Thursday, December 29, 2011

Loans in Irish Banks

Here we will give a look at the asset side of the balance sheets of Irish banks, looking specifically at loans and in particular at some large changes that seemed to have occurred in October based on the most recent release of the Central Bank’s Money, Credit and Banking Statistics.

First up, is the total amount of loans on the balance sheets of the domestic banks, broken into the covered group (AIB, BOI, IBRC and PTSB) and the non-covered group (Ulster Bank, National Irish Bank, etc. and also credit unions).

Total Loans in Domestic Banks

There has been a fall in the amount of loans on the balance sheets of the covered banks.  Some of this is due to repayments on existing loans exceeding the amount of new loans issued but most of the drop from a peak of €513 billion in July 2009 can be explained by the transfer of over €70 billion of developer loans to the National Asset Management Agency (NAMA) and the sale of loans to other banks.

The total amount of loans the covered banks had was steady at around €400 billion from May of this year but there was another sharp drop to €377 billion in October.  It would be possible to explain this drop in a chart or two but we will use the drop as a reason to have a fuller look at the loans on the balance sheets of the banks.

Loans in the non-covered domestic group peaked at €165 billion in October 2008 and have fallen by more than half since then, although for 2011 loans in the non-covered domestic group have been relatively steady.  In January they were €79 billion and by October they were also €79 billion.  From January to November 2010 these loans fell steadily from €113 billion to €99 billion.

The large drop in December 2010 (from €99 billion to €79 billion) can be explained by departure of Bank of Scotland (Ireland) from the Irish market.  The loans still exist but they were transferred to Bank of Scotland’s parent group in the UK and no longer appear on the Central Bank of Ireland’s aggregate banking balance sheet statistics. 

From here on we will focus on the €377 billion of loans on the balance sheet of the covered banks.   It is important to note that these are non-consolidated figures, that is they just cover the Irish operations of the banks.  Here is the Irish/non-Irish resident split of the loans.

Loans by Origin in Covered Banks

Loans to Irish residents peaked at €364 billion in June 2009.  Repayments but mainly transfers to NAMA saw this fall under €300 billion May of this year.  Loans to non-Irish residents from the covered banks have fallen from €156 billion in June 2010 to €102 billion now. 

The large drop in October from the first graph can be mainly attributed to the drop from €294 billion to €275 billion in loans to Irish residents, though loans to non-Irish residents also fell (from €108 billion to €102 billion).

Looking at loans to Irish residents (because it is the largest drop but also because we don’t have this breakdown for loans to non-Irish residents) gives a further insight into this drop.

Irish Resident Loans in Covered Banks

Loans on the balance sheets of the covered banks to the private sector (households and businesses) peaked at €256 billion in October 2008.  They then showed a consistent fall over the next three years at stood at €178 billion in September 2011.  From here the big fall in October 2011 can be seen with a drop to €157 billion. 

The exposure of balance sheets of the covered banks to Irish private sector loans has fallen by nearly 40% in the past three years.  The increase in loans to general government are the €30 billion of Promissory Notes given to the IBRC during 2010.

To get a further insight into the changes to private sector loans we have to move away from the balance sheet data and move to the data presented on overall credit in Ireland.  This is credit forwarded by all credit institutions and not just the covered banks but the covered banks make up about two-thirds of the total.  Here are the private sector loans to the household, non-financial corporation, financial intermediary and insurance on the balance sheets of all banks operating in Ireland going back to the start of 2005.

Loans to Private Sector by Sector

It is clear that that the reason for October drop is to be found in the household sector.  The drop in business loans from a peak of €170 billion in August 2008 to €87 billion now is almost fully explained by the transfer of developer loans to NAMA. 

The next step is loans by purpose for the household sector.

Household Loans by Purpose

There seems to have been a huge drop in loans for house purchase (residential and investment) to the household sector over the past few years from a peak of €128 billion in May 2008 to €81 billion in October 2011, with a €17 billion drop in that month alone. 

Of course, Irish households are not repaying debt at that rate and a drop of €17 billion in one month is absurd.  The transaction data provided by the Central Bank show that loans for house purchase to the household sector declined by €319 million in October.  The €17 billion drop is on the balance sheets of the banks not the households (and is down to one of the covered banks as we have seen above). 

So what gives?  The next table from the Central Bank gives outstanding amounts (including securitised loans).  Here are loans for house purchase to the household sector.

Household Loans for House Purchase

This explains what has happened in October.  Loans for house purchase on the balance sheet of the covered banks fell but only because securitised loans increased by the same amount. 

We can see that the total amount of loans to the household sector from bank operating in Ireland stopped rising in 2008 and has been falling gradually since then.  The stepped drop at the end of 2010 is again explained by the departure of Bank of Scotland (Ireland) from the Irish market.

