15/2/2013: Euro Area Banks: Staff & Admin Costs 2008-2011

Brilliant data set on Staff and Admin costs in domestic banking sectors across the Euro Area (H/T to Lorcan Roche Kelly aka @LorcanRK via twitter), via ECB (link) :

So run through these. Over 2008-2001, Admin & Staff costs in banks:

• Declined by 7.84% across the entire Euro Area;
• Went up in Cyprus by a massive 21.9% (banks are now bust), in Spain by 12.16% (banks are largely bust), in Portugal by +4.26% (many banks are zombified)
• Fell marginally by  -0.05% in Italy (some larger banks in pretty dire shape), -3.2% in Greece (banks are bust).
• Fell significantly in Ireland by -26.4% (banks are bust), Luxembourg by 36.5% (brassplates operations), and by 31.3% in shaken Estonia (banks are operating in high risk, low growth environment). Fell consistently in line with overall state of the crisis across the banks-related sectors of the economy in the Netherlands (-10.81%) and overshooting economy's woes in Belgium (-23.2%).
• Fell massively in Germany, where overall banking sector was not as badly mangled (-59.6%).

Go figure...

15/2/2013: Irish CDS mid-day

Mid-day CMA update on CDS markets: Ireland slipping slightly after good rally and so are other peripherals:

Not a game-changer, but then again, Sovereign CDS are hardly a 'game' anymore, given thin trading and other constraints. Still, pleasant to see 167.01 5-year spread.

15/2/2013: Loose Lips of Brendan Howlin & Jens Weidmann's Bother

Strong words today on the Irish Promo Notes deal from ECB's Jens Weidmann via Bloomberg (link to full interview here):

"It’s important that we draw a clear line between monetary and fiscal issues. The transaction in Ireland demonstrates how difficult it is for monetary policy to free itself from the embrace of fiscal policy once you’re engaged. The Irish government in its very own statements underscored the fiscal elements in this transaction.

"I’m rather strict when it comes to the definition of monetary financing. It’s important to draw a clear dividing line and accept the limitations of Article 123 for our actions. It’s not difficult from that to guess what my position is. [I would guess he is 'troubled' by the deal]

"The Irish government liquidated the IBRC. That has repercussions on net financial assets and has to be assessed against the background of Article 123. Of course the Eurosystem has to make sure that its actions are in conformity with its rules and statutes. [Widemann here clearly links NPV from the deal (small but positive by my estimates at EUR4.3-6.5bn, with some other analysts getting their estimates out to EUR8bn or roughly 25% of the original Promo Notes issuance or 30% of the remaining outstanding amounts) to the issue of whether the deal is legitimate.]

"I’m not passing a legal judgment on a particular transaction, but I think it is clear from what I said that I’m very concerned about monetary policy being too closely intertwined with fiscal policy and crossing the line to monetary financing. That’s why I was very skeptical about some of the decisions in the past, and you can be sure that I apply the same benchmark to this transaction.

"Once you cross a certain line, setting a precedent, it’s very difficult to come back and argue against the next similar transaction. That’s why it is important to define our mandate narrowly, so we’re not drawn into fiscal policy matters. There is a reputational issue, there’s a credibility issue. It might make it more difficult to focus on our main objective credibly. If governments had wanted to provide additional funding to Ireland, they could have tapped the ESM.

"We took note of this issue in the Governing Council. Our deliberations aren’t public. Apart from that, the transaction is out there, it’s known, it’s very transparent. Everybody has his own judgment on this -- I have mine.

"The transaction as such is technically a bit complex but it has a fiscal nature as stated by the Irish government. That’s clear enough." [Oh, here we come: Irish Government and senior Ministers have gone out talking about the 'social' dividend on the deal 'savings' etc. This might just bite the Government back. Rhetoric about Government spending (in any way) at least a share of the deal short-term cash flow savings will clearly signal that the Irish Government has pulled ECB into monetary financing and thus opens up the whole affair of the deal to legal challenge in Germany. As they used to say in WWII: 'Loose Lips Sink Ships'... care to listen, Minister Howlin?]

14/2/2013: New Compensation Model for Rating Agencies

I wrote yesterday about two studies on the effectiveness of the rating agencies (link here). Another interesting study on the agencies and their performance was published in Spring 2012 issue of the Journal of Structured Finance (vol 81 number 1, pages 71-75). Authored by Malesh Kotecha, Sharon Ryan, Roy Weinberger and Michael DiGiacomo and titled Proposed Reform of the Rating Agency Compensation Model, the study looks at the current model of rating agencies compensation - the so-called issuer-pay model whereby issuer of securities being rated paying for the rating delivery - in light of the apparent conflicts of interest implicit in the model. The authors propose an alternative model based on fee levied on new issues and secondary markets trade. Fees would be deposited in a dedicated fund which will pay these out to the rating agencies. The agencies will be rotated on a performance basis, taking into account accuracy of their ratings over time.

