Brendan asked me a while back to subject my suggestion (see the "Darag's proposal to exit Anglo at least cost" thread) to wind-up Anglo to analysis in the context of number in the very useful summary of Anglo's assets and liabilities Key Posts. I've finally had a chance to do so.
I've started a new thread because I'd like to reflect a broadened scope; it makes little sense to estimate the cost of a single proposal in isolation if the idea is to try to figure the best way out of this mess.
I'd like that the basis for this discussion is strictly that "we are where we are" and ignore completely past decisions. This thread (hopefully) will be about numbers only.
The figures I used previously were based on semi-remembered numbers from Anglo's published 2007 consolidated balance sheet. I guess it is not surprising that things have changed quite significantly since then which affect my analysis: particularly Anglo's repurchase of some of its own sub-debt but even more significantly NAMA.
I still have questions regarding the summary of assets and liabilities given in the other threads, but let's roll with it for the moment. I've consolidated some of the figures as a simplification.
I have to say, I do not know all the relevant numbers - in such cases I have tried to identify and highlight my assumptions and would welcome input to correct or verify them. I'm sure there is a tonne of mistakes in this but I'm hoping that with others' input, this thread could evolve into something useful. It's not just the numbers but also some of my reasoning could be faulty. I'm just hoping I haven't made a blunder as embarrassing as that made by a certain Mr Lucey recently.
But at least it might be a start. Also I've rounded the figures in many places.
Our assumptions:
Assets:
Customer loans (realistic valuation): 20B
NAMA bonds: 18B
Loans to banks: 13B
Government bonds: 3B
Bank bonds: 4B
Investments (including derivatives): 6B
Government promissory note: 8B
So the total liquidation value of Anglo would be 72B. However I'm not sure that the capital promissory note can not be counted among the other assets in the event of liquidation; I'll talk about this again below.
Liabilities:
Sub debt: 2.4B
Guaranteed notes: 7.4B
Unguaranteed medium term notes: 6.7B
Short term notes: 1.5B
Derivatives: 2.7B
Retail deposit: 15B
Commercial deposits: 12B
Other bank deposits: 9B
Central Banks: 24B
So the total liabilities would be let's say 80B.
Sunny pointed out a flaw in my previous reasoning: we can simply forget about the previous equity the government put into Anglo (4B was it?). It's gone no matter what is done with Anglo.
Now the options:
Option 1 - immediate liquidation.
Because the government has guaranteed practically all the liabilities of the bank, this means the government stepping in to cover the hole in the balance sheet.
This is the easiest to calculate - we've 80B worth of liabilities and 72B worth of assets.
So seemingly for 8B, the government could completely liquidate Anglo and ensure ALL depositors and bond holders were fully paid off. Given that we seem to be facing a huge capital injection bill (10/12 billion? please correct me here), this actually looks quite attractive (to me anyway).
However, I think there is a problem here. I'm not sure but I don't believe that the government's capital promissory note can be sold in this situation and even if it can then the state will have to stump up 8B to the purchasers. My understanding is that this note is purely to support the capital ratio of the bank and is only required if the bank is to remain operational. If it were planned to liquidate Anglo, then you there is NO need to maintain any capital reserves and I presume promise would expire (please correct me?). Actually it does not affect the numbers either way.
In effect, selling Anglo's assets would only raise 64B. So the true cost of this option would be 16B.
Summary: The benefit is that all depositors and bond holders get paid off. No fear of contagion; i.e. no transferring the problem to other state backed (directly or indirectly) institutions like the ICB or other Irish retail banks. The cost to the state would be 16B. (Anglo are claiming it would cost 27B? where did they get this figure?)
Option 2 - liquidation on/at the expiry of the guarantee.
This is where the usual process of haircuts, etc. are applied to debt holders when there is a shortfall. This is a trickier calculation than the above.
Again, I am assuming the promissory note is worthless in the event of liquidation. So we we are starting with 64B of cash from asset sales to cover 80B worth of liabilities.
How would this pan out? Sub-debtors get burned (2.4B) leaving 77.6B of liabilities to be covered without touching our 64B of cash.
Next, pending an answer to Duke's question in the "summary of liabilities" thread, lets assume that the Central Bank loans are fully collateralized so that it is impossible to realise the 64B from selling off assets without repaying them. So the ECB/ICB gets 24B. That leaves us with 40B to cover the remaining 53.6B of debts.
I'm not sure about the derivative liabilities (2.7B) but I imagine that they are closely entwined with the derivative assets so - like the repo situation with the central banks, I'm not sure the latter can be sold/liquidated without also unwinding Anglo's obligations in this regard (please correct me here). So we have to pay these off. That now leaves us with 37.3B of cash to pay back 50.9B of debt.
