Ireland's debt is accumulating
The Standard and Poor's (S&P) downgrade of Irish sovereign debt to AA- on Aug. 25 was consistent with the other rating agencies, yet it had a greater effect on market sentiment. This is largely a question of timing--in the weeks since the Moody's downgrade on July 19, the extent of Ireland's banking crisis has become better understood.
The Irish banking sector faces several problems:
--Asset write-downs. The scale of asset write-downs and debt defaults to which Irish banks, building societies and firms are subject has grown as assessments of the residential and commercial property and development portfolios of institutions have come to light.
--Banking crisis. Although no Irish bank failed the stress tests of 91 European banks, the European Commission approved 24.3 billion euros ($31.1 billion) to support the nationalized Anglo Irish Bank on Aug. 10. Three weeks later, on Aug. 31, Anglo Irish Bank reported the worst half-year results in Irish corporate history--a loss of 8.2 billion euros. The European Commission is expected to rule in the next few weeks on the Irish government's plan to split Anglo Irish into "good" and "bad" banks, though the weak capital base of any configuration of the former limits the relevance of such a scheme. In addition, Ireland's two main banks, Bank of Ireland and AIB, are now heavily subsidized and have also reported massive losses this year. AIB must raise 7.4 billion euros to meet new capital reserve rule requirements, or face state control.
--NAMA strategy. The prospects for a Swedish-style asset recovery under the National Asset Management Agency is rapidly decreasing. At the outset, it was expected that 80 billion euros of loans would be transferred from banks to NAMA, with a modest haircut of 20%. However, the write-downs are now well over 50%, averaging 38% for Anglo Irish Bank loans, while the Irish Nationwide BS loans were transferred at a 90% write-down. Due diligence has found that the banks misled NAMA about the real value of their loan books as well as the number of debts producing income streams.
--Public finances. The government's commitment to cut Ireland's deficit from 14.3% of GDP in 2009 to 3.0% by 2014 lacks credibility. Already, the state is borrowing 25 billion euros annually to finance public services despite harsh cuts in public sector spending. Rising unemployment and the associated uptake of social benefits are a further strain. Future hardship is likely, as the major domestic mortgage lenders have raised their non-fixed rates three times this year, despite the stability of the ECB rate. On Aug. 26 bond investors pushed 10-year Irish bonds to 344 basis points over German bonds.
Debt dynamics. The economic crisis in Ireland is about debt--individual, institutional and firm, and state. Peculiar to Ireland is the deep intertwining of the banking sector, state institutions and property developers, which produced convoluted, low-collateral loans, a porous regulatory culture and complacency about continuing property-based asset escalation. In a small state, gargantuan property loans take on similar-size debt.
Raising capital. Irish banks face debt repayments of about 30 billion government-guaranteed euros in September, with an equivalent amount of bank debt liabilities maturing in the rest of the year. Owing to the increased cost of Irish state borrowing, these banks will have to pay more than expected, which means they must raise fresh funds in the markets. Such banks' funding costs are normally based on government bond yields coupled with a premium. (The cost of Irish bank bond credit default swaps on senior debt has also risen.) If the banks have trouble raising capital to refinance, they will have to rely on the ECB, which further weakens sovereign debt spreads. The banks can use NAMA bonds (government-backed bonds which replace the real-estate loans deposited with NAMA, which are ultimately ECB-backed) to raise capital.
Outlook. Despite short-term success in raising capital in bond markets, debt is accumulating. Future Irish governments will have to pay back these bond-based borrowings. Taxpayers now face a generation of repayment. This debt, rather than the deficit, is the real fiscal challenge facing the Irish government and its partners within the euro-area.
To read an extended version of this article, log on to Oxford Analytica's website.
Oxford Analytica is an independent strategic-consulting firm drawing on a network of more than 1,000 scholar-experts at Oxford and other leading universities and research institutions around the world. For more information, please visit here.
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The Irish banking sector faces several problems:
--Asset write-downs. The scale of asset write-downs and debt defaults to which Irish banks, building societies and firms are subject has grown as assessments of the residential and commercial property and development portfolios of institutions have come to light.
--Banking crisis. Although no Irish bank failed the stress tests of 91 European banks, the European Commission approved 24.3 billion euros ($31.1 billion) to support the nationalized Anglo Irish Bank on Aug. 10. Three weeks later, on Aug. 31, Anglo Irish Bank reported the worst half-year results in Irish corporate history--a loss of 8.2 billion euros. The European Commission is expected to rule in the next few weeks on the Irish government's plan to split Anglo Irish into "good" and "bad" banks, though the weak capital base of any configuration of the former limits the relevance of such a scheme. In addition, Ireland's two main banks, Bank of Ireland and AIB, are now heavily subsidized and have also reported massive losses this year. AIB must raise 7.4 billion euros to meet new capital reserve rule requirements, or face state control.
--NAMA strategy. The prospects for a Swedish-style asset recovery under the National Asset Management Agency is rapidly decreasing. At the outset, it was expected that 80 billion euros of loans would be transferred from banks to NAMA, with a modest haircut of 20%. However, the write-downs are now well over 50%, averaging 38% for Anglo Irish Bank loans, while the Irish Nationwide BS loans were transferred at a 90% write-down. Due diligence has found that the banks misled NAMA about the real value of their loan books as well as the number of debts producing income streams.
--Public finances. The government's commitment to cut Ireland's deficit from 14.3% of GDP in 2009 to 3.0% by 2014 lacks credibility. Already, the state is borrowing 25 billion euros annually to finance public services despite harsh cuts in public sector spending. Rising unemployment and the associated uptake of social benefits are a further strain. Future hardship is likely, as the major domestic mortgage lenders have raised their non-fixed rates three times this year, despite the stability of the ECB rate. On Aug. 26 bond investors pushed 10-year Irish bonds to 344 basis points over German bonds.
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Raising capital. Irish banks face debt repayments of about 30 billion government-guaranteed euros in September, with an equivalent amount of bank debt liabilities maturing in the rest of the year. Owing to the increased cost of Irish state borrowing, these banks will have to pay more than expected, which means they must raise fresh funds in the markets. Such banks' funding costs are normally based on government bond yields coupled with a premium. (The cost of Irish bank bond credit default swaps on senior debt has also risen.) If the banks have trouble raising capital to refinance, they will have to rely on the ECB, which further weakens sovereign debt spreads. The banks can use NAMA bonds (government-backed bonds which replace the real-estate loans deposited with NAMA, which are ultimately ECB-backed) to raise capital.
Outlook. Despite short-term success in raising capital in bond markets, debt is accumulating. Future Irish governments will have to pay back these bond-based borrowings. Taxpayers now face a generation of repayment. This debt, rather than the deficit, is the real fiscal challenge facing the Irish government and its partners within the euro-area.
To read an extended version of this article, log on to Oxford Analytica's website.
Oxford Analytica is an independent strategic-consulting firm drawing on a network of more than 1,000 scholar-experts at Oxford and other leading universities and research institutions around the world. For more information, please visit here.
Related articles:
