Archive for April 1st, 2011

On Wednesday, just 48 hours ago, Irish Life and Permanent (ILP) published its annual report and accounts for 2010. The balance sheet is reproduced below. It doesn’t show a bad position at all with net capital of €1.6bn. And yet 24 hours later, the Central Bank of Ireland stress tests showed the bank needed €4bn of additional capital. Okay, €0.3bn of this was a “capital buffer” but the ILP still needed €3.7bn to cover imminent losses.

People ask why Anglo could show such positive results in 2008 and claim that its losses on property lending would be capped at €500m. Has the accounting profession learned nothing since? Sadly it’s not an April Fool’s Day joke.


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Amidst the excitement of the stress test announcements yesterday, you might have missed the monthly Central Bank of Ireland publication of the financial position of Irish banks as at the end of February, 2011 which provides an up to date picture of deposits. In summary, deposits continue to flee our banks, at a reduced pace overall compared with late last year but deposits from the private sector in the six State-guaranteed banks (see below) reduced at an alarming rate from €111.9bn to €108.6bn, 3% in one month. The deposits seem to be moving to non-State guaranteed banks though overall there is still €1.7bn less private sector deposits in all Irish banks, between January and February 2011 – perhaps debts are being paid off or the money is being transferred overseas. I am at a loss to square the claims by the IMF and others that deposits are “sticky” – as far as I can see deposit flight from the State-guaranteed banks is accelerating.

There are three tables which cover (1) all banks (2) banks that serve the domestic economy and (3) “covered institutions”, that is, the State-guaranteed banks

All banks operating in Ireland (including those located in the IFSC and which don’t serve the domestic economy – complete list here)

Domestic Irish banks (some 20 financial institutions which serve the domestic economy – list here)

State-guaranteed banks (Allied Irish Banks [AIB], Anglo Irish Bank [“Anglo”], Bank of Ireland, the Educational Building Society [EBS], Irish Life and Permanent and Irish Nationwide Building Society [INBS])

(1) Monetary Financial Institutions (MFIs) refers to credit institutions, as defined in Community Law, money market funds, and other resident financial institutions whose business is to receive deposits and/or close substitutes for deposits from entities other than MFIs, and, for their own account (at least in economic terms), to grant credits and/or to make investments in securities. Since January 2009, credit institutions include Credit Unions as regulated by the Registrar of Credit Unions. Under ESA 95, the Eurosystem (including the Central Bank of Ireland) and other non-euro area national central banks are included in the MFI institutional sector. In the tables presented here, however, central banks are not included in the loans and deposits series with respect to MFI counterparties.

(2) NR Euro are Non-Resident European depositors

(3) NR Row are Non-Resident Rest of World depositors (ie outside Europe)

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Just like Judge Moriarty’s 2400-page report last week which may cost the State €250m and deserves to be read cover to cover, so also does the Financial Measures Programme published yesterday by the Central Bank of Ireland (CBI). It represents the output from an exercise reported to have cost €20m and having now studied it, I can offer the opinion that it is a text worthy of study by all; even if this is not your area, there’s a decent five-page glossary included that might help anyone who wants to understand the whole banking crisis. And at less than 100 pages, it’s a pamphlet compared to the Moriarty tomes. There is a fair smattering of presentational errors, mind eg table headings on page 31.

The key question probably is “is the CBI report any good?” It uses work from BlackRock Solutions, project managed and “challenged” by the Boston Consulting Group. It was peer-reviewed by staff from the Italian and French central banks as well as named and un-named experts and consultants in Ireland – the named third parties are Deloitte, Mazars, Ernst and Young, Clayton Euro Risk Management, Situs, Arthur Cox, Matheson Ormsby Prentice. Funnily enough Barclays Capital doesn’t get any mention. But based on the professionals involved,  it probably should be good but for myself, I found the report unconvincing but that was mainly through the non-disclosure of information (what interest rate assumptions are used, for example). A key concern on here is property values, and I am not sure that a 59% peak-to-trough fall for residential and a 69% peak-to-trough fall for commercial, both in Ireland, is sufficient to cover “even extreme and improbable losses”. That said, who amongst us has a crystal ball. But still.

(1) According to the CBI, the stress (=adverse) loan losses are “not considered likely to materialise; they are merely an input designed to ensure the associated capital requirements are fully convincing to the market as being sufficient to cover extreme and improbable losses”

(2) BlackRock Solutions is responsible for the loan-loss estimates. Other inputs from elsewhere are also used in the calculations.  Many of the inputs like interest rates, probability of default, losses given default just aren’t shown. With respect to interest rates, there is a statement that the rates used in the European Banking Authority stress tests which are now ongoing were used (1.5% in 2011 and 1.8% in 2012) – however those rates just go to 2012 and are base rates as opposed to retail rates. Compare this with the UK stress test documentation two weeks ago, and for me, I’m left scratching my head as to whether our own tests are sufficiently transparent.

