Irish banks are hugely profitable

In the midst of the disaster that is the Irish banking failure, it is useful to note that Irish banks are hugely profitably businesses on an day-to-day or operating basis. 

Irish banks are not losing money and are generating big profits.  The problem is that Irish banks lost absolutely vast amounts of money when they issued huge loans to developers that they have no chance of getting back.  These losses are only now being addressed and are threatening to drown this country.  Any profits the banks are making are small in comparison to these huge losses but there are profits there nonetheless.

If we take the most recent financial reports for some of our main banks.

Bank	Operating Profit	Reported Profit
Allied Irish Bank	€2,962 million	-€2,656 million
Bank of Ireland	€1,050 million	-€1,469 million
Anglo Irish Bank	€636 million	-€12,709 million
Ulster Bank	£281 million	-£368 million

These four banks reported operating profits of close to €4 billion.  We already own one of them (Anglo), are well on the way to owning another (AIB) and have a sizeable stake in a third (BOI).  On this basis owning these businesses is not a bad thing.

However, the process of owning these has seen us commit almost €75 billion to cleaning up their appalling balance sheets: €45 billion for NAMA and €30 in recapitalisation.  The annual profits outlined above will not even be enough to cover the annual interest charges on the huge debt burden we are creating with our ‘solution’ to this mess.

Our banks may be profitable but it is lose/lose for us.  We are losing money to the banks whose profits are so high only because their charges are so high.  We are losing money to the world to pay the interest on all this debt we are creating so that these banks can survive.

Details of the figures used above are given below the fold.

The operating profit figure for Allied Irish Bank is on slide 9 of this presentation.  AIB made a bad debt provision of over €5 billion that turned the operating profit into a reported loss of €2.6 billion.

Bank of Ireland recently published preliminary nine month results for the period ending 31 December 2009.  On page 11 of this report we see the operating profit of just over €1 billion for the period.  BOI’s bad debt provision was €4 billion. A tax credit for €344 and a gain on the repurchase of liabilities of just over €1 billion, gave BOI a reported loss of  €1.469 billion.

Anglo Irish Bank reported 15 month results for the peri0d to the end of December 2009.  Anglo actually made an operating profit of €2.394 billion in this period as per page 38 of this report.  However €1.758 billion of this was due to the profits on the non-recurring purchase of financial liabilities.  Removing this we get the €636 million figure used above.  Anglo’s bad debt provision was nearly €15 billion, resulting in the bank reporting the largest loss in Irish corporate history.

Ulster Bank is part of the Royal Bank of Scotland group and is not part of the NAMA process.  The 2009 results for the bank are on page 70 of this report.  Ulster Bank’s operating profit of £281 million is wiped out with a bad debt provision of £649 million, giving the reported loss of £368 million.

The trouble with debt

NAMA has begun the process of buying toxic debt from our ailing financial institutions.  The first tranche sees €16 billion in loans being bought for a price of €8.3 billion – a ‘haircut’ of 47%.  This €8.3 billion is being borrowed to finance these purchases.  In essence, public debt is being created to buy private debt which may or may not be paid back.

Three years ago the amount of money being borrowed by Johnny Ronan, Liam Carroll, Bernard McNamara and their ilk had no effect on the ‘man on the street’.  With NAMA buying the loans issued to these developers with public debt it is not only Johnny Ronan who is taking a kick in the groin.

At the end of 2009, Ireland’s general government debt stood at €106 billion.  In 2009 the total amount of economic activity in Ireland was valued by the Central Statistics Office at €163.5 billion.  Using this Gross Domestic Product (GDP) figure means that Ireland has a debt to GDP ratio of 64.5%.

For households this figure may appear to be a very low debt figure.  Consider a household with a net income of €40,000 and an outstanding mortgage of €200,000.  This household has a debt to income ratio of 500% and this would be normal for many families.  If the state has a debt ratio that is eight times less surely this should not be a problem.

