6/9/2013: Euromoney Country Risk Survey: Upgrading Irish Banking Sector Risks Outlook

Some good news for Ireland out of a number of surveys today. First, BlackRock Investment Institute survey of country experts shows Ireland improving economic outlook 6 months forward - details here: http://trueeconomics.blogspot.ie/2013/09/692013-blackrock-institute-survey-north.html

Now, Euromoney Country Risk survey shows significant improvements in market experts assessment of Irish banking sector stability:

While both reflect opinions of experts, including experts within the specific sectors, the two are good indicators of the general direction toward gradual improvement in country economic outlook. Let's hope the Budget 2014 and mortgages arrears workouts do not derail this trend.

7/8/2013: Sunday Times, July 21, 2013: New Financial Order

Catching up on some of my past articles from the Sunday Times, here's an unedited version from July 21, 2013.

Five years into the Great Recession collapse of Irish domestic investment, underpinned by the unprecedented in history of the EU drop in lending to indigenous enterprises, continues to act as the main force holding back Irish recovery. Despite serious policy efforts to unlock banks lending, especially to the SMEs sector, expanded by the current Government and its predecessor there are many structural reasons as to why a return to the rampant lending and lending-backed investment in this economy remains elusive. After years of waiting for lending to return, we need to shift our policies focus away from attempting to refuel another SMEs credit bubble toward incentivising new forms of capital formation and accelerating the rate of existent debt restructuring in the real economy.

This week, research published by the Bruegel Institute reminded us about the horrors of the Irish credit system collapse. Looking at the outstanding credit to non-financial corporations from September 2008 through April 2013, the researchers found that Irish banking system experienced the largest decline in overall credit of all EU27 states. Ireland's outstanding credit to non-financial companies has fallen more than 50 percent over the period covered in the study, with the second-worst performing economy, Spain coming in with a more benign drop of 30 percent. Bankrupted Greece is in a distant fifth place, having posted a 'mere' 25 percent credit contraction.

Most recent Central Bank data, relating directly to the SMEs lending in Ireland, shows that new lending in Q1 2013 was 41 percent below the Q1 average for 2010-2012, despite the figures showing a slight rise quarter on quarter. Netting out new loans issued for financial intermediation and property, credit extended to SMEs in the first three months of this year was down 11 percent compared to the 2010-2012 average for the same period.

Strikingly, as Irish credit volumes shrunk faster than in any other EU state, interest rates for loans to Irish enterprises under EUR1 million in volume have declined in line with those for the lower credit risk economies. When it can be had, Irish SMEs credit is priced in line with such countries as Denmark, the Netherlands, Sweden and the UK.

On the other hand, SMEs’ demand for loans remains high. In Q2 2013, according to the latest ISME survey, demand for new credit rose to 41 percent from 38 percent a year ago. On average, 48 percent of all companies that applied for funding in the first six months of 2013 were refused credit by the bank, slightly down on 51 percent average rejection rate for 2012.

Good news: demand and refusal rates are starting to move in the opposite directions, just as credit supply is beginning to turn positive. Bad news: all improvements are shallow in nature and are yet to show sustainability over time.


All of this presents us with a paradox: while credit demand is high, both supply of loans and the cost is low. The reason for this is that Irish SMEs and banks are continuing to operate in a highly abnormal environment. Changing this will require reducing a severe debt overhang in the Irish SMEs sector, regulatory changes aimed at improving banks ability and incentives to restructure legacy loans, and a lengthy period of time to heal the overall collapse in SMEs willingness to undertake risky investment.

All indicators suggest that gradual improvements in the credit quality of SMEs are not keeping up with rising demand for loans.

Per ISME data, 12 percent of SMEs that do require bank finance abstain from applying for it; over half of them in fear that making an application can lead to the banks shutting down existent credit facilities. Of those SMEs that do apply, 28 percent saw demands for overdrafts reductions imposed onto them. Over half of the credit requests made but the SMEs were for overdrafts or invoice discounting/factoring.

This largely confirms the findings of our recent research based on the ECB data collected at enterprise level across the euro area. Applied to Ireland, our findings strongly suggested that significant contributor to the decline in credit was due to structural insolvency of SMEs’ balance sheets. These drivers are not being dealt with fast enough at the policy and banks levels to allow for the recovery in private sector investment.

Firstly, Irish SMEs remain heavily exposed to legacy loans secured against or for the purpose of property investment. Back in the early 2008, several investment banks have estimated that up to 90 percent of Irish business sector loans issued from 1998-1999 through 2006-2007 were exposed to the risk of collapse in property valuations. The main outcome of this is a wave of bankruptcies that is still consuming the sector. High debt levels tied to property loans mean that over one half of all Irish SMEs loans are currently in arrears, based on the Central Bank estimates. Referencing dynamics in residential buy-to-let markets (representing household side of the investment markets) and new lending data for SMEs, my own estimates suggest that closer to 70 percent of all SMEs loans still outstanding are either in arrears or at risk of failing.

However, even for the enterprises that survived the immediate drop in asset prices, property values decline has meant reduced borrowing capacity for years to come, greater propensity to avoid seeking new credit, and weakened existent production base. Behavioural studies suggest that SMEs hit by the property valuations declines, in contrast to newer enterprises formed after the property bust, will tend to reduce their future borrowings, even if they are given access to new finance. This applies also to companies that have completed successful debt restructuring. In addition, as SMEs lower their investment in new equipment, product R&D, and strategic and operational improvements, they reduce their future competitiveness and profit margins.

Secondly, Irish SMEs are operating in the environment of malfunctioning debt restructuring mechanism.

In a normal recession, banks hold sufficient capital to actively engage with SMEs in restructuring their debts. At the same time, short time span of a normal recession means that a bulk of businesses liquidations extend into the period of early economic recovery. Sales of distressed business assets, in normal recession, often take place in rising markets.

