Ovebanked, Underfunded, and Overly Optimistic: The New Face of Sovereign Europe, and Ireland in Particular!
Ireland has finally admitted the horrendous condition of its banking
system. I actually give the government kudos for this, and await the
moment when the US, China and the UK come forth with such frankness.
That being said, things are a mess, I have forewarned of this mess for
some time now. First, the lastest from Bloomberg: Ireland's Banks Will Need $43 Billion in
Capital After `Appalling' Lending
March 31 (Bloomberg) -- Ireland’s banks need $43 billion in new
capital after “appalling” lending decisions left the country’s
financial system on the brink of collapse. The fund-raising requirement
was announced after the National Asset Management Agency said it will
apply an average discount of 47 percent on the first block of loans it
is buying from lenders as part of a plan to revive the financial
system. The central bank set new capital buffers for Allied Irish Banks Plc and Bank of Ireland Plc and
gave them 30 days to say how they will raise the funds.
worst fears have been surpassed,” Finance Minister Brian Lenihan said in
the parliament in Dublin yesterday. “Irish banking made appalling
lending decisions that will cost the taxpayer dearly for years to
Dublin-based Allied Irish needs to raise 7.4 billion euros
to meet the capital targets, while cross-town rival Bank of Ireland
will need 2.66 billion euros.Anglo Irish Bank Corp., nationalized
last year, may need as much 18.3 billion euros. Customer-owned lenders
Irish Nationwide and EBS will need 2.6 billion euros and 875 million
The asset agency
aims to cleanse banks of toxic loans, the legacy of plungingreal-estate prices and
the country’s deepest recession. In all, it will buy loans with a book
value of 80 billion euros ($107 billion), about half the size of the
economy. Lenihan said the information from NAMA on the banks was “truly
Lenders must have an
8 percent core Tier 1 capital ratio, a key measure of financial
strength, by the end of the year, according to the regulator. The
equity core Tier 1 capital must increase to 7 percent.
equity core tier 1 ratio stood at 5 percent at the end of 2009 and Bank
of Ireland’s at 5.3 percent. Those ratios exclude a government
investment of 3.5 billion euros in each bank, made at the start of 2009.
Credit-default swaps insuring Allied Irish Bank’s debt
against default fell 6.5 basis points to 195.5, according to CMA
DataVision prices at 8:45 a.m. Contracts protecting Bank of Ireland’s
debt fell 7 basis points to 191 and swaps linked to Anglo Irish Bank’s
bonds were down 3.5 basis points at 347.5.
pay the buyer face value in exchange for the underlying securities or
the cash equivalent should a company fail to adhere to its debt
agreements. A decline signals improving perceptions of credit quality.
If Allied Irish can’t raise enough funds privately,
the state will step in with aid, Lenihan said. It is “probable” the
government will then end up with a majority stake, he said.
Ireland may not be able to afford to pump more money into the banks.
The budget deficit widened to 11.7 percent of gross domestic product
last year, almost four times the European Union limit, and the
government spent the past year trying to convince investors the state is
in control of its finances.
The premium investors
charge to hold Irish 10-year debt over the German equivalent was at 139
basis points today compared with 284 basis points in March 2009, a
Ireland’s debt agency said it doesn’t envisage
additional borrowing this year related to the bank recapitalization. It
is sticking to its 2010 bond issuance forecast of about 20 billion
euros, head of funding Oliver Whelan said in
“The bank losses, awful as they are, represent a
one-off hit. It’s water under the bridge,” said Ciaran O’Hagan, a Paris-based
fixed-income strategist at Societe Generale SA. [What is the
logic behind this statement? Has the real estate market started
increasing in value? Are the banks credits now increasing in quality?
Will the stringent austerity plans of the government create an
inflationary environment in lieu of a deflationary one for the bank's
customer's assets???] “What’s of more concern for investors
in government bonds is the budget deficit. Slashing the chronic
overspending and raising taxation by the Irish state is vital.” [This
is a circular argument. If the government raises taxes significantly
in a weak economic environment, it will put pressure on the bank's
lending consituents and the economy in general, presaging a possible
furthering of bank losses!]
Juckes Says Outlook `Frightening'
March 31 (Bloomberg) -- Kit Juckes, chief economist at ECU Group Plc,
talks with Bloomberg's Linzie Janis about the outlook for Ireland's
banks after the government set out plans to revive the country's
Now, notice how prescient my post of several months ago was, The Coming Pan-European Sovereign Debt
will attempt to illustrate the "Overbanked" argument and its
ramifications for the mid-tier sovereign nations in detail below and
over a series of additional posts.