If the household was to devote all of their income to paying off the mortgage it would take five years before the balance would be cleared (assuming zero interest).  In order to clear the National Debt of €106 billion, Ireland would have to devote the value of all economic activity to paying off the debt for just under eight months.  What takes a family five years could take the country eight months.  There are two reasons that make this comparison false.

Firstly, while a family make have access to their entire income to spend as they wish the government can only spend that part of national income they collect in taxes.  In 2009 the Irish Exchequer collected €33 billion in tax revenue.  With this amount available it would take three years and two months to pay off the National Debt if we poured every euro of tax revenue into it (again assuming zero interest).

Second, the average household will borrow a large amount of money once and then proceed to pay it off over the following years.  Therefore a young family might start off with a huge debt ratio and this will reduce over time as the family hopefully pay the debt back.  The parents in the family would like to bequeath a house to their children rather than leave them the legacy of a huge debt.  Governments tend to borrow, keep borrowing and show little inclination to every pay it back.

In 1995 the Irish General Government Debt was €38 billion.  Ten years later with some years of unprecedented economic growth the General Government Debt in 2005 was €38 billion.  We had not paid back one cent.  What family would enjoy ten years of huge earnings and not pay down their debt.  Families may try to avoid leaving a huge debt legacy to their children, governments have no problem leaving such a legacy to the future generations.  Ten year olds can’t vote.

In 2009 the Irish government ran an Exchequer deficit of €24 billion.  In last December’s Budget the Minister for Finance announced that we would be borrowing a further €20 to fund government expenditure in 2010.  There is no sign that borrowings over subsequent years will be substantially lower.

The announcements this week will see further huge increases in the National Debt.  NAMA will borrow about €45 billion to buy huge amounts of rubbish loans.  The realised value of these loans may be substantially less.  The State is borrowing another €8.3 billion to plough into the rubbish bank that is Anglo Irish Bank.  There could be another €10 billion put into this black hole.

There are plenty of families around the country who have substantial amounts of debt.  But that likelihood is that over the coming years they will pay this off and be debt free by retirement.  The Irish state is in huge debt but the problem is that we are showing no indication of paying it back and in fact are likely to add huge amounts to it over the coming years.

Greece is the problem child of the Eurozone and they have a debt ratio of around 115%. By the end of 2010 Ireland is predicted to have an ‘official’ debt ratio of 78%. And that is only because we have convinced to EU to allow us to keep the NAMA borrowings and the further Anglo recapitalisation funds ‘off balance sheet’. Our true borrowings are much closer to Greece.

Brian Lenihan finished his statement to the Dail saying ‘others believe in us, we must believe in ourselves.’ He finished his budget speech last December saying that “we have turned the corner”. It is very clear that was not true. A quick analysis of the true debt figures from Ireland will mean that others will not believe in us for much longer.

Can we measure Private Sector Credit in Ireland?

One of the most commonly used measures of the “bubble economy” in Ireland was the expansion of private sector credit in Ireland.  This is the total amount of money lent to Irish residents from our financial institutions.  The pattern on this variable for the past decade is very clear.

