Consolidated Loan Liabilities

The release on Thursday of the 2011 Institutional Sector Accounts by the CSO gives an insight into the financial stocks (assets and liabilities) and non-financial flows (income, consumption and savings) of the main sectors of the economy.  One addition to this year’s release is the inclusion of ‘consolidated’ tables for the financial tables.  As the release says:

This year both consolidated and non-consolidated tables are presented for the first time for the Financial Accounts.  The consolidated analysis allows a clearer view of transactions and balance sheet positions between institutional sectors. Transactions between entities in the same institutional sector are netted out in this consolidated presentation.

The end of year (consolidated) stock of financial assets and liabilities is shown excluding stocks which exist between units within the same sector. This view of the accounts can be very useful when analysing financial instruments such as loan liabilities as the consolidated view removes inter-sectoral balances.

Here are the consolidated debt liabilities of the household, government and non-financial corporate sectors at the end of 2011.

The differences between the non-consolidated and consolidated figures for the household sector are zero, while there are about €5 billion of extra liabilities on the government’s non-consolidated accounts (likely related the Housing Finance Association).  

The big difference is for the NFC sector where the consolidation reduces the liability figure by €45 billion.  These are liabilities owed by the resident NFC sector to other counter-parties in the resident NFC sector, i.e. domestic intra-company loans.

A recent table from the IMF which included the following 2012 totals for the gross, non-consolidated debts of the three sectors as a percent of GDP got a lot of attention, including in The Wall Street Journal.

• Household: 117%
• NFC: 258%
• Government: 118%

It can be seen that the figures for the household and government sectors reconcile roughly with those in the above table.  The 2012 deficit and return to bond markets of the government sector explain the increase that will be seen in 2012.  The figures that can’t be similarly reconciled are those for the NFC sector.

The 258% of GDP figure used by the IMF is a much greater than the 168% of GDP figure consolidated figure now provided by the CSO.  Some of the difference is due to the consolidation that removes domestic intra-sectoral balances.  It is also the case that the CSO have revised down the earlier figures. 

When they first reported the 2010 non-consolidated loans figure for the NFC sector it was €337 billion.  In this year’s release that figure has been revised to €298 billion.

It will also be the case that a significant proportion of the consolidated loan liabilities of NFCs are to the Rest of the World - predominantly the borrowings of foreign multinational
corporations resident in Ireland.  Thus the 168% of GDP figure in this week’s release is still an exaggeration of what might be considered “Irish” corporate debt, which is some level less that 168% of GDP.

According to data from the Central Bank lending from Irish-resident banks to Irish-resident NFCs peaked at €175 billion in the third quarter of 2008, of which €115 billion was to property-related sectors.  The lending to the property-related sectors is a mess and huge amounts of it won’t be repaid.  Transaction data shows that the €60 billion of non-property related lending to Irish NFCs has declined by the €6 billion in the interim.

The figure for “Irish” NFC debt will be high at the moment but it is still the case that much of the NFC loans are delinquent property-related loans that will not be repaid.  A large portion of these remain to be resolved but this process will reduce the NFC debt figure.

This process also means that the total of household, government and NFC debt results in some double-counting.  There are around €50 billion of property-related loans now controlled by NAMA in the NFC figure and the government loans figure includes the €25 billion of Promissory Notes to the IBRC to cover the losses on these loans. 

Either the developers will repay the loans they have taken out (they won’t) or the government will repay the Promissory Notes (they will).  They won’t be paid twice.  The government debt figure also includes monies for the recapitalisation of the pillar banks.

The most recent recapitalisation from March 2011 provided money to cover losses on household and business lending that the banks will incur before the end of 2013.  This has added to the government debt figure but when these inevitable losses are (eventually) resolved they will reduce the household and NFC debt figures.

Both the household and Irish NFC sectors have seen reductions in the amount of debt they are carrying for the past four years.  This process will continue through repayments and the eventual writing down of unpayable debts.  The ongoing deficits mean that the debt of the government sector continues to increase.

Ireland has a massive debt problem, and this top-level analysis does not reflect the huge difficulties faced by individual households and businesses, but the problem is not intractable.  The level of debt is probable somewhere around €500 billion.  This is three times GDP and four times GNP.

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Defusing ‘The Mortgage Timebomb’

In this weekend’s Sunday Business Post, commentator David McWilliams has an article under the title “It’s time to defuse the mortgage timebomb”.  The piece concludes with:

“In addition, the longer this goes on, the more the banks become zombie banks incapable of breathing credit into the market.  A deal must be done right now.

