The Central Bank of Ireland has released an addendum to its Financial Measures Programme report covering loan losses at Anglo and INBS. It concludes the loan losses estimates that were produced last September are still satisfactory.
What does this mean for the remaining Anglo bondholders (€200 million paid out on last Friday)? The government’s policy on this issue is a little unclear to me at this point. The Irish Times reported in April
the head of financial regulation Matthew Elderfield said losses may be imposed on senior bondholders at Anglo Irish Bank and Irish Nationwide Building Society if the cost of the two failed institutions rises above the current €34 billion bill.
This wording also suggests the converse—that without evidence of higher losses than €34 billion, senior bondholders would be repaid in full. However, I doubt if policy on this issue is being set by Mr. Elderfield. In the week after the stress test announcements, government politicians continued to maintain that they wanted to see burden sharing with Anglo and INBS bondholders. For instance, listen to junior minister Brian Hayes discussing the issue here on the April 2nd edition of Saturday View (56 minutes in).
There isn’t really any need to base such a decision on whether the Central Bank announces combined losses of more than €34 billion. An amended version of the Credit Institutions bill could be introduced that allows the Minister to apply haircuts to all bonds issued by banks that required enormous support from the state, and perhaps this is what government politicians have in mind when they say they are still pushing for burden sharing.
Anyway, there has been no official response to this release from the Department of Finance, who have instead preferred to issue press releases on the subdebt buybacks proposed by BoI, EBS and ILP. My guess is that the government is hoping this issue will just fade away but, if asked, they will still claim that Anglo senior debt shouldn’t be paid out on but that they’re still “discussing the issue with their European partners”.
As a purely political matter, I’d guess that if and when Ireland gets a lower rate on its EU loans, that may prove to be the moment that they admit they had to give up on haircuts for Anglo bonds. Investors who bought these bonds at steep discounts over the past year (because so many people assumed the government would not pay out on them) will have obtained a fantastic rate of return.
While having to put another €24 billion into the banks is hard to stomach, I am still surprised by the overwhelming negativity in the reaction to the release of the stress test results. I think there were three big questions going into yesterday:
(1) Would we get the information necessary to reduce the large range of uncertainty about ultimate banks losses that has been weighing so heavily on the creditworthiness of both the banks and the state? The detailed information on bank balance sheets and projection assumptions used allows anyone interested to reengineer the calculations as necessary, and is a step change from the kind of information analysts were working with before. The bank balance sheets and loan loss projections are now far less of a black box.
(2) Would the banks end up sufficiently well-capitalised to overcome the difficult funding environment? By my calculations, allowing for the capital buffers, Core Tier 1 is close to 10 percent under the stress scenario and close to 17 percent under the base scenario. [Note that the stress scenario is binding for all four tested banks this time round; see Table 16] We will have very well capitalised banks. Continue reading “Anti-gloom on the stress tests”
The Central Bank’s stress test announcements will be available on this webpage at 4.30. A webcast of the press conference will be available here. The Minister for Finance’s statement is here.
Following on Kevin’s post, here are a few more thoughts for possible discussion in advance of the stress test results.
1. I think the criticism of the insufficiently adverse assumptions for 2010 has been overdone. While it does raise questions about our ability to forecast the future when we have such a hard time estimating the past, getting 2010 wrong really shouldn’t matter. If BlackRock are taking as hard a look at the balance sheets as we are led to believe, current conditions should already be incorporated in the loan loss estimates. The value of the baseline and adverse scenarios is in understanding how things might evolve from here. In other words, it is the delta from 2010 that matters.
2. A related criticism is that the ESRI/TSB house price index is underestimating the true decline in house prices (the index has house prices down by 38 percent from peak by Q4 of 2010). But again the current state of the housing market should be reflected in the current state of the loan book. If house prices are really down 50 to 60 percent, then the declines under the adverse — or even the baseline — scenario truly get us into Morgan country.
3. There appears to be a “my (preferred) stress tests are more stressful than yours” attitude to the choice of the adverse scenario in the stress-testing exercise. But I think this sometimes reflects a misplaced view of the purpose of the adverse scenario. In addition to seeing what bank losses would be under an adverse (but somewhat arbitrary) scenario, the adverse scenario plays an important role in triggering recapitalisation. In the current exercise, my understanding is that recapitalisation will be triggered if the Core Tier 1 falls below 10.5 percent (please do correct me if this is not correct as the documentation is not that clear). Thus the toughness of the test must be judged by looking at the combination of the adverse scenario and the target ratio under that scenario. A 10.5 percent target is an extremely tough target by any measure. Under the last round of tests, the baseline target was 8 percent and the stress (adverse) scenario was 4 percent. The former has been raised by 4 percentage points to 12 percent; the latter has been raised by 6.5 percentage points to 10.5 percent.
It is noteworthy that IL&P was the only one of the tested banks to fall foul of the 4 percent stress scenario last time round (see here). It is not really surprising that they are in deep trouble with a stressed target of 10.5 percent. This sensitivity to the stress scenario must reflect the importance of mortgages (and in particular buy-to-let mortgages) on the balance sheet of IL&P, and also the large additional assumed declines in house prices under this scenario.
The next milestone in Ireland’s crisis resolution efforts will be the March 31st stress tests. In addition to revealing important information to financial markets, the results of the tests are likely to impact the political debate about the appropriate crisis resolution strategy, not least the contentious issue of default. At the moment, there appears to be a lot of confusion about what the stress tests are all about, which is important to clear up in advance to prevent the release being counterproductive in terms of the political debate. I offer some thoughts after the break, but I hope others will weigh in on the thread. Continue reading “Stress Tests”
It was great to see Jon Ihle, one of Ireland’s best financial journalists, writing in the Sunday Business Post yesterday. Missing Jon’s weekly insights was one reason to mourn the Tribune’s demise.
Jon has an informative piece on the coming bank stress tests: see here.
We are clearly being prepared for some additional bad news on the bank losses, and maybe for once we will be surprised on the downside. In interpreting the additional capital needs, however, it will be important to distinguish between estimates of additional losses and the new capital required to meet higher capital ratio targets.
The EU/IMF terms require A baseline capital level of 12 per cent for all banks – far above the normal 8 per cent regulatory level at which Anglo and INBS are being allowed to operate.
But if the stress level is as high as 10.5 per cent – meaning capital could not fall below that point even under dire conditions – bankers expect the baseline level could go as high as 16 per cent, imposing huge recapitalisation costs.
AIB and Bank of Ireland have been included as two of the 91 banks chosen for the stress test being conducted by the Committee of European Banking Supervisors. They don’t do too well in JP Morgan’s version of the test, reported here. Results will be released on 23 July.