The criticism of such an approach to compensation model - as noted by the authors - stems from 

-- the disincentive to rating agencies under the proposed changed model to innovate in ratings models development (higher potential errors etc)

-- the fact that the US bonds market is global in coverage and thus requires competitive pricing systems, 

-- difficulty of devising a merit-based rotating system and setting appropriate levels of fees; and

-- the new model introducing a transactions tax.

Overall, the weakest point of this proposal is undoubtedly its failure to consider the US markets role as global issuance platform with any transaction tax eroding cost competitiveness and the failure in recognising that global scope of rating agencies and the US markets also implies severe limits on new compensation model ability to capture the activities of these agencies.

13/2/2013: Rating Agencies Role & Effectiveness: 2 recent studies

In light of all the cases being filed against the rating agencies and in light of the general controversy surrounding them, here are two recent papers dealing with the topic of rating agencies performance and the links between their ratings and investors' decisions.

One interesting paper was published in the Journal of Banking & Finance )vol 36, number 5, May 2012, pages 1478-1491) by Thomas Mahlmann titled "Did Investors Outsource Their Risk Analysis to Rating Agencies? Evidence from ABS-CDOs".

The paper looks at the floating-rate tranches from collateralised debt obligations (CDO) backed by asset-backed securities to test whether yield spreads at the point of issuance (origination) act as good predictors of future performance. The paper found that, once we control for rating at issuance and other deal-specific data, yield spreads do indeed indicate future performance. However, this result is primarily due to tranches that were initially rated below AAA.

The study concludes that at the issuance / origination, investors did not rely only on ratings, when pricing the CDOs studied. The study econometric evidence also indicates that ratings were inadequate for CDOs because these instruments are much riskier than corporate bonds.

Another paper, published in the International Journal of Finance and Economics (March 2012) by Eduardo Cavallo, Andrew Powell and Roberto Rigobon, titled "Do Credit Rating Agencies Add Value? Evidence from the Sovereign Rating Business" look at the credit downgrades made during and after the financial crises asking whether rating agencies opinions provide any incremental information to the market.

The answer to the question is yes. Rating agencies opinions on sovereign risks do explain a portion of variation in three macroeconomic variables, relevant to the market: exchange rates, stock market indices and future sovereign bond spreads, once the authors control for observed bond spreads.

The study also found that rating agencies upgrades (downgrades) are correlated with:

1. decreases (increases) in the spreads one day forward;
2. increases (decreases) in the stock market;
3. nominal exchange rate appreciation (depreciation) relative to the USD.

Top level conclusion: the ratings do contain information about specific credit and the rating's informational content is in addition to other publicly available market data, such as credit spreads.

13/2/2013: BlackRock panel economic outlook for H1 2013

Not surprisingly - and in line with the likes of CESIfo Index measuring global economic conditions (see link here) - BlackRock Institute report on global economic outlook also signaled that analysts' expectations are turning positive.

Here are two key charts for North American and Western Europe:

I like the cautious, but overall improving outlook for Ireland: still significant proportion of experts expecting continued recession, but crucially, Ireland is (at least in expectations) well-decoupled from the peripheral euro area countries.

Do note Spain's position as the worst expectations performer in the group - must I remind you, Mario Draghi recently praised Spain as the country that serves as an example of how to 'stabilise' crisis-hit banking sector... right...

13/2/2013: CESIfo Index shows improvements in Global Economy

CESIfo institute has issued its analysis of the global economy and... some good news: per CESIfo index tracking global growth, world economic climate indicator finally is up after two consecutive declines.


The increase in the index "was mainly driven by significantly more positive assessments of the 6-month [forward] economic outlook." At the same time, "assessments of the current economic situation improved only slightly. After 6 months of stagnation, the prospects for the world economy seem to be brightening."

• Asia led the global index rise, with region index "now higher than its long-term average once again. Both assessments of the current economic situation, and especially expectations, have brightened considerably." 
• In the case of North America "the rise in the economic climate indicator was mainly due to improved assessments of the current economic situation. Despite the improvement, the current economic situation is not completely satisfactory in this region." 
• Per CESIfo release: "The current economic situation is also unfavourable in Western Europe. Assessments of the 6-month [forward] economic outlook, on the other hand, were significantly more positive, which led to a moderate overall improvement in the economic climate." 