In a severe balance sheet recession, like that experienced today in Ireland, banks transfer costs of keeping the non-performing enterprises alive to other clients. One sign of this is that charges on short-term loans, often used to cover balance sheet pressures, tend to rise slower than charges on larger, capital investment-linked loans. From the bottom of the interest rate cycle through May 2013, cost of new credit for loans up to EUR1 million based on floating rate rose 33 percent. Cost of loans over EUR1 million with over 1 year fixation rose 87 percent. Such cost transfers harm better companies' ability to raise investment, while slowing down the rate at which the insolvency works through to weed out the unsustainable businesses. End game - delayed resolution of the debt crisis at the expense of suppressed capital investment and growth.


All of the above helps explain why less than a third of all Irish SMEs that do apply for credit from their bank end up drawing down any loans. But the above also suggests the policy direction that should be taken in trying to increase domestic capital formation while continuing to pursue system-wide deleveraging.

Unlocking investment requires, first and foremost, finding new sources for funding business expansion, distinct from bank lending. Such sources include equity financing and direct borrowing. The Government needs to develop incentives for equity investment in, and peer-to-peer and public-to-business lending to Irish SMEs.

To expand the pool of potential investors, we need to open these platforms and Irish investment services to international investors and institutions. Government re-insurance scheme for exports finance can be a good step forward in making Irish SMEs more attractive to foreign investors and freeing up some operating capital for growth. Another similar measure would involve more state co-investment in existent enterprises (as opposed to new ventures) based on their ability to generate intellectual property, associated with new products and services development.

While stimulating new forms of SME funding, Ireland also needs to accelerate the process of business insolvency resolution. This will require two major changes in the way our insolvency process is regulated.

We need to recognize the necessity for allowing banks to treat business equity as lower risk asset when restructuring legacy loans for sustainable enterprises. This can help increase debt-for-equity swaps between lenders and borrowers. In return, such swaps can allow banks to use their limited resources on deleveraging out of unsustainable loans. We also need to revise our targets for banks deleveraging, potentially extending the period over which the pillar banks are required to reduce their loans exposures and increase allowance for SMEs loans to be held by the banks. To reduce overall systemic risks, we can require banks to put their restructured SMEs loans through more rigorous stress-testing.

The second major change is to relax the constraints on entrepreneurship and professional standing for business owners going through bankruptcy proceedings. This will allow for a quicker return of past entrepreneurs to new ventures and will aid SME sector deleveraging.

All of the research on SME credit in the Euro area and Ireland shows that both supply and demand drivers are responsible for the collapse of investment during the current crisis. Instead of attempting to rebuild the legacy systems based on unsustainable lending, we need to think outside the box to identify new ways for funding productive investment. Both banking and the SME sector will require significant changes to deliver on this.
                                                                                                   

Box-out:

Largely ignored by the Irish media headlines, there is a new longer-term threat to our economy emerging from the EU's penchant for policies harmonisation. This week, at the talks in Vilnius, Lithuania, EU officials were discussing the need for pan-European regulation of data protection. In part, these talks were driven by the EU-US Free Trade Agreement negotiations and the recent scandal relating to e-spying. However, the main impetus for harmonising European regulations is the emerging imbalances in the ICT services investment across the EU. Ireland’s EU partners, especially Germany and France, are unhappy that our, allegedly, light-touch regulations act as a major attractor for foreign direct investment in ICT sector, ‘stealing’ jobs from Germany and tax revenues from France. The risks implied by harmonisation of EU regulations in this area are of significant economic concern. It is, perhaps, ironic that data protection regulations or their potential harmonisation did not make it into the ESRI's latest paper on ICT-related FDI, titled "Boosting Foreign Direct Investment in the Information and Communication Technologies Sector: What Works?" published this week. Foreign providers of ICT services in Ireland dominate the sub-sector which acts as the sole source of growth in Ireland from 2008 through today. Between Q1 2008 through Q1 2013, Irish ICT services credit to the current account rose from EUR5.86 billion to EUR9.35 billion. In Q1 2013, ICT services trade surplus exceeded our economy’s total external balance by 37 percent. Squeeze this sector through regulatory harmonisation and Ireland’s latest recession will look like a walk in a park, while our debt sustainability risks will go back to 2011 levels.

19/7/2013: Detroit officially files for Chapter 9

So after much of prevarication and discussions with the unions (there always discussions with the unions involved), the City of Detroit has filed for Chapter 9 federal bankruptcy protection. Detroit recently missed USD40 million payment to its own pension system and has amassed estimated USD18.5-20 billion in long-term liabilities.

Washington Post has an excellent timeline on the crisis: http://www.washingtonpost.com/blogs/wonkblog/wp/2013/07/18/detroit-just-filed-for-bankruptcy-heres-how-it-got-there/

The city has shrunk over the decades from over 1.8 million in 1950 Census to around 700,000 currently (2010 Census put Detroit population at 713,777). In 2000-2010 the city population fell by 25% with the city rankings in the US by population falling from 10th largest to 18th largest. Meanwhile the six-counties Metropolitan Detroit area population is healthy at 4.296 million and ranks 13th largest in the US.

Quote from the Washington Post: "The official unemployment is now 18.6 percent, and fewer than half of the city’s residents over the age of 16 are working. Per capita income is an extremely low $15,261 a year…"

And another quote: "“The city’s operations have become dysfunctional and wasteful after years of budgetary restrictions, mismanagement, crippling operational practices and, in some cases, indifference or corruption,” Orr wrote in May. “Outdated policies, work practices, procedures and systems must be improved consistent with best practices of 21st-century government.” (Detroit has been a one-party city run by Democrats since 1962.)"

A good compendium of information on Chapter 9 bankruptcy for the cities from the Business Inside here: http://www.businessinsider.com/municipal-bankruptcies-explained-2013-7

Apocalyptic imagery of the city: http://www.marchandmeffre.com/detroit/

And my earlier post on the lessons Detroit bankruptcy process offers in comparatives to Ireland's errors in relation to the banks crisis:
http://trueeconomics.blogspot.ie/2013/06/662013-detroit-is-about-to-go-bankrupt.html
As usual, this blog was ahead of the Irish news curve by a month...

