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Archive for November 19th, 2010

Allied Irish Banks PLC (AIB) has this afternoon released an interim management statement which continues to paint a distressing picture for what was Ireland’s largest bank. Highlights

UPDATE: 20th November, 2010. Thanks to the commenters for pointing out that AIB reclassified the UK and Polish deposits at the end of June 2010.  This has clarified the update immediately below. It seems that AIB’s deposits went from €84bn in Dec 2009 to €83bn in June 2010 (including €23bn held in the UK and Poland) to €71bn today. It is unclear from the AIB statement if the €13bn is from all deposits (including the UK and Poland) or just the €59bn non-UK/Poland. If the latter then that means that 22% of deposits have “flown” since June 2010.  If the trend of increased household savings in 2010 was the same as 2009 then this means that withdrawals by corporates and institutions were partly offset by increased deposits by households. UPDATE: It has been pointed out that although household savings might be increasing as measured by the Central Statistics Office, it seems that household deposits fell by 2% in the year to September, 2010. So the deposit flight might consist of a marginal reduction in household deposits and a substantial reduction in corporate/institutional deposits.

UPDATE: 19th November, 2010. Well now I am thoroughly confused – looking at the balance sheet for AIB at June 30th 2010, I see that customer accounts were down €23bn from the end of 2009. If customer accounts are now “only down” by €13bn then that implies that deposits increased by ~€10bn in the four and a half months to 11th November, 2010. And remember this was the period when the guarantee was due to run out and AIB’s credit rating was cut on 8th October, 2010 by S&P. If this interpretation is correct then why didn’t AIB shout it from the rooftops today – if deposits did indeed increase by ~€10bn in the most recent four months then surely that is a positive that should be highlighted?

(a) The bank claims to have lost 16% of its deposits since the start of 2010 (note 43 on page 149 of the 2009 Annual Report shows deposits of €83bn and AIB say that has reduced by €13bn to the end of last week). The bank is dependent on ECB/Central Bank of Ireland funding. Unlike Irish Life and Bank of Ireland, AIB don’t indicate if the deposit flight tailed off after the renewal of the guarantee in September 2010.

(1) The State, via the National Pension Reserve Fund, is now on the line to underwrite €6.6bn of new capital raising at €0.50 per share (current share price €0.45). €2.9bn of the €6.6bn will come from a conversion of preference shares (the State presently owning €3.5bn of 8% yielding preference shares). At current prices, the State will end up owning 93.92% of AIB (CORRECTION: 20th November, 2010. I see that Simon Carswell in today’s Irish Times is putting the State shareholding at 94% so here are the workings  – In May 2010, the State through the NPRF received 198,089,847  shares in lieu of the 8% dividend on preference shares. The State said this amounted to 18.6% of AIB’s shares implying there were 1,065m shares in total. The proposal now is to inject €6.6bn at €0.5 per share ie to receive 13.2bn shares. This will mean that the State owns 13.2bn shares from this forthcoming issue plus 198m from the dividend in lieu payment in May 2010, ie a total of 13.398bn shares out of a total of 14.265bn or 93.92%) And that assumes that the sale of AIB’s Polish operation – 70.5% of Bank Zachodni WBK gets both regulatory and shareholder approval, it’s not clear what the delays are. There is no indication that junior bondholders will be subjected to haircuts so at present, there is a lamentable paying off of junior bondholders at the expense of our pension fund.

(2) There may have been some jiggery pokery with the €10.4bn capital requirement as AIB seems to have only booked a 56% haircut on the €4.4bn of €5-20m loan exposures which the Minister for Finance decided in September should remain with AIB and BoI. The AIB NAMA loans are expected to incur a 60% haircut. Why should the lower value loans which are expected to be more green fields in Athlone have a lower haircut than the €20m+ exposures?

(3) AIB claim their 90+ days of arrears mortgages amounted to 2.6% of their mortgages at the end of September 2010. Interestingly they claim the Central Bank was to release figures showing 6.6% of mortgages were over 90 days in arrears – “the overall market figure for the same arrears category published by the Central Bank of Ireland was c.6.6% at the end of September.”. In fact, just on Wednesday the Central Bank released their Q3 figures which showed 5.1% of mortgages in arrears over 90 days. Did the Central Bank trim their statistics at the last minute? You could easily become paranoid here!

