Will credit really start to flow to Irish SME’s?

Finance Minister Brian Lenihan has published and SME Lending Plan from AIB and Bank of Ireland in which each of them indicate an intention of making €3 billion available to SME’s in 2010/11

Which customers are likely to be in a position to use such additional resources and what impact will the provision of these facilities have on lenders? Borrowers that qualify are supposed to be exporting firms. .

An SME employs fewer than 250 persons; have a turnover of less than €50 million and a balance sheet less than €43 million.

Total lending to SME’s at 31 December 2009 amounted to €32.28 billion

	€ Million
Loans	26,340
Overdrafts	2,833
Finance and Leasing	2,407
Invoice Discounting	700
	€32,280

This proposal indicates a potential 19% increase in credit availability

There were 33,192 applications for credit amounting to €1.854 billion in the fourth quarter of 2009; 131,500 for all of 2009. Credit applications for the fourth quarter of 2008 amounted to €2.892 billion. The approval rate is estimated to be 84%. The utilisation rate for overdrafts is 52%.

Profile of Credit Applications

Sector	Number of Applications Q4 2009	Amount Sought € Million	Total Borrowing
Agriculture and Forestry	9,512	379	4,150
Fishing	128	10	325
Mining and quarrying	89	9	303
Manufacturing	1,742	198	2,630
Electricity, Gas and Water	63	16	279
Construction supply	1,808	61	1,249
Wholesale and repair	4,507	346	6,954
Hotels and restaurants	1,776	125	7,327
Transport, storage and communications	1,442	69	1,512
Financial intermediation	251	15	348
Real estate and business activities	7,783	390	3,816
Health and social work	1,071	99	1,472
Other community and personal services	3,030	137	1,915
TOTAL	33,192	1,854	32,280

Each of these sectors has issues from a banking perspective which I will comment on in the context of the change in their overall borrowing profile between December 2005 and December 2009

Credit Trends 2005 – 2010

Resident non-government credit, excluding personal borrowing, residential mortgages and lending to the educational sector increased by 121% in this five-year period.

The following table summarises the change in each sector and the relationship between the deposits maintained in each sector and how these relate to borrowing by these sectors as a whole:

Sector	Change in borrowing Dec 2005 – 09 € Million	Resident Deposits Dec 2009	Resident Credit Dec 2009
Agriculture and Forestry	1,554	2,496	4,933
Fishing	-70	112	336
Mining and quarrying	177	294	415
Manufacturing	1,628	5,989	7,137
Electricity, Gas and Water	513	898	1,120
Construction	5,495	3,578	15,042
Wholesale and repair	4,867	4,591	12,591
Hotels and restaurants	3.903	655	10,905
Transport, storage and communications	781	3,766	3,005
Financial intermediation	46,540	45,106	82,676
Real estate and business activities	61,598	14,781	93,845
Health and social work	1,845	894	2,679
Other community and personal services	1,034	4,800	2,832
TOTAL	€129,865	€87,960	€237,516

These sectors, in their entirety had credit outstanding of over €237 billion at the end of December 2009, a year in which our GDP reduced by 7% to €176 billion. The SME component of this, €32.2 billion was 13.5% of the overall total.

The level of credit they were responsible for increased by 121% in the previous five years. The deposits of these sectors maintained. €87.9 billion means that the overall ratio of deposits to loans was 2.7.

It is very hard to see much action in the construction sector given the collapse in demand or in the hotel and restaurant sector given the huge overcapacity as a consequence of tax breaks valued at €1 billion. Real estate is dormant and there will not be much international growth in agriculture.

Supply Perspective

The Financial Regulator has insisted that Tier 1 capital at AIB, which in common with its counterparts, is to be 8% means that additional capital of €7.4 billion is necessary by 31 December 2010. It is not yet clear where this is to come from.

AIB is the dominant force in the Irish deposit market laying claim to customer current and deposit accounts worth €52 billion of its total customer account base of €83.9 billion.