Unless we default on our national debt, the guaranteed note holders (7.4B) have to be paid off. Our cash pile is now 29.9B and our outstanding debt obligations come to 43.5B.
That leaves deposit holders and bond/commercial paper holders. These have to be treated equally so they get paid 68c in the euro.
The cost to the government depends on how much of this bond dept is held by state even if it is indirectly: assume that nearly all of the 9B deposits with the other banks are held by other banks covered by the government guarantee (is this realistic?). Let's say that the write-down will cost the other banks 3B which the state will have to indirectly pay for.
Summary: The cost to the state would be about 3B (on the other bank deposits write-down); individuals with deposit accounts would be hit (just under 5B); commercial deposit holders get hid for about 4B (which may hurt vulnerable businesses in this fragile economy) and institutional bond/note holders would lose 3-4B.
Option 2b - option 2 but with a compensation package for deposit holders.
This is basically the "darag" suggestion.
The government would offer a compensation package for deposit holders but the cost depends on how generous the state wants to be in this regard. The total depositor loses would be roughly 8B (commercial and retail but not "other bank" which are already accounted in the 3B cost of option 2). This gives the government some flexibility which importantly would provide some important political capital. I think 3-4B would be generous.
Summary: as above but the cost to the state would be 6/7B depending on how generous the government want to be.
Option 3 - continue to run the bank hoping a future profit stream will fill the hole.
This seems to be the option currently planned and favoured by the government. I personally am very skeptical that Anglo will discover some new profitable banking niche but even in stating this I am deviating from my own stipulation that this thread be about numbers only.
So let's try some whatifery: there's a 8B hole in it's balance sheet and it is relying on a 8B government promissory note to allow it to trade as a bank at all. It needs the equivalent of 16B in present value cash - which (being generous I think) translates to a future income stream of about 1B a year (very rough estimate - depends on the banks cost of capital - say around 6%?).
So if Anglo can generate about 1B a year in profits then it could easily service the hole in its balance sheet and provide an equity cushion to operate as a bank with a reasonable capital ratio.
The state would have to come up with a capital injection first though. Let's say it needs 8B to fill the balance sheet hole and 8B equity injection to meet capital ratio requirements (currently in the form of a promissory note). So if things went sour we are looking at writing off all this equity - the state would lose 16B of state exposure in present value terms.
Summary: the cost to state would be either zero IF the bank can generate 1B a year profits or over 16B if it fails to achieve profitability.
Conclusions.
I want to hold off making any conclusions until I have more confidence in my reasoning and numbers here.
I've started a new thread because I'd like to reflect a broadened scope; it makes little sense to estimate the cost of a single proposal in isolation if the idea is to try to figure the best way out of this mess.
I'd like that the basis for this discussion is strictly that "we are where we are" and ignore completely past decisions. This thread (hopefully) will be about numbers only.
The figures I used previously were based on semi-remembered numbers from Anglo's published 2007 consolidated balance sheet. I guess it is not surprising that things have changed quite significantly since then which affect my analysis: particularly Anglo's repurchase of some of its own sub-debt but even more significantly NAMA.
I still have questions regarding the summary of assets and liabilities given in the other threads, but let's roll with it for the moment. I've consolidated some of the figures as a simplification.
I have to say, I do not know all the relevant numbers - in such cases I have tried to identify and highlight my assumptions and would welcome input to correct or verify them. I'm sure there is a tonne of mistakes in this but I'm hoping that with others' input, this thread could evolve into something useful. It's not just the numbers but also some of my reasoning could be faulty. I'm just hoping I haven't made a blunder as embarrassing as that made by a certain Mr Lucey recently.
But at least it might be a start. Also I've rounded the figures in many places.
Our assumptions:
Assets:
Customer loans (realistic valuation): 20B
NAMA bonds: 18B
Loans to banks: 13B
Government bonds: 3B
Bank bonds: 4B
Investments (including derivatives): 6B
Government promissory note: 8B
So the total liquidation value of Anglo would be 72B. However I'm not sure that the capital promissory note can not be counted among the other assets in the event of liquidation; I'll talk about this again below.
Liabilities:
Sub debt: 2.4B
Guaranteed notes: 7.4B
Unguaranteed medium term notes: 6.7B
Short term notes: 1.5B
Derivatives: 2.7B
Retail deposit: 15B
Commercial deposits: 12B
Other bank deposits: 9B
Central Banks: 24B
So the total liabilities would be let's say 80B.
Sunny pointed out a flaw in my previous reasoning: we can simply forget about the previous equity the government put into Anglo (4B was it?). It's gone no matter what is done with Anglo.
Now the options:
Option 1 - immediate liquidation.
Because the government has guaranteed practically all the liabilities of the bank, this means the government stepping in to cover the hole in the balance sheet.
