Bank Resolution

It is being reported (by eg Simon Carswell on the Irish Times website) that, in addition to the four-year fiscal framework, there will be an early resolution of the banking issues as part of the IMF/European deal.

De-leveraging the banks further through private sector deals for bank assets, including non-NAMA impaired assets, has long been an option, as argued here before. The tracker mortgages constitute an impaired (though performing) asset which can no longer be marked at par (as appears to have been the case) in computing the balance sheet hole if market disposal is contemplated. Carswell uses the phrase ‘heavy discounts’ and on the face of it the cost of funds, minus the c. 2% return on these mortgages, put them well under water. There are moving parts – the ECB funds are cheap, for example, and the replacement liabilities, and their cost, is unknown.

The banks wrote a very large piece of derivative business when they extended these mortgages and did not (or could not) hedge, so far as I can see. The risk is in the form of an uncovered exposure to an interest rate spread beyond their control. It looks as if this is about to be marked to market.

19 replies on “Bank Resolution”


Arguably there was a natural hedge from the retail deposit book, which has blown up due to the ridiculous price being paid for deposits now. I say ridiculous as the banks are cannibalising themselves as they pay an ever higher rate for a share of the same pool. In addition, the guarantee has meant significant deposits are being held in zombie banks aka Anglo and INBS and are lost to the system as these ‘banks’ pay crazy rates competing on a level playing field with the others.
You are right though that the MtM of trackers is probably c. 2% assuming funding rates normalize, but it’s worth pointing out that this probably applies to all loan books on all EU banks balance sheets and yet again the Irish banks will be the ones fessing up and taking the hit up front.

One interesting option would be for the banks to offer to split the difference on trackers, ie to MtM the tracker and offer a 50/50 split via cash sent out or a reduction in the mortgage. Would have the double benefit of a boost to confidence as people get some cash to either spend or save, or alternatively eat materially into the negative equity black hole for many. Finally getting rid of trackers would likely boost transactions in a dormant property market.
The cost would be more capital required in the banks, I reckon it’s approx 4 bio assuming a 50/50 split, 2% mtm, trackers of 50 bio and remaining life of average 10 yrs.

You don’t necessarily have to compute the size of the hole to sell/give away AIB to HSBC. You just have to have a put/call structure around the price contingent on what happens over the next 10 years. If AIB makes money above a certain threshold then HSBC sends a cheque to the government; if the hole is indeed bigger than we think, then somebody has to write a cheque to HSBC. Simple.

The easiest way would be to do it with an equity partnership, no? The state keeps, say, 40% of AIB in trust in the NPRF and sells the rest. If more capital is required, then the state ‘pays’ with its equity. It would require, though, a vastly capitalised bank in the first place.

Presume it is known (or least discoverable), the extent to which banks, not covered by the Irish guarantee, hold ECB tracker mortgages on Irish properties and/or properties subject to some kind of lien on Irish resident tax-payers.

Yes – just like the Public-Private partnership for the motorways now being mentioned as security for the debts run up – with Irish taxpayers on the hook:-)

This is a nice idea in theory

You sell part of the loan book to a deposit taking institution with access to cheap funding..HSBC is the elegant example. In Simpleton’s model they get an ROA/ROE in a corridor …say for example around 15% plus or minus. Now here is the problem
*very few institutions in Europe are in a position to access cheap funds-they all have loan-deposit ratios around 150%. Santander is paying 4% for deposits in Spain.
*those that do have excess liquidity find that it all outside Europe. HSBCs excess deposits are in Hong Kong. Fungibility is a bit of an issue.

I can think of only three sources of capital for this kind of tranaction
*hedge funds or private equity
*the Chinese policy banks

So what is a mortgage book receiving circa 2.5% and paying at least 4%.

I would have thought 85c in the € was generous.

What is the total value of tracker mortgages on the Irish banks books?


Irish Times Link on ‘Bank Resolution’ (Santa is early this year)

After over two yrs – I wish the IMF success with finding a formula [did I really wish the IMF success?_Yes I did] ….. and I could live with 3% interest on the ‘bail-out’ – well worth it due to systemic risk nature of Irish Banks to the Euro, the Eurozone and the European Project …

Think Monday due to Portugal budget this week … which will pass.

The Govt has guaranteed the banks debts. Generally, a guarantee usually only covers obligations to the extent that the guaranteed party. Therefore, if the creditors of the bank agree to a reduction in their rights, or a majority can vote for a reduction of the debts by using a Collective Action Clause as has happended with Anglo subbies, then a Guarantee would normally only cover the reduced liabilities of the banks. (Obviously there are two different guarantees in force).

The beneficiaries of the Bank Guarantee are now wholly reliant on the funding from the ECB and the IMF to get their money back. The ECB and the IMF are not party to the guarantee. Therefore it is theoretically possible that the IMF/ECB could use the process of agreeing funding to enforce losses on bondholder. For instance, they might say we will give you €x to be loaned to the banks subject to the banks enforcing losses of y% on bondholders of senior debt under guarantee no. 1 and losses of z% on subbies.