The banks set aside €16 billion in the last capitalisation round to cover bank loans in the residential market.  Taking the total mortgage lending book of €112 billion, the implied total default on the entire book is where we are now in terms of arrears, 16 per cent.  However, not all these arrears will be total write-offs, so there is enough cash in the tank now to do a debt for equity at 50/50 right now.  The gives the punter a break and the bank an upside option over time.

But maybe the reason the banks have been tardy in moving – after all, they were dressed down by the Central Bank last week – is that they think €16 billion isn’t enough.  If it isn’t, we need to go back to Frankfurt and come up with a figure that covers all bases and say to the ECB: “We need more cash and you will have to cough up”.

We know the Germans need a success in Ireland.  We know that we can only have success if the total banking problem is solved, and we know that the pending mortgage crisis has not been addressed yet.

Wouldn’t it be sensible to put it all in one big bang solution?”

The trouble with “big bang” or soundbite solutions is that they are rarely effective for complex problems.  At the top-level it seems the problem in the residential mortgage crisis is simple – too much debt – but there are a number of subtle complexities that mean top-level solutions will be ineffective.

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Meeting the fiscal targets

The eighth quarterly review of the EU/IMF programme for Ireland was concluded last week and once again Ireland was praised for steadfast policy implementation and the expectation that fiscal targets will be met once again.  Statement here.  The general government deficit targets for 2011 to 2013 are

• 2011: 10.6% of GDP
• 2012: 8.6% of GDP
• 2013: 7.5% of GDP

At the conclusion of the sixth review back in April a statement released by the Department of Finance said that:

“We are pleased that we have met our targets, all measures have been implemented and the programme is on track. This successful outcome illustrates, once more, the ability and the commitment of the Irish State to implement a challenging programme effectively.

Economic data released since the last Troika review in January has shown that the Irish Economy has returned to growth in 2011, the first time since 2007, our underlying deficit for 2011 is 9.4% - significantly ahead of the target of 10.6%, our tax take is growing and we are on track to meet our 8.6% deficit target in 2012.”

Last week the Department’s statement was equally ebullient:

“The programme remains on track and we continue to meet all of our targets. We are confident that the headline deficit targets of 8.6% of GDP will be achieved in 2012 and we remain fully committed to reducing our deficit to below 3% of GDP by 2015.

Back in April there was delight that the “underlying” deficit was below the 2011 limit.  By September that delight was that the “headline” deficit would be below the 2012 limit.  The deficit is falling (albeit slowly) but I wonder what deficit measure will be used to ensure we are below the 2013 limit?

It should also be noted that the March statement said “our underlying deficit for 2011 is 9.4% - significantly ahead of the target of 10.6%”.  What was the deficit target set at the time Budget 2011? Among other places, the answer can be found in the third paragraph of page 12 in The Economic and Fiscal Outlook released with the Decemeber 2010 budget:

“The measures being introduced in Budget 2011…will reduce the General Government Deficit to 9.4% of GDP.”

The 10.6% limit comes from the December 5th 2010 Council Recommendation to Ireland under the Excessive Deficit Procedure which set out the deficit limits for each year out to 2015 by which time Ireland has to bring the general government deficit under the Maastricht limit of 3% of GDP.  Budget 2011 was a couple of days later but as the late Brian Lenihan said in his budget speech:

In the National Recovery Plan, we have set out the timetable for achieving this adjustment over the next four years. These targets are reflected in the Joint Programme of Assistance. Because the European Commission has more conservative forecasts for the medium-term, we have been given an extra year to reach the 3% deficit target required under the Stability and Growth Pact. But this changes neither our targets nor our timetable for reaching them.

The Department of Finance deficit target for 2011 was 9.4%.  As the recent Maastricht Returns Information Note has shown the actual 2011 deficit was 13.4% of GDP, but excluding direct payments to the banks the deficit was 9.1% of GDP.  As pointed out previously this does not exclude direct receipts from the banks.  This 9.1% of GDP deficit is below the 9.4% of GDP budget day target. 

There was never a deficit target of 10.6% of GDP that we could be “significantly ahead of”.

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Some quirks of national income accounting

In 2011 real GDP was 6.8% lower than the peak recorded in 2007.  In 2010 prices, real GDP was €170.4 billion in 2007 and was down to €158.7 billion in 2011.  With net exports making a positive contribution to GDP growth over the period the collapse in the domestic economy is masked in the headline fall in GDP.