Lastly, a ray of hope: http://www.businessinsider.com/after-filing-bankruptcy-detroit-is-on-the-verge-of-an-epic-comeback-2013-7

Which echoes some of my tweets on the subject (read from the bottom tweet up):

23/6/2013: Sindo & Indo: "'Bondholders are f***ing us up the arse' – Anglo"

With slow drip of a freshly leaking faucet, we are getting more and more granularity on the events surrounding Anglo collapse and the events leading up to the Guarantee. Here's the latest instalment:
http://www.independent.ie/irish-news/bondholders-are-fing-us-up-the-arse-anglo-29365626.html

It is impossible to assume that this information, in pretty much the same words, was not conveyed to the Taoiseach and the Minister for Finance before the issuance of the Guarantee. Which, of confirmed, would imply wilful act on their behalf in securing the payouts to the bondholders against all information available.

It is also virtually impossible to imagine, given this information, that the IL&P did not know well in advance of the fated 'deposits'-'loans' swap of late September 2008 that its funding arrangements with Anglo were high risk and not exactly kosher. Which implies that the Irish Fin Reg also knew the same. If the Fin Reg did not know this, its lack of awareness would signify an absolute level of incompetence that would be staggering even by the pretty high bars for incompetence set during Bertie Era.

In short, the two material bits in the article linked above are... well... staggering in their importance.

Updated: more on the same from 
http://www.independent.ie/business/irish/inside-anglo-the-secret-recordings-29366837.html 
now down on tapes and making the case for accusing Anglo senior staff of knowingly manipulating the bank relationship with the CBofI/FinReg!


So while Bondholders were 'f***ing up Anglo', Anglo was f***ing up the entire financial system of Ireland with Ireland's financial system cheerful approval. The only ones who got f***ed up in the end were... Irish taxpayers. Happy times!


Updated: ZeroHedge on the same: http://www.zerohedge.com/news/2013-06-24/anglo-irish-picked-bailout-number-out-my-arse-force-shared-taxpayer-sacrifice

And Anglo 2008 accounts have been released: http://trueeconomics.blogspot.ie/2013/06/2462013-anglo-2008-annual-report-is-out.html

20/6/2013: Stalled Irish Banks Reforms: Sunday Times, June 16, 2013

This is an unedited version of the Sunday Times article from June 16, 2013


The latest data from the Central Bank shows that in two years since the current government took office, Irish banking sector is not much closer to a return to health than in the first months of 2011.

Objectively, no one can claim that the task of reforming Irish banking sector is an easy one. However, credit and deposits dynamics in the sector point to the dysfunctional stasis still holding the banks hostage. Despite ever-shrinking competition and vast subsidies extended to them, Irish banks are not investing in new technologies, systems and models. Banks’ customers, including businesses and households, are thus being denied access to services and cost efficiencies available elsewhere. In short, the Government-supported model of Irish banking is failing both the sector and the economy at large.


In April this year, total inflation-adjusted credit advanced to the real domestic economy, as measured by loans to Irish households and non-financial corporations, stood at EUR175,419 million. Since Q1 2011, when the current Government came to power, real credit is down EUR32,302 million. This figure is equivalent to roughly twice the annual rate of gross investment in the economy in 2012. Total credit to non-financial corporations has now been in a continuous decline for 48 months.

Half of this contraction came from loans over 5 years in duration. These loans are more closely linked to newer vintage capital investment in the economy, generation of new jobs, R&D and innovation activities, as well as new exports, than loans with shorter duration. Let’s take this in a perspective. The fall in total longer duration lending since mid-2009 is equivalent to losing 70,000-90,000 direct jobs. Factoring in interest income plus employment-related taxes, the foregone credit activity has cost us close to the equivalent of the tax increases generated in Budgets 2012-2013.

It would be fallacious to attribute credit supply declines solely to the property related lending. Based on the new data reported this Thursday by the Central Bank, loans levels advanced to private enterprises have fallen, between Q1 2011 and Q1 2013 in all sub-sectors of the economy, with largest loans supply declines recorded in domestic, as opposed to exports-oriented, sub-sectors.  All loans are down 6%, while loans to companies excluding financial intermediation and property related sectors are down 5.8%.

However, on the SMEs lending side, some of the steepest loans declines came from the exports-focused enterprises, such as ICT sector, where credit has fallen 9.7% on Q1 2011, or in computer, electronic and optical products manufacturing where loans are down 6.5%. Even booming agriculture saw credit to SMEs falling 5.7% over the last two years, while credit for scientific research and development is down 13.3%.

The picture is, in general, more complex for the levels of credit outstanding in the SMEs sector. On the demand side, in Ireland and across the euro area, there has been a noticeable worsening in the quality of loans applications filed with the banks during the crisis. In a research paper based on the ECB SAFE enterprise level survey data for euro area SMEs, myself and several co-authors have identified the problem of selection biases in companies’ willingness to apply for credit. In simple terms, SMEs more desperate for funding due to deteriorating balancesheets are more likely to apply for credit today. In contrast, healthier firms are more likely to avoid applying for bank credit.

ECB data also shows that Ireland’s problem of discouraged borrowers is much worse, than the euro area average. For example, in Ireland, 21% of all SMEs that did not apply for credit stated that they did so for fear of rejection, almost 3 times the rate of the euro area average and nearly double the second worst performing economy – Greece.


On the funding side, Irish banks have been and remain the beneficiaries of an unprecedented level of funding support compared to their euro area counterparts.

A recent research paper from the Dutch think tank CPB, titled "The private value of too-big-to-fail guarantees" showed that through mid-2012, the pillar banks in Ireland have availed of the largest subsidy transfers from the sovereign and Eurosystem of all banking systems in Europe. Funding advantages, accorded to the largest Irish banks, alone amounted, back in June 2012, to more than double the share of the country GDP compared to Portugal, and more than seven times those in Spain and Italy.

Removal of the explicit Guarantees was supposed to serve as a major step in the right direction. Alas, Irish pillar banks continue to depend for some EUR39.5 billion worth of funding on Eurosystem.  The latest Fitch report on the pillar banks shows that this reliance is likely to persist as loan/deposit ratios remain relatively high. Latest figures put Bank of Ireland, AIB and PTSB loan/deposit ratios at around 120%, 130%, and over 200%, respectively.

