The Irish Economy

Brian Lucey makes the case for senior bond holders to bear a share of the Anglo losses post-September.   You can access his Irish Times opinion piece here.

The FT’s Lex column gives its pithy assessment of Nama.

A flavour:

Nama is an odd creature: part debt collection agency, part property developer. As well as toxic loans, it may end up with a portfolio of property which was collateral for the banks’ lending binge. It was meant to fix the broken banks, convince taxpayers they might be repaid and reassure the markets the banks’ liabilities would be met in full. Facing in three directions, it has not appeared convincing in any: slow, bureaucratic, initially indecisive, almost excessively transparent (every toxic loan is assessed individually).

It concludes a bit more hopefully.

The apparently newly branded Central Bank of Ireland has released the latest summary data on mortgage arrears here.  

A total of 36,438 mortgage accounts were in arrears over 90 days in June 2010, up from 32,321 in March. This meant that 4.6 percent of mortgages were in arrears, up from 4.1 percent in March and 3.3 percent in September 2009.  However, mortgages in arrears have a higher average balance (€190,000 compared to an average of €149,000 for the full sample) so the 4.6 percent of mortgages in arrears accounted for 5.9 percent of the total outstanding mortgage balance.

The arrears on the overdue loans totalled €559 million in June. Those in arrears over 180 days are, on average, behind on 10 percent of their total balance.

Last month, Philip noted the new Central Bank release on Money and Banking. Philip pointed out the new presentation of the data in a more useful format, with figures presented for what is essentially an IFSC and non-IFSC breakdown.  I had meant at the time to chip in to note some other useful improvements but didn’t get around to it.

So, with this month’s release now available (with figures through July), let me first point out that the Bank are now making historical time series available (not sure a direct link works, so click on Statistics on the — newly rebranded! — webpage and then on Data under Credit, Money and Banking Statistics along the left hand side.)

The Bank are also now releasing figures that make the underlying credit situation easier to understand. Detailed figures on lending to households and non-financial corporations, including a breakdown by duration, are now available. The charts on year-over-year lending to firms and households in the press release are based on levels series that are cleaned for factors such as NAMA or exchange rate adjustments that affect the figures for total loans on the reported aggregate bank balance sheets.

Most useful of all, to my mind, is that the Bank now publishes figures for net amounts of new lending (i.e. new lending minus loans paid off) for both firms and households. For example, go to spreadsheet A.5 and click on the tab labelled Transactions and you’ll see these figures broken down by sector and maturity.

These figures are quite volatile from month to month. However, I ran up a chart (see below) of the three month moving average of net new lending to firms and households and it makes it pretty clear that there was a step down in credit availability in late 2008 and that net new lending has been negative for most of the past two years.

This time last year we were inundated with government politicians telling us that NAMA was going to get credit flowing. Well, there’s very little evidence of this occurring yet.

Simon Carswell reports on an interview with Anglo’s Mike Aynsley  and Maarten van Eden in this morning’s Irish Times.  The number that jumps out is the extra €20 billion Mr. Aynsley claims it would cost to wind down the bank.  

Winding down the whole bank would cost €20 billion – on top of the cost of the split, which stands at about €25 billion – he said.

Maarten van Eden, Anglo’s chief financial officer, added that the split option would also retain €47 billion of the bank’s funding, which would otherwise have to be provided by the Government.

This comprises €23 billion of customer deposits, €16.5 billion of wholesale funding and €7 billion provided by other banks, he said.

A few observations: First, the €47 billion does not include funding from the ECB and Irish central bank, which I presume would be available (subject to liquidity programmes in place) in the wind-down scenario.  Second, surely Anglo’s “deposit franchise” is dependent on the government’s liability guarantees, and again it is not obvious that these it would not be available in a wind down – after all, the bank is presently not engaging in any new business either.  Finally, even in the worse case scenario where the deposit funding disappears, would it really be that much more costly if the government had to borrow to pay off the funders directly?   As it is, the markets are well able to see through the consolidated balance sheet of the government and the nationalised (and semi-nationalised) banking system.  And even with the guarantee, Anglo must offer premium rates (e.g. 3.5 percent on one-year deposits).

