Housing prices playing a housie game !

Peculiar trends spotted in the US and UK housing prices released last week. While both the indexes recede from previous month levels, UK housing index declined consecutively for fifth month end of Nov-10.  Whereas, US housing index  shows a new declining trend after the government stopped paying people to buy houses earlier in the year. It may be too early to comment on double dip in US housing prices though !

The fall from historic peak levels in both these matured housing markets are quite significant, but it was steeper in case of US (28.6%) compared to UK (12.2%). Talking about recovery in the housing prices from March' 2009 lows, UK ranked over US residential market, albeit  the latter was showing signs of sustained property market recovery.

The probable repercussions from these housing trends can be 1) fall in housing demand but an increase in supply of homes causing mismatch; 2) further fall in bank loan volumes 3) loan interest spreads may remain flat or decline thereby reducing net interest margins for banks and finally 4) continued weak demand may put downward pressure on housing prices.

Intercutting Spain-Ireland-Greece (EU bailouts severe than Euro crisis)

Will it be Spain after Ireland & Greece ?

Spain economy operates on a two-tier banking system which is quite different from the other Euro regions. At one end are the strong Spanish banks like Banco Santander, BBVA and Banco Popular Español that have a diversified presence in Euro-zone and at the other end are 'Cajas' or unlisted Spanish savings banks that account for about half of the country’s banking system. Cajas had amassed unwanted real estate on their books, that eventually led to rise in bad loans and their downfall; when the Spanish housing bubble burst. Two Cajas were seized by Bank of Spain on the verge of collapse whereas others are still undergoing restructuring. 

The big picture is that the top quartile banks weathered the downturn using accumulated general provisions and also able to raise wholesale funds from the market, smaller savings banks like Cajas remained under distress. A recent Bank of Spain regulation tightened rules on provisions Spanish banks have to make against real estate exposures on their balance sheets, which resulted in additional provisions of roughly 20-30 bps on risk-weighted assets. Further, as per publicly available sources, in the year 2010, estimated property assets on balance sheets of Cajas (€ 45 bn) were higher compared to Spanish banks (€ 22 bn). As a result, Cajas are more susceptible to systemic problems in Spain. This explains how the top Spanish banks are distinctive from the vulnerable Irish banks when the latter fell into the clutches of government hands.

On a macro-level, the real problem of Spain is high level of unemployment (about 20%). Nevertheless, the recent spurt in the Euro-denominated Spanish bank bonds spreads to a record 147 bps is suggestive of refinancing issues. It led to an increase in the debt spreads of strong Spanish banks but still they have reason to repose; unlike small savings banks. The much-expected consolidation in the Spanish banking sector may be round the corner as it provides enough opportunities for top Spanish or international retail banks to take over smaller ones. Simply speaking, top Spanish banks are still safe, while we must continue to look into the developments in other Euro regions especially Belgium and Italy where primarily regional banks like KBC, Dexia, and Uni-Credit dominate. 

Ireland heaves a sigh of relief ! (bailed out similar to Greece)

Ireland was bailed out by EFSF (The European Financial Stability Facility) for Euro 85 billion

The trouble in the Irish banks surfaced the G-20 Seoul summit talks yesterday. Allied Irish bank (ALBK) and Bank of Ireland (BKIR), top two in that region, are down by 75% and 60% on YTD basis respectively. They currently trade somewhere near to March 2009 lows taking backseat in global banks. Both the financial models have undergone structural transformation in demarcating toxic and illiquid property assets from its core banking franchise. It involved tranche-wise disposal of impaired assets to NAMA (National Asset Management Agency) at record discount levels ranging from 30 – 60% to its carrying value (the latest ALBK’s tranche discounted at 60% on 8-Nov).

The present performance of these two Irish banks seems to have falsified their EU stress test results. Core capital levels continue to be impacted by increased credit loss provisions at a high end range of 3-4% of their risk weighted assets. ALBK’s core capital level is virtually 0% and BKIR at 7% mainly because it had converted a part of Irish government’s preferred stock into equity and also from rights issue. ALBK has proposed equity capital rising in Nov-10 including part conversion of government preferred stock, the completion of which, would increase core tier 1 to 5%.

To sum up, the growing uncertainty in Irish economy, in particular its property market can have serious repercussions on two key things – one is the discount factor for NAMA transfers and secondly bank’s provisioning for credit losses. Net-net the result is loss-making banks and their declining core capital levels.  Investors are demanding 5 yr CDS spread of 1150 bps for ALBK, which is almost double the previous high of 600 bps in March 2009. One concern that market has about the ability of the Irish government to bailout anymore banks after it already bailed out Anglo Irish Bank during the current crisis. Albeit, other key areas of concern for these banks are high loans/deposits ratio (about 140%), low coverage rates (below 0.5x) and high efficiency ratio (above 60%).