I would echo what the other said. Moreover if you were to apply a leverage ratio of 10x assets to equity, the cost of credit would have to go up. BOI median ROA has been around 1% plus or minus for the last 20 years and will likely be less than that in the future due to the absence of higher margin lending. Leveraged 10x gives a ROE of max 10% i.e below the cost of equity. The sector return in the rest of Europe is going to be about 13-15% in a normal environment. Therefore, Irish banks and the banking sector here will not attract capital. The net results will be some or all of the following
*the state will not be able to recoup its equity or exit the stakes it holds or
*ROAs will have to go up by 50% to be achieved by higher cost of credit
*there will be less credit available anyway due to the need to deleverage

I think 10x unweighted A/E is too low just as 30x adjusted A/E is too high.

That said, congrats on putting Fahey in his box.

Thanks for the clarification but I have to echo what Eoin Bond and Tull have said especially on the area of pre existing provisions and capital.

Also your idea of a leverage figure of 10x is economic suicide. If we take your argument and simplify capital as simple equity, BOI had €5.3 billion of equity Tier 1 at Dec 31 2009. I know you don’t like Tier 1 definitions etc but I assume you don’t have a problem of using the Risk Weighted Assets figure rather than plain asset figures. Under your proposals, BOI would be allowed a balance sheet size of €53 billion RWA. They had €98 billion RWA in Dec 2009 so you would require BOI to deleverage their balance sheet by 45%. Good luck getting credit into the economy with that requirement.

We all want banks to have enough capital and be properly capitalised but there is a balance to be struck. Otherwise we would just tell to have 20% Tier 1 and never worry about them again. I don’t think just throwing numbers out there at Dail joint committees without proper analysis to back you up is the way to go. Despite whatever professional experience and judgement you might have. There is enough political grandstanding as is.

By the way, well done on dealing with Frank Fahy the way you did!

A lot of what you say is true. The disclosure to the public by the banks generally. As such it is difficult to know with certainty what exposures are on their balance sheets at any give time. However the downside of this is that one cannot be definitive about loan losses & capital requirements. Yet you are quite definitive.

The one person who should be in position of the requisite information is the new FR, yet you seem to dismiss his assessment of the capital requirements. Does he not have more information than you do.

Lastly, it is clear from your analysis that you seek the banks to hold more capital than any other regulator. I can think of no system in the developed world that would demand a through the cycle Equity/Assets ratio of 10x. The nearest ratio to that is the new basle 3 proposal which is tier 1/adjusted assets of 30x.

Your demand for more capital is a fair one but I do not think it is clear from your advocacy that a key reason for the difference between you an the FR is that you would require banks to hold more capital than he does. Instead it looks like you are accusing the authorities of cooking the books to arrive at a lower capital requirement.

thanks for the reply and analysis.

However, i dont see any mention of their pre-existing loss provisioning which can be netted off against the NAMA haircuts, or any mention of the fact that they’ll have a good deal less risk weighted assets on their balance sheet post-NAMA, and so will require less capital to be held as a result. Would these not materially alter your figures for required new capital?

Perhaps readers might consider the following…

AIB originally and defensively admitted in mid 2009 that it held €24bn in NAMA bound bad loans. Apply a modest average write-down of 40%. This amounts to €9.6bn. Experience and prudence would indicate that AIB should round the write-down to €10bn and seek to build up its capital resereves by that amount. Remember, AIB will need a good cushion to buffer increasing loan losses in the sub €5m property loans and also in its Household Mortgage book and also in its general lending book.

I have always been a proponent of conservative common sense banking based on common sense definitions and terms. I’d caution against getting hung up on formula based rules clouded by jargon definitions such as tier 1. tier 2 etc. Straightforward old fashioned capital levels and definition (e.g. equity at 10% of total assets) are more meaningful. Together with the assurance of the application of fundamental Banking principles such as prudential fractional reserving under competent trustworthy Board Directors and Managers gives depositors the confidence and trust to place their deposits with the bank. In this context it’s relevant to remind readers that AIB has consistently fallen far short in providing dependable financial information for at least the last 3 - 4 years to date.

In the case of Bank of Ireland, once again events and patchy and unreliable information over the last 3 years lead me to be quite circumspect in assesing its re-capitalisation requirments. BoI originally and defensively admitted, in mid 2009, that it held €16bn (not the later revised downwards €12bn) in NAMA bound bad loans. Once again, apply a modest average write-down of 40%. Experience and prudence would indicate that BoI should round the write-down to €6.5bn and seek to build up its capital resereves by that amount. Remember, BoI will also need a good cushion to buffer increasing loan losses in the sub €5m property loans and also in its Household Mortgage book and also in its general lending book.