Sometimes when trying to find patterns in the data one discovers some of the ‘quirks’ of national income accounting.  This graphs shows subcategories from the ‘Consumption’ and ‘Investment’ components above which contributed to the rise and fall of GDP over the past decade.

Neither are major components of GDP.  In 2007, their total made up just 5% of GDP but by 2011 they provided just 3.2%, indicating a faster fall than for the overall GDP number over the period.  Here is a chart of them in nominal terms where the collapse in the ‘investment’ category is even more accentuated.

The component of consumption is ‘expenditure outside the state’ and is spending by Irish residents on goods and services that takes place outside of Ireland.  This is a contribution to GDP as consumption is defined as:

Final consumption expenditure consists of expenditure incurred by resident institutional units on goods or services that are used for the direct satisfaction of individual needs or wants or the collective needs of members of the community. Final consumption expenditure may take place on the domestic territory or abroad.

Since 2008, real expenditure outside the state by Irish residents has fallen 32%.  Spending less money abroad may mean more money available for expenditure in Ireland.  The drop in household income means this substitution is not happened and consumption expenditure by Irish residents in the state is also falling. 

Still, it is somewhat noteworthy that the drop in something which would expect to harm other economies (where the spending was happening such as places like this) is actually recorded as part of the drop in Irish GDP.  Opposed to that, it can be said that less spending (regardless of where it happens) means less consumption of goods and services which means less satisfaction and well-being for people.

The fall in the subcategory of investment included in the graph has been even more dramatic and since 2006 in real terms is down 86%.  The ‘costs associated with the transfer of land and buildings’ include conveyance and other professional costs of property transaction as well as estate agents’ fees.  However, the biggest item in this was Stamp Duty.  The definition of gross fixed capital formation says:

3.111 . For both fixed assets and non-produced non-financial assets, the costs of ownership transfer incurred by their new owner consist of:

a) charges incurred in taking delivery of the asset (new or existing asset) at the required location and time, such as transport charges, installation charges, erection charges, etc.;

b) professional charges or commissions incurred, such as fees paid to surveyors, engineers, lawyers, valuers, etc., and commissions paid to estate agents, auctioneers, etc.;

c) taxes payable by the new owner on the transfer of ownership of the asset.

In 2006, the ‘costs associated with the transfer of land and buildings’ was €4.5 billion in nominal terms.  The amount of Stamp Duty collected from land and property in the same year was €3 billion.  Unsurprisingly, this has collapsed since and in 2010 just €0.2 billion of Stamp Duty was collected from land and property transactions, a drop of more than 90%. In 2011 the ‘costs associated with the transfer of land and buildings’ contributed less than €0.4 billion to GDP.

Perhaps surprisingly, Stamp Duty from all property transactions is included in GDP.  In general, second-hand house sales do not contribute to GDP as the purchase of the asset by the buyer is offset by the sale of the asset by the vendor.  Sales of new houses do add GDP as there is a net addition to the capital stock and the collapse in purchases of new homes by the household sector accounts for much of the 55% drop in real investment seen over the past four years.  However, Stamp Duty and related transaction costs from all property transactions are included in GDP.

Since 2007, real GDP has fallen about €12 billion in 2010 prices.   Using the same prices, real total domestic demand has fallen by about €33 billion (driven by the collapse in investment with smaller falls in final consumption expenditure and net government expenditure on goods and services).  

From the above charts we have seen that around €3.5 billion of this real drop (equivalent to 30% of the fall in GDP and 10% of the drop in total domestic demand) is due to Irish residents spending less money on consumption outside of Ireland and the virtual collapse in Stamp Duty liabilities from land and property transactions.

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The ‘Underlying Deficit’ and the banks

This week the Department of Finance have released the Autumn Maastricht Return and a useful information note which includes this table.

Ireland entered the Excessive Deficit Procedure (EDP) in April 2009 and the deadline for restoring the deficit to below the 3% of GDP Maastricht Limit was subsequently extended twice.  The current deficit limits come from a December 2010 Council Recommendation and were set at

• 2011: 10.6% of GDP
• 2012: 8.6% of GDP
• 2013: 7.5% of GDP
• 2014: 5.1% of GDP
• 2015: 2.9% of GDP

It seems that the actual deficit for 2011 of 13.4% of GDP was hugely in excess of the 10.6% of GDP limit set under the EDP.  However, the information note highlights that part of the reason for the 2011 deficit was because “[a] significant amount of this deficit arises from capital injections into financial institutions that took place in July”.

The information note then presents the underlying deficit which “excludes the effect of capital injections into financial institutions in 2009, 2010 and 2011 and gives a better picture of the balance of receipts and expenditures of general government.”  This was presented in next table.