CESIfo Index panel "on average expect short-term interest rates to remain largely unchanged over the next six months. However, they believe that long-term interest rates are set to increase slightly. On worldwide average, economic experts expect moderate growth in the value of the US dollar over the next six months."

12/2/2013: Small step down, but doesn't hurt either...

Nice move in CDS markets for Ireland earlier today - not large, but good positive. Also, note relative distance in implied probabilities of default between Ireland and Portugal:

11/2/2013: What's David Hall's Case is Now About?

In light of the recent changes to the IBRC position and the Promo Notes, there can be some confusion around the case David Hall has taken against the Minister for finance. In particular, the confusion can arise due to the claims that we have made a "deal" on the promissory note and in light of the IBRC Bill 2013 provisions (Article 17). Let me try to (speculatively, I must add) shed some light.

The promissory notes were a product of the Credit Institutions (Financial Support) Act 2008 passed by the Dail Eireann on October 2, 2008. More specifically, the Minister for Finance, in allocating capital funds to the insolvent Irish banking institutions (see more of the background on this here: ), relied upon the provisions of the 2008 Act, Section 6. However, article 6.3 of the Act clearly stated that “Financial support shall not be provided under this section for any period beyond 29th September 2010, and any financial support provided under this section shall not continue beyond that date.” Furthermore, the Minister was given such powers (limited by the above date) to appropriate “all money to be paid out or non-cash assets to be given by the Minister… may be paid out of the Central Fund or the growing produce thereof” (Section 6(12)).

Furthermore, to the point of Defense in the case, Article 6(4) of the Act stipulates that “Financial support may be provided under this section in a form and manner determined by the Minister and on such commercial or other terms and conditions as the Minister thinks fit. Such provision of financial support may be effected by individual agreement, a scheme made by the Minister or otherwise.” This section is still covered by the 29th September 2010 cut-off date, but in so far as it covers (potentially) multiannual commitments created before that date but with a maturity beyond that date, it is unclear if this section covers the duration of the original Promissory Notes. Regardless of whether it does or not, the section is constrained explicitly by Section 6(5) which states: “Where the Minister proposes to make a scheme under subsection (4) – (a) he or she shall cause draft of the proposed scheme to be laid before each House of the Oireachtas, and (b) he or she shall not make the scheme unless and until a resolution approving of the draft has been passed by each such House.”

David Hall is claiming that in a democracy and under article 17 of the Irish Constitution the Dail and our elected representatives have the power to appropriate funds from the central fund (which, like all the rest of the Government funds, is made up of receipts and our taxes).

The point here is that David Hall is saying that it is not constitutional that one person, namely the Minister for Finance, or any future Minister for Finance, could spend monies (or future moneys) through issuance of bonds, various securities, even using another Promissory Note without any upper limit being set on such payouts and without any cabinet or Dail approval or vote.

According to David Hall’s case, this constitutes the core threat to the democracy enlisted within his claim. He believes that under the constitution that TD should have to vote on such expenditure and that they cannot give away their constitutional powers.

The fact that the current Promissory Note (and only in relation to IBRC notes) has been changed and eliminated does not alter the risk of future breaches of constitutionality (if David Hall is correct in his challenge) or abuses of the public purse.

11/2/2013: Irish Pharma Sector: December 2012

As promised in the previous post, ehre's some analysis of the breakdown for data for the Basic Pharmaceutical Products and Preparations Sector (BPP):

• Overall volume of production in the sector rose to 150.6 in December 2012, up strongly (+20.48%) m/m and even up y/y on year (+7.73%). However, compared to December 2010 the index is down 9% and relative to monthly peak it is down 16.47%. Back in December 2011 the index fell 15.53% y/y so there is some consolation there.
• 3mo average through December 2012 was down 5.79% on 3mo average through September 2012 and 11.53% down y/y.
• Overall, short-term rise in the index m/m is encouraging, but also consistent with pharma companies beefing up Q4 numbers.

Most worrying is the trend in Turnover - the series that tell us about profitability of the sector and returns in the sector. The series are sensitive to currency valuations, but overall they are closer in relationship to core pharma - the patent stuff.

• Turnover fell in December from 123.1 in November to 107.5 a drop of 12.67% m/m and down 39.47% y/y. Compared to December 2010 the index is now down 29.32% 
• The rate of fall is accelerating: in December 2011 the index rose 16.77% y/y as opposed to December 2012 fall of 39.47% y/y. 
• 3mo average through December 2012 was down 12.93% on 3mo average through September 2012 and 26.92% down on 3mo average through December 2011. Current 3mo period was down 21.55% on same period in 2010.