Private sector credit rose continually from €100 billion at the start of the decade to break through the €400 billion mark towards the end of 2008.  This has been a fall back since then, and the most recent figure from February is €365.5 billion.  This has occurred because repayments on existing debt have been more than the issue of new loans and because the banks have begun to slowly write down the value of bad debts on their balance sheets.
The huge increase in PSC from 2000 was often quoted to back up the claim that Irish households were “swimming in debt” and had borrowed huge amounts of money.  Statistics were quoted which divided the total amount of debt with the total population to give measures of borrowing per capita. For example €400 billion in debt divided by a population of 4.4 million gives an average debt of over €90,000 per capita in 2008 or over €200,000 per household.
But with all the revelations about NAMA and the Irish banking collapse there must be doubt now cast on how these PSC figures actually relate to the ‘man on the street’.  We are only now getting a clearer picture of the activities of bankers and developers in Ireland.
Yesterday, NAMA announced they were taking €16 billion in loans off the Irish banks in the first tranche of a total of €80 billion.  NAMA have revealed that half of this $80 billion total relates to just 100 borrowers.  The other €40 billion relates to some 1,400 people.
These 100 biggest borrowers are having an average of €400 million in debt transferred to NAMA.  These are figures that are almost beyond comprehension.
What has this to do with Private Sector Credit? Well, it is clear that a huge amount of the credit issued in Ireland was going to a very small group of people.  This had little effect (up to now) on the debt of the average person in Ireland.
If we ignore the borrowings of these 1,500 being transferred to NAMA there is €285.5 billion in private sector credit remaining.  Dividing this by the current population estimate of 4.5 million people gives an average debt per capita of just under €63,000.  Taking out just 1,500 people from a population of 4.5 million sees the average debt per capita fall by nearly €30,000 or nearly 33%.  This group of borrowers makes up 0.03% of the population.
Of course we can’t ignore these borrowings.  They may be removed from private sector credit.  But they have been transferred to the public debt (even if it is off balance sheet).  Public debt is debt owed by the public.  This means it is now owed by ‘the man on the street’.

Is Eurozone inflation about to become an issue?

Eurostat today released a flash estimate of Eurozone inflation for March.  They estimate the annual rate of inflation to be 1.5% – a big jump from the 0.9% rate recorded in February.

From an Irish perspective the important thing is not necessarily the factors that determine the rate as we are a small proportion of the Eurozone (<2%).  Rather the issue is the impact the rate has on ECB interest rate policy.

The ‘price stability’ target of the ECB is measured with an inflation rate of ‘about 2%’ (shown by the red line in the graph).  We can see that for 2005, 2006 and most of 2007 the inflation rate stayed very close to this target.  This was achieved through of set of interest rate increases beginning in December 2005 which say the ECB rate increase from 2.00% to 4.00%. 

In mid-2007 the inflation rate went about the 2% target.  This prompted a further rate increase of 0.25% to 4.25% in July 2008 when the inflation rate was above 4%.  This move was met with widespread criticism as the ‘Global Financial Crisis’ was in flow and the inflation rate quickly plummeted, even turning negative for a time in mid-2009.

The ECB responded with large cuts in interest rates and by May 2009 their key rate was at a record low of 1.00%.  It remains at this level.

As we can see the inflation rate for the Eurozone is showing a trend that may bring it back up to the 2% target.  This may accelerate the ECB’s desire to increase rates.

With the Irish economy still in the grip of the recession and many struggling to make repayments on loans and mortgages, an increase in interest rates is not what we want to see.

Of course, this is not the first time that ECB interest rates will not have been suitable for Ireland. See here.

CSO Data from last week

The CSO were busy last week with a lot of key economic data released.  The data published included

• Quarterly National Accounts (Q4 2009)
• External Trade (Jan 2010)
• Balance of Payments (Q4 2009)
• Quarterly National Household Survey (Q4 2009)
• Construction Output Index (Q4 2009)

Below is a set of slides on some key indicators using the updated data series.  I may add commentary on some of the patterns at a late date but for the moment I will allow the reader to draw their own conclusions.

CSO Data March 2010

Cooking the books

Today has been a tumultuous day on the economic front with public sector pay negotiations concluding, Quinn Insurance going into administration, and, of course, all the banking and NAMA related announcements.

The biggest of these is undoubtedly the latter of the three.  The numbers used in today’s analysis of the Irish banking failure are staggering.  The ‘Big Bang’ was that Anglo Irish Bank will require anything up to an additional €10 billion on top of the €8.3 billion it will receive “this week”.  With €4 billion given to the bank last year this is a total state contribution of €22.3 billion.

Yet, in interviews after today’s statement, the Minister for Finance, Brian Lenihan, said that today’s measures would not lead to any additional borrowing by the National Treasury Management Agency on behalf of the State.