And there are further issues with funding in the system. By mid-2014, AIB is required to raise EUR3.5 billion to redeem the preference shares held by the National Pension Reserve Fund. Bank of Ireland will have to find EUR1.8 billion for the same purposes. In both cases there are questions as to how these funds can be secured in the current markets without either further reducing money available for lending or tapping into taxpayers’ funds.


Subsidies to the ‘reformed’ Irish pillar banks go hand-in-had with the regulatory protectionism, which completes the picture of massive transfers of income from the productive economy to the zombified banking sector.

Since 2008, Irish financial services continue to experience ongoing process of consolidation and, underlying this, the reduction in overall competition. Data from the ECB shows that the number of financial institutions operating in the country has fallen in 2012 to the levels below those recorded in 2000-2008. Dramatic declines in the fortunes of the third and the first largest lenders – Anglo and AIB - should have led to a drop in the combined market share held by the top 5 banks. Instead, the market share of top 5 credit institutions rose over the years of the crisis.

To a large extent, this reflects exits of a number of foreign lenders from the market. However, unlike in the case of the US and the UK, there are no new challengers to the incumbent players in the Irish asset management, investment, corporate and merchant banking, and credit unions sector. Neither the regulators, nor the banks have any incentives to encourage new players' entry.

And this has direct adverse impact on the overall health of the economy. When we studied the effects of banking sector concentration on firms’ willingness to engage with lenders, we have found that higher concentration of big banks’ power in a market is associated with lower applications for credit and higher discouragement.

As the result of the reforms undertaken in the Irish banking sector, our banking services are left to stagnate in the technological and strategic no-man's land.

Mobile and on-line banking systems remain nothing more than appendages to the existent services, with only innovation happening in the banks attempting to force more customers to on-line banking to cut internal costs.

Currently, worldwide, banking services are migrating to systems that can facilitate lower cost customer-to-customer transactions, such as direct payments, e-payments, peer-to-peer lending, and mixed types of investment based on combinations of equity and debt. All of this aims to reduce cost of capital to companies willing to invest. Irish financial services still operate on the basis of high-cost traditional intermediation and the Government policy is to keep hiking these costs up. Instead of moving up to reflect the true levels of risks inherent in Irish banks, deposit rates for non-financial corporations and households are falling. Interest on new business loans for non-financial corporations is up 105 to 197 basis points in April 2013, depending on loan size, compared to the average rates charged in Q1 2011. Over the same time, ECB policy rates have fallen by 75 basis points. This widening interest margin is funding banks deleveraging at the expense of investment and jobs.


Combination of the lack of trust in the banking system, alongside the lack of access to direct payments platforms means that many businesses in Ireland are switching into cash-only transactions to reduce risk of non-payments and invoicing delays. Currency in circulation in Ireland is up 10.3% on Q1 2011 average, while termed deposits are down 6.3%.

With big Pillar Banks unable to lend and incapable of incentivizing deposits growth, we should be witnessing and supporting the emergence of cooperative and local lending institutions. None have materialized so far. If anything, the latest noises from the Central Bank suggest that the credit unions can potentially expect to take a greater beating on the loans than the banks will take on mortgages and credit cards.

All-in, Irish banking system is far from being on a road to recovery so often spotted in the speeches of our overly-optimistic politicians and bankers. The credit squeeze on small businesses and sole traders is likely to continue unabated, and with it, the rates of business loans arrears are bound to rise.

Box-out:
In this month’s survey of economists by the Blackrock Institute some 64% of the respondents stated they expected euro area economy to get e little stronger over the next 12 months and none expected the recovery to be strong. In contrast, 74% of respondents thought German economy will get better and 81% forecast the same for the UK. In the case of Ireland, however, only 57% of respondents expected Irish economy to become a little stronger in a year through June 2014 (down on 75% in May 2013 survey). None expected this recovery to be strong. Interestingly, 69% of respondents describe Irish economy's current conditions as being consistent with an early or mid-cycle expansion - both normally consistent with above-trend rapid growth as economy recovers from a traditional recession. Thus, the survey indicates that majority of economists potentially see longer-term prospects for the Irish economy in the light of slower trend growth rates. Back in 2004-2005, I suggested that the Irish economy will, eventually, slowdown to an average rate of growth comparable to that of a mature small euro area economy. This would imply an annual real GDP growth reduction from the 1990-2012 average of 4.9% recorded by Ireland, to, say, 1.8% clocked by Belgium. Not exactly a boom-town prospect and certainly not the velocity that is required to get us to the sustainable Government debt dynamics.

10/6/2013: Fitch on Irish Banks

Both Fitch and S&P have in the recent past questioned the model of Irish banking sector crisis resolution on the foot of the apparent link between the banks balance sheets and the exchequer.

Today, Fitch issued another report on Irish banking sector, titled "Peer Review: Irish Banks"

The report claims that Irish banks' current ratings "are constrained by the significant risks that remain in the Irish banking system. However, support remains an important rating driver and Fitch considers that the Irish authorities' propensity to support the 'pillar' banks, Bank of Ireland (BOI) and Allied Irish Banks, p.l.c. (AIB) remains undiminished, despite the withdrawal of the Irish Bank Eligible Liabilities Guarantee (ELG) in March 2013."

Crucially, "Fitch believes that the pillar banks' performance will continue to track within the stress case scenario of the 2011 Prudential Capital Assessment Reviews (PCAR), however these tests were framed on a Basel II basis. Since then capital expectations of market participants have increased. The 2014 PCAR may revise the stress assumptions and requirements to align more closely with Basel III." The kicker is that the banks will need new capital ('might need' another state injection as opposed to 'will need' capital).

"As Irish banks' capital ratios continue to be eroded and a return to profitability only appears feasible in the longer term, the banks may need to raise additional capital before they can contemplate a future independent of state support", Denzil De Bie, a Director in Fitch's Financial Institutions Group told Reuters.

