Davy Research says that with property such a big component of Irish credit and the economy in recession, everything suggests that credit will start to shrink Irish PSC (Private Sector Credit) growth continues to look respectable on a year-on-year (yoy) basis with growth in October running at 9%. However, focusing on yoy numbers misses the turning points; month-on-month (mom) trends are therefore much more important to us at this juncture.
In October, PSC rose by €2.1bn mom (+€1.2bn in September), although ex-growth to non-bank IFSC companies (nothing really to do with the Irish economy), the rise was just €0.5bn. The latter equates to a monthly growth rate of no more than 0.1-0.2%. Mortgage balances rose by just €26m during October, while the yoy growth rate dropped to 7.6% – its lowest since 1986.
On the other side of the balance sheet, M2 (all currency and deposits including the Post Office) fell significantly mom such that the yoy rate went negative for the first time (-2.6%). It had been up 2.6% yoy in September. Resident deposits (what we normally focus on) fell in the month by 2.2% to €176.8bn. There was a bounce-back in the nonresident number of €4bn (down €12bn in September) due to the guarantee such that all deposits in the system were flat. Interestingly, the clearing banks saw big inflows in the month while the non-clearers saw big outflows.
Finfacts Reports: Central Bank says annual rate of growth of Irish residential mortgages in October fell to a 22-year low
Davy analyst Scott Rankin says that almost every factor "we can think of is putting downward pressure on credit growth in Ireland. Combined, these factors create a genuine risk that credit will start to shrink over the coming year."
Real GNP is set to decline 2% this year and 3.4% next year, and in nominal terms Davy sees output falling over 6% peak to trough. In normal circumstances, credit growth would be very limited in this kind of environment.
Property lending accounts for 62% of all credit outstanding, and this sector is in freefall.
Activity levels in the mortgage market are off significantly, with the number of mortgages issued for house purchase down 35% yoy in Q3 and 15% quarter-on-quarter. House prices are off 14% from peak, according to the ptsb index, but this index measures only what is selling. The clearing level for a typical new house today could be off 30%+.
The volume of transactions in the commercial property market is down by probably two-thirds to three-quarters. Meanwhile, the value of commercial property is down 23% from peak, according to the London-based property index firm IPD, but off anything from 30-50% on a mark to market basis.
On top of ongoing liquidity pressures, Irish banks are now under massive pressure to conserve capital in order to drive their core equity ratios above 7%.
A general move to write off loans will also reduce the level of credit outstanding.
The only factors that argue the opposite include:
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Banks' willingness to roll-up interest on property loans – be they mortgage loans but particularly property development loans. All property development loans tend to have interest roll-up as a standard feature. However, what started as "unanticipated" roll-up (i.e. interest that was not being paid down as houses failed to sell) has moved on to become "authorised" interest roll-up. The latter is where the banks restructure the loan in some way.
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However, Davy's back-of-the-envelope analysis suggests that interest rollup on development loans could be having only a marginal impact on credit growth. "If we take the €39bn that is speculative lending according to the Central Bank, one-quarter of interest roll-up on all of this at say 8% per annum (3% over LIBOR of 5%) equates to only €0.8bn per quarter. That would be around 0.8 percentage points of the 2.6% quarter-on-quarter growth seen in C&P lending in Q3," Scott Rankin says.
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Repayment rates are lengthening as cash flow dries up. For instance, out of course repayments on residential mortgages have reduced significantly as workers no longer earn bonuses etc. Whether this downward pressure is sufficient to turn the yoy rate negative is a moot point. For instance if credit fell by €0.5bn each month from here, it would be next July before the yoy rate went negative (see Figure 1).
What happened credit in prior Irish recessions?
In Figure 2 Davy shows Irish PSC growth since 1980 (the furthest back Davy can get data) in nominal and real terms. Nominal PSC growth has never turned negative on a yoy basis even during periods of recession (i.e. 1991, 1985/1986 and 1982/1983. It has, however, fallen over a period of many months.
Looking at the data in real terms (after inflation), however, credit declined during each of these recessions. In fact, from much of the early 1980s, one can see that credit was shrinking in real terms. This was a terrible period for Ireland and indeed for the banks which traded at price/books as low as 0.4-0.8x for most of this period (see Figure 3).
You can bring a horse to water…
Rankin asks what can be done to ensure that Irish credit does not shrink during 2009/2010? The first thing is that Irish banks recapitalise a process that looks inevitable now. This takes away the pressure banks have from rating agencies and investors to meet the new hurdle rate, which is a core equity ratio of 7.5% on average across Europe (see Table 2).
He says the second is to improve liquidity. The government's guarantee has already helped the banks improve their liquidity profile, and indeed AIB and BoI have tapped the senior debt markets in recent weeks though only for small bite-size chunks (€2bn each). ACS mortgage bonds also fall under the guarantee; if these could be sold onto the market, it would also help as would the government buying up MBS paper directly, he says.
