Morgan Kelly’s Bank Loss Calculations

There has been some debate on this website and elsewhere about the calculations underlying Morgan Kelly’s recent Irish Times article. Morgan has kindly agreed to provide a spreadsheet illustrating his calculations. You can find the spreadsheet here.

From Morgan’s email to me: “As you can see, my optimistic scenario is for a loss of 75 bn, offset by 25 bn equity, leaving the Irish Times figure of a 50 bn bill for John Taxpayer. My realistic scenario is for a loss of 105 Bn.

I also include a brief calculation of the post-nationalization value of AIB and BofI. Given their extraordinary operating costs of 4.5 Bn, the taxpayer is looking at an annual loss of 1.5 Bn, and that is before including the cost of tracker mortgages.”

Update: Note this is a slightly updated version of the spreadsheet put up Sunday night, fixing a typo. The “realistic loss” scenario should have been 105bn not 115bn.

24 replies on “Morgan Kelly’s Bank Loss Calculations”

Am I missing something but where is the income before provisions included in the calcs?

Also post all the nasty stuff, when the bank loan books are righ sized they are still loss making on Dr Kelly’s calcs. He is too harsh here. The operational cost base would be reudced to reflect reality.

@ tull,

Could you post (say) a google spread sheet modifying Prof. Kelly’s assumptions accordingly with respect to your suggestion, so we could compare? It would make things a bit clearer.

I suspect the total should be 106 for the realistic scenario if the losses on irish property are 10% (In the calculation Morgan uses 20% it seems – 0.2*F2 in cell in O2 and similar in O3 to O7)?

The problem with Mr. Kelly’s view is that it is not nearly pessimistic enough. You cannot subtract equity from losses to get taxpayer loss, not without leaving no banking system. While this might well be the best move by the state, it is a little late for that. So you have to leave equity capital in the banks and you probably have to leave it at the putative Basle III levels (8+% of real money – no navel lint, no comic book collection, no lucky pennies).

Any losses the banks take, beyond income, are going to have to be stumped up by equity capital. Until they are mostly recapitalised, this will come from the state.

Most of the banks have a majority of their residential mortgages as trackers. While interest rates are low and the cost of funding high, banks are not really going to be making very much. I believe the losses indicated in Mr. Kelly’s spreadsheet are net. His estimates of profitability in the banks post trauma are in the footnotes at the bottom of the page.

@ yogan

I will leave that to Dr Kelly or Dr Whelan to indicate where Pre Provision operating profits are taken a/c of in the calcs. Also, it is not clear to me, whether the equity is the pre crisis equity level or the post recap equity level.

I see the profits estimates post trauma. I think they are unrealistic. A bank either makes money or it does not exist as an entity. If you had a loan book of 150bn with no other assets, a properly capitalised and funded industry should make at least 1bn off that -70bps Return on assets or thereabouts. The cost base would have to adjust to make it so.

“The cost base would have to adjust to make it so.”
I agree. The problem comes when you look at the base you are making your profits off. Over-leveraged, overpaid (so pay decreasing – to increase competitiveness), underemployed (i.e. high levels of unemployment)… and that’s just on the residential side. You can add in a level of corporate debt that is probably unsustainable too, barring the bigger companies. The unwind of the bubble economy is going to be huge – increasing margins to the level they ‘need’ to be at risks precipitating another crisis.

It doesn’t really matter whether it is a pre-crisis or post-crisis level of equity (except to say that a post-crisis level implies a further state capital injection); the simple fact is that if you want to have banks, you have to leave equity in them, even if this is just an equity level to reflect a reduced balance sheet. Then you have to apply a more rigorous loan-loss standard, disregarding Basle II so that you provision over the cycle – each new loan will have a higher implied cost than previously, even if that cost can be clawed back later in the economic cycle; the initial period of adjustment is going to be stiff.

The figures in the spreadsheet are completely inconsistent with the figures in Kelly’s op-ed piece. Are there two Morgan Kellys in UCD?

The biggest loss item in the op-ed piece is 100bn of property development loans with a loss of 33 per cent = 33bn (under optimistic scenario).
The biggest loss item in the spreadsheet is 37.5+62 = 100bn land + commerical with a loss of, wait for it, 66 per cent = 66bn!! (under optimistic scenario).

Why, oh why, has one-third suddened jumped to two-thirds????? This means an additional 33bn of losses on land+develop that were not included in the op-ed piece. Why have they doubled?