(4) AIB has cut 600 staff in the past year.

(5) The bank has put on hold the sale of its UK operation. Although Northern Ireland property values and business show poor results, the mainland is performing better.

(6) The outlook is uncertain. AIB forecast 2011 GDP in the State at +1.75%. Unemployment will weigh on any recovery. The only positive I took from the statement was that AIB’s mortgage book appears unusually healthy. It’s probably the all-pervasive gloom but I find myself suspecting that even that assessment of the mortgage book is too optimistic.

(7) And for a management statement that relates to a period that ended 45 days ago, no operating profit or net profit quantum though there is a general statement that they’re reducing. Are things that bad?

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News that last night Westminster City Council granted planning permission (their system hasn’t been updated yet but the application was granted with some “minor” amendments) to Paddy’s Maybourne Group, which owns the 5-star Berkeley, Connaught and Claridge’s hotels in London. The permission allows another 40 rooms to be added to the rear of Claridge’s increasing the number of rooms to 243. A positive development for Paddy and perhaps it might assist in the refinancing talks that appear to be continuing with Northwood. Who will fund the development of Claridge’s though? The NAMA banks appear constrained. NAMA itself is apparently locked out of the debt markets alongside the Irish government. Perhaps Maybourne may secure development finance as part of the refinancing of the group. I would have said it faces a challenge.

Meanwhile Paddy’s appeal of the recent decision of the High Court towards his challenge to NAMA taking over his loans, is set to be heard by the Supreme Court before Christmas 2010 though there is no guarantee that their decision will be made anytime soon. Paddy of course may have rights of appeal to Europe. The Irish Times is reporting that NAMA has agreed to Paddy keeping his loans at the NAMA Participating Institutions pending the outcome of the appeal. So the NAMA PIs will keep some €2.1bn of lending, probably beyond the end of this year. Why did NAMA not pursue the transfers? It is known that NAMA is exercising close control of borrowers at the banks (even prior to transfer of loans) and this is evidenced by the 16-odd approvals NAMA has given the banks to commence foreclosure proceedings (a fact revealed at yesterday’s hearing before the Committee on the Public Accounts). However, without a comprehensive business plan and schedule of assets, can NAMA feel confident in Paddy’s exposures to non-NAMA banks, for example? Is NAMA helping out the State and the banks by leaving what are performing loans with the banks? Again, a puzzling decision by NAMA.

And also puzzling is why Paddy doesn’t take new legal action to stop his loans going to NAMA – they confirmed yesterday at the CPA hearing that they have been effectively frozen out of the debt market alongside the Irish State, though they expect to have set up their funding programmes by the end of December 2010 (setting up a programme involves setting the terms of any debt issue and appointing companies to manage the issue – “setting up” is distinct from actually going to the market for actual funds). If I were Paddy I would be worried that my loans were to be transferred to an agency that, contrary to the NAMA Act, would appear not to have the intended wherewithal to help maximise the value of my assets.

Remember you can find the background and all the latest news on the Paddy McKillen judicial review at this dedicated TAB.

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Solvency or liquidity? It’s almost as if we’re back in September 2008 and that fateful meeting on Upper Merrion Street where the Minister for Finance, Brian Lenihan, was persuaded that the banks were confronting a liquidity crisis but that they were essentially solvent. Remember that liquidity refers to having cash on hand, so if you pop out for a sandwich at lunch today and forget your wallet, you could explain to the café that you have a liquidity problem but you’ll pay them at the end of the day. Liquidity means that you do have assets worth more than your liabilities – it’s just that you can’t lay your hands on the cash you need right away. Giving a loan to someone who has a liquidity problem is less risky than in the next scenario because if you need collect your loan the person has assets worth more than their liabilities.

As it turns out, the banks back in September 2008 had an insolvency problem (as well as a liquidity problem). Insolvency means your assets are worth less than your liabilities. Oddly enough you can be insolvent but still be liquid – so you go for your sandwich today and you pay for it without any problem but unfortunately you own a house that is in negative equity, so if you had to settle your mortgage today you would be bankrupt. But on the face of it the banks were solvent back in September 2008, their assets which included loans they had advanced to property developers were worth far more than their liabilities which included deposits from customers and money they owe to the bondholders. However that assessment was wrong – although the value of the deposits and bondholders was shown correctly in the banks’ accounts, tragically the value of the loans to developers were vastly overvalued and as we now know are worth less than 50c in the euro.