It would be good to get commenters’ views on the €20 billion premium cost estimate.

With almost two years having passed since the Irish banks reached crisis point, it’s worth reflecting on how effective the government’s policies have been.  Here’s a piece I wrote for this month’s Business and Finance on this subject. I gave the government A for effort and D- for execution. Written prior to yesterday’s Anglo figure, the D- might have been generous.

The report is here. The press statement is here. The loss for the first half of the year is reported at €8.2 billion. And “The Minister for Finance has recapitalised the Bank with a further €8.58bn effective 30 June 2010, bringing total capital support to €22.88bn.”

As the Apres Match version of the Minister might say, that’s a lot of noughts.

In this Jackson Hole paper,  Carmen Reinhart and Vincent Reinhart find that the negative impact of severe financial crises on macroeconomic performance is long lasting, with real house prices remaining below the previous peak a decade after the crash, unemployment remaining at an elevated level and a cumulatively-large decline in GDP growth.

The international media are gradually noticing that our plethora of banking sector policies have not worked to restore the Irish banking sector to health but are threatening the health of the public finances. An editorial piece from the Financial Times is highly critical. It concludes:

It is time to staunch the bleeding. As Irish state guarantees near their expiry date, some banks will not be able to refinance their balances. The government should prepare insolvent banks for forced debt-for-equity swaps, which would instantly recapitalise the banks in question and cap the government’s exposure. This cannot be done frivolously; European institutions are exposed and EU partners must be consulted. But someone must put an end to the practice of handing banks blank cheques. Some Irish pluckiness would benefit us all.

I take it the FT will now be dropped from the long list of august international institutions that the government rolls out to claim support its banking policies.

De Volkskrant has a piece on Ireland, transgoogled here.

They start by saying that Ireland was a role model for austerity at the start of the year, but is now a reason for concern. They give two reasons, the first of which is the unknown but large cost of saving the banks. Secondly, they do not believe that the government will deliver in the next budget.

Standard and Poor’s have downgraded Irish sovereign debt from AA to AA- and their outlook for the rating (not the economy) is negative. S&P cite the rising cost of the banking bailout as in their statement and project a debt-GDP ratio of 113% in 2012.

On the banking costs, they state

We have increased our estimate of the cumulative total cost to the government of providing support to the banking sector from about €80 billion (50% of GDP; see “Ireland Rating Lowered To ‘AA’ On Potential Fiscal Cost Of Weakening Banking Sector Asset Quality; Outlook Negative,” published June 8, 2009, on RatingsDirect), to €90 billion (58% of GDP) …

We have increased our estimate of the cost to the Irish government of recapitalizing financial institutions to €45 billion-€50 billion (29%-32% of GDP) from €30 billion-€35 billion (19%-22% of GDP). 

Our estimate includes two main components: the upper end of our estimate of the capital we expect to be provided by the Irish government to improve the solvency of financial institutions, and the liabilities we expect the government to incur in exchange for impaired loans acquired from the banks.

Irish ten year bond yields have risen above 5.5 percent this morning and the spread against their German equivalent, at about 340 basis points, is the highest it has been in recent years. The NTMA have objected to the downgrade, arguing that S&P were using an “extreme estimate” of the cost of the banking bailout.

This week’s edition of The Economist reports on the lrish banking crisis: you can read it here.

One of the aspects of the CEBS European stress test exercise that has been commented upon quite widely is their decision to only apply haircuts to sovereign debt held on the trading books of the banks examined. However, most of these bonds are held on the “banking books” on the understanding that they are being held to maturity and the CEBS exercise assumed no sovereign defaults over the time horizon considered, so no haircut was applied to this portion of the bond portfolio.

In reality, the trading book\banking book distinction is arbitrary. In the case of a default or restructuring on these sovereign bonds, the distinction is meaningless. In the case of a bank failing, the distinction also doesn’t mean much: If the assets of the bank need to be sold off to meet liabilities, then bonds originally intended marked as hold to maturity the banking book may still have to sold off at market values.