I have always been a proponent of conservative common sense banking based on common sense definitions and terms. I’d caution against getting hung up on formula based rules clouded by jargon definitions such as tier 1. tier 2 etc. Straightforward old fashioned capital levels and definition (e.g. equity at 10% of total assets) are more meaningful. Together with the assurance of the application of fundamental Banking principles such as prudential fractional reserving under competent trustworthy Board Directors and Managers gives depositors the confidence and trust to place their deposits with the bank. In this context it’s relevant to remind readers that BoI has consistently fallen far short in providing dependable financial information for at least the last 3 - 4 years to date.

I hope that I’ve addressed readers’ concerns and that my explanations, which are tempered and seasoned by my professional experience and judgement are clear. I’d like to thank readers for their views and comments.

Every good wishes

Gregory C.

Q3 2006 4.3% 2.6% 2.7%
Q4 2006 1.9% 0.1% 0.9%
Q1 2007 0.9% -0.2% -0.4%
Q2 2007 -2.7% -3.2% -2.5%
Q3 2007 -2.9% 0.3% -0.4%
Q4 2007 -1.5% -3.2% -3.8%
Q1 2008 -2.6% -2.9% -2.0%
Q2 2008 -3.9% -2.4% -3.2%
Q3 2008 1.6% -2.6% -1.5%
Q4 2008 -4.2% -2.6% -2.4%
Q1 2009 -9.0% -2.8% -4.3%
Q2 2009 -3.5% -3.4% -3.9%
Q3 2009 -5.7% -4.2% -3.9%
Q4 2009 -7.5% -6.2% -7.7%
Q1 2010 -10.3% -3.5% -4.8%
Q2 2010 -3.5% -0.8% -1.7%

Looking at the quarterly house price series there would have been plenty of times where it would appear we are “stabilizing” only for the pace of falls to pick up again.

No matter what trend analysis might show by all most any fundamental measure property is still significantly overvalued.

I think prices still have atleast another 30% to 40% to fall. Until the rental yield returns to normal prices will continue to fall.

@JtO
Irishpropertywatch is showing rents falling again

The link to the NIRSA report is below - they’re the people of the 350,000- -vacant- homes fame though they set out that figure in some detail in the report and also consider vacant homes using another basis (overall they and other sources seem to agree the “overhang” is 100,000+ though gross vacancies may well be over 300,000)

By the way they conclude that housing prices will remain depressed for some time. The media have already claimed that NIRSA are predicting declines of upto 60% from peak - in fact what they say is that other economists have estimated declines in the 40-60% range - isn’t this how Kevin O’Rourke got labelled with the 70% decline?

http://www.nuim.ie/nirsa/research/documents/WP59-A-Haunted-Landscape.pdf

And wrt to house prices, perhaps the store of land and property-based collateral being built up by NAMA is a factor in the apparent stabilisation - and which may be at an artifically high level.

Volume of mortgages issued is as low as it has been this century. If this was GDP figures, you’d be calling it a catastrophe. Ah, but now you are only concerned with price data?

I’m still waiting for those GDP figures you promised. Many were surprised by the level of price deflation last year and by the fact that it continues this year.

“So, even if the Great One is proved correct in his forecast of an 80pc fall from peak, I may well not be around to congratulate him”

Come on, where is the optimism!

One of the few timeseries on house price trends indicates stabilisation. However, this does not suit the thesis. What do we conclude? There has to be a flaw with the data. Clearly it must be dismissed.
At the peak of the boom, the followers of Dr Pangloss could see that the data was wrong. Now after a 40% plus fall, the Cassandras are playing the same game.

gdp up 2.7pc in Q1 - ignore it, it was all exports
car sales up almost 100pc in June - ignore it, it was the scrappage scheme
manufacturing output up 9.5pc in May - ignore it, it was all chemicals.
merchandise exports up 8pc in May - ignore it, it was all chemicals again
Irish banks pass EU stress tests - ignore it, they fiddled the tests
house prices fall slows down in Q2 - ignore it, the sample was too small

Re the slowdown in the house prices fall to 1.7pc in the latest quarter, it may well be case that we shouldn’t make too much of it. Several quarters would be needed before we could say definitely that prices were levelling out. However, it fits in with recent rental data. Both the CSO and Irish Property Watch report rents levelling out or even increasing very slightly in the first half of 2010. Just as a matter of interest, if house prices fell by 1.7pc every quarter from now on, it would be almost 10 years before the fall from peak reached 60pc and almost 20 years before the fall from peak reached 80pc, Morgan Kelly’s prediction. So, even if the Great One is proved correct in his forecast of an 80pc fall from peak, I may well not be around to congratulate him.