Sovereign Risk Alpha: The Banks
Are Bigger Than Many of the Sovereigns
is just a sampling of individual banks whose assets dwarf the GDP of
the nations in which they're domiciled. To make matters even worse,
leverage is rampant in Europe, even after the debacle which we are
trying to get through has shown the risks of such an approach. A sudden
deleveraging can wreak havoc upon these economies. Keep in mind that on
an aggregate basis, these banks are even more of a force to be
reckoned with. I have identified Greek banks with adjusted leverage of
nearly 90x whose assets are nearly 30% of the Greek GDP, and that is
without factoring the inevitable run on the bank that they are probably
experiencing. Throw in the hidden NPAs that I cannot discern from my
desk in NY, and you have a bank that has problems, levered into a
country that has even more problems.
Notice how Ireland is the
nation with the second highest NPA to GDP ratio. This was definitely
not hard to see coming. In addition, Ireland has significant foreign
claims - both against it and against other countries, many of whom are
embattled in their own sovereign crisis. This portends the massive
exporting and importing of financial contagion. Reference my earlier
post, Financial Contagion vs. Economic
Contagion: Does the Market Underestimate the Effects of the Latter?
wherein I demonstrate that Ireland's banking woes can easily
reverberate throughout the rest of Europe, affecting nations that many
pundits never bothered to consider. Irish banks will be selling off
assets, issuing assets and bonds in an attempt to raise capital just as
the Irish government (contrary to their proclamations) will probably
be issuing debt to recapitalize certain banks. This comes at a time
when the Eurozone capital markets will be quite crowded.
Expected higher fiscal deficit
and bond maturities due in 2010 have increased the need for bond
auction financing for all major European economies. Amongst all major
European economies, France and Italy have the highest roll over debt
due for 2010 of €281,585 million and €243,586 million,
and France are expected to have the highest fiscal deficit of €125.1
billion and €96.0 billion, respectively in absolute amount for 2010
(this is without taking into consideration any possible bailout of
Greece and/or the PIIGS, which will be a very difficult political feat
given the current fiscal circumstances), Ireland and Spain are
expected to have the highest fiscal deficit as percentage of GDP of 12%
and 11%, respectively. See our newly released Spanish fiscal
analysis for a more in-depth perspective, see our premium subscriber
report on Spain's fiscal condition and prospects: Spain
public finances projections_033010 2010-03-31 04:41:22
terms of total financing needed for 2010 (which includes 2010 bond
maturities, short-term roll over debt and fiscal deficit), France and
Germany top the list with € 377.5 billion and €341.6 billion,
respectively while the total finance needed as percentage of GDP is
expected to be highest for Belgium and Ireland at 26.3% and 22.4%, respectively.
recent spate of bond auction failures across Europe is forcing
governments to increase premiums on new bond auctions (higher yields),
which in turn is resulting in a decline in existing bond prices.
PIIGS - A troublesome area
Now, to focus on the contagion effect of Ireland,
specifically, let's borrow from our yet to be released foreign claims
model in order to see who may be effected from the rush to pull capital
out of extant positions to fill the leveraged NPA holes left by the
has the largest claims against the UK as a percentage of the its
respective GDP, the largest in the world. In the rush to raise cash to
sell assets, expect some fire sales in the UK. For those who may be
wondering how this may affect the UK, see our premium subscription
report on the UK's public finances and prospects (recently updated to
include the last round of government projections): UK Public
Finances March 2010 2010-03-29 06:20:38 615.90 Kb
can also be expected to pull assets our of the ailing PIIGS group as
well, since they are, bar none, the biggest lender to that group as a
percentage of GDP. No wonder their banks are having problems. There
biggest exposure? Italy! See our premium analysis of Italy's public
finances and prospects: Italy
public finances projection 2010-03-22 10:47:41 588.19 Kb as well as
their other major exposures: Spain
public finances projections_033010 2010-03-31 04:41:22 705.14 Kb
Public Finances Projections 2010-03-15 11:33:27 694.35 Kb.