There are 35bn of “business loan” losses in the op-ed piece at a loss rate of 20 per cent.
There are 53bn of “corporate loan” losses in the spreadsheet at a loss rate of 10 per cent.

There are 140bn of mortgage loans in the op-ed piece.
There of 124bn of mortgage loans in the speadsheet.

There are 20bn in personal loans in the op-ed piece.
Personal loans are not mentioned in the spreadsheet.

But here is the kicker!!! The op-ed piece was deeped flawed because, as pointed out here on this web site, Kelly forgot about shareholders equity. Lo and behold, some 8 days later, a spreadsheet appears with, wait for it, 25bn of shareholders equity.

Would, by any chance, the upping of the loan loss rate from 33 per cent to 66 per cent have anything to do with the fact that shareholders funds were mistakeningly (and embarrasingly?) excluded from the op-ed piece?

Oh, by the way, both the op-ed piece and the speadsheet mistakenly omit subordinated debt which will absorb about 5bn of losses across all the banks. But no doubt sub debt will appear in the next spreadsheet along with a 71 per cent loss rate on property loans, so a 50bn hit to the taxpayer it is.

It’s great stuff.

“A global regime for shutting down failing banks should be created that would force shareholders, lenders and creditors to bear the costs, with the broader industry, rather than taxpayers, footing any remaining bills, the main international banking body said on Monday.

The lobby group, which represents more than 400 of the world’s largest banks and insurers, also recommends that the industry picks up the remaining costs through a post facto levy.”


You blend erudite argument with wit!

How very capitalist of them!

When banks fail, they should fail! A new deposit for the amount insured, should be made at another bank for the depositor. No feather bedding for managers and shareholders at all!

We should thank Morgan Kelly for making his analysis public. It is an example of intellectual honesty (and a willingness to put the truth first) that we should all applaud.

Having said that, I’m not sure I would agree with his assumption that private sector lending in the economy will reduce to 100% of GNP of €150bn. NB GNP is now only around €130 bn.

As of 2008, private sector lending exceeded 250% of GNP here and 200% in the US and UK. I would expect – at most – a reduction to 150% GNP over the next 10 years with GNP growth doing some of the work.

A point not included by Morgan Kelly in his analysis (but which actually supports his argument) is that the economics of EMU have changed so that, whereas we enjoyed inappropriately low interest rates in Ireland over the decade 1997 – 2007, we will have to endure inapprppriately high interest rates for the forseeable future.

This is because, using a Taylor Rule framework, (a) our inflation rate has swung from above the Eurozone average to below it and (b) our spare economic capacity (using % unemployed as a proxy) has swung from below the Eurozone average to above it. On both these accounts, interest rates appropriate to the Eurozone as a whole will have swung from being too low (1997 – 2007) to being too high for Ireland (2008 – ???).

That will add significantly to the impetus for deleveraging and make pessimistic outcomes more likely than the current consensus admits as it overlooks the very credit mechanism that got us (and Spain and Greece) into this mess in the first place.

@ All,

Dumb question – why is AIB’s corporate debt abroad so large? Are the AIB subsidiaries in Poland and USA still included in this spreadsheet? Does it bear mentioning Brian Lucey’s old argument from one of his Irish Times column pieces, which advised that AIB should remain diversified across several regions, instead of concentrated into one small island?

If all Irish banks were to divest themselves of their subsidiaries, what difference would it make to the bottom line. Assuming the factor of increased exposure to the Irish economy wasn’t a problem. Which of course it is, a major one. Can it be argued it was a wise move, looking back now for AIB to hold such a large chunk of foreign corporate debt? I assume also, it would be easier to find buyers for the same in a more liquid market – than it would be to find buyers for stuff such as Irish residential debt.

Looking at the spreadsheet, the thought that automatically flashes across my brain is – Wow, this is why we have very large hedge funds and financial instruments. Take a place such as Korea for instance, who has concentrated so much of its economic activity around semi-conductors and manufacturing. I don’t know what exactly is the best policy with regard to banking in countries with excessive exposure to one industry or market. But looking at Morgan’s spreadsheet, it would appear to me, that AIB at least had tried to balance Irish exposure, with the same elsewhere. BOH.

AIB have been big business lenders in the UK for some time. Probably to the same people they were lenders to here… think Quinlan et al.

Honohans response to the Kelly article today (interview with Bloomberg)…

““You mentioned an article by Morgan Kelly. For me, there’s
no news in the calculations it presents. It’s as if he’s
exclaiming ‘oh my goodness, there are a lot of losses here.’ And
yes, there are a lot of losses. But we’ve measured them out, we
know what they are. He is right in his perception that it’s a
heavy price to pay. It’s a heavy burden. But I’m sure that it’s
a manageable burden in terms of the large-scale management of
the state’s finances.””