The old kicker is that assets and capital held by the Irish banks remain weak, "with high NPLs and impairment charges, especially against commercial real estate and residential mortgage loans. Although the rate of deterioration slowed at BOI and AIB in 2012, Fitch believes impairment charges could increase during 2013 and 2014, with arrears reaching a peak in 2014, as the banks accelerate the resolution of mortgage arrears in line with new targets set by the Central Bank of Ireland in March 2013."

"Asset quality is weak in the Irish banks, with NPL ratios of 16%-40% in the Fitch-rated
institutions at end-2012. The banks also report a significant portion of their loan book to be past
due but not impaired."

Peaking of mortgages arrears per PCAR2011 starts in 2014 and goes on in 2016-2017.

"Underlying pre-provision operating profitability is structurally very weak because of the long-term, very low-yielding mortgage loans in their books. Until rates rise, Fitch considers that a return to sustainability will only be possible as the various restructuring and cost control plans of the banks begin to yield results. Fitch expects a return to operating profitability to be delayed until at least 2015 because of the continued erosion of earnings from high but reducing impairment charges."

Now, recall that per PCAR2011, Irish banks were supposed to fund their full losses out of operating profits starting with 2015. So far, Fitch is not saying there is excess (above PCAR2011 stress test assumptions) level of stress in the system, but Fitch does seem to point to the already recognised two pressure points:
- continued deterioration on the assets quality side, and
- Basel III.

And the banks are still dependent (and will remain for some time to come) on state/central bank supports: "with loan/deposit ratios still at a high 130%-230% in the Fitch-rated banks at end-2012, wholesale, government and European Central Bank funding still forms an important, albeit reducing, component of the Irish banks‟ funding bases." Why? Because deleveraging is by far not complete:

On banks doing their bit to get credit flowing to the economy:

And per stabilisation of deposits:

10/6/2013: Did UK Taxpayers 'Rescue' Ireland?..

An interesting story today in The Times. Here's a report on it from The Telegraph (http://www.telegraph.co.uk/finance/business-news-markets-live/10109577/Business-news-and-markets-live.html go to 7:10am post). Emphasis is mine:


"The Times is leading with the story that Britain has given a back-door bailout worth around £10 billion to the Republic of Ireland in an arrangement that was never explicitly approved by Parliament. The money has been pumped into Ulster Bank, a subsidiary of the state-owned Royal Bank of Scotland which was rescued by a public cash injection of £45 billion five years ago."

What's the gist? "New figures show that Ulster Bank, which operates predominantly in the Republic despite its name, has accounted for approximately one in every four pounds of losses at RBS since 2008... Almost one pound in every four injected into the two state-backed banks by the Government has gone directly into the Irish economy, the two lenders' subsidiary accounts show."

How so, may I ask? "Between 2009 and 2011, RBS made "capital contributions" totalling €9.13bn (£7.6bn) to its Dublin-headquartered subsidiary Ulster Bank Ireland. Over the same period, Lloyds transferred £6.41bn to its Irish operation, Bank of Scotland (Ireland), before dissolving the business.
The total – £14bn – amounts to more than a fifth of the £65bn UK taxpayers injected into RBS and Lloyds in 2008 and 2009, and is expected to rise further. Analysts estimate that RBS transferred another £2bn last year."

How so, I ask again?

You see, in reality, there was no £10 billion bailout from the UK to the Republic of Ireland and the money injected into Ulster Bank did not go 'directly into the Irish economy'. What did happen is that a bunch of bondhodlers and interbank lenders to the Ulster Bank were made whole on the liabilities which the Ulster Bank would not have repaid, were the UK taxpayers not pumping money into it. Truth is, the UK taxpayers, like Irish taxpayers, were made subsidies to the international banking funding scheme. Not to the Irish economy or to the Republic of Ireland.

The UK taxpayers did lend money to the Irish Government under the Troika+ 'rescue' deal and we shall say thank you to them for this much, especially since these loans were made on terms that matched fully multilateral loans. But the Republic of Ireland and its economy have nothing to say on the UK taxpayers being wrongfully made pay ever cent on the euro of the Ulster and BOSI borrowings.

Full stop.

6/6/2013: Detroit is about to go bankrupt... differently from the Irish banks

So who is to say sovereign (or rather quasi-sovereign) defaults are a rarity in fiscal + currency unions? Here's a story about forthcoming, well-flagged in advanced Chapter 9 bankruptcy for Detroit: http://www.theepochtimes.com/n3/93438-detroit-facing-chapter-9-bankruptcy/

And, guess what - the story is telling in more than just one context. The terms and conditions of the restructuring will be ugly, but manageable... And the sequencing of events is revealing:

• Step 1: Detroit had $15.7 billion debt load it cannot repay - diagnosis was set as insolvency. 
• Step 2: The city was taken over by the state of Michigan and emergency manager was appointed.
• Step 3: The state of Michigan needed a calm evaluation of the problem confirming the diagnosis of insolvency and it was deemed to be structural (economy suffering from unsustainable levels of unemployment, declining population, loss of revenues, etc, but also cost overruns).
• Step 4: Rating agencies dropped ratings on Detroit debt and debt limits kicked in before then.
• Step 5: Chapter 9 bankruptcy, forced deal with the unions and Financial Advisory Board was set up with very clear termination objectives.

The sequencing of events above is distinct from what has happened in the case of Ireland's banking crisis resolution, where the above steps were re-ordered as follows:

1. Steps 4 and 5 (resolution steps) took place ahead of any assessment and diagnosis postulation and confirmation (banks guarantee issuance)
2. Step 3 took place next in the form of PCARs assessments
3. Step 2 (takeover) took place only after the PCARs
4. Diagnosis was never fully correctly established - all banks, save for Anglo and INBS are still considered officially solvent
5. Step 5 never took place with exception of Anglo and INBS

In other words, we never created a security cordon around the banks that would have resulted in banks takeover prior to guarantees and recapitalisations and this has meant that the banks were always able to use the threat of disclosure of insolvency as the means for bargaining out improved position vis a vis the taxpayers. 

Best proof of this: at no point in time did the state of Michigan tell the markets or the nation or its own taxpayers that Detroit will never be allowed to go bust. In contrast, during 2008-2010 period, Irish Government repeatedly asserted that the banks will be provided all and any funding necessary to stay in business. 