This is the easiest to calculate - we've 80B worth of liabilities and 72B worth of assets.
So seemingly for 8B, the government could completely liquidate Anglo and ensure ALL depositors and bond holders were fully paid off. Given that we seem to be facing a huge capital injection bill (10/12 billion? please correct me here), this actually looks quite attractive (to me anyway).
However, I think there is a problem here. I'm not sure but I don't believe that the government's capital promissory note can be sold in this situation and even if it can then the state will have to stump up 8B to the purchasers. My understanding is that this note is purely to support the capital ratio of the bank and is only required if the bank is to remain operational. If it were planned to liquidate Anglo, then you there is NO need to maintain any capital reserves and I presume promise would expire (please correct me?). Actually it does not affect the numbers either way.
In effect, selling Anglo's assets would only raise 64B. So the true cost of this option would be 16B.
Summary: The benefit is that all depositors and bond holders get paid off. No fear of contagion; i.e. no transferring the problem to other state backed (directly or indirectly) institutions like the ICB or other Irish retail banks. The cost to the state would be 16B. (Anglo are claiming it would cost 27B? where did they get this figure?)
Option 2 - liquidation on/at the expiry of the guarantee.
This is where the usual process of haircuts, etc. are applied to debt holders when there is a shortfall. This is a trickier calculation than the above.
Again, I am assuming the promissory note is worthless in the event of liquidation. So we we are starting with 64B of cash from asset sales to cover 80B worth of liabilities.
How would this pan out? Sub-debtors get burned (2.4B) leaving 77.6B of liabilities to be covered without touching our 64B of cash.
Next, pending an answer to Duke's question in the "summary of liabilities" thread, lets assume that the Central Bank loans are fully collateralized so that it is impossible to realise the 64B from selling off assets without repaying them. So the ECB/ICB gets 24B. That leaves us with 40B to cover the remaining 53.6B of debts.
I'm not sure about the derivative liabilities (2.7B) but I imagine that they are closely entwined with the derivative assets so - like the repo situation with the central banks, I'm not sure the latter can be sold/liquidated without also unwinding Anglo's obligations in this regard (please correct me here). So we have to pay these off. That now leaves us with 37.3B of cash to pay back 50.9B of debt.
Unless we default on our national debt, the guaranteed note holders (7.4B) have to be paid off. Our cash pile is now 29.9B and our outstanding debt obligations come to 43.5B.
That leaves deposit holders and bond/commercial paper holders. These have to be treated equally so they get paid 68c in the euro.
The cost to the government depends on how much of this bond dept is held by state even if it is indirectly: assume that nearly all of the 9B deposits with the other banks are held by other banks covered by the government guarantee (is this realistic?). Let's say that the write-down will cost the other banks 3B which the state will have to indirectly pay for.
Summary: The cost to the state would be about 3B (on the other bank deposits write-down); individuals with deposit accounts would be hit (just under 5B); commercial deposit holders get hid for about 4B (which may hurt vulnerable businesses in this fragile economy) and institutional bond/note holders would lose 3-4B.
Option 2b - option 2 but with a compensation package for deposit holders.
This is basically the "darag" suggestion.
The government would offer a compensation package for deposit holders but the cost depends on how generous the state wants to be in this regard. The total depositor loses would be roughly 8B (commercial and retail but not "other bank" which are already accounted in the 3B cost of option 2). This gives the government some flexibility which importantly would provide some important political capital. I think 3-4B would be generous.
Summary: as above but the cost to the state would be 6/7B depending on how generous the government want to be.
Option 3 - continue to run the bank hoping a future profit stream will fill the hole.
This seems to be the option currently planned and favoured by the government. I personally am very skeptical that Anglo will discover some new profitable banking niche but even in stating this I am deviating from my own stipulation that this thread be about numbers only.
So let's try some whatifery: there's a 8B hole in it's balance sheet and it is relying on a 8B government promissory note to allow it to trade as a bank at all. It needs the equivalent of 16B in present value cash - which (being generous I think) translates to a future income stream of about 1B a year (very rough estimate - depends on the banks cost of capital - say around 6%?).
So if Anglo can generate about 1B a year in profits then it could easily service the hole in its balance sheet and provide an equity cushion to operate as a bank with a reasonable capital ratio.
The state would have to come up with a capital injection first though. Let's say it needs 8B to fill the balance sheet hole and 8B equity injection to meet capital ratio requirements (currently in the form of a promissory note). So if things went sour we are looking at writing off all this equity - the state would lose 16B of state exposure in present value terms.
Summary: the cost to state would be either zero IF the bank can generate 1B a year profits or over 16B if it fails to achieve profitability.
Conclusions.
I want to hold off making any conclusions until I have more confidence in my reasoning and numbers here.