Ireland’s underlying deficit for 2011 was estimated to be 9.1% of GDP well below the 10.6% limit set under the EDP.  So using the underlying deficit Ireland “met the deficit target”.

For 2012, it can be seen that General Government Balance and the underlying deficit are the same (8.4% of GDP) as there are no planned deficit increasing capital injections for the banks this year.  With the EDP deficit limit of 8.6% it can be seen that for 2012 Ireland is in line to “meet the deficit target”.

However, direct capital injections are not the only impact the banking-related measures that have been introduced over the past few years have on the general government balance.  If one is trying to get “a better picture of the balance of receipts and expenditures of general government” then it would be prudent to remove all the temporary effects on the bank bailout on the general government balance.

We can get the impact of the banks on the 2012 General Government Deficit from two sources:

1. From the September Exchequer Statement we must include the following receipts and expenditures:

Non-Tax Revenues:

• Central Bank Surplus: €958 million (usually around €200 million)
• Guarantee Fees: €799 million
• Contingent Capital Interest: €300 million

Non-Voted Expenditure*

• Interest: some portion of national debt interest (€4,065 million to date)
• EBS Promissory Note: €25 million (no general government balance impact)

(*There is also €1,300 million for the purchase of Irish Life but that is classed as a financial transaction rather than expenditure as the Exchequer added an asset worth an equivalent amount (apparently)).

Determining how much of the debt interest that will be paid this year is due to bank bailout is difficult as borrowing is not made for specific or earmarked purposes.  We could as easily say that the bank bailout money came from Income Tax while social welfare payments came from borrowing as say the bank payments came from borrowed money. 

However, it is pretty clear that the bank payments have increased the Exchequer Borrowing Requirement over the past few years.  Here are the payments that have been for the banks from the Exchequer Account since 2009.

• 2009 – Anglo Irish Bank: €4,000 million
• 2009 – National Pension Reserve Fund: €3,000 million
• 2010 – Irish Nationwide: €100 million
• 2010 – Educational Building Society: €625 million
• 2011 – Irish Life and Permanent: €2,300 million
• 2011 – Promissory Notes: €3,085 million
• 2011 – Bank Recapitalisation Payments: €5,268 million
• 2012 – Irish Life Limited: €1,300 million
• 2012 – Promissory Notes: €25 million

The total amount of these payments comes to €19.7 billion.  Using an assumed interest rate of 4.5% this would imply an annual interest bill of just under €900 million.  There is also interest on the €3.4 billion bond that was issued in March to make this year’s €3.06 billion Promissory Note payment to the IBRC.  This will contribute €140 million to the 2012 interest bill.

It is clear that the Exchequer interest bill from the bank bailout will be around €1,000 in 2012.

Using all of the above figures it can be seen that with additional revenues of around €1,850 and additional expenditures of €1,050 million the Exchequer Balance is probably around €800 million lower than would be the case if the full impact of the banking measures was removed.

2. The NPRF performance update for the six months of the year says:

On 20 February 2012 Bank of Ireland paid a preference share dividend of €188.3m in cash.

On 14 May 2012 Allied Irish Banks paid the preference share dividend of €280m

The NPRF has received €468 million so far this year from the banks (though the AIB dividend was paid in the form of 3,623,969,972 ordinary shares.)  

All told, the effect of the banks is to reduce the 2012 General Government Deficit by around €1.3 billion.    As shown above Ireland run a 2012 general government deficit of €13.6 billion which will be around 8.4% of GDP and below the Excessive Deficit Procedure limit of 8.6% of GDP.

However, if the full impact of the banking-related measures was omitted to calculate an alternative underlying deficit for 2012 the deficit would be €14.9 billion (actual deficit of €13.6 billion less than €1.3 billion gain from the banking-related measures).  This would be  an estimated 9.2% of GDP.

This underlying deficit excluding the impact of the banks means Ireland would be in breach of the 8.6% limit set out under the Excessive Deficit Procedure.  The Council Recommendation says that:

the projected annual deficit path does not incorporate the possible direct effect of potential bank support measures.

It is not specified what this means.  It could be argued that increases in national debt interest and central bank surplus income are indirect effects of the bank support measures (but it is also the case that these roughly offset each other). However, receipts of nearly €800 million of bank guarantee fees and €300 million contingent capital (subordinated bond) interest are surely direct effects of the bank support measures and should be excluded from the EDP calculation.

If that was the case Ireland would not be below the 8.6% of GDP limit set for 2012.

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