I’ve come across two interesting alternatives to the CEBS stress tests. The first is this report from the OECD, which takes a macro look at the topic. They calculate that 83% of the exposure to EU sovereigns is held on the banking book and the report gives a good sense of the exposures of banks in different countries to various types of sovereign risk.    

The other alternative comes via the Calculated Risk “Some Investor Guy” series on sovereign debt. The Guy linked to this rapid response piece from Citi, redoing the analysis on a bank by bank basis. Applying the haircut to the banking book as well as the trading book, the number of European banks that fail the test rising from 7 out of 91 to 24 of 91.

His Beijing speech is available here.

As flagged by Paul Krugman, P O’Neill writes on the Irish situation at A Fistful of Euros: you can read it here.    [Unlike some others on this site,  this economist picks his user name from a long Irish tradition, rather than relying on The Wire or former communist regimes for inspiration!]

In case you did not know already, Lucey and Lyons wrote a reminder.

Patrick Honohan is interviewed by Ambrose Evans-Pritchard here.  Warning: the article uses AIB as an acronym for Anglo-Irish Bank.

In recent days the heads have AIB and Anglo have called for an extension of the bank guarantees.  (Colm Doherty’s conference call transcript here; Mike Aynsley’s interview with RTE here.) This has caused understandable dismay given the almost unimaginable costs the original blanket guarantee placed on Irish citizens.  But we should not allow the mistake of guaranteeing already locked-in funds for a period long enough to allow most of them to escape to colour the case against guarantees on new borrowing.   (It should be said that with the government’s effective “no-creditor-left-behind” policy, it is not obvious that losses would have been imposed on long-term creditors with or without the original guarantee.) 

In looking at the case for continuing with prospective guarantees it is important to consider how the credit system would evolve without them.  Without guarantees the cost of new funds would increase, leading to increased pressure to raise rates on new business and household lending.  Moreover, without guarantees there would be greater market pressure to increase capital ratios, which in the current environment is likely to be met by greater deleveraging.    The credit squeeze would worsen. 

I have thought since the outset of the crisis that balance-sheet constraints on credit supply have received disproportionate blame for the credit collapse relative to credit demand and borrower creditworthiness considerations.  But one factor I didn’t fully appreciate is how uncertainly about future credit supply can affect current demand.  Businesses will want to limit their debt exposure when there is a risk that their legs will be cut from under them when they try to refinance.   This may go some way to explaining Colm Doherty’s revelation that 40 percent of overdraft facilities are not being taken up.   (Simon Johnson makes a similar point in recent testimony before the U.S. Senate Budget Committee; this wide-ranging testimony is well worth a look more generally.)

The sustained deleveraging by banks, businesses and households risks a Japanese-style “lost decade” for the Irish economy.   The recent soft numbers, which have come in despite the stronger performance of broader European economy, could be an early warning.  Restoring confidence in the stability of credit supply is an important part of the policy challenge.   Unfortunately, guarantees on new bank liabilities will probably have to remain a while longer. 

I know that the NTMA have already admitted as much but just in case there were any remaining doubts that Eurostat are counting the promissory notes towards this year’s budget deficit, the picture below is a screencap from Eurostat’s publicly available database. Yes, our deficit in the the first quarter of 2010 was 36.51% of GDP. I believe the figure for the year will be about 20%. (Yes it’s my first time using a picture! Perhaps now you can see why.)

In this new paper (joint with Gian Maria Milesi-Ferretti of the IMF), we empirically examine the factors explaining the cross-country variation in the severity of the global crisis.  We find that the pre-crisis level of income per capita, increases in the ratio of private credit to GDP, current account deficits, and openness to trade are helpful in understanding the intensity of the crisis. International financial integration did little to shield domestic demand from the country-specific component of output declines, while those countries with large pre-crisis current account deficits saw domestic demand fall by much more than domestic output during the crisis.  (Forthcoming in IMF Economic Review.)