So the banks were insolvent back then and since September 2008, we (the citizenry of the State) have committed to pumping €46-52bn into the banks. We were told by our new-ish Financial Regulator and by our Minister for Finance, both as recently as 30th September, 2010 – 45 days ago –  that “today’s announcement brings full clarity to the costs and methods of recapitalising the banks”. As for the source of the funding of the €46bn – €11bn was to come from our pension reserve, €4bn in cash was borrowed in 2009 and pumped into Anglo and the remainder, €31bn, was to be pumped into the banks as promissory notes which would then be borrowed by the State over the next 15 years. That was the position on 30th September, 2010 – 45 days ago. It seemed sorted. What has changed?

(1) Have further losses been identified at the banks? If I understood Peter Mathews (independent Irish banking consultant that like a Cassandra has been shouting from the rooftops for the past two years that losses in Irish banks are far greater than officially recognized) correctly last night during his appearance on RTE’s Prime Time TV programme, he is now saying that losses in Irish banks (I guess he is talking about the six under the State guarantee – AIB, Anglo, BoI, EBS, Irish Life and Permanent and INBS) will be €91bn (€66bn for commercial losses and €25bn for losses on residential mortgages). I understand Trinity College Dublin professor, Constantin Gurdgiev to have been estimating losses at €70bn and last week economist Morgan Kelly seemed to be predicting losses of €70bn in Anglo, AIB and BoI alone (excluding INBS and EBS). The government/official forecast however appears to be around €50bn – I say “appears” because it is not always the case that like is being compared with like (some provisioning already exists for loans and some State funding might be recoupable and some profits might be made from discounting bondholder redemptions and from continuing operations). But the official line is in the €50bn zone and that is substantially different to these other three. Under normal conditions if you were to set the opinion of individuals outside the banks against the opinion of an army of bankers, accountants, auditors, financial regulation and central bank personnel you would expect the official line to be the better estimate except that during the past two years these individuals above have tended to be more accurate in their predictions which were substantially at odds with the official predictions. Are they right this time?

(2) If the problem is a liquidity problem, then why does the ECB not continue in its role of lender of last resort? It seems that, apart from the ECB, no-one wants to lend to Irish banks at reasonable rates at the moment and if I understood Pat Rabitte on the same Prime Time programme last night, he asserts that the Irish banks are paying (a bargain) 1.5% to the ECB for the present emergency assistance. And if rates demanded on the open market for lending to Irish banks is so elevated as to be impractical, then isn’t that a true “emergency” and shouldn’t the ECB be providing unlimited assistance? We signed up to the euro a decade ago and with that exchanged a large part of our autonomy with domestic monetary policy in return for (a) price stability and (b) a stonking great central bank in Frankfurt with €1tn reserves. As much as we would now like to abandon the euro and re-introduce our former currency, the Punt, that notion is dismissed for economic and political reasons. So we have this currency yoke around our necks and instead of inflating/devaluing or minting/printing our way to recovery we continue to struggle with a currency more befitting German and French needs. Fine, we accept that reality but why are we being deprived of one of the euro’s great advantages – the strength of the reserves in the ECB? If Irish banks need another €100bn of liquidity then why isn’t that forthcoming from the lender of last resort?

So what is the problem? Does the ECB believe that the losses in the banks have been understated and that more capital (solvency) is needed? Does the ECB believe that the statements given just 45 days ago are inaccurate? I must say that if this is the case, Ireland has the right to feel short-changed by the stress tests undertaken earlier this year and which were published at the end of July 2010 in respect of the two main “Irish” banks – Allied Irish Banks and Bank of Ireland. In addition we have a new-ish €340,000 a year Financial Regulator that conducted what he terms a Prudential Capital Assessment Review and concluded just 45 days ago that given the €46-52bn of funding announced by the government, that our banks would meet (nay, exceed) international capital requirements. Our formidable Central Bank governor, Patrick Honohan also added his name to the estimates just 45 days ago. So unless the Financial Regulator, Central Bank Governor and EU Stress tests were all wrong then why is this not a liquidity problem which properly falls within the reserve of the ECB to resolve.

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