece in the Frankfurter Allgemeine proposing a new hard currency made up of Germany, Austria, Benelux, Finland, the Czech Republic, and Poland, but without France. The piece entitled The Alternative says deflation policies may push Greece to the brink of civil war and concludes that Europe would better off if it abandoned the attempt to hold together two incompatible halves. It can be done, the piece says."

So the rationale for a German exit is there. As it has been since the first day of the Euro creation and the massive pan-European euphoria (or call it chauvinism) that engendered the idea (no matter how absurd) that EU can absorb the entire Continent into its folds and stretch into Asia via 'acquisition' of Turkey, plus the grand delusion of the Euro becoming the reserve currency of the world. Only now, this rationale has real feet - the markets gave them these by exposing the weakness behind Europe's great experiment. The markets did exactly that with the USSR in the 1980s, with Asia in the second half of the 1990s, Russia in 1998, New York in the 1970s, Orange County in the 1990s, Latina America in the 1980s and then in 2002-2003. They will, once the European day-dreams are fully dealt with, do the same to China's economy on state steroids. After all, this is what the markets are designed to do - expose lies and support the true value.

But, says Evans-Pritchard, "What makes this crisis so dangerous is not just that Europe's banks are still reeling, with wafer-thin capital ratios. The new twist is that markets are no longer sure whether sovereign states are strong enough to shoulder rescue costs. The IMF warned in last weeks Fiscal Monitor that the tail risk of a widespread loss of confidence in fiscal solvency could no longer be ignored. By 2015 public debt will be 250pc in Japan, 125pc in Italy, 110pc in the US, 95pc in France, and 91pc in the UK."

Do I need to remind you what it will be like in Ireland? Check out here. And that's with only direct cost of Nama factored in. 122% of the national income by 2015! And our Minister for Finance dares to call us turning the corner.

Evans-Pritchard is right in his analysis of 'solutions' to the Euro crisis: "There is a way out of this crisis, but it is not the policy of wage deflation imposed on Ireland, Greece, Portugal, and Spain, with Italy now also mulling an austerity package. This can only lead to a debt-deflation spiral. ...The only viable policies short of breaking up EMU or imposing capital controls is to offset fiscal cuts with monetary stimulus for as long it takes. Will it happen, given the conflicting ideologies of Germany and Club Med? Probably not. The ECB denies that it is engaged in Fed-style quantitative easing, vowing to sterilise its bond purchases euro for euro. If they mean it, they must doom southern Europe to depression. No democracy will immolate itself on the altar of monetary union for long."

Note to all folks eagerly rubbing their hands in hope of getting their hands on Government 'stimulus' to offset deflationary effects of austerity in Ireland: Evans-Pritchard is talking about Euroarea-wide massive emission of liquidity. I called for that months ago in the Indo and in Mail articles. And on this blog as well. Back then, before the current sovereign bonds crisis hit, I thought an issuance of €1 trillion directly to citizens of Europe would do the trick. Now, we are more in the need of issuing €3 trillion. This should be split as follows:

• €2 trillion issued directly to each adult and child inhabiting Europe (EU27) and
• €1 trillion issued to the EU16 sovereigns on the basis of each sovereign share of the total Euroarea population.

Wait another month, and we'll need €4 trillion...

Of course, there's always an option of Germany leaving the Euro and setting up a separate, credible currency. It's the lower cost solution, for it requires no replay of the same crisis 10 years from now - which is, of course, an inevitability given the nature of the Euro area. No matter whether fiscally integrated or not.

Economics 16/05/2010: IMF on fiscal stability III

Continuing with IMF data on Fiscal Stability (see earlier posts here and here), tables below detail Irish public spending breakdown between payment to Public Sector employees, Social Welfare, Capital and Current expenditure heads.

Table 3a. Expenditure Structure: Advanced Economies, 2008 (as a share of GDP)
Table above shows primary fiscal expenditure breakdown by broad heads across 32 developed nations. Ireland GNP adjustments were added by me. The figures are for 2008 and reflect:

• The fact that Ireland had the second highest primary government expenditure as a share of economy of all countries. A burden of Government that is, frankly, unprecedented for a mature, competitive economy, especially when one considers the fact that we, Irish taxpayers, receive virtually nothing exceptional in return for our cash.
• We managed to have the fifth highest proportion of public spending that is being swallowed by pay to our grossly over-compensated public sector workers. Denmark, Iceland, Malta and Sweden were ahead of us in these terms. I can't vouch for Malta, but in all three other states, taxpayers get a lot more services for their money.
  