The aggregate banking data for Ireland has been difficult to interpret due to the large volume of international banking activity that is routed through Dublin but which has little to do with the domestic financial system. In a welcome development, the Central Bank has re-organised how it publishes the aggregate banking data. In addition to publishing data for ‘all credit institutions’, it now also publishes data for ‘credit institutions (domestic group)’.  Data and explanations are available here.

In approximate terms for June 2010, the domestic group accounts for 59 percent of the aggregate balance sheet of all credit institutions but 87 percent of domestic deposits and 87 percent of domestic loans (94 percent of loans to domestic private sector).

HT Calculated Risk

I surely have better things to do with my time but, yes, I spent the evening reading AIB’s half year report (with the Airtricity boys doing us proud in the background.) As John already noted, the report has a lot of pretty bad news in it, so I thought I’d point out some sort of positive news (before getting back to the bad stuff).

Liquidity Situation

The good news? Despite concerns that have been expressed about a looming “wall of cash” moment, AIB looks as though it’s in a position to get through to the end of the year paying back all its debts, though this may require ECB assistance.

(more…)

“The six months to June 2010 was a very difficult period for AIB and its customers.”  So begins management’s overview of AIB’s interim results for 2010—and it’s hard to disagree.   Bank watchers were looking for news in three main areas: impairments on non-NAMA bound loans, operating profits, and progress on asset disposals.   Today’s release managed to disappoint on all three. 

Provisions for impairment were €2.3 bl. (including €1.2 bl. for loans “identified for potential transfer to NAMA”).   Operating profit before provisions fell 46 percent from the same period last year, with significant falls in the net interest margin.   And Colm Doherty was not especially forthcoming on how well the disposals of Polish, UK and US assets are going, although his presentation to analysts did give the sense that AIB were being forced into a fire sale in poor market conditions—hardly encouraging. 

Other “news” included the (inevitable) plan to follow BOI in raising the rate on variable-rate mortgages by about half a percentage point, and the (sensible) call to extend the guarantee on both shorter- and longer-term liabilities given the continuing difficult funding environment. 

The interim report is available here.   Colm Doherty’s presentation and Q&A is available here. 

The results for the stress tests on 91 European banks were released yesterday evening.   A reasonably detailed description of the tests and results is available from the Committee of European Banking Supervisors’ (CEBS) website.   The results for AIB and BOI are available from the Irish Central Bank’s website.   As Michael Hennigan points out, the overall passing score was 84-7, and so the release of the results has not quite made the waves expected.   Both Irish banks passed with a bit to spare despite the relatively high Tier 1 target of 6 percent.   However, the results factored in capital raising plans to the end of the year, and the jury is still out on how much of the €7.4 bl. AIB can achieve without additional government help.  

Some analysis here: Irish Times; Irish Independent; Financial Times.

Writing in today’s Irish Times, Ashoka Mody argues for the need to introduce a special resolution regime for banks as well as “fiscal benchmarks and supporting rules, along with a technical voice in the form of “fiscal councils” to evaluate budgetary risks.”

Mr. Mody is assistant director in the European department of the International Monetary Fund and has lead the IMF’s article for team that has visited Ireland in recent years. While Mody’s senior IMF status makes him worth listening to, it’s also worth noting that he has a considerable research record as an economist including this interesting work on the effects of budgetary institutions.

On RTE radio this morning (on Today with Pat Kenny with, em, Myles Dungan) Fianna Fail TD Frank Fahey said:

I stand by what I said about NAMA from the very beginning. NAMA is being funded … the bonds are being funded by the European Central Bank.

Now I know that language is a flexible thing and perhaps philosophy graduates could spend all night debating what the meaning of “being funded” is. But, I would suggest that the only reasonable interpretation of this statement is that it implies NAMA are receiving funds from the ECB.

This is not at all true. The ECB has no direct relationship with NAMA at all. NAMA bonds can be used by the banks that have received them as collateral for loans from the ECB but that’s it, that’s the full extent of the ECB’s involvement in relation to NAMA. Furthermore, AIB and BoI executives told the Oireachtas last year that they had no particular plans to use the bonds in this fashion.