Bank of Ireland has a similar customer account total, €85 billion – but only €35 billion of this is derived in Ireland. The remainder is sourced in the UK and capital markets. Additional credit means additional capital.

AIB’s credit commitment to these sectors at 31 December 2009 and its NAMA relationship is as follows:

 

Sector	Change in borrowing Dec 2005 – 09 AIB Resident Loans € Million	Resident Deposits NAMA AIB Bound Loans Dec 2009 €Million
Agriculture and Forestry	2,015	24
Fishing
Mining and quarrying
Manufacturing	3,108	37
Electricity, Gas and Water	844	64
Construction and Property	15,930	18,055
Wholesale and repair
Hotels and restaurants
Transport, storage and communications	2,382	621
Financial intermediation
Real estate and business activities
Health and social work
Other community and personal services
TOTAL LOAN BOOK (IE)	€69,911
TOTAL LOAN BOOK (GROUP)	€103,341

Bank of Ireland had an Irish loan book of €63,450 million, slightly less than that of AIB. The make-up of it was:

 

Residential mortgages	28,350
Property and Construction	9,450
NAMA	8,100
Corporate and SME	14,850
Consumer	2,700
TOTAL LOAN BOOK (IE)	€63,450
TOTAL LOAN BOOK (GROUP)	€119,439

Green shoots of economic recovery tentatively anticipated to materialise by late 2010

The first of the 2010 expenditure cut announcements have been made by Brian Lenihan, Minister for Finance when he indicated that a combination of €3 billion in expenditure cuts and tax increases will be necessary in 2011.  Savings of €2 billion are to be derived from reducing the cost of public services and the reform of income taxation.  Up to €1 billion has been saved on capital expenditure adjustments.

The Government also propose to spend €5.5 billion in 2011 on additional productive capacity. 

Taxation Adjustments

There is little scope for adjustments in marginal income tax rates.  Nearly half of all income earners in Ireland will pay no income tax in 2010.

The PRSI funded social insurance fund is believed to be insolvent.  The Government now intend to a universal social contribution to be paid at a low rate on a wide base.  This will effectively replace PRSI, the Health Levy and the Income Levy.  Water charges are likely to be introduced.

Seeding a return to growth

The Irish Government is anticipating a return to economic growth in the second half of this year with a stronger trend becoming apparent next year, led by exports. Job creation of 25,000 next year and 45,000 annually in later years are projected to meet the job requirements of a society that currently has in the region of 450,000 unemployed persons.

Labour Costs

The Government is quick to point out that Ireland is the only member state of the EU where labour costs are falling (-5.25%) but are more reluctant to mentioned that Ireland ranks 26th among the EU-27 in labour cost competitiveness.  Negative inflation may take some of the sting out of this goal.

Balance of Payments

The Irish Balance of Payments is projected to move into surplus this year following an adverse trend in 8 of the last 9 years.

Unique character of Irish downturn

The collapse of the Irish economy is a consequence of the wholly undisciplined provision of excessive credit.  The Irish population increased overall by 19% in the decade to 2008; the stock of residential units increased by 60% but the credit available to pay for this excess increased by over 500% – all having taken place without effective regulatory supervision by a combination of devious, duplicitous, incompetent retarded morons and dysfunctional imbeciles in charge of banks, all generously indulged with political patronage.  The level of Irish taxation derived from the property sector doubled to over 12% in the seven years to 2006.  Tax incentives for developers, both of houses and commercial properties, such as hotels, led to huge overcapacity as economically illiterate buffoons built more and more shacks without any marketing rationale.

Much of this credit was sourced on the international money markets rather than being derived from customer deposits.  The tax take on these property transactions was very high but it was used to spur an utterly unsustainable level of public spending, especially on welfare – some attributable to unemployment increased but a great deal of it attributable to politicians playing Santa Claus without adequate vetting of welfare spending.  Welfare fraud alone is estimated to cost the Irish Exchequer €1.5 billion in 2010.