Also, on the banks…

“On banks’ capital, bad loans:
“The worst is not over for loans. Loan losses are still
going to pile up and our forecasts in this regard are not behind
those of other commentators. Indeed, taking those additional
future loan losses that are ahead of us has been central to our
calculations. We want to make sure the banks put in enough
capital now, so that as some of that capital is used up meeting
the loans losses, it will still plateau through the worst of the
cycle at more than 7 percent equity and 8 percent core tier 1.
We’re being very demanding on that.”

On state-controlled banks:
“The two big banks can achieve the capital targets with no
significant further injection of state funds, depending on
exactly how much they realize on disposals they are making. For
Bank of Ireland, it is unambiguous. They have been able to get a
rights issue underwritten and so they are raising the additional
capital they need from the market.”
“There will be a conversion of the state’s preference
shares into equity, but not new cash.”
“In the case of AIB, a similar story, but not quite as
clear cut. It depends on how much they realize on the disposals
they are making. It’s not completely clear whether AIB would go
the equity market soon. I don’t rule it out.”
“We’ve made quite aggressive assumption on loans losses.
Of course no one can know if they are fully sufficient. But we
have a base case and a stress case which are much more
aggressive than what has been done in some other countries.
That’s the two big banks, fixed by the end of the year. I think
it’s quite good news.”
“People may not fully internalize and appreciate that
we’ve fixed the banks until they suck it and see. It may be some
months before the market fully realizes that this is working
“Anglo Irish Bank is the other bank. The losses there are
much more severe, enough to wipe out its initial accounting
capital and implying that the state is injecting substantial
funds that will never be recovered. Between Anglo and the
smaller institution Irish Nationwide, 25 billion euros has been
mentioned and I think that number is broadly right.”
“One way of thinking about the losses is that the
shareholders of the banks have taken about half of the losses
incurred by the system and the state has the other half. It’s a
huge hit for the state, something that is of the same order of
magnitude as last year’s borrowing.”
“it’s because of the decisive recapitalization under way
for the two big banks that I’ve been saying that we are well on
the way to reducing the risk for both sides, banks and state.
The banks are floating away from dependence on the state and
will be free standing. We’ve put that process in place. They are
not going to be dependent on coming back to the state for more
money. If people examine in detail what we’re putting in place
and do the sums, they will realize that the state will no longer
have the problem of unresolved banks hanging over it. The money
being poured into Anglo isn’t finished yet, that’s clear, but we
know how much it is going to be. So that cloud over the state’s
finances should be dispelled.””


How shall we put this politely. Dr. Kelly does not agree with Dr. Honohan and Mr Elderfield. Time will tell who is right and whose numbers stand up to scrutiny.

The only point of disagreement seems to be whether the debt the state has taken on is ‘manageable’. If it is not, then it must surely be likely that the higher case loan losses are likely (as, if the state gets into difficulties, it will have to cut the stimulus it is pumping in).

Am I reading Mr. Honohan’s statement right? For those who want to know the esteemed govnor’s views on bank crisis resolution, they could do worse than look at:

@ Yoga,

So what initially looks like diversified risk at a glance of Morgan Kelly’s spreadsheet – in fact, is just one big awful balled together pile of risk – which all tracks back to the same bad sources. Stephen Berlin Johnson, an amazing author wrote a book called The Ghost Map, about the history of cities, London in particular, and their fight against disease spread. I always think of that book, when I think about Irish banks for some reason. Back in the days of the Ghost map, they didn’t understand that disease spreads by water of course. They imagined it had something to do with bad smells. BOH.

@ yogan,

The point of disagreement is over the solvency of the 2 systemically important banks. Dr Kelly’s spreadsheet implies that the big 2 are insolvent on the “optimistic scenario” and deeply insolvent on the “realistic scenario.” Moroever, they will be unprofitable post clean up according to his footnotes. BTW, how could an insolvent institution even get to the point where it could continue to lose money?

Dr Honohan on the other hand believes that by end of 2010 BOI and possibly AIB will be fit for purpose.

That is a pretty big gap. Interestingly, they are probably bot on the same page as regards Anglo.

“how could an insolvent institution even get to the point where it could continue to lose money?”
Can you hear the drums Anglo?