particular interest may be the prospects of the various banks caught
in this interwoven web (premium subscription material). To date, these
analyses have proven to be right on the money:
- Greek Banking Fundamental Tear Sheet
- Italian Banking Macro-Fundamental Discussion Note
- Spanish Banking Macro Discussion Note
also has the second highest claims (as percent of GDP) against the
central and eastern European nations, who happen to be in a full blown
depression. The withdrawal of assets, banking support and credit will
exacerbate both Ireland's problems and that of these nations. See The Depression is Already Here for Some
Members of Europe, and It Just Might Be Contagious! to find that
Ireland can exacerbate the problems of Austrian, Swedish and Belgian
banks by pulling capital out of the CEE region, and yes, they are truly
in a depression:
Belgium and Sweden, while apparently healthy from a cursory
perspective, have between one quarter to one half of their GDPs exposed
to central and eastern European countries facing a full blown
Click to Enlarge...
exposed countries are surrounded by much larger (GDP-wise and
geo-politically) countries who have severe structural fiscal
deficiencies and excessive debt as a proportion to their GDPs, not to
mention being highly "OVERBANKED" (a term that I have coined).
So as to quiet those pundits who feel I am being sensationalist,
let's take this step by step.
In economics, a depression is a sustained,
long-term downturn in economic activity in one or more economies. It is
a more severe downturn than a recession, which is seen as part of a normal business cycle.
Considered a rare and extreme
form of recession, a depression is characterized by its length, and by
abnormal increases in unemployment, falls in the availability of credit, shrinking output and investment, numerous bankruptcies, reduced amounts of trade and
commerce, as well as highly volatile relative currency value
fluctuations, mostly devaluations. Price deflation, financial crisis and bank failures are also common elements of a
There is no widely agreed definition for a
depression, though some have been proposed. In the United States the National Bureau of Economic Research determines
contractions and expansions in the business cycle, but does not
declare depressions. Generally, periods
labeled depressions are marked by a substantial and sustained shortfall
of the ability to purchase goods relative to the amount that could be
produced using current resources and technology (potential output). Another proposed
definition of depression includes two general rules: 1) a decline in
real GDP exceeding 10%, or 2) a recession lasting 2 or more years.
go on, let's graphically what a depression would look like in this
modern day and age...
is characterized by ... shrinking output and investment ... reduced
amounts of trade and commerce.
In order for the CEE region to improve, it must avoid
the shocks associated with financial and economic contagion from far
flung regions such as Ireland. The reality of the matter is that it may
not be that easy. BoomBustBlog premium subscribers may download the
CEE bank exposure analysis to see which banks we feel have the highest
exposure to such an incident, or more realistically, string of
incidents: Banks exposed to Central and Eastern Europe.
From an empirical perspective, Ireland is in a prime position to
export contagion. Not only does it have the 2nd highest banking NPAs to
GDP ratios in the developed world, it has one of the highest foreign
claim to GDP rations as well. I have already demonstrated how these
foreign claims just happen to be concentrated in today's problem areas,
but Ireland has spread this exposure far and wide as well. It is
second only to Switzerland (due to Swiss private banking industry) in
claims against developed countries. It is also second only to the Swiss
in its total foreign claims as a % of GDP.
up in my Pan-European Sovereign Debt Crisis analysis, a closer look at
Spain, a thorough analysis of Ireland's public finances prospects, an
empirical look at Portugal and the total Foreign claims model. To
illustrate how complex the foreign claims web is, imagine the
intertwined prospects presented here for Ireland, multiplied by all of
the nations of economic significance in the world!
complete Pan-European Sovereign Debt Crisis series, see:
- The Coming Pan-European Sovereign Debt
Crisis - introduces the crisis and identified it as a pan-European
problem, not a localized one.
- What Country is Next in the Coming
Pan-European Sovereign Debt Crisis? - illustrates the potential for
the domino effect
- The Pan-European Sovereign Debt Crisis:
If I Were to Short Any Country, What Country Would That Be.. -
attempts to illustrate the highly interdependent weaknesses in Europe's
sovereign nations can effect even the perceived "stronger" nations.
- The Coming Pan-European Soverign Debt
Crisis, Pt 4: The Spread to Western European Countries
- Smoking Swap Guns Are Beginning to
Litter EuroLand, Sovereign Debt Buyer Beware!
- Financial Contagion vs. Economic
Contagion: Does the Market Underestimate the Effects of the Latter?
- "Greek Crisis Is Over, Region Safe",
Prodi Says - I say Liar, Liar, Pants on Fire!
- Germany Finally Comes Out and Says,
"We're Not Touching Greece" - Well, Sort of...