(3) The aim of the programme, of which these stress tests form part, is to place the Irish banking system in a position where it can function without a reliance on Irish and other state supports (including the IMF presumably). Yesterday’s publication is presumably the start of the process because for me, what is contained in the publication yesterday is not sufficient to convince risk investors.

(4) When reading the BlackRock loss estimates you should bear in mind that they exclude existing provisions for losses.

(5) BlackRock’s modelling extends out to 30 years but the results are really only examined over the next 33 months to the end of 2013

(6)  The CBI engages in some jiggery pokery with its introduction of a new banking term “additional capital buffer”. It might just as easily stated the true Core Tier 1 capital incorporating the “additional capital buffer”.

(7) The four financial institutions (hereafter called “banks” even though EBS is a building society and Irish Life and Permanent is a bancassurer) are forecast to make operating profits of €3.9bn in the three years – 2011, 2012 and 2013. Operating profits exclude loan losses and any losses that arise on deleveraging.

(8) The four banks are forecast to lose €13.2bn on selling assets in the next three years. This is a phenomenal cost – it is practically €100m per week, every week for the next three years. And this loss is unnecessary in the sense that it will only arise because the banks are being forced by the ECB/EU/IMF to sell assets now.

(9) The deleveraging plans are a bit of a paradox. On one hand there is a commitment to sell assets in the next three years. On the other hand there is a commitment to avoid fire-sales. What happens if macroeconomic conditions means that the irresistible force meets the immoveable object?

(10) The CBI comes up with a form of words to deny the baseline scenario is a forecast – “In fact, given uncertainties in the current climate, it is improbable that either the base or stress scenario will prove to be accurate across the macroeconomic indicators”. Hmmm, I’m still not convinced.

(11) The Loan to Deposit Ratio (LDR) was 180% at the end of 2010. The target at the end of 21013 is 122.5% “agreed with the External Partners” This is the first time that I have seen this published.

(12) At the end of 2010 the four banks had gross (before provisions for losses) loan balances of €274bn

(13) Page 22 says that BlackRock used forward assumptions on house prices and interest rates. But no-where in this document is there any detailed information on the interest rate assumptions.

(14) BlackRock assumed that house repossession levels would converge with the UK, not Nevada as reported in the media yesterday. Again, it is not clear what those UK levels are – the distressed ones in the early 1990s or ones prevalent today.

(15) Derivatives and other non-loan balance sheet exposures. You might recall Pat Rabitte saying on RTE radio last year that he was concerned by rumours of multi-billion euro exposures at some banks. This review  seems to conclude that there is no exposure but this is what the sole paragraph in the entire 88-page report has to say on the subject (emphasis mine) : “In addition to forecasting loan losses, Black examined banks’ securities and derivatives portfolios.  BlackRock analysed a portfolio of €59.8bn in securities in 1,597 individual positions. The majority of the securities at the institutions were used as liquidity instruments for cash management purposes. AIB and BOI also supplied data on small portfolios of more illiquid assets held on their corporate balance sheet. Pricing discrepancies for all positions spot-checked were not material. BlackRock also performed a high-level review of individual derivatives positions. These instruments were almost exclusively of the type generally used to support hedging and funding programmes, consistent with the institutions’ stated objectives. In the time available, the objective was not to conduct a full review of positions. Instead the intent was to provide comfort on the nature of the portfolios by assessing their size and shape and conducting non-statistical spot checks. Spot checks revealed no material differences” For myself, I am not re-assured by “non-statistical” checks and it is also unclear who oversaw, or “challenged” this work.

(16) BlackRock is estimating lifetime losses on the €274m loan book of €28bn (baseline) and €40bn (adverse). Having read this report a couple of times I am still unclear how the CBI has arrived at a 3-year stress loss of €27bn but the CBI does say that it discounted BlackRock’s numbers by 31%. Or more specifically how did the CBI think that a €3bn of additional “contingent capital” for losses after 2013 was going to be adequate to cover €13bn of losses that BlackRock is projecting?

(17) Anglo and INBS get a footnote mention in appendix I. The conclusion is that existing loss estimates are adequate as supposedly verified by a PwC review in Q3/4, 2010 and an “Independent Consultancy” review in Q4, 2010 and applying the adverse stress tests to the INBS and Anglo loans books.  I would be sceptical. For example last year it was reported that one third (yes 33%) of INBS mortgages were in arrears compared with less than 5% for all banks. There has been consistent criticism of Anglo’s and INBS’s lending standards. So is it appropriate to apply the stress test results from the other four banks? I don’t know how exactly they have been applied but I remain sceptical.