The borrowing projections for the year were outlined in the Budget and are best seen from Table 10 of the Stability Programme Update (page 19).  The actual outturn for 2009 and the projections for 2010 are given below.  The table in the SPU also gives projections for 2011 to 2014 but the European Commission has already rubbished these as being based on overly optimistic growth predictions.  Anyway here’s my version of the table.

Table 10: Projections for the Public Finances
	2009	2010
CURRENT BUDGET
Expenditure
Gross Voted Current Expenditure	55,957	54,940
Non-Voted (Central Fund) Expenditure	4,992	6,932
Gross Current Expenditure	60,949	61,872
less Expenditure Receipts and Balances	15,701	14,748
Net Current Expenditure	45,248	47,123
Receipts
Tax Revenue	33,043	31,050
Non-Tax Revenue	836	2,355
Net Current Revenue	33,879	33,405
CURRENT BUDGET BALANCE	-11,368	-13,718
CAPITAL BUDGET
Expenditure
Gross Voted Capital	6,907	6,445
Non-Voted Expenditure	4,829	825
Payment to the NPRF	3,000	-
Gross Capital Expenditure	15,737	7,270
less Capital Receipts	1,128	536
Net Capital Expenditure	14,609	6,734
Capital Resources	1,464	1,672
CAPITAL BUDGET BALANCE	-13,272	-5,062
EXCHEQUER BALANCE	-24,641	-18,780
GENERAL GOVERNMENT BALANCE	-19,260	-18,720
% of GDP	-11.70%	-11.60%

The key figures for 2010 are Net Current Expenditure of €47.123 billion and Net Current Revenue of €33.405 billion.  Both of these figures, and in particular the revenue prediction are doubtful, but they give a best-case Current Budget Deficit of €13.718 billion.  It is true that today’s banking announcements do not change this.  The Public Service Agreement 2010 - 2014 may do so.

On the capital side the Government have planned for Net Capital Expenditure of €6.734 billion.  With Capital Resources of €1.672 billion this gives a Capital Budget Deficit of €5.062 billion.

Combining the Current and Capital Deficits gives an Exchequer Deficit of €18.780 billion, down from €24.641 billion last year.  This is the money we need to borrow to keep the government operating.  Today’s announcement, we are told, will not lead to any increase in this borrowing, with the NTMA target to raise €20 billion still standing.

With the Current Budget Deficit forecast to deteriorate by at least another €2.5 billion this year, the planned reduction in the Exchequer Deficit of almost €6 billion comes from the Capital Account.
The deficit on the Capital Account is forecast to improve by almost €8 billion this year.  This is driven by two factors.

1. Capital Expenditure in 2009 included a €3 billion contribution to the National Pension Reserve Fund.
2. The 2009 Non-Voted Capital Expenditure figure of €4.8 billion included the €4 billion used to recapitalise Anglo Irish Bank last May.

Budget 2010 did not include a provision for either of these.  We will not be making a contribution to the National Pension Reserve Fund in 2010.
However, in relation to the state-owned Anglo Irish Bank, the Minister for Finance today said that:

“I am providing €8.3 billion this week to support the capital position of the bank to take account of the bank's losses to date…I must point out that the bank will need further capital to cover future losses and accomplish the restructuring of the bank and its balance sheet. The current estimate is that this could be of the order of a further €10 billion.”

If everything else in the government’s projections held, the addition of this one provision will increase the Exchequer Deficit to €27 billion (€18.7 billion + €8.3 billion).  This would mean Exchequer borrowing of 16.7% of GDP this year!
But we are told there will be no additional borrowing and the NTMA target of €20 billion holds. What gives? Cue the Minister again:

“The bank’s capital support is being provided by the State in a way which spreads the cash requirements over an extended period of time. I am injecting the capital this week in the form of a promissory note, payable over a number of years into the future. In essence this means the amount will be paid over a period of 10 to 15 years, thereby reducing the impact on the Exchequer this year and stretching the payments into the future.”