Is the expression “looking for apocalyptic house price falls” a tad provocative? Given that 450,000 net migrated (immigration – emigration) during the Celtic Tiger years (1994 – 2008), could we have a reciprocal reversal during the next decade? I dunno, won’t it come down to how well our economy is performing relative to our competitors and there are upsides and downsides. However in terms of the next few years, wouldn’t the betting be that we have negative net migration? For what it’s worth the ESRI seem to think so. So I don’t think you need to be looking for apocalyptic house price falls to conclude that on balance there will be large scale negative net migration.

Even with 6,000 net new souls in 2009 (though I’d be willing to put money on there being a drop in the 12-month period to April 2010 when the CSO publish their estimates in Sept), new (in the sense of presently unbuilt or vacant) houses will be required. The question is how the overhang plus new build compares with new demand. I’m suggesting that for the next 3-7 years at least that the dynamic should tend to depress house prices.

The Q2 fall according to PTSB was 1.7%, Q1 was 4.8% and Q4, 2009 was 8.3% so you could say the trend is towards a stabilisation. I’m saying that there are factors at play now which might not be in a few months and those factors are tending to prop prices up above their natural level. NAMA would be at the fore. What developer is selling property at any price now when NAMA may assist the developer in riding out the downturn and selling at a better price when the LEV returns? What developer with partly completed estates is selling at whatever he can get when NAMA have €5bn to help him complete his project? What bank is pushing their lenders to sell at any price and consequently recognise a loss in their books and put in jeopardy the value of NAMA-bound loans? There are other factors at play. As we’re talking about scrying the future, all we can do is declare the factors we judge to be in play. And I think that further bigger falls are in prospect.

Permanent TSB had 20% I think of the market. Does anyone know what they have now? If you examine the Q1 IBF mortgage stats, you’ll see that lending had fallen off the cliff and recent media reports imply further tightening in credit and lending criteria. If PTSB had 20% of the market then they would have had 800-odd mortgages to examine in Q1. What’s the number for Q2? Given that we don’t seem to know the total number of transactions (PTSB mortgage plus others mortgages plus non-mortgage transactions) how would you assess margin of error? There is plainly a point at which the number of transactions examined will expose your results to significant error. There were 4,224 new mortgages on property in Q1,2010 compared with 32,000 in Q4,2005. Are there sufficient PTSB mortgages now to enable a defensible survey?

From their 2009 accounts -
Irish residential lending:
2008: 4.2bn
2009: 0.9bn
81% decline.
UK residential lending:
Closed in 2008
Commercial lending:
Closed in 2008
Consumer finance:
2008: 1.1bn
2009: 0.3bn
72% decline

EBS and AIB have been crowing about increasing market share. Unfortunately, I can’t find any statistics about this. The IBF seem to have pulled this section from their reports and pulled all the old stuff too (unless it is now behind the paywall?).

While I can believe that PTSB continue to hold 20% of residential mortgages, I don’t think the idea that they are issuing 20% of new mortgages is tenable.

few things:

1. most of those looking for the apocalyptic house price falls are also factoring in massive negative demographics (think Joan Burton and her “500k will leave” forecast). You admit that demographics in 2009 were still in fact positive.
2. similar accepted demographics assume that more houses will in fact be required in the coming years due to an eventual change in our social make up from baby boomer to old ager.
2. house prices are falling at a slower pace at the half way stage of 2010. Given basic ceterus paribus trend dynamics, wouldn’t the full year figure likely (and i use the term admittedly very softly) be less than the benchmark figure?
3. PTSB is still one of the biggest (THE biggest?) mortgage lenders, so to say its “a very small sample” is a touch miseading.

He seems to be making his assumptions based on his superior judgement. He talks about it here at the joint commitee but doesn’t go into much detail.

http://debates.oireachtas.ie/DDebate.aspx?F=FIJ20100505.xml&Page=1&Ex=H2#H2

I honestly don’t know what to make of him to be honest. He talks about himself in the third person a fair bit which always worries me! His reply here to NAMAwinelake’s good blog shows he doesn’t really understand NAMA either.

http://bankermathews.com/2010/07/22/response-to-namawinelake-blog/#more-272

Having said that, can we please put a muzzle on people like Frank Fahy. The guy is clueless.