So how good is it? Well, it will be the market that decides whether or not to start lending to Irish banks again. The announcements yesterday won’t in themselves make that happen, but will the implementation of the measures outlined – the deleveraging, the restructuring, the additional capital injections – allow our banks to wean themselves off central bank support? Time will tell. Was there any avoiding the stress testing? Actually there probably was, because the EBA is undertaking the similar work though there is an argument that the involvement of BlackRock and the detailed bottom-up testing was needed here. Could the stress tests have been improved? Probably, certainly the review of derivatives looks cursory, certainly there is a dearth of information and justification for the assumptions used. Like many things in life I suppose, time will tell.

UPDATE: 9th May, 2011. The Irish Independent reports that the cost of the stress test was €30m and that in addition to the three previously-identified service providers (BlackRock Solutions, the Boston Consulting Group and Barclays Capital),  seven other local companies were also engaged. The companies named are Ernst and Young, and law firms Arthur Cox and Matheson Ormsby Prentice. It has not been disclosed how much each firm was paid. What is concerning about the revelation of the involvement of these firms is the commitment that was apparently given in the IMF/EU Memorandum of Understanding that firms that had been involved previously with Irish banks would not be used in the stress tests as it was felt a fresh set of eyes might produce more credible and accurate results. The breakdown of the €30m bill will be of interest as it will indicate the degree of involvementof each firm. Did BlackRock bill €5m and Ernst and Young bill €10m?

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During the mayhem that was the release of the Central Bank stress test results yesterday – the video feed from the Central Bank that didn’t work, RTE’s truncated coverage of the news conference and the poorly-planned choreography which saw Governor Honohan’s presentation clashing with Minister Noonan’s statement in the Dail – I was rushing to catch up with what Minister Noonan was announcing in terms of the future of the Irish banking sector. When I first heard the expression “pillar banks”, I thought he mean “PLAR banks” after the acronym used in the stress tests – Prudential Liquidity Assessment Review – but no, what he was setting out was a landscape in which there would be two “Irish” banks formed around AIB and Bank of Ireland. This entry examines why we need two, and why we simply can’t support one, an obelisk bank.

When you think of pillars, you think of columns supporting a structure like a building or in the case of Islam, a religion. I tend to think of the Stability and Growth Pact which we signed up to as part of our membership of the euro – that Pact is aimed at keeping a lid on inflation and not destabilising the finances of any one country and demands that countries adhere to two pillars of financial probity : keeping deficits below 3% of GDP and keeping debt below 60% of GDP. What I always found curious was that our Finnish friend, Olli Rehn, seemed to strongly defend the first pillar as he demanded Ireland cut its deficit to 3% by 2014 but seemed completely oblivious to the second pillar in foisting a debt to GDP of well over 100% on Ireland. But yesterday the use of the word “pillar” was to denote the two banks that would support a future Irish banking sector. But why two?

Firstly, we presently have more than two banks. Ignoring EBS, Permanent TSB (part of the Irish Life and Permanent group), Anglo and Irish Nationwide Building Society, we also have at least four “foreign banks” serving the domestic economy : Rabobank (through ACC Bank and Rabobank Online), KBC, Danske (through National Irish Bank) and Royal Bank of Scotland (through Ulster Bank). In addition there are other banks with a marginal presence, eg Nationwide UK is a High Street deposit taker only. And lastly we have the Post Office and credit union networks. So why do we need two “Irish” pillars, AIB and Bank of Ireland?

Competition? This is simply ridiculous. For example, it took the entry of the Bank of Scotland/Halifax into our market in the late 1990s to really shake up the mortgage market and today tracker mortgages, which were a particular feature offering of the new market entrants, account for most of our mortgages (over 400,000 out of the 780,000) – it was not AIB or Bank of Ireland that created such innovative products. More generally, the duopoly of AIB and Bank of Ireland did not deliver a competitive retail banking system for decades. In addition we now have a Financial Regulator that has over 500 staff – is that body not capable of ensuring that a single “Irish” bank provides competitive services. And what about the “foreign” banks, won’t they act to stop uncompetitive behaviour. And lastly remember that there are other potential entrants to our market – yes, the Cardinal consortium’s reported offer of €600m for EBS was rejected but there will be other interest in a domestic banking system once our economy recovers.

The particular reason I would prefer to see just one “Irish” bank is that if we let the other go, we can possibly see billions of euros in savings to our bailout bill by burden sharing with bondholders. And to remind us of the bondholder position in February 2011 as collated by the Central Bank of Ireland:

We might also see the €13.3bn capital requirement at AIB shared, for example through a debt for equity swap.

The announcements were made lickety-split yesterday and it has taken some time to appreciate what is being proposed. Isn’t it now appropriate to challenge the notion that we need two “Irish” banks?

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