“Moroever, they will be unprofitable post clean up according to his footnotes. ”
I think the implications of this are twofold – they will have to reduce their costs more sharply – selling chunks of themselves may help, in addition to other cost reductions. They will need more than 2% margin…

I think it is a mistake to extrapolate the NAMA haircut for the big two from the initial loan writedowns. We’ll probably see them inch up as we go through the tranches – they having been selected in such a way to make that happen. If you wanted to build confidence, you would do that, no?

Mind you, I think Mr. Honohan and Mr. Elderfield underestimate both the level of mortgage/consumer debt stress that is present and the willingness of Irish people to walk away (to the other side of the world if necessary) to elude it.

The final piece of the puzzle, I think, is the amount of leeway the Mr. Elderfield gives the banks in marking their remaining assets. Can they get away with hold to maturity accounting on distressed loans? (i.e. those that are behind, but might get back on track.

(a) 33% to 67%

D. Terry’s criticism of an apparent increase in optimistic property losses from 33% in the IT article to 67% in the MK Spreadsheet seems justified.

Which figure is more correct though? NAMA valuations suggest it will be somewhere between the two.

It is not clear how NAMA valuations can be extrapolated downwards to loans less that €5m. Those borrowers may have bought at worse prices or they may have more non-development land collateral.

(b) Equity

It is not clear to me what these figures include. Do they include new equity such as that raised by BoI? Do they inclue assets which can be sold? Do they include the value of future profits (which MK considers illusory but others think will return)? Can anybody clarify this for me?

Also it is important whether it includes post-crisis and pre-crisis equity. Any additional post-crisis equity not paid for by the taxpayer should be added to pre-crisis equity to calculate total loss absorption.

(c) Temporality

The speed with which losses will have to be funded is relevant. People often invest in loss making enterprises which will make profits in the future. That is half the reason for investment. Where losses have to be funded after state support has been withdrawn then those losses will not fall on the tax-payer.

S&P says Irish houses may be “undervalued” now (though will probably fall further first)…


“Irish property ‘could be undervalued’

Ireland’s property market could be undervalued, a new report said today, with the steady fall in house prices caused by oversupply in the market.

However, the report from Standard and Poor’s did not rule out further declines in prices.

In a report on the European housing market published today, S&P said Ireland’s ongoing markjet correct “seems overdone”, and estimated priceds were undervalued by about 12 per cent.

The agency said Irish house prices, which recorded an 18.5 per cent decline in the 12 months ending December 2009, were showing a marked difference to other European markets, which have displayed signs of pulling out of the recent price correction.

“Fundamentals driving the Irish market have nevertheless improved dramatically. The market appears undervalued today compared with long-term historical averages,” the report said.

Mortgage lending continued to fall, however, despite falling interest rates contributing to a rise in affordability for buyers.

House completions are also falling, with 26,420 completed last year compared with 51,724 a year earlier, according to Government figures. In the first quarter of the year, completions totaled 3,759 – almost half of the figure recorded a year earlier.

However, rents continue to fall, slipping 13 per cent in the 12 months to March, following a 30 per cent decrease in 2009.

“We think the economy will likely remain unsupportive for another year at least,” S&P said.

The report said consumer caution stemming from unemployment and fiscal tightening by the Government would contribute to further house price falls, with predictions of a further 10 per drop over the year before it finally hits a trough in 2011.”

@Eoin – “Ireland’s property market could be undervalued… However, the report from Standard and Poor’s did not rule out further declines in prices”

Crikey – talk about making sure you have both options covered. Who wrote that report? You’re fired.

I’m surprised they didn’t pull out the phrase of the year for 2009 – “declining at a slower rate”.

I suspect the phrase of the year for 2010 will be “austerity package.”


Imagine that. That could never be.
NAMA would be sitting on loans backed by undervalued assets. That would not be possible.
The mortgage losses in the Irish banking system would be lower than expected on here
Imagine if the banks were fit for purpose as Dr H states and actually started lending again.

No it could not be. There has to be a typo. Are you sure its not 12% overvalued. The group think here that we are doomed has to be correct.

@ yoga

Many thanks for that link to the Governor’s book. I note the reference on the back cover to two ‘interesting chapters’ on ‘bank closures’. No sign of that happening yet.

Without yet having read it, I would guess that it is silent on crises within a situation of monetary union without fiscal union. Neither, probably, does it address our political constraint, such as the fact that the most obviously insolvent bank is so deeply enmeshed in the business of the governing party that it can’t be cut loose.

@ tull

We’re not doomsayers. Just sensibly sceptical. Once bitten etc.

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