The peril of NAMA and the blind faith of the taxpayer

Scope and role of NAMA

IRELAND’s National Assets Management Agency (NAMA) is being set up to buy the most dodgy loans to property developers’ on the balance sheets of Irish banks. The existence of these loans is said to be preventing the banks from lending to the authentic, productive segment of the economy and enabling that segment to stimulate economic recovery.  They lent too much to too few property developers and speculators but it acted as steroids would for bankers’ bonus enhancement.  Many a good Sunday afternoon in the corporate boxes at Croke Park, Punchestown and the Curragh was enjoyed on the strength of it!

These loans are to be valued on the basis of a prescribed methodology, as defined in the Bill. Their valuation will be lower than that recorded in the balance sheet of the lending bank. Valuation is not to be determined by the inflated assumptions and price structure on which they loans were first approved. The assets which were provided as security for the loans will be valued on the basis of a price is realistically achievable in the medium to longer term in term. NAMA will be the largest property owner in the country and will have the bargaining power that goes with this status. This means that it should be able to choose when to put property on the market without depressing market prices unduly.

It is intended that the elimination of uncertainty and the cleaning up of bank balance sheets to more truly reflect the genuine underlying values of their assets and liabilities will revive our financial system and provide credit to businesses that need it and the interests of depositors will also be more secure. 

The recent court case involving ACC Bank could put a spanner in works of NAMA if emulated.  Not all banks will entertain the NAMA agenda as evidenced by the approach of its parent since 2002, the Dutch AAA rated Rabobank,

 

Can Irish banks be trusted?

All of the foregoing is predicated on the Government having no role in the commercial conduct of Irish banks.

The Government has rejected, at least for now, the option of nationalisation, arguing that it is better that the banks’ maintain a presence on the stock market and conduct themselves within the constraints and disciplines of that marketplace. But is this great act of faith not a bridge too far for the Irish banks? It sends a shiver through my spine that almost frightens the living daylights out of me to see these morons’ self-policing.  Some of them are not fit to be the janitors removing cigarette butts from the latrines in the staff toilets, even with the protection of plastic gloves and goggles!

Were these banks not supposedly operating within the constraints and disciplines of the investment market for decades only to end up as the basket cases that they now are? The same disciplines that allowed them foster a nationwide culture of tax evasion (including personal tax evasion by themselves), offshore accounts for indigenous residents, scam charges on customer accounts and the cute-whore approach did not seem to conflict with their notion of discipline.

When one peruses the annual and interim reports of these awful banks it is abundantly clear that their all-consuming love affair with the property sector was intense, passionate, titivating and, of premier importance,  bonus yielding. But have these dysfunctional gobshites any understanding of the needs and dynamics of authentic economy?

I frankly fear they do not and are incapable of learning and the more I see of their Windsor Tie Knots, their grimaces of injured innocence and the ugly oversized cuff-links perched on their starched white shirts, the less convinced I become.

As the nation awaits the debate of the NAMA Bill in the Oireachtas next month many of us are utterly mesmerised by the complexity and scale of the proposed NAMA project and the level of risk that it involves is beyond the comprehension of the average person. The value of the assets concerned, around €90 billion, is equivalent to the total personal expenditure of all the citizens of the State in an entire year in good times. It is three times the amount of tax the Revenue Commissioners will collect in 2009 and it is over 50% of the likely GDP in 2009. 

 

Impact of lower credit ratings’

Many are being hurt by mortgage interest rate and cost increases.  But the Government see these as reflecting commercial marker realities.  They are careful not to spell out what these realities are.  But could they have anything to do with degraded ratings and subversive transactions for which no one has been held accountable in a court of law?

The investigation by the Chartered Accountants Regulatory Board was being overseen until recently by the board Chairman who is also a director a bank being investigated.  Can you imagine the bean-counters even allowing such a juxtaposition to materialise for the sake of their own credibility in society?