30/4/2013: 2012 Was Not a Year of Brilliance for the Central Bank

From the Opening Statement by Governor Patrick Honohan at the publication of the Central Bank of Ireland Annual Report 2012, 30 April 2013


"Two major elements of the Bank’s work during 2012 came to decisive junctures early this year – the liquidation of IBRC and related replacement of the promissory notes with marketable government bonds; and the introduction of an enhanced mortgage arrears resolution framework, which was announced in recent weeks. All of these measures are ultimately concerned with creating the environment for sustainable economic growth and reduction in unemployment."

It is my opinion that 2012 marked the year when the Central Bank has done the least to deliver on any meaningful reforms and change that can create or sustain "the environment for sustainable economic growth and reduction in unemployment". The bases for my opinion are:

1. In 2013, the Central Bank attempted (key word here) to introduce an enhanced mortgage arrears resolution framework. The new framework is 'enhanced' only to the extent that the previous framework was proven to be a complete failure. However, looking forward and setting aside the failures of the very recent past, the new framework is not consistent with the goals for either reducing unemployment or enhancing prospects for economic growth. Some of my criticism of the new framework in the context of these two objectives can be found here: http://trueeconomics.blogspot.ie/2013/04/1842013-legalising-modern-version-of.html
2. In 2013, the Irish Government has undertaken a swap of one financial liability (promissory notes) with another (government bonds). This transaction has been deemed by myself, many others, including the IMF, to have near-zero impact on debt sustainability when it comes to the Irish Government debt. The transaction was net positive for cash flow, albeit moderately, and hugely positive for PR. while th CB of Ireland did benefit significantly from improved security underlying the ELA, this benefit came at a cost to the rest of the Irish economy in the form of the conversion of the quasi-sovereign debt (promo note) into long-dated sovereign bonds.
3. Beyond the above two points, there has been very little progress on any tangible reforms in the banking sector in Ireland. We are still pursuing a duopoly model of the domestic banking market,  and there is no effective discussion, let alone effective resolution of the problem of lack of new entrants and lack of restructuring of the existent lenders. We have no new models of banking and lending in the country emerging after six years of this crisis and, if anything, we are now consolidating the strategic space in our banking services to a singular model of low-quality, low-access services supplied at an excessive cost. Both AIB and Bank of Ireland are pursuing this model, leaving customers to pick up the tab for reduced access to services and increased charges on the remaining services. This hardly supports Governor Honohan's claim that the Central Bank is working on creating and sustaining environment for growth.
4. All banking sector performance parameters have been either not improving or deteriorating over 2012 within the directly state-influenced covered group of financial institutions.

Slapping ad hoc targets on the banks to reduce mortgages arrears and then introducing masers to give them power well in excess of that awarded to the borrowers is about as productive of a measure for dealing with mortgages crisis as giving hospitals management targets for reducing the number of trolleys in corridors while removing patients protection from malpractice.

The Central Bank-supplied 'framework' is thus simply not fit for purpose, neither by the criteria of dealing effectively and humanely with the debt crisis (by first removing the unsustainable debt in systemic, transparent and fairly-priced fashion, then by addressing future moral hazard), nor in terms of placing the burden of crisis resolution where the causes of the crisis rest (proportionally with both the banks and the borrowers), nor in respect of the Central Bank claimed objectives of delivering supports for economic recovery.


Updated: Central Bank of Ireland has made a claim of 2012 'profit' of EUR 1.4 billion. But wait, a business makes profit by taking investors' / equity holders' / lenders' or own funds, purchasing inputs into production, producing something and then selling that something to willing customers who pay for these goods from their own funds. Central Bank of Ireland took claims imposed by the Government of Ireland on consumers and taxpayers, gambled these claims on the banks, who were basically compelled to take 'as offered' these Central Bank-supplied 'goods' and then collected from these captive banks pay (which the banks promptly ripped-off their customers - aka consumers and taxpayers). The Central Bank subsequently relabelled these rip-off charges 'profits' and remitted them back (EUR 1.1 billion) to the Exchequer. So can anyone explain to me what Central Bank produced that someone voluntarily was willing to buy with their own cash?

23/4/2013: Updating the cost of banking crisis data

Nice update from the ECB on the cumulated cost of the banking crisis in Europe, now available through 2012. The net effect, summing up all assumed sovereign liabilities relating to the crisis, including contingent liabilities, and subtracting asset values associated with these liabilities are shown (by country) in the chart below:

Note the special place of Ireland in the above.

For the euro area as a whole, net liabilities relating to the crisis back in 2007 stood at EUR 0.00 (EUR36.72 billion for EU27). By the end of 2012 these have risen to EUR 740.15 billion (EUR 734.23 billion for EU27).

Net revenue losses for Government arising from the banking sector rescues, per ECB are:

19/4/2013: More from the IMF on Irish banks...

Getting back to the IMF GFSR report released earlier this week. Some nice charts worth a quick comment or two:

Two things worth noting in the above:

1. Increase in covered bonds for Irish banks, absent, pretty much, any serious issuance between 2007 and 2012 and maturing of some bonds. This may be linked to the deteriorating quality of assets against which the bonds were secured, requiring 'top-ups' with new assets. In effect, this means that to maintain existent level of funding a bank will require more assets to be put aside.
2. Massive, relative to GDP, exposure to MROs + LTROs for the Irish banks. Let's keep in mind that some Irish banks were precluded from participating in the second LTRO due to lack of suitable collateral. Even with that, Irish banking sector exposure to LTROs relative to GDP is the largest of all countries in the sample.

The next two charts plot relationship between banks' lending to households and corporates and the growth forecasts for the economies:

By both charts above, Ireland appears to be basically just on the borderline between the core and the peripheral countries. Of course, this means preciously little, since Irish banks basically are issuing no new loans and thus whatever rates they report are heavily, very heavily biased in favour of higher quality borrowers. Here's how this bias works: the bank in Ireland issues a loan to company A for the amount X and duration W. The rate on this loan is r=f(A,X,W)  such that if A quality is higher then rate r  is lower, if X is larger, the rate is higher, and if W is longer, the rate is also higher. We control all other variables that might influence the rate quoted. If the case of the same company looking for the same loan outside Ireland, the bias above would imply a lower rate quoted, or a smaller loan granted or for shorter duration, or all or any permutations of the above. 