Chart below illustrates just how much out of line the turnover index is relative to historical readings and the contrast to volume of production index:

11/2/2013: Irish Industrial Production & Turnover: December 2012

Still catching up with data updates following a busy week lecturing.

Last week CSO issued data for december 2012 on Industrial Production and Turnover. Here's the detailed breakdown.

On Production volumes side:

• Index of production in Manufacturing Sectors rose to 112.0 in December 2012 up 11% on 100.9 in November 2012. Year on year index is up 2.85% - anaemic, but at least positive. 
• However, compared to December 2007 the index is still down although insignificantly at -1.72%. The issue here is that de facto this means that Irish Manufacturing Sectors are static over the last 5 years. 
• 3mo average through December is down 3.77% on 3mo average through September 2012 and is 7.15% down on 3mo average through December 2011. Thus, longer term dynamics, smoothing out some of the m/m volatility are not encouraging. 
• On shorter end of dynamics, however, things are slightly better: December reading is 112 and it is well-ahead of 6mo MA of 106.75 and 12mo MA of 108.99.
• Index of production in All Industries also improved in December to 108.8 up 1.58% y/y and 8.47% m/m.
• Compared to December 2007 the index is down significantly at -4.26%, which again shows that Industrial activity in Ireland has fallen relative to 5 years ago or at the very least - has not risen.
• 3mo average through December 2012 is 3.83% behind 3mo average through September 2012 and 7.01% below 3mo average through December 2011.
• As with manufacturing, shorter end of dynamics is more positive with December 2012 reading at 108.8 ahead of 6mo MA of 105.12 and 12mo MA of 107.19. 
• Modern sectors activity rose strongly at 9.3% m/m to 120.6 in December 2012, although y/y rise was much weaker at 1.86%. 
• The index is ahead of December 2007 by a marginal 1.82%.
• 3mo average through December 2012 is 7.68% below 3mo average through September 2012 and 9.61% below 3mo average through December 2011.
• Shorter dynamics are not too positive: the current reading of 120.6 is only marginally ahead of 119.82 6mo MA and is below 12mo MA of 124.05. 
• All dynamics in the Modern Sectors show steep falloff in Pharma activity.
• Lastly, Traditional Sectors activity returned to contraction in December, falling to 86.9 (-1.3% y/y and -1.25% m/m). The index is now 15.35% below where it was in December 2007. 3mo average through December 2012 is 1.73% down on previous 3mo period and is 1.37% down on same 3mo average in 2011. Worse than that, after posting a surprise uplift in November, the index is now running only slightly ahead of 6mo MA of 85.5 and 12mo MA of 85.13.
• So on the net, good news is that outside Traditional Sectors time series in volume activity are trending up in last two-three months. Bad news is - we are still off the levels of activity consistent with 2011 and are way off from regaining any sensible growth on 2007.

Chart to illustrate:

On Turnover Indices side:

• Manufacturing Sectors turnover fell from 101.1 in November 2012 to 97.0 in December 2012, down 3.10% m/m and down 10.76% y/y, both steep declines. Compared to the same period of 2007 the index is now down 9.5%. 3mo average through December 2012 is down 4.35% on 3mo average through September 2012 and is down 6.36% y/y.
• This index is pretty volatile m/m but overall, 6mo MA is at 98.93 and 12mo MA at 98.33 - both ahead of December monthly reading.

New Orders sub-index for all sectors is trending flat over the recent months (as per chart above) reaching 96.9 in December 2012, down from 100.1 in November 2012, so the index is down 3.2% m/m and it is down even more significant 10.9% y/y. Compared to December 2007 the index is down 11.6%. On 3mo dynamics the index is down 5.04% period on period and 6.7% y/y.

I will blog separately on dynamics in the phrama sector next.

11/2/2013: Bailout 3.0 and precedent research

Ireland Bail-out 3.0 (this time more benign than 1.0 - the original Troika lending arrangement, but less benign than 2.0 - the 2011 alteration to the terms of the Troika lending arrangement in the wake of Greek bailout 2.0... I know, one can wreck one's head on this forest of bailouts) has been heralded as a 'historic' achievement.

Here is the original (unedited) version of my paper from 2010 on

1. the necessity of such a deal, which makes me deem the deal to be net positive, and 
2. the volumes of relief that we need (well in excess of EUR4.3-6.9 billion NPV benefit my model estimates the deal will provide over 40 years duration) which makes me deem the deal to be insufficient in terms of relief provided.

Read, again... http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1985617

Note, the title of the book in which this featured as a chapter is What if Ireland Defaults.