Two weeks ago, just after downgrading Portugal’s sovereign debt to junk, credit ratings agency Moody’s sent an email to Bloomberg, which then reported : “Moody’s Investors Service said today that it continues to “differentiate significantly in terms of the credit profile” in the ratings assigned to peripheral European countries.” Many in Ireland took heart at Moody’s apparent acceptance that it did not lump Ireland (projected peak debt:GDP of less than 120%, bailout programme being delivered to plan, return to GDP growth in 2011) in with Greece (projected debt:GDP of 172%, delusional bailout programme and GDP to contract by 4% in 2011).
Sadly the national pride in being differentiated by Moody’s didn’t last very long – Moody’s downgraded our own debt to junk seven days later on 12th July, a move Moody’s claimed was sparked by the terms of the new European Stability Mechanism and the likelihood that Ireland will need a second bailout in 2013. We then took a predictable battering on bond markets with downgraded junk status, though the claim thatIreland is fully-funded for the next two years means it was a virtual battering because we are not borrowing in the bond markets at present. And then, just to ratchet up the tension, lingering doubts aboutSpain’s debt and new doubts inItaly saw our bond yield reaching record levels. Worrying.
Step forward the National Treasury Management Agency (NTMA), Ireland’s state agency that manages the national debt which issued an information note last Friday saying “the purpose of this note is to show that Ireland has sufficient funding under the EU/IMF Programme to cover all its financing requirements until the end of 2013”. The note itself was reported on irisheconomy.ie where there was some airing of its contents. The purpose of this entry is to provide an overview together with some additional comments and clarifications from the NTMA in respect of queries from here.
The information note shows in simple terms the amount of funding we have to hand in the State at present, the bailout loans from the EU and IMF, the funding of the deficit, the repayment of maturing debt and the bank recapitalisation. In addition there is a line for “market funding” which for 2011 and 2012 shows the net difference between the sale of NTMA financial products* to retail customers and the maturity of such products. This “market funding” line also shows €1.8bn of sales to the debt markets in 2013 and prompts the NTMA to say later in the note “Ireland has only a minimal funding need from the wholesale debt markets in 2013”. In summary, based on the projections in the note, it is shown that with just €1.8bn of additional external funding, we will make it to the end of 2013 and still have a reserve of €5bn available then.
So, how sound are the bigger numbers?
(1) The deficit is shown in the information note is based upon the April 2011 Stability Programme Update produced by the Department of Finance, and projects GDP growth of 0.8%, 2.5% and 3% in 2011, 2012 and 2013 respectively. Is that still realistic? It would seem so. Judge for yourself from the latest projections
(2) The bank recapitalization is based on the stress tests of four of our banks in March 2011 (AIB, Bank of Ireland, EBS and Irish Life and Permanent) and the stress tests of the two zombie banks Anglo and INBS in May 2011, which taken altogether identified additional capital needs of €24bn. Of this, €5bn was to be funded through the buyback of subordinated bonds at a discount. Now the €5bn may not be reached through buybacks alone, and the status of at least one legal action in respect of some of Bank of Ireland’s plans is unclear. But having said that, last week Bank of Ireland alone announced that it had raised €1.96bn in capital through the bond buybacks and the bank is also arranging a rights issue which could potentially see €1.91bn of new capital raised. So from here, it seems that the banks have a reasonable chance of generating €5bn. But what about the €24bn overall recapitalization required identified in the stress tests, is that still valid?
(3) It is now nearly four months since the results of the first stress tests were announced on 31st March, 2011. At a reported cost of €30m and conducted by BlackRock solutions with extensive oversight, it is fair to say that the stress tests were generally well-received by the market, though there were notable criticisms. Bond yields, share prices and deposits in Irish banks all improved in the days immediately after the announcements. That all changed when Portugal sought a bailout in the second week of April and since then those three metrics – bond yields, share prices and deposits – have all deteriorated.
The view on here is that the stress tests are now redundant because of the deterioration in (a) our sovereign bond prices and elevated risk of default (b) residential property prices and (c) commercial property prices, since March 2011, suggesting that the adverse scenario used in the stress tests is inadequate. The NTMA disagree and say the results still hold and that in any event, there is a considerble buffer in the results. Taking each of the headings
(a) sovereign bonds. The NTMA point to the EBA stress test results last week which confirmed the adequacy of capital at all three tested Irish participating institutions – AIB, Bank of Ireland and Irish Life and Permanent. However it appears that the EBA tests did not take any account of the vertiginous rise in Irish bond yields that started in April 2011. The EBA tests appear to have used the same adverse assumptions as applied in the Irish stress tests.
(b) commercial property. Jones Lang Lasalle (JLL) produced its Irish quarterly commercial real estate index last week which recorded the largest quarterly drop in prices in two years (5.7%) and also predicted that if Ireland abolishes all Upward Only Rent Review leases there would be an additional 20-30% decline. That would bring prices down 80% from peak (63% current decline less 30% of 63% = 82%). The adverse scenario in the March stress test was a 22% decline in 2011 and a peak to trough fall of 70%. In response, the NTMA bizarrely says that it bases its projections on a competing index in Ireland, the IPD index produced in association with the Society of Chartered Surveyors in Ireland. Fair enough, and its quarterly index for Q2, 2011 will be published next Tuesday 26th July. But the IPD has very closely correlated with the JLL index and both were showing 61-62% drops from peak at the end of Q1, 2011.
(c) residential property. In view of the fact that the two Allsop/Space auctions in April and July showed Irish residential property was now selling at 60%+ off peak values and the March stress tests had an adverse scenario of a 60% peak to trough fall, it would seem that the stress tests underestimate potential losses on residential property. In response, the NTMA say that the CSO index indicates residential property is just 41% off peak prices and that the Allsop/Space auctions are limited in scope and relate in the main to distressed property, that is repossessed property, and accordingly it is the CSO index which should inform an assessment of stress tests. The NTMA have a point though critics might claim that because the CSO index does not take account of cash sales, it is underestimating the scale of falls in a market where mortgage credit is severely restricted. I think this heading will continue to be argued over unless we get better price discovery with more auctions or the introduction of the House Price Database.
So overall then, how realistic are the NTMA projections? I think there might be arguments about whether or not the bank stress tests are still valid, and if additional capital is needed. And if, for example, €10bn of additional capital was needed by the banks, then we would run out of cash in the middle of 2013. But if we accept the bank stress test results are still valid, we seem to have a decent chance of getting to the end of 2013. We will need the IMF and EU to agree to use the €16bn “saving” in the bank recapitalization – remember €35bn of the bailout was earmarked for the banks and if they only need €19bn then that will potentially leave €16bn – for funding maturing debt or the deficit. Lastly, even if we do make it to the end of 2013 without a second bailout, we will need repay a large maturing sovereign bond, totaling €11.9bn on 5th January 2014. And we will need have funding in place well in advance of this. All told then, unless we can regain access to the debt markets, we will be seeking a second bailout before the end of 2013.
UPDATE: 21st July, 2011. The NTMA has published its annual report for 2010 which shows its sales/maturity of its own retail financial products as follows:
NAMA Wine Lake 