Here is an interesting point. In the first chart above, Irish house loans rates went up during the crisis, but corporate loans rates went dramatically down during the crisis. Now, houses-related loans within the Irish banking system are currently in default at close to 20% rate, while SMEs loans are in default close to 50% rate. High quality corporates are probably in the same rate of default today as in 2007. Which means that corporate loans book of Irish banks should be posting default rates (NPLs) of similar or larger proportions as house lending book. Yet the rates for two types of loans have moved in the opposite direction and very significantly.

On foot of the above, question for our Dear Leaders: Are Irish banks, for purely political reasons (recall Government's repeated exhortations about the need for the banks to 'do their bit for the economy', 'lend to our SMEs' etc), using house loans pricing to subsidise corporate loans issuance?

Just in case you start harping on about Irish corporates having better debt loads than households, IMF has the following handy charts:

And more: Irish corporates have exceptionally poor interest coverage ratios:

Keep in mind - the above applies only to listed firms, not to privately held ones...

19/4/2013: Mountains to climb, canyons to wade across

Nice visual from Pictet gang, sizing up two banking systems:

That was pre-'rescue' of Cypriot economy from itself by the 'benevolent' Troika Partners...

Recall, the package deal includes scaling back Cypriot banks to ca x3 GDP, or cutting the sector back to just about where it was in mid-2012 for Iceland, given the magnitude of GDP contraction from 2012 levels that this would require. It will be the case of roughly 'Look to your left, look to your right - either both of the bank clerks next to you are gone, or you are gone with one of them in tow'.

Updated:

And another visual from Pictet folks:

17/4/2013: IMF's succinct summary of Irish banking mess

IMF's GFSR Chapter 1 offers a nice visual highlighting the fact that Irish banking system is still the sickest of all banking systems in Europe, bar that of Greece (which doesn't count, for anyone with a will to argue the point, as it has been comprehensively destroyed in rounds of sovereign debt restructuring and by all Troika MOUs is yet to undergo the 'repairs' similar to those allegedly 'completed' in Ireland in 2011):

And a footnote explaining the chart:

25/3/2013: Cyprus is unique in its problem... oh, wait...

So you'd think Cyprus is the 'bad boy' in grossly-overweight-financial-services club? Oh... right:

Source

Now, wait, I am sure the Department of Spin is going to come after me pointing that 'Ireland's figures include IFSC'... my reply... so what? Cypriot figures include Sberbank & VTB... and, unlike the-best-in-the-class Ireland, Cyprus is just starting to deleverage its financial services sector.

23/3/2013: Sunday Times 10/03/2013

This is an unedited version of my Sunday Times article from March 10.


Some two years ago in these very pages, I have described the prospects for the Irish economy as following a flatline trend with occasional volatility. In other words, back in the beginning of 2010, the economy’s prospects for the near-term future were consistent with an L-shaped recovery: stabilization followed by near-zero growth.

Taking the first three quarters of 2012, in headline terms, the above prediction has translated into 2009 to 2012 GDP growth of just 0.22% per annum, GNP decline of  0.16% per annum and domestic demand drop of 4.81% per annum. Again, let’s take a look at the above numbers from a different angle. Compared to the pre-crisis levels, the latest GDP data shows that over 2011-2012, Irish economy was able to close just 22% of the gap between GDP peak and the Great Recession trough, implying that it will take Ireland through the end of 2014 before we get our GDP back to the half-point of the Great Recession. At the same time, Domestic demand continued to hit crisis period lows in 2012 and all international projections show that 2013 will be another post-2007 low for these data series.

With these rather depressing statistics in mind, one is warranted to take with a grain of salt ever-more frequent and boisterous pronouncements from the Government that Irish economy has ‘turned the corner’. Ditto for the ever-more saccharine messages from the EU policymakers to the ‘best pupil’ in their austerity policies ‘class’.

And the most recent data – through Q4 2012 and January-February 2013 – is offering no signs of any statistically significant improvements in the economy compared to the rather abysmal 2012.

Mortgages arrears were once again up in the last quarter of 2012. While the rate of increases was markedly slower than in previous quarters, number of accounts currently in arrears 21.4% year on year. As of the end of 2012, some 186,785 private residencies-related mortgages are either in arrears, in temporary restructuring or in the process of repossessions – almost 25% of all accounts outstanding  if we were to use as the base total accounts numbers comparable across the 2009-2012 horizon.  All in, some 650,000-700,000 Irish residents are currently under water when it comes to paying on their original mortgages. Some turnaround in the economy to witness.

Data for January-February 2013 on new cars registrations shows that not only the motor trade is continuing to suffer from on-going collapse in sales, but that there is no indication of any substantial improvement in either the Irish households or the Irish SMEs outlook for the future. New private cars registrations are down 20% year-on-year over the first two months of 2013, while new goods vehicles registrations are down 21.4%. This shows clearly that Irish consumers are not engaged in purchasing large-ticket items and, supported by the declines in durable goods consumption evident in the retail sales data, signals that consumers have little real credence in the ‘green shoots’ theory espoused by our Government officials and business leaders. Lack of demand uplift in goods vehicles, on the other hand, shows that when it comes to capital investment, Irish businesses are also refusing to buy the hype of economic turnaround. In any cyclical recovery, capital expenditure, especially on rapidly depreciating items such as vehicles used in transporting goods for wholesale and retail trade, logistics and transportation services, is one of the leading indicators of improving economic conditions. Data for the first two months of this year shows no such uplift.

Core retail sales, once stripping out motor sales, are showing a slightly more upbeat activity. While all retail business activity has declined on average over 3 months through January 2013 compared to year ago, some encouraging signs of uplift were present in the Department Stores sales, and sales of electrical goods when it comes to volume and value of sales. Nonetheless, two factors continue to characterize Irish domestic consumption: extremely low activity from which any increases might take place, and exceptionally anemic trend in any rises we do record.

