Goodbody chief economist: Dermot O’Leary comments: Economic View; Roll on 2010 - - "Statistics can be used to prove a lot of things. In this regard, yesterday’s Q3 national accounts can either be taken to signify, technically at least, that the Irish recession has ended or that the domestic economy continues to contract sharply. Our own interpretation of the data is that we have now passed the most severe point in the recession, but that it would be premature to call an end to it (even though we might need some cheer ahead of Christmas). The facts speak for themselves. Although GDP did increase by 0.3% qoq in Q3, seasonally-adjusted, if we strip out multi-national profits to arrive at the GNP estimate, we find that it contracted by 1.4%, with all components of expenditure – consumption, investment, government spending, exports and imports – in negative territory.

On an annual basis, GDP fell by 7.4% in Q3, while GNP declined by 11.3%. Moreover, the fall in output has already reached record levels, with GDP down by a little more than 10% from the peak and GNP down by over 15%. In current terms, the drops are 15% and 20%, respectively. More important than these numbers though is where the economy will go in 2010. Yesterday’s numbers do not change our view that the economy will contract once again next year, albeit at a much slower pace than the annus horribilus in 2009. Investment activity, led by the continuing decline in the construction sector is expected to fall by 20%, while recent government cost-cutting will also subtract from growth.

The biggest swing variable is consumption, where falling employment (confirmed by this week’s data), along with full-year effects of tax increases and falling wages, we believe, will lead to a further contraction of 2%. Net exports will, once again, contribute to growth as it has done over the past number of quarters. We remain comfortable with our projection of a fall in GDP of 1% next year, but we would also caution on exiting this year despondent. We have known for some time that a sharp contraction in output was in store. We have also known that actions had to be taken to get the country out of this appalling vista. With real action being taken to tackle the problems in the public finances, developments also afoot in the form of NAMA to address the banking issues and falling costs restoring some lost competitiveness, the foundations have at least been laid for a recovery in the Irish economy."

Goodbody's Anna Lalor comments: Irish Financials; Basel Committee consultative documents on capital and liquidity - - "The Basel Committee (BIS) yesterday released two consultative documents on the measures it proposes to implement to “strengthen the resilience of the banking sector”, being proposals, these may change by the time they are finally set as standards. It does not, at this stage, provide its estimates of target capital levels, with these expected to become clearer later next year following the impact assessment of its proposals that it intends to carry out in H110. Some of the proposed measures appear to be in their early stages and have yet to be fleshed out, however, there are a number of areas where BIS’s thinking appears to be quite well advanced, namely on; (i) the components of equity tier 1 capital; (ii) counterparty risk measures and; (iii) standardised liquidity measures for both financial institutions and regulators. It plans to have the final standards set out by end-2010, with phased implementation by 2012 (depending on the outcome of the impact assessment and if “economic recovery is assured”).

On capital, the BIS proposes a simpler structure composed of Tier 1 (going-concern) capital, of which common equity must be the predominant form, and Tier 2 (gone-concern) capital. Innovative Tier 1 capital securities are to be phased out. The BIS will set minima for ratios of Common Equity Tier 1, Tier 1 capital and Total capital to risk weighted assets. The proposed definition of common equity (or equity tier 1) excludes any items that the BIS believes would not necessarily be realisable were a bank wound up, but that are included in the current equity tier 1 calculation. These include: minority interests; unrealised gains and losses on debt instruments, equities, own use properties and investment properties; cash flow hedge reserve (appears it relates to projected off balance sheet cashflow hedges); deferred tax assets (which rely on future bank profitability to be realised, so not clear how much of current net deferred assets on the banks balance sheets would be excluded); treasury stock; investments in the capital of certain banking, financial and insurance entities which are outside the regulatory scope of consolidation; the shortfall of the stock of provisions to expected losses (currently deducted 50% from Tier 1 and 50% from Tier 2) and; net defined benefit pension liabilities. It looks like the treatment of Life entities may change, but it is not 100% clear at this stage what the implications are for IL&P (by which time it is likely to be two entities) and BOI. These proposed changes to the components of equity tier 1, are likely to impact the minima to be set by BIS post the impact assessment, which makes the current market targets of 7-8% equity tier 1 capital levels (including a buffer over some assumed minimum) less clear. However, in the meantime, we can expect the market to focus on banks being well capitalised on the existing equity tier 1 calculation.

So what are the most significant potential impacts for the Irish banks on this new Common Equity calculation? Over time, we can expect AFS and cashflow reserves to normalise to zero (given the maturity profile of the mainly debt instruments and the increased focus of holding higher quality liquid assets). The more significant issues relative to the current calculation of equity tier 1 capital are: (i) the deduction of the net defined benefit pension liability (presumably an issue for many banks internationally); (ii) the deduction of net deferred tax assets (probably a larger relative issue for the Irish banks, given the scale of losses being incurred this credit cycle and the upcoming NAMA losses - AIB and BOI estimate at deferred tax asset on the Government guided 30% haircut of €757m and €582m, respectively); (iii) the deduction of minority interests and investments in other financial institutions (which potentially has an impact for AIB with its minority interest in BZWBK and investments in M&T, BACB and Hibernian Life, which also gives it a potentially greater benefit from the sale of M&T and/or BZWBK in a “new Basel” situation) and; (iv) it is unclear at this stage what the potential impact of owning a life business may be for the equity tier 1 calculation.

The BIS among other measures, has also proposed changes to counter-party risk weighting (with an incentive to move to central counterparties), the introduction of a back-stop leverage ratio, the build up of capital buffers, more powers for regulators in relation to the payment of dividends, a potential capital surcharge for systemically important institutions and measures to reduce or counter pro-cyclicality. On liquidity, it has outlined two key ratios for banks: (1) a shorter term Liquidity Coverage Ratio, which measures the amount of high quality assets a bank have to cover net cash outflows in n acute short term stress scenario and; (2) a longer term Net Stable Funding Ratio, which is “intended to promote longer term structural funding of banks’ balance sheets, off-balance sheet exposures and capital market activities”."

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