The Information Note from the Central Bank to the October Money, Credit and Banking Statistics gives mention of this securitisation in a footnote of page 2:

This is due to a credit institution derecognising loans from the statistical balance sheet that had been securitised, in line with the methodology applied by the reporting population in general.

Hmmm.  One the covered banks didn’t realise that it had been reporting €18 billion of securitised loans on its balance sheet that shouldn’t have been there at all.  How very reassuring.  So what did it replace the €18 billion of mortgages on its balance sheet with?  If we go back to the aggregate balance sheet data of the covered banks we can probably infer the answer.

Irish Securities held by Covered Banks

There was an €19 billion rise in the holding of securities issued by the Irish private sector.  This has risen quite significantly recently with most of the rise occurring when the banks received NAMA bonds for their developer loans in 2010.  It was largely steady for the past year until the almost vertiginous rise in October which as we have seen is as a result of “a credit institution derecognising loans from the statistical balance sheet that had been securitised”.  It now seems they had €18 billion of bonds they didn’t know about as well!

The above graph also shows that the banks hold about €16 billion of bonds in Irish banks.  It is not clear how many of these are from the covered banks or in fact if much of it is the banks’ holding of their own bonds.  The rise in the banks’ holding of Irish government bonds can also be seen and stood at €12 billion in October.  This is about 14% of the total stock of Irish government bonds.

I can’t say that there is much to be learned from digging into this non-securitised / securitised shift in October.  It is hard to say who is now carrying the risk of these loans.  It is probably a company linked to the bank as it is unlikely they would have overlooked a transaction with an external third party.


  1. Thank you for the digging.

    "This is due to a credit institution derecognising loans from the statistical balance sheet that had been securitised, in line with the methodology applied by the reporting population in general. "

    Er, doesn't this mean the bank has 18 bn fewer in assets? Wouldn't that be called insolvency in some books?

  2. I'd don't think the digging got us very far apart from learning that someone went "oops, sorry about that" and possibly even did it without the sorry!

    It looks like the €18 billion has been replaced in the reporting by a debt security from an Irish resident private sector entity. It is hard to tell what this is.

    Overall the balance sheet position remains the same as the drop in reported mortgages is offset by the rise in reported debt securities held as assets. It is a pretty amazing admission to make. €18 billion is nearly 12% of GDP.

  3. Given that no debt securities have been issued on the open market, though, one would have to assume that these were self-issued securities, would one not?

    In which case, insolvency is indeed the issue.

  4. The Central Bank removed the "self-issued" bonds from the banking statistics a few months ago so if the bank involved was using them to balance the balance sheet they wouldn't (or shouldn't anyway) appear here. Plus these bonds would be from a "monetary financial institution" but the increase is debt securities is under the "private sector" heading.

    I would guess that one of the banks packaged up a big chunk of its mortgage book and passed it on to a subsidiary or related company and took a bond in return (maybe to use as collateral somewhere). I don't think they've lost €18 billion but that is only a guess!

  5. Assets have been re-labelled "in line with the methodology applied by the reporting population in general". There has been no fall in assets, just a change of accounting treatment.

    So, why this talk of losses, insolvency etc ? What am I missing ?

    (I don't think that I am missing *anything at all* - nor is the bank in question here, if I read the story right)

  6. Hi Fergus,

    I agree. There is no risk of insolvency here. It's just a bit unusual that €18 billion of mortgages were "derecognised", albeit belatedly, in one fell swoop. As it can only be one of AIB, BOI or PTSB that is a huge portion of their mortgage loan book (probably more than half in all cases).

  7. Fergus,
    As you say, there may be no story. On the other hand, shrinking visible balance sheets by offloading underperforming assets to SPVs at par (for effectively internally generated bonds in return) is a problem that German Landesbanken found themselves with. Eventually the losses come home to roost.

    On the other hand, this could be a tricky funding arrangement whereby an overcollateralised SPV is set up to garner a decent rating and so secure commercial paper or secured funding. One would have to suspect travelling Wilburrys in this case...

    We'll have some idea who it is when the financial numbers for the banks are out.

  8. @Seamus
    "There is no risk of insolvency here."
    Ah come on, you know we're not talking about cash-flow insolvency. It is balance sheet insolvency that matters to a bank.

    The question is whether the bonds received in return represent a fair value for the mortgage security offloaded. This is a particularly acute question if it is an internally generated transaction and not a sale. If they do not (they overvalue the mortgage securities) then it is at best balance sheet window-dressing.

  9. @ yogan,

    Obviously there is a continued big risk of insolvency in the Irish banks. That's why we've given them €62 billion. But the potential losses are as a result of the underlying mortgages not this particular "transaction" which is what the "here" referred.

