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Archive for October 27th, 2010

I’m between two minds on the health of the hotel sector. It is undoubtedly suffering from poorer bookings and overcapacity in the sector has been an identified problem for a few years now. The industry body, the Irish Hotel Federation (IHF) is giving the impression it is fighting for the very survival of its members during the downturn, and it has come out with a predictably self-interested pre-Budget submission. As with CIF yesterday, there’s nothing in itself wrong with that, and remember the hotel sector, along with restaurants, provide 6% of all employment (8% of female employment) and the sector has been a solid contributor to the economy.

The reason I’m in two minds is that although some hotels are producing losses, others are profitable (consider a few examples here and here and here). Local authority charges, water and energy costs and the minimum wage are all pressures on the sector in light of reduced demand for rooms, greater competition and a shortage of reasonably-priced credit. Last week, a hotel marketing firm Select Hotels reported a doubling in turnover during the past year. The company represents 24 independent hotels in the State and brings together a specialised marketing service which is shared amongst the member hotels. So whilst it is accepted that some hotels are facing very difficult challenges, it does seem that some have adapted and can still turn profits, even with existing local authority charges which seem to be a particular bugbear.

The hotel sector is particularly worried about the drying up of reasonably priced credit lines. The withdrawal of Bank of Scotland (Ireland) from the market came as a major blow as that bank had established itself in the hotel sector. However the Irish Small and Medium Enterprises Association (ISME) reported a month ago that credit conditions did seem to be improving for small and medium businesses. And of course hotels have the Credit Review Office which seems to be dealing with a tiny workload which indicates also that credit conditions are improving. Lastly, the IHF use their statement to again implore government to ensure NAMA is “to be operated in a way which does not distort the operation of the hotel market either through below cost prices of NAMA operated hotels should this arise or inappropriate disposal of assets”.

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It is hard not to suspect that Bank of Ireland is in a shockingly perilous state at present. We are waiting more than three months now for the publication of the EU Decision on the bank’s restructuring (the Decision was announced on 15th July 2010 and as is usual the Decision was to be vetted for confidential information before publication – that this vetting has taken over three months is prompting suspicion about the content of the Decision). The bank last week announced a sale of its subsidiary, Bank of Ireland Asset Management, for €57m to US financial services giant, State Street. Apparently the sale was a condition of the EU granting approval of State-aid and its wider restructuring proposal but because we haven’t yet seen the Decision it is not clear why the disposal was necessary. Last week also saw the bank place GBP £300m of 3-year debt at an interest rate of 5.75% which of course excludes issue and other costs including payment for the State-guarantee. According to BoI’s interim report for the first six months of 2010, the bank has an interest margin (simplistically the difference between the interest rate it must pay for its finance versus what it achieves on its lending to customers) of 1.41%.  If BoI is borrowing from the market, as it did last week, at 5.75% then it needs to lend that out at 7.16% to maintain its June 2010 lending margins. And those margins are below the long term averages of at least 1.75%. September 2010 also saw a bizarre decision by Ireland’s Minister for Finance, Brian Lenihan, to raise the threshold on BoI loans to be transferred to NAMA from €5m to €20m. This has the effect of deferring a crystallisation of the true level of losses on these loans and consequently causing a capital hole that might necessitate the State providing additional capital which would tip State-ownership from 36.5% today to over the 50% mark and majority State control. Tough times for Bank of Ireland.

And today the bank is reported to have announced a new debt placing, this time for €500m repayable in 2 ½ years. It is not entirely clear from the Irish Times story and indeed there is nothing on the Bank of Ireland website or it would seem any stock exchange notification to confirm the interest rate payable on this borrowing (the Bank of Ireland investors website seems to constantly link to “pages not available”) – the Irish Times say “410 to 420 basis points more than the benchmark mid-swap rate, according to two people with knowledge of the sale” and “euro-denominated financial bonds due in one to three years and bearing a rating equivalent to the Irish government’s AA- at Standard and Poor’s pay an average spread of 130 basis points”.  German 3-year rates are trading at 1.22% this morning so I would expect the rate offered here to be that plus 4.15% or 5.37% in total. Factor in issue costs and the price of the State-guarantee and you are possibly looking at over 6%. Depressingly this new debt needs to be State-guaranteed, and of course our State bond debt is trading at near record levels (6.6% on 10-year bonds as I write this) which might part explain the high interest rates.