Leaving all that aside, it seems that we should welcome the IMF insisting on the banking sector being tidied up once and for all as part of the deal. This gives us leverage with the banks and the international money markets and should speed our recovery. It is probably of great benefit to us that foreign banks, and particularly UK banks, are so exposed to our
economy and needful of its recovery.

Does anybody know why we are still persisting with the fiction that the NPRF equity investment of 6.6bn is a commercial deal. Even on optimistic consensus estimates, the normalised earnings power of AIB is probably only about 800m so this is a normal ROE that is lower than AIBs Cost of Equity.

Moreover, there is also a suspicion that this is about 3bn short of the real requirements.

How can the NPRF plough 6.6bn into AIB without knowledge of the business model?

The MtM isn’t just a matter of marking to the real cost of marginal funding (though that would give rise to a huge discount of itself).

The other ineluctable problem with trackers is that they are a late-period, peak of market invention, and thus most likely comprise the worst secured mortgage lending on the banks’ books. It’s reasonable to assume that the tracker books are under-secured to the tune of at least 40%, and probably well higher.

Hard to see other than an enormous discount being sought by any potential buyer – unless they have foreknowledge of a sudden and imminent surge in mortality rates in the 30-45 age cohort, which could transfer the losses to the mortgage protection policy-writing life assurers. Barring banks hiring assassins, this doesn’t seem likely.

Taking a very long view, despite the bizarre refusal of the Euro to collapse, Ireland’s policy of borrowing more than we repay may be sufficient to keep matters going, until the creditors themselves become so squeezed that they accept 30 cent on the Euro or some such. It makes sense therefore to lever the damage done to these creditors as much as possible, using the funds they advance against them.

Outrageous, eh?

MPLT: Deposits a ‘…natural hedge..’, but only so long as one of the main the contingencies to be hedged did not arise. Therefore a very incomplete hedge. No point saying that the contingency which has actally arisen should not, theoretically, have arisen.

Aiman: Further problem is that default rates must currently be artificially low (2% easy to afford). As the policy rate heads back up, default becomes more likely.

@colm -agree totally. Which would scare a tracker lender more – a MtM valuation (based purely on performing to maturity), or a default?

Will it be possible to downsize the banks without getting the bondholders to chip in ? I mean, it was nice to repay them in full over at Anglo but now that the sovereign has limited wiggle room …

FT report UK and German bank exposures to Ireland of €149 and €139bn respectively.

Nice to see the IMF won’t be wearing the green jersey. It really does look like the proverbial “bordel de merde”.

It is interesting to note that Michael Noonan has ssaid he understands there is a conflicy between the IMF and the ECB/EU with the IMF preferring to impose losses on creditors and the ECB/EU considering that a bad policy.

On the one hand, it would be very damaging if Ireland were to be the one Eurozone country to default. On the other hand, if some degree of default is necesary to allow us to get out of this hole then perhaos we should welcome the IMF’s imprimateur. It is hard to see how we can get out without the hole being made smaller rather than bigger by this IMF/EU intervention.

The ECB might be able to reduce the risk of default by some sort of QE whereby they puchase Irish bank assets but that would be politically difficult and economically uncertain. In the absence of a willingness to take such steps, perhaps the ECB should allow the IMF to start the surgery. Unsustainable debts are generally overcome by default or inflation, not by further borrowing at increased rates.

It is worrying that there could be an intensification of NAMA. The only positive intensification might be if NAMA assets were transferred to a bad bank that could at least behave as a bank and not an AMC.

The EU are saying that by 2013 they will have a mechanism in place to make bond holders share in bank insolvency. In the mean time, they want Ireland to be the good guys and not to hurt any of their financial institutions who have invested in insolvent banks not to mention insolvent sovereigns tied to insolvent banks. And they call that what?

Is this not entirely hypocritical? Let them put their money where their mouths are. If they say they cannot implement this for another 3 years is this not a bare faced admission that their monetary policies were totally inadequate in the first place. Well, little old Ireland should not have to pick up the cost for poorly designed systemic flaws by being given money at unsustainable and impossible interest rates which will eventually lead inevitably to debt restructuring after a lot of lives have been destroyed and a lot of people have emigrated.

Just for illustration, I calculated a theoretical position.

A €150,000 mortgage with 15 years to run, currently held on a 0.6% tracker margin yields 1.6% in annual interest to the bank. Discounting the total payments at 4% (assumed cost of funds going forward) yields a present value of €125,942, a 16% discount.

THis would be the market value if the yield differential is assumed to remain constant. In other words, a tracker margin of 0.6% would be assumed to remain at the same discount to cost of funds (relatively speaking) for the entire life of the mortgage.

An excessively pessimistic assumption surely?

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