Apart from being clueless about the authentic economy our friends with the golden cuff links had no difficulty ramping up credit until it surpassed 200% of gross domestic product as though it were competing with Iceland in the financial services Olympics.  The could do this because the vey same Government “had no role in the day-today commercial operation of the Irish Banks” – so they could do what they liked and to hell with the consequences, as long as it did not impair their personal remuneration.

NAMA does not have a mandate now to deal with dodgy residential loans.  The individual mortgage bearer is not as  ‘systemically important’ enough to matter as Anglo Irish Bank, a bank where no fewer than five chartered accountant ran they show.

 

The Alan Greenspan influence on Irish banking

Capitalism in the United States and elsewhere was energised by an approach proselytised by Alan Greenspan the Former Chairman of the US Federal Reserve Board (the Fed) to the effect that the enlightened self-interest of owners and managers of financial institutions would lead them to maintain a sufficient buffer against insolvency by actively monitoring and managing their firms’ capital and risk positions. It was against this background that a plethora of so-called financial instruments, derivatives, sub-prime mortgages and securitised assets.

Greenspan was a passionate advocate of the free market. He was appointed to the chairmanship of the Fed by Ronald Reagan in August 1987 and held this position throughout the presidencies of George H Bush, Bill Clinton and George H W Bush until he was replaced by Ben Bernanke in 2006. The 1987 stock market crash coincidentally occurred the following October. Greenspan used the tools of monetary policy to guide the US economy.

This means controlling the availability and cost of money – so varying the interest rate was a central feature of the Fed’s tool kit throughout his tenure to particularly control the threat of inflation and maintain the value of the US $ at a satisfactory level on foreign exchange markets. The Republican Party, starting with Reagan, was a very strong advocate of reducing government influence and this meant that the Fed avoided the toolkit of fiscal stimulus – government borrowing, spending and taxation, to guide the economy. Their approach was to allow the market determine virtually everything.

The crucial difference between these newer financial products and traditional financial assets, such as stocks and shares, is that cash is directly exchanged for an asset concurrently in the case of a share purchase. Credit problems do not fester like rats in a sewer.  The incidence of risk is minimised so the calculus of a bookmaker are not as necessary. Auditors can audit share transactions.

Derivatives and similar financial products are based on underlying contracts that can remain unsettled for very long periods. Some of the more complex derivatives can involve thousands of contracts and hundreds of contracting parties. Values are determined by an independent index – such as FX rates, interest rates, share prices etc.  If there is an adverse movement in a relevant index of indices there may, or may not be a guarantee in place to trigger a payment.If there is no guarantee, or collateral underpinning a derivative their value is a function of the credit worthiness of the various connected parties but the apparent profits are recorded as earnings before money changes hands. 

What happens in practice is that banks involved with derivatives and similar assets accumulate large quantities of ‘paper assets’, liabilities and counterclaims – an opaque cobweb of mutual dependence and dependence on third parties that are often unidentifiable. This minefield has yet to raise its head in the context of the assets and liabilities of Irish banks and building societies.

This meant that investors are not in a position to understand and analyse banks and financial institutions because these instruments can be underpinned by thousands of contracts and hundreds of counterparties. Their value and the value of their underlying financial assets can therefore be over or understated by a crippling variation, as was demonstrated by the collapse of Bear Sterns.

 

Limitations of transparency

Transparency is a much bandied word especially when it comes to averting future problems. Bu there is no reporting mechanism that can either define the risk of measure the value of a complex set of derivatives. They are not audited and they are not regulated.

I will be interested to observe the level of transparency that applied to NAMA.  The nationalised Anglo Irish Bank has billions of € in impaired loans, including loans to directors and managers,  but it is not possible to ascertain if these include the loans approved for the purchase of the Irish Glass Bottle site at Ringsend, Dublin to which the State’s Dublin Dockland Authority is a joint venture partner, notwithstanding that the current Government appointed Executive Chairman of Anglo Irish Bank was also the Government appointed Chairman of Dublin Docklands Development Authority in succession to Lar Bradshaw, formerly a director of Anglo Irish Bank. The current Chairman of Dublin Docklands Development Authority, Niamh Brennan, is an accomplished UCD professor and the leading academic advocate in Ireland of transparent, credible corporate governance!  Will our patience ever be rewarded?