With the Eurostat confirmation that our population grew at 6,000 in 2009 (the lowest 12-month growth since 1991) and with an excess supply of housing at 35-350k and new homes being built at 6-15k/year I would suggest that on a supply:demand basis houses have some way to fall yet.

http://europa.eu/rapid/pressReleasesAction.do?reference=STAT/10/110&format=HTML&aged=0&language=EN&guiLanguage=en

The PTSB index shows that for Q1/2 the decline is 1/2 the full year benchmark scenario. It is likely to be based on a very small sample given the further decline in mortgage lending and the fact that PTSB has what? 20% of the market?

IMO, NAMA itself as the biggest putative property owner in the State with a mandate to sell at the LEV and holding itself out to be the rescuer of developers is probably the biggest obstacle to property reaching its bottom.

@BL
CDS on the 2 Irish banks are in this week.AIB -100bps BOI-80bps. Other EZ banks in as well but not as much. Bond markets seem to be fooled by this charade as do equity markets- SX7P up by 7% since Friday close. Probably only bear closing. Will you be callingfor the resignation of Dr H?

http://www.esri.ie/irish_economy/permanent_tsbesri_house_p/

Given the last Irish Banking Federation figures for mortgages in Q1 showed that 4224 mortgages were provided and although the latest report from Q2 isn’t available recent press reports suggest lending criteria have been tightened up. PTSB has what? 20% of the mortgage market? On Q1 data they would have had 840 mortgages. How many for Q2? And these are spread across Dublin and Outside Dublin and by different size of home. At what point does their analysis become statistically suspicious?

Agreed that the residential property tests look weak. Here is a summary of the various recent projections/predictions and assuming the EU expect the bottom to be at the end of 2011

Residential Property In Ireland Peak to Decline from
Source Date Trough start Jan 2010
EU Adverse Stress Test July 2010 46% 21%
EU Benchmark Stress Test July 2010 42% 15%
Kevin O’Rourke July 2010 70% 54%
Moodys July 2010 45% 20%
Goodbody July 2010 50% 28%
Jim Power (1) July 2010 40% 12%
S&P June 2010 41% 14%
Moodys May 2010 46% 21%
DKM May 2010 45% 20%
David McWilliams April 2010 64% 47%
Fitch Mar 2010 45% 20%
Paddy Power (2) Jan 2010 40% 12%
IT Pundits Jan 2010 38% 9%
Anglo Plan (3) Nov 2009 47% 23%
Morgan Kelly Jan 2009 80% 71%

ESRI/TSB figures for Q2 just out. They show the smallest quarterly decline since the onset of recession, just 1.7pc in the quarter (slightly over 0.5pc a month), bringing the total decline since the 2007 peak to 35.3pc. Not good news for the more pessimistic forecasts in this list.

re Banker Mathews

(a) he suggests paying 47bn for the NAMA loans. Aren’t we paying c.42-43bn now?
(b) i couldn’t find a spreadsheet with his AIB/BOI figures - honestly may have missed it, but i couldn’t find it.
(c) he makes a lot of ‘definitive’ statements which are actually only his analysis/opinion, ie “My previous letter (November 7) clearly shows how the NAMA experiment will result in losses on loans recoveries of not less than €11.65bn”. (even though this ‘loss’ should actually be negated by the now smaller consideration being paid to the banks…)
(d) he uses an awful lot of capital letters, for no particular reason, in his blog, this always makes me uneasy.

That’s not a pending loss. It is just a liquidity analysis and so that table is just looking at outgoing cash flow’s according to contractual maturity date. From what I can see from their accounts, they have roughly a €1 billion “potential loss” on a €390 billion derivative book as of the 31st Dec 2009.

There is that weird pending 5bn derivative loss in BoI’s accounts that I’ve never seen an adequate explanations for… http://online.hemscottir.com/ir/bir/ar_2010/ar.jsp?page=170&zoom=1.0&layout=single
(see p.295 - it seems to be 6 bn now?). I doubt it, though. I think Mr. Mathews is from a pre-derivative banking age, hence his belief that a bank can just be wound down quickly.

has to be bigger than that. BOI is transferring 12bn to NAMA. A 3bn additional requirement would imply a 25 percentage point increment to the haircut, putting it into the Nationwide bracket. It would be a 10 point increment approx to AIB’s haircut.

My 2nd point still stands, if Matthews can stand up his numbers. Honohan and Elderfield would be guilty of a major effort to mislead investors, even worse than the previous incumbants. Given their lofty valuations, perhaps their stock is a short.