That Bank of Ireland is borrowing at levels which would seem to place annual interest well over 6% seems like commercial madness. When its Standard Variable Mortgage rate is 3.4% here (and just 2.99% in the UK), when businesses expect to be able to borrow at Euribor + 1-3% (roughly up to 4% today), it is plainly madness for Bank of Ireland to seek debt at such high interest rates unless it’s being shovelled into credit cards or personal finance. Unless it has no choice but to borrow at these rates. And that is why Bank of Ireland may well be in a very perilous state today.

UPDATE: 28th October, 2010. Simon Carswell at the Irish Times seems to have better information on the debt issue.  No notification yet to the stock exchange or announcement from BoI, so let’s assume Simon is correct. The debt issued was €750m, not €500m as reported by the Irish Times yesterday. The interest rate on the debt is 5.9%  (not 5.4% which was my interpretation yesterday of what the Irish Times had reported) which presumably excludes issue and other costs including the cost of the State guarantee.  The issue was oversubscribed 1.3 times at €1bn and apparently buyers are widely spread, so this is not an ECB or closed sale, it’s the real McCoy. The bloody great elephant in the room with the pink tutu on gving a rendition of  The Prodigy’s “Firestarter” is that this debt is totally uneconomic and highlights just how perilous a position BoI has reached.

UPDATE: 29th October, 2010. Whilst the markets are making their own minds up on BoI (currently trading at €0.50 a share), the media continues to ignore the pink tutu-wearing, Prodigy-impersonating singing elephant in the room – that borrowing at 5.875% excluding costs and State-guarantee fees in a euro market where mortgages and business loans are sold at 3-4% is madness. The FT (free registration required) concentrates on the process of the sale – originally it was to be for €500m but demand at €1bn pushed the offer up to €750m. There were 68 accounts which bought the debt and most were from continental Europe (with only 35% in the UK and Ireland – oddly enough there don’t seem to have been any other buyers from North America or the Far East). “This deal demonstrates Bank of Ireland can access the market and that’s been one of the critical concerns about the sector” said a chap from Deutsche Bank. It demonstrates far more than that I think.

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It seems that there has been a lot of negativity about NAMA around these here parts recently – is NAMA facing a cash-flow crisis, the abandoning of Tranche 3, lack of transparency in the disposal of assets (and the apparent absence of any code of practice for the disposal of property by proxy), general delays and under-resourcing. However it should be pointed out that this blog is neutral on NAMA and has drawn attention to apparent successes such as its first apparent disposal in the UK. And three months ago, we reported on the thumbs-up that NAMA was receiving from senior finance professionals in the State, when the last quarterly Deloitte survey was published. The Deloitte survey for this quarter published yesterday paints an entirely different picture.

A balance of just 3% of chief financial officers (CFOs) in the State think that NAMA will restore lending, down from a balance of nearly 60% three months ago. Now this still means that more CFOs think NAMA will restore lending than not but the collapse in confidence is striking. Deloitte implicitly attribute it to bigger than expected haircuts and Paddy McKillen’s legal challenge (and remember to be on tenterhooks next Monday 1st November at 10am when the judgement is scheduled to be handed down, though don’t be surprised if there is an appeal lodged before 11am). I think the results shown by Deloitte are a fair reflection of the growing awareness that four of the five banks are so undercapitalised now that they are incapable of significant lending and as evidenced by the 5.75%+ rates that Bank of Ireland had to pay last week in its debt placing which incidentally was State-guaranteed, banks are not able to use the certainty of NAMA bonds to attract additional funding at economic rates. What NAMA is doing, and doing pretty well by most accounts, is placing true values on some loans. That should have some value but in the context of the big picture and what NAMA was set up to do, it might be time for a review of the project.

Elsewhere in the Deloitte report, there is evidence of a slight improvement in sentiment towards NAMA restoring credibility in the banking sector which may puzzle some in light of the previous paragraph. However, I believe this merely reflects the fact that NAMA is putting credible values on a large proportion of banks’ lending. Cemeteries are full of graves with credible people, and banks may well end up with broadly believable balance sheets (non-NAMA and sub-threshold NAMA loans apart) but that doesn’t mean they won’t effectively be dead. This part of the survey is also significant as it shows those CFOs previously on the fence and undecided about the issue now tending to be negative.

The reports deals with far more than NAMA of course and makes for interesting reading. One final NAMA-related item is sentiment towards commercial property valuations. Whilst the previous quarter indicated CFOs were concluding that commercial property was beginning to reach its true value, this quarter indicates that CFOs are again of the view that commercial property prices are distinctly overvalued. Not a good omen for those who wish to see commercial property prices stabilise or increase – CFOs will after all be at the heart of any major decision affecting their company’s property strategy.

 

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