    When there are losses on these mortgages this transaction will not eliminate them though, as you rightly say, it may protect the balance sheet of the bank from displaying them. The losses will still exist. All in all it is very unsatisfactory and given the sheer scale of the amounts involved I'm surprised that it has generated so little attention.

  10. @yoganmahew

    AIUI, nothing has been offloaded; there has been no "transaction".

    One label has been removed. Another label has been affixed. For statistical reporting purposes.

    End of story, no ?

  11. @Fergus
    As I say, it depends on valuations. Banks use mark-to-market accounting when it suits them. When it doesn't, they use mark-to-spoof. This is part of the problem there is in banks (mostly not in Ireland at this stage). Swapping out underperforming assets at a rich value to an SPV where the liability for losses is not removed has been used to hide losses in the past.

    There's no particular reason to suspect this in the current case (see my benign explanation above), but past performance by Irish banks is a guide to present 'finesses'.

    What's important is to distinguish off-balance sheet financing from window dressing. As I say, it will take publication of financial statements before we know what's going on.

  12. The Central Bank released the November Money, Credit and Banking Statistics today. The shifts outlined here are still there with no significant changes in the month to November.

  13. @yoganmahew

    1. Which Irish bank has swapped out assets to an SPV in order to hide losses in the past ? (Please don't mention NAMA !)

    2. There is no off-balance sheet issue here. the bank in question AFAICS is just re-classifying assets which have been, and remain, ON balance sheet.

    3. Moreover, the classification appears to be simply to achieve consistency between all banks providing reports for use in compiling the Central Bank aggregate statistics. Therefore, the published balance sheet of the "covered bank" may not change - in fact, *probably* will not because...

    4. What the bank appears to have been doing up to now is *the opposite* of window-dressing. It has, all along, apparently been showing €18bn of mortgage loans due to it as, er , mortgage loans due to it, rather than as securitised bonds.The new treatment, if carried through to the published balance sheet, would in earlier times, perhaps be characterised as "window-dressing". (Nowadays, we tear away all curtains on principle).

    5. It follows, ISTM, that the stress-tests etc probably treated the €18 billion as loans rather than bonds (to the extent that the testers made such a distinction) and made their capital shortfall calculations accordingly.

    6. Perhaps the new treatment, if it is not merely statistical, may bring good news in terms of a lower need for regulatory capital for the bank in question. I am not going to hold my breath on that one, though.

  14. Hi Fergus,

    If it was a simply reclassification then the offsetting asset rise should be under the heading "monetary financial institution" which includes the bank itself. As it is the debt security which now appears on the balance sheet is from the "private sector" and in turn it can be seen that it comes from "other financial intermediaries".

    There has been some form of transaction and not just a reclassification. At this stage it is hard to tell if this is significant but I still think it is unusual that an error, such that it was, of this size was made in the first place. Here is the definition of "other financial intermediaries":
    - - - - - - - - - - - - -
    Other Financial Intermediaries and Auxilliaries (OFIs) refers to financial corporations and quasi-corporations (except insurance corporations and pension funds) principally engaged in financial intermediation by incurring liabilities in forms other than currency, deposits and/or close substitutes for deposits from institutional units other than MFIs, or insurance technical reserves. Also included are financial auxiliaries consisting of all financial corporations and quasi-corporations that are principally engaged in auxiliary financial activities. This sector includes non-bank credit grantors, investment funds, treasury companies, hire purchase companies, securities and derivative dealers and financial vehicle corporations (FVCs).
    - - - - - - - - - - -

    And for what it's worth here is the CB's definition of securitisation:

    - - - - - - - - - - -
    ‘Securitisation’ means a transaction or scheme whereby: (i) an asset or pool of assets is transferred to an entity that is separate from the originator and is created for or serves the purpose of the securitisation; and/or (ii) the credit risk of an asset or pool of assets, or part thereof, is transferred to the investors in the securities, securitisation fund units, other debt instruments and/or financial derivatives issued by an entity that is separate from the originator and is created for or serves the purpose of the securitisation.
    - - - - - - - - - - - -

    In both (i) and (ii) I think the key phrase is "separate from the originator".

  15. @Fergus
    1. Did I say 'Irish' bank?
    2. This is clearly not the case, as Seamus points out above.
    3. Yes, so it is forced rather than desired. What does this tell us about what has happened? Enforced deleveraging? Sold to an entity supported by a different classification of loans? (Bank loans SPV 18 bn in form of SPV corporate bonds to buy 18 bn in residential mortgages?).
    4. Securitised bonds don't show up as owing to the bank.
    5. I wonder what the next round of stress tests will have to say about mortgage loans?
    6. Yes, but if there is loss-sharing (!) on the new loans to the SPV, then it is a loss delayed, not one avoided.