On the investment front, gross domestic capital investment remained basically unchanged in the first 3 quarters of 2012 compared to 2011,ann there are currently no signs that this situation has changed since the end of Q3 2012. We are now into the fourth consecutive year of gross investment failing to cover amortisation and depreciation of the capital stock accumulated over the years of the Celtic Tiger. Recalling that our growth success over 1992-1998 was predicated on a rapid catching up in capital stock and quality relative to our, at the time more prosperous European partners, this means that the ongoing crisis is effectively erasing any capital gains achieved post 1999.

In short, domestic side of the economy shows no green shoots of any harvestable variety. And the potential headwinds we are likely to face in the near-term future are still severe.

In property markets and when it comes to mortgages arrears, we face a long list of risks that are yet to play out.  Impacts of property taxes introduced in the Budget 2013, the upcoming lifting of the banking guarantees,  and the saga of the Personal Insolvency regime reforms all represent distinct threats to the fragile stabilisations achieved in these areas of the economy.

On business investment front risks are also mounting, rather than abating. Continued lack of bank credit and strong indications that in the near term Irish banks are likely to follow their other Euro area counterparts in dramatically hiking the retail interest rates for both existent and new loans.

When it comes to consumers’ appetite for spending, latest consumer confidence data shows significant deterioration in confidence in February, compared to January 2013 and to 2012 average. If anything, when it comes to consumers’ reported outlook for 2013, things are getting worse relative to 2012, rather than better.

Which leaves us with the Government’s old favorite signal of the recovery: Irish exports.  The hype about Irish external trade prowess is such, that even a usually somber IMF has recently waded in with a lengthy paper outlining how Ireland is likely to turn back to Celtic Tiger era prosperity on foot of booming exports.  In summary, the IMF missive, titled Boosting Competitiveness to Grow Out of Debt – Can Ireland Find a Way Back to Its Future concluded that “Ireland is poised to return to its path of strong growth and low imbalances” on foot of “enhanced competitiveness”.

The idea that ‘exports-led recovery’ is Ireland’s only salvation from the systemic and structural crises we face is not new. Previous Government put as much credence into this proposition as the current one. Alas, this idea – as I have pointed out repeatedly – is simply not reflected in the reality of the Irish economy for a number of reasons.

It is true that Irish exports growth has improved significantly during 2009-2012 period, rising from negative 3.75% in 2009 to a positive 6.25% in 2010 and 5% in 2011. In the first three quarters of 2012, exports of goods and services were up 6.8% on the same period of 2011.

Alas, the composition of our exports has shifted dramatically toward more services exports, as opposed to goods exports. In addition to reducing the overall level of real economic activity and employment associated with every euro worth of exports, this shift also has meant a number of changes that further divorce our external trade activity from economy. Firstly, most of employment creation in the exports-oriented services sectors, such as International Finance and ICT services, is oriented toward specialist, highly educated foreign employees, instead of domestic unemployed or underemployed individuals. Secondly, services exports are associated with greater cost (or imports) intensities as they require higher payments for patents and intellectual property, which are neither taxed in Ireland, nor are developed here. This means that while exports of services generate high revenues, much of these revenues is not captured within our economy. Thirdly, exports of services, as opposed to exports of goods, are more concentrated in a handful of giant MNCs. This fact, known as the ‘Google effect’ drives up the cost of hiring skilled workers for Irish SMEs, reduces margins at Irish enterprises, lowers investment into Irish SMEs, and actually undermines our competitiveness, rather than improving it.

In short, booming exports along the current trend can actually cost this economy its ability to sustain indigenous entrepreneurship and investment in the long run. Instead of supporting growth and recovery, the green shoots of some of our exporting activities can turn out to be super-strong weeds of the economy suffering from a classical Dutch disease where resources flow to an increasingly inefficient use in specialist sectors, exposing the society and the economy at large to future adverse shocks.

Lastly, as with other indicators, the latest data, covering only goods exports, shows that our external trade is suffering from a significant slowdown in global demand and the pharmaceutical sector patent cliff. Once again, I warned about both of these factors more than a year ago.

At the same time, on the more positive note, the ongoing US and global economic recovery should provide some support for goods exports from Ireland, especially in the areas relating to capital investment goods and equipment in months ahead.

In short, the miracle of the ‘exports-led recovery’ is simply nowhere to be seen at this point in time, despite the fact that exporting activity continues to expand and despite the fact that this activity represents the only bright spot on our economic horizon.

After five years of the greatest economic crisis in the modern history of this nation, it is time to ask our political leaders a question: at what point in time does one’s rhetoric of economic turnarounds becomes an unbearable burden to one’s political and social reputation? For the previous Government it took just under 3 years to face the music of its own making. For this Government, the clock is ticking on.

Box-out:

Having achieved a relatively underwhelming progress on restructuring the Promissory Notes of the IBRC, the Government has turned its attention in recent weeks on attempting to restructure our debts to the European sides of the Troika. However, the issue of the Promissory Notes is still an open topic. Last week at a conference in Brussels I had a chance to speak to some senior decision makers from the European Parliament and the EU Commission who unanimously voiced their concern over the potential for the ECB to alter the terms and conditions of the Irish Promissory Notes restructuring deal. ECB has two material powers to do so. Firstly, it can simply alter by a majority decision the technical aspects of the deal. Secondly, the ECB has the ultimate power to determine the overall schedule of the sales of the long-term bonds issued to replace the Promissory Notes to the private investors. This latter power is very significant. Under the current arrangement, the Central Bank of Ireland has committed to an annual schedule of minimum disposals of bonds. Based on this schedule, the cumulative long-term benefit of the deal to Ireland can be estimated in the range of Euro 4.5-6.3 billion over the 40 years horizon. Accelerating the rate of disposals by a third on average over the deal horizon can see the net gains to the Exchequer declining by more than a quarter. Hardly a confidence-inspiring outcome for the Government that put so much hype behind the deal.