• Crucially, none of our competitors - smaller open economies that actually do create jobs - had the size or the structure of public spending close to that of Ireland.
• Our generosity of the social benefits is significantly above average in absolute terms. When one realizes that the other countries we are being compared against all have older populations and higher unemployment (remember - these are 2008 figures), we can safely claim that Irish social benefits system is amongst the top two most generously funded in the entire developed world.
  

Now, consider how these expenditures are allocated relative to the total primary Government budget:
Table 3a. Expenditure Structure: Advanced Economies, 2008 (as a share of the total primary expenditure)
Table above shows that:

• Ireland had the second largest proportion of its primary expenditure allocated to the capital budget in 2008. Lest we forget, parts of the Irish Government's capital budget, under the NDP accrue to personnel spending as well - including NDP-specified expenditures on 'human capital', and other soft things.
• The above clearly distorts spending priorities reflected in employees compensation and social benefits shares of total primary spending.
• Despite this, our public sector employees have still manged to capture a greater share of the total primary spending that average.
• It is also worth noting that some countries with greater share of public expenditure accruing to the employees' compensation include countries with functions defense forces, such as Israel and members of NATO.

Stay tuned for more revelations from the IMF database...

Economics 15/05/2010: IMF on fiscal stability II

Continuing with IMF Fiscal Outlook update released yesterday (see the first post here) - I have compiled IMF data on Ireland's fiscal position, and added some GDP/GNP gap and Nama analytics. As usual, the table below should be self-explanatory:
So quick conclusions:

• For all the talk about Government doing the right things, our deficit is record busting for 29 leading advanced economies in 2010 and 2011 in terms of share of GDP. It is expected by the IMF to decline only marginally to 28th and 27th ranks in 2014-2015.
• Despite repeated assurances to the markets and the EU, Ireland is not expected to reach 3% deficit limit by 2015, with IMF expecting our deficit to be -5.3% of GDP in the end of 2015.
• When converted to a more realistic measure of our income - GNP - our deficit is jaw-dropping 16% in 2010. It is forecast to be at -6.9% in 2015.
• Iceland, Portugal and Greece are expected to significantly outperform Ireland in terms of deficit in 2010-2015.
• For all the talk about 'small Government', Irish Government spending as a percentage of our economy (GDP) has increased dramatically between 2000 and 2009, rising by over 50%.
  
• In 2009 our Government's share of the economy measured by GDP was in excess of the average for the advanced economies.
  
• In terms of GNP, our Government's share of economy was over 34% higher than the average for the advanced economies.
• In 2010, Irish Government's share in the economy is expanding, despite the chorus of voices from the Left that we are not having a public sector expansion. It is forecast to rise to 46.6% of the entire economy relative to GDP and 61% in terms of GNP. Average for advanced economies is expected to be 43.2% (a decline on 2009).
• Last year, we ranked as the economy with second largest share of GNP accruing to the State. In 2010 we will be the first economy.
• Irish Government's graft on Irish economy was heavier than that of Sweden in 2009 and will remain such through 2015.
• Despite having none of the superior public services supplied by the Swiss Government, Irish economy is paying its Government a toll (in terms of economic income captured by the State) that was 6.4% greater than in Switzerland in 2005, rising to 41% in 2008, to over 61% in 2009. This is the true measure of the rip-off-Ireland carried out by the Public Sector here.
• The same rip-off is expected to grow over 2010-2015, rising to 66% in 2010 before declining to 53.5% in 2015.
• Low government debt has been paraded by the State officials and politicians as a crowning achievement of this economy. Back in 2000-2007 that might have been warranted, despite the fact that, when measured relative to GNP, our debt was not really that much lower than that of some of our peers.
• The debt situation has changed dramatically since then. This year, despite all the talk about the Government's corrective actions on deficit, our debt is going to put us as 24th-ranked country in the advanced countries. In 2011 we will slip down to 25th.
  
• By 2015, factoring Nama our debt to GDP ratio will stand at 122% - ranking us 3rd worst performing advanced economy in the world by debt/GDP metric. Ex-Nama, we will hit 122% of debt/GNP.
  

These numbers put into perspective my arguments that the Government is not doing its job of controlling public spending. Three 'tough' Budgets behind us, we are still rolling down the slippery slope of fiscal insolvency.

The latest talks about finding €3 billion in fresh cuts is yet another plaster on a gaping shark bite of our fiscal policy wreck. We need to find €15 billion in cuts, NOW, folks, and we need to abandon Nama, before we can call in the press and tell them that Ireland is on the mend.

There will be more analysis based on IMF data coming in days to come. So stay tuned.

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.