    One may argue that more can kicking should have taken place, but having embarked on the road to loss recognition, it appears a little risky to reverse course to can kicking, even if all the other bold children in the EU are doing it.

  16. @seamus
    I am not saying that no transaction *ever* took place, just that it did not necessarily take place in September or anytime recent.

    For simplicity, let us say that Bank X has lent €50 billion to its home mortgage clients, of which,say, €45 billion is outstanding and €40 billion (say) is still deemed recoverable. At some point in time - it may have been pre-2008 - it decided to bundle some of these loans separately and hold them in another entity.

    Let us suppose that the original amount of these was €25 billion, and €19 billion of that is still expected to be repaid in full. Perhaps these are all non-tracker mortgages. (I have no idea what they are.)

    Maybe the "other entity" is a wholly-owned subsidiary of the bank, but let us suppose that it is entirely separate i.e. the bank owns no part of it.

    So, the bank moves that bundle into the other entity. As we are assuming the other entity is "independent", there has to be a price paid by the latter. Some of it may have been cash, but I will assume all of it to have been in the form of bonds.

    So now, the bank's balance sheet has about 50% less mortgage loans. It also has a bond where no bond was before, of an equivalent amount, unless the bond is less secure. (If it is less secure, the explanation given for the re-classification would be deliberately misleading: does anyone believe that possible just now ?) The *balance sheet total* is unaffected, taken as a whole, but the *total loan balances* reported in the statistical returns to the Central Bank should, on the face of it, have fallen.

    Why did they not, until this Autumn ? I have no special information on this, but my surmise is that the bond transaction was so structured that the bank continued to bear a large share of the credit risk. (It almost certainly still administers the loans in every way.) So much so, that the bank considered it more accurate to treat the mortgages as still "its own".

    Of course, if the "other entity" is entirely owned and controlled by the bank, this would apply even more forcefully.

    Why, then, would the bank have bundled these loans separately at all ? If that is what happened, I can only speculate fruitlessly. It seems to me more likely that the loans in question were in fact made by the "other entity" from the start, and that the bank considered it more accurate to report its advances to that entity as mortgage advances. But that is only speculation.

    Whatever really lay behind the previous treatment, for some reason it changed in September 2011. The reason given suggests that it was a matter of consistency - other banks with similar arrangements were not treating the bundles in the separate entities as part of their mortgage loan portfolios.

    Only by examining all the arrangements can one say whether the consistency is good or bad, but it seems unlikely to me in the current climate that the bank which has now re-classified such a large amount from a relatively clear designation to a less clear one did so voluntarily.

    In other words, I suspect that it suited the authorities' presentational agendas.

    But nothing "real" has changed, or happened. IMHO, of course.

  17. @yoganmahew

    Reclassifying €19 bn in loan assets as bonds moves them out of the loans category; it does not move them off the balance sheet.

    The assets do indeed "still show up as owing to the bank". A bond is merely a different kind of loan.

    Nothing in what Seamus has reported necessarily means that "can-kicking" has replaced loss-recognition.

    However, a statement from the Central Bank would be welcome.

  18. 1. I should not have, in my last comment, made any reference to the issue of recoverability of loans, as the figures in the relevant returns are stated to be gross of impairment provisions.

    2. The month of the change was of course October 2011, not September.

    3. We don't know the exact amount involved, but €18 billion is probably a better figure to use than €19 billion.

  19. @Fergus
    3. Er, it was you who introduced the 19 bn figure... know a little more about this than you care to mention?

    "The assets do indeed "still show up as owing to the bank". A bond is merely a different kind of loan."
    Yes, they show up as a different category of loans, though. Is there a new stress test on the way? With higher haircuts for mortgages? (Particular classes of mortgages for example?).

    Given that Irish banks have to hold 12%ish of assets as capital (roughly speaking and subject to risk weighting), does a move to a thinly capitalised SPV not reduce the capital requirement of the bank substantially?

    PS I agree with you about arms length, but holding the risk of the bonds and perhaps also, as I said, a first-loss risk - some of the SPV bonds are effectively subordinate/mezzanine/equity.

  20. @yoganmahew

    Ha ! I have no information on this that does not come from Seamus and the sources he cites.

    I really do not know which is the more accurate figure, but I notice that Seamus first referred to a drop from 294 to 275, then from 178 to 157 and other figures showed differences of about the same. However, he started to use €18 billion then and stuck to it, as did you. It's probably better to standardise at the former, despite the reference to "an €19 billion rise in the holding of securities issued by the Irish private sector".