Sweden’s response to a systemic banking crisis

Governments should avoid the onset of a systemic financial sector crisis in the first place but, of course, avoidance is never optional! It is merely an aspiration!

When a crisis does occur it is the unequivocal responsibility of government to maintain liquidity so as to avoid a credit crunch; to restore confidence when this has been undermined and to ensure that the capital base or capital reserves of the national banking system is adequate following a period of excess lending. These are the views of Bo Lungdren, currently Head of the Swedish National Debt Office and formerly Sweden’s Deputy Minister for Finance when the Swedish banking crisis unfolded in the early 1990’s. He spoke at a lunch meeting of the Institute of International and European Affairs in Dublin on Tuesday, July 7^th.

Lungdren succeeded Carl Bildt, the former Prime Minster of Sweden and current Foreign Minister, as Leader of the Moderate Party from 1999 to 2003. But when he was a member of the Swedish Government confronted with the banking crisis his party was one of four parties in a minority coalition government.

The Swedish crisis bears some resemblance to that currently occurring Ireland but the similarities. The Swedish financial system had been deregulated in 1985 and the inflationary period which ensured between 1985 and 1990 caused a property boom which evolved into a property bubble. Private sector credit in Sweden increased from 85% to 135% of GDP in the five years prior to the bubble bursting.

The crisis in Sweden was of a more moderate scale than that in Ireland. It cost €6.5 billion to repair the damage (4% of GDP), of which €2 billion was recouped within five years. Two of the seven mid-sized Swedish banks were nationalised (Nordenbankenn now known as Nordea and Gota Bank) and one of the seven did not participate in the government support programme. Ireland has already injected €11 billion (7% of Ireland’s GDP) in three banks – the recently nationalised Anglo Irish Bank, Bank of Ireland and AIB Bank.

The difference in scale is illustrated by the amount of credit outstanding at the time of crisis in both countries. Private sector credit in Ireland has increased from 136% to 216% of GDP in the five years (2003 to 2008) prior to the collapse of the banking system here. Household debt in Ireland, according to the most recent Quarterly Bulletin from the Central Bank of Ireland indicates that household debt outstanding in Ireland is €148 billion – a figure that is in excess of 80% of current GDP.

The Swedish crisis was regional in nature – impacting the financial systems of Norway and Finland to some extent. Its resolution was expedited by a currency devaluation. The complexity of the current crisis aggravated as it is by the asset securitisation phenomena has uncovered a scale of loss that had not been anticipated.

The Swedish approach was to guarantee the depositors and creditors of the financial system – but not the shareholders. The incidence of moral hazard was curtailed by exacting accountability among those who caused the crisis. directors, management and shareholders. The Swedish Government decided to what extent it would support banks’ in difficulty. They did not determine or directly influence this matter.

Lungdren was discreet enough not to offer public advice to the Irish Government although he did share his opinions with the Oireachtas Committee on Finance and the Public Service.

Sweden did not establish a bad bank, an equivalent to Ireland’s National Asset Management Agency and he cautioned against discounting the price of assets taken on by a bad bank on the grounds that the capital vacuum created had to be filled. Assets should be valued on the basis of ‘mark to market’ if a quick recovery of the financial system is to be achieved. He also emphasised the importance of transparency if the credibility and integrity of a rescue initiative is to be maintained. Stress tests are merely base-line scenarios and must be treated accordingly.

Swedish banks incurred losses of €25 billion during that crisis. Credit losses in Ireland have been estimated by the IMF to potentially be €35 billion and the Irish economy is about half the size of the Swedish economy.

Some Swedish banks are apparently experiencing fresh difficulties as a consequence of exposure to the economic crisis in Baltic countries, especially Latvia and Estonia.