Back in August 2011 economist Morgan Kelly predicted further losses for the Irish Banks as many buy-to-let investors would be unable to meet repayments. In the last few weeks a clearer picture is emerging as the banks are finally reporting these losses as they begin to make their way through the system. David McWilliams writes about the Banks insolvency as follows:
When we see the figures coming from the various banks, it is not difficult to see that something similar is happening in Ireland. Whether the banks end up bust again, the second time in three years, will depend on how the ECB reacts but it looks like the banks, having been bailed out and having received huge government capital injections, could now be in the process of going bust.
The ECB is trying to mask the problem.
Interestingly, the reason that the banks might be going bust gradually is because the ECB is giving them money at 1pc so that they can mask the inconsistencies in their business model for another year or two. But when that money runs out or the ECB’s policy reverses, which it must eventually, where will they get the cash to operate?
Morgan Kelly predicted last year that it would be the buy-to-let and McWilliams backs this up.
Figures for Irish Permanent released the other day reveal what similar figures for AIB and Bank of Ireland indicated in the past few weeks. The mortgage book is unravelling. The negative equity, which up to this was being shouldered by the population, is now forcing people to miss payments.
Obviously the place you are seeing this is in the “buy-to-let” portfolio where 25pc of Irish Permanent’s loans are not only in negative equity, but are actually non-performing. In other words, they have been defaulted on. The other part of its total loan book, the normal residential mortgage book, is deteriorating rapidly.
For example, close to 21,000 customers are in arrears of 90 days. This is up a quarter on last year to 12pc of all loans. The pace of deterioration in the loans book is alarming because it seems that bad loans have risen by 100pc in two years.
Irish Permanent’s loans-to-deposits ratio remains 227pc, down from 247pc last year. What this means is that the delinquent management of this bank borrowed so much in the boom to lend out that now — even after three years of contracting — for every €1 deposit the bank holds, it has lent out more than €2.27. For the bank to be viable, it has to get this ratio back to €1 of deposits equal to €1 of lending.
This implies that it has to aggressively cut lending or aggressively increase deposits or a combination of both.
For the banks to increase deposit rates would not be a good move as McWilliams points out, it would cost too much.
If the bank gets into a deposit war at a time when there is no demand for loans because people and companies don’t want to borrow, it is toast.
Why? Because its cost of capital is likely to be greater than its return from that capital. That is how you go bust.
For now the ECB is lending to Irish Banks and keeping the show on the road but can’t give out loans because the loan/deposit ratio is out of whack.
So it is unlikely that Irish banks will go bust as long as this remains in place.
So gradually the banks will just become safe deposit boxes for the ECB, taking in money but not lending out because they have to get that loan/deposit ratio down to 100pc.
What does this mean for the Irish economy? It means a zombie banking system presiding over a zombie economy where credit conditions tighten progressively because they have to if the banks are to become functional again.
So as the banks take money out of the economy and causing house prices to contract further, a default is the only likely outcome, it’s just a matter of when.
The more credit the banks take out of the economy, the more house prices continue to fall and the higher negative equity becomes; therefore arrears get higher, and the greater the pace at which arrears translate into defaults.
This is how the gradual becomes sudden, because the gradual is making the sudden more and more likely.
The only way out of this is to default on many of the Irish banks’ creditors. But as much of the debt has already been turned into sovereign debt and as the ECB is the creditor, the ECB will need to be central to a deal.
Where does this leave the Irish which is expecting to have debt of between €220 to €250 billion by 2014?
Irish insolvency is now less a matter of economics than of arithmetic. If everything goes according to plan, as it always does, Ireland’s government debt will top €190 billion by 2014, with another €45 billion in Nama and €35 billion in bank recapitalisation, for a total of €270 billion, plus whatever losses the Irish Central Bank has made on its emergency lending. Subtracting off the likely value of the banks and Nama assets, Namawinelake (by far the best source on the Irish economy) reckons our final debt will be about €220 billion, and I think it will be closer to €250 billion, but these differences are immaterial: either way we are talking of a Government debt that is more than €120,000 per worker, or 60 per cent larger than GNP.