The NAMA bonds are fully backed by the Irish government. They are a liability of the Irish state, albeit one entered into at the same time that it acquired some property assets that may or may not yield enough to pay off the bonds.

It is long past time for government politicians to stop misleading the Irish public that NAMA somehow involves the state getting money from the ECB. I would plead with any journalist interviewing Deputy Fahey or any other commentator making this claim in the future to point out to them that it has no grounding in fact.

Details here. Mysteriously, there are no Anglo loans being transferred yet in this tranche. We’re told “Loans will be acquired from the remaining institution – Anglo Irish Bank – over the coming weeks after all necessary due diligence material has been received and evaluated.” It does seem deeply odd that the bank that NAMA is supposedly having the greatest difficulty processing information from is one that is fully owned by the state. An alternative intepretation offered by Jagdip is that the delay relates to EU State Aid nexus.

The discounts on these loans are higher than the first tranche. I don’t think, however, that I can agree with Brian Woods II that this raises the potential profit for NAMA. The new tranche reflects new information on valuations not available when the business plan was put together, though unlike the first tranche, no valuation estimates have been provided. So, in this case, the lower prices paid likely also reflect a lower long-term economic value. It would, of course. be nice to see NAMA re-issue the business plan after each tranche but it ain’t gonna happen.

The documents released yesterday show that the government were aware in September 2008 that, at least under stress scenarios, Anglo Irish Bank was going to be insolvent. (more…)

On the day that we found out that, contrary to the mantra of “everything was done on the basis of the best possible advice” the Irish government failed to follow the expert advice it received from Merrill Lynch when it decided to introduce a blanket guarantee, the state broadcaster brought on David Murphy to explain the implications. Viewers of the Six-One news were treated to the following exchange:

Sharon ni Bheolain: So with the benefit of hindsight and knowing now what we do know particularly about the value of those assets underpinning the loans, can we say that the blanket guarantee was the wrong way to go or is that an oversimplification?

David Murphy: I think in hindsight the guarantee probably was the right way to go and that’s exactly the conclusion that Patrick Honohan came to in his recent reports on the banks. The question though is “did they guaranteed too much?” and they did include subordinated debt in the guarantee. That was something that Merrill Lynch warned against. Merrill Lynch did make a number of warnings about introducing the guarantee. It said that Europe won’t be happy and that was right. It said that there will be a negative knock-on consequence for borrowing money in financial markets and that was right too. But it looks as if the government probably did choose the right option finally.

David reckons Patrick Honohan says that with hindsight the guarantee issued was the right way go. Let me turn the microphone over to Governor Honohan:

the extent of the cover provided (including to outstanding long-term bonds) can – even without the benefit of hindsight – be criticised inasmuch as it complicated and narrowed the eventual resolution options for the failing institutions and increased the State‘s potential share of the losses.

As I have discussed here before, Honohan’s arguments in favour of some sort of guarantee do not in any way mean his report backed the full blanket guarantee that was introduced. Rather than backing the guarantee with the benefit of hindsight, he opposes it even without this benefit!

So the only argument David Murphy can produce to defend the blanket guarantee is the claim that someone who opposed it (albeit in diplomatic language) was exactly in favour of it. Perhaps David had another argument and I have missed it.

More seriously, I heard An Taoiseach on the radio today defending the decision to introduce the blanket guarantee on the grounds that this was required to keep access to funding open for the Irish banks. Again, I’d defer to Governor Honohan, who argued in his report that the inclusion in the guarantee of existing long-term bonds “was not necessary in order to protect the immediate liquidity position. These investments were in effect locked-in.”

So, let’s recap. The government did not, in fact, follow the best possible advice that it paid for when introducing a blanket guarantee. Governor Honohan is not an advocate of blanket guarantees. And blanket guarantees are not necessary to deal with short-term liquidity problems.

Still, at least the government has David Murphy’s support.