Ah, the bank needs the money now so we’ll give them a ‘promissory note’ (a what?) for the €8.3 billion.  We’ll give them the actual money over 15 years so it doesn’t look bad on the books.  And this to a bank he hopes to partly sell on in five years.

What Minister Lenihan seems to be saying to everyone (including bond markets) is “I know we have a liability because of Anglo. You know we have a liability because of Anglo. Everyone knows we have a liability because of Anglo. But if I keep it off the books with a ‘promissory note’ everything will be appear fine and we’ll definitely look good in comparison to the Greeks.”

With the borrowings to fund the NAMA operation also ‘off balance sheet’ there seems to be little relevance to the officially published government debt figure.  This should rise by €16.8 billion based on today’s measures: €8.5 billion for the money spent by NAMA on rubbish loans and €8.3 billion given to Anglo to recapitalise a rubbish bank.  But our debt figure won’t change one jot.

They may “believe in us” now, but how long will it last?

“Others believe in us”

Minister for Finance, Brian Lenihan, concluded his statement to the Dail today by saying:

[O]thers believe in us. We must now begin to believe in ourselves.

He used quotes from some external commentators to support this view. A short extract from his statement shows this.

Our determination to deal with this imbalance in our public finances through firm and decisive action has engendered real confidence in our economy on the international stage. The world out there believes in us and in our ability to work our way through our difficulties and return to growth.

Jean Claude Trichet said: "In the case of Ireland very, very tough decisions have been taken by the government and rightly so,"

More recently, Mr Trichet’s colleague, Jose Manuel Gonzalez-Paramo on the ECB said: “The Irish measures are very courageous. They are going in the right direction.”

The French Finance Minister, Christine Lagarde said: "Ireland has set the high standard the rest of us must follow".

On a recent visit to Ireland, the German Minister for European Affairs, Dr. Werner Hoyer said: “I think there is a deeply rooted trust and confidence in this country’s ability to sort out its problems. … There is a fundamental belief that the Irish are going to solve it.”

Already, we have reaped the benefits of this growing confidence. Since last April’s Supplementary Budget and the announcement of the decision to establish NAMA, borrowing costs have fallen and our bond spreads have halved.

We have wondered about this before with some posts under the banner ‘they like us, they really like us’.  See here and here for examples.

This week has seen more pieces in the international media along similar patterns.  For example, today Bloomberg carries a piece under the heading ‘Ireland Breaks From Greece to Lead Europe Bond Gains’.   The piece was written before the NAMA announcement was made.  The first paragraph begins the positive view that pervades through the entire piece.

Ireland’s bonds are poised to outperform those of every other euro member except Austria this quarter as investors bet it will be more successful than countries such as Greece in cutting its budget deficit.

Further on in the piece an economist from Ignis Asset Management declares that “Ireland has left the pigsty for the time being and it has come out smelling of roses”.

The Financial Times have already given their view on the state of the nation and even predict the quick return of the Celtic Tiger!  In a piece called ‘Signs of Celtic Tiger clawing back growth’ they start:

After almost two years of unrelieved misery during which Ireland had sometimes appeared, in local parlance, to have lost the run of itself, a battered and moth-eaten Celtic Tiger may be picking itself up.

And this piece finishes:

Taken together, and with the right policy tweaks, this could offer Ireland a route back to the authentically Tigerish 1990s rather than the long recession of the 1980s.

You can listen to the author of the above piece make the case in an interview with Tom McGurk from 4FM here.

The Minister is absolutely right.  Others do believe in us.  But why? 

How will the “others believe in us” quote fare in comparison to the way the Minister finished his Budget speech last December?

Our plan is working.

We have turned the corner.

I commend this Budget to the House.

It is clear that “turning the corner” has not gone to plan.  How long will the “others believe in us” mantra last?