# Review of Anglo's Loan Book



## Brendan Burgess (17 Jun 2009)

I thought it would be useful to extract the key numbers from Anglo's interim [broken link removed]as of 31 March 2009. This interim statement has a lot of useful information and is worth reading directly.

We can then do an estimate of the real value of the loan book and estimate the loss.

*By Sector:*
Investment, Business Banking and Other Loans: €54.6 B
Land bank loans: €10.6 b
Development Property : €7.1 

Total Loans: €72.3

*By Asset Quality:*
Impaired Loans: €10.7 
Past due but not impaired: €12.9b
Lower quality, but not past due: €5.2b
Satisfactory Quality: €4b
Good Quality: €39B
Total €72.3 B

Provision for impairment already made: €4.9b
Anticipated further impairments: €2.6 b

Accounting rules do not allow the bank anticipate impairments arising from events after 31 March 2009.


“Two thirds of development lending is lending in Ireland and covers all phases of development from unzoned land to completed units, some of which are contracted for sale or pre-let.

Development exposure, both residential and commercial, represents half of the total impaired loan balance with 30% of the total land and development portfolio impaired."


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## Brendan Burgess (17 Jun 2009)

No one knows the real value of these loans because we can't predict the future. 

But it says that it has €39 billion of "good quality loans". I imagine that these have a low loan to value and that the borrower is making the repayments. They are probably also secured on other valuable assets. 

They have €17.7 billion of loans on development property. If  we assume that they lent at 80% LTV originally, then this development property was worth €22 billion. 

"30% of the total land and development portfolio impaired"
That seems low.

Development property has probably fallen 70% from peak to now. But only a small proportion of the lending would have been done at the peak. So let's assume a 50% reduction in the value of the property. That brings it down to €11 billion.  So the loss would be around €7 billion. But some of this would be secured or guaranteed by other assets, so let's say that the loss will be €5 billion. 

Most businesses are struggling at the moment, but most are actually paying their rent. So most investment properties are ok. They may in many cases be worth less than the outstanding mortgages, but if they are covering their rent, then they are ok. Let's charge 10% against non development loans, so that would be €6 billion. 

So total loan losses would by my estimates be €11 billion which is higher than their estimate of €7.5 billion, but it is of the same rough order.

This means that the loan book is worth €61 billion, which is a lot more than the €35 billion estimated by Brian Lucey. 

Of course, no one knows. And if property values fall further and if economic conditions deteriorate further, then the €11 billion will be too low.

Brendan


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## onq (17 Jun 2009)

I understand you may want to review only the figures you presented here, Brendan, but you included the link to the report and it all seems to be on-topic.
May I draw your attention to p.35 of the Report, Section 14: this refers to a "Total Derivatives Figure" of "217,453" located under the  Column headed "Contract Notional Amount €m"

This suggests the amount of derivatives is over €217 billion.
This figure seems to be presented separately from all other figures.
It totally dwarfs them and I cannot assess it in terms of its potential liability.
What, in your or anyone else's opinion, is the possible implication of these derivatives for Anglo Irish Bank's situation?
Given the relative lack of hard data on the loan amounts and the scale of the derivatives figure, I think this is a very important issue to address.

ONQ


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## Brendan Burgess (17 Jun 2009)

Hi Ong

Initially, I thought that was  a misprint and that they meant millions, not billions.

On rereading the note and the accompanying text, it seems that the asset value is €4.7 billion and the liabilities are €4 billion. 

I don't think that the €217 billion notional value is that relevant, but I do not understand these products very well. I gather that most of them are used to hedge against risk in their mortgage and deposit book. 

I think that they have stopped trading in them.


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## z109 (17 Jun 2009)

Brendan said:


> Hi Ong
> 
> Initially, I thought that was  a misprint and that they meant millions, not billions.
> 
> ...


The €217 bn is the total derivative book.

About €27 bn is for hedging purposes.

The remaining €192 bn is a trading book. That is the buying and selling of contracts, mostly interest rate swaps, for speculative purposes.

The real worry, to my mind, is the contracts they have sold. We have no breakdown of the balance of the book, so we don't know if they were chasing interest rate movements and failing to hedge what they were selling. To use M. Trichet's word, the movement in interest rates has been 'brutal' in the last two years. During that time, Anglos trading derivative book increased by 70% each year (from €100 bn to €170 bn by the end of 2006 and from €170 bn to €254 bn by the end of 2007). Anglo used to provide a breakdown of their trading book (for example in the 2005 accounts), but strangely they stopped doing this at it started to increase massively.

Compare the notional size of Anglo's book with that of INBS, for example. INBS only does hedging. Given that derivatives have accounted for a fair part of the damage done to the financial system and that we can see that Anglo is not noted for its genius in other areas, are we to suppose that their derivatives desk is staffed by market beating magicians?

edit: the fair value in the asset and liability accounts is modelled by the same methods that said that Subprime RMBS were a good investment...


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## North Star (17 Jun 2009)

Guys you assume that the derivatives are a liability. The mark to market could be positive and this will be an asset. INBS are probably not the best comparrison perhaps use AIB or BOI and adjust for balance sheet size.


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## Brendan Burgess (17 Jun 2009)

Hi North Star

I don't think that people are assuming it is a liability. They are assuming it is a risk. 

And as Yog says, I would not be happy to let the Anglo guys gamble with my money.

Brendan


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## z109 (17 Jun 2009)

I used INBS as an example of what a small bank-like operation should be doing.

Anyway, AIB has a derivative book of €260 bn notional value at the end of 2008 on €182 bn assets. A ratio of 0.7

BoI have €194 bn assets (end 2008), but the page in their annual report that shows their derivatives is missing:
[broken link removed]
(My conspiracyometer is on overtime at the moment... )
but the breakdown is there on P.207 €394 bn notional amount. Giving a ratio of 0.49

Anglo have €217 bn derivative book on €88.5 bn assets (2009 Interim statement). A ratio of 0.41

My concern is, as AIB put it in their accounts:


> Derivatives are measured initially at fair value on the date on which the derivative contract is entered into and subsequently
> remeasured at fair value. Fair values are obtained from quoted market prices in active markets, including recent market transactions,
> *and from valuation techniques, and discounted cash flow models and option pricing models as appropriate.* Derivatives are included in
> assets when their fair value is positive, and in liabilities when their fair value is negative, unless there is the legal ability and intention
> to settle net.


It is the modelling of value that I have worries about.

Also note that the derivatives section of the PWC report was considered too sensitive to release...

Also please have a look at P.208 of the BoI Annual report and tell me what you think it means?
[broken link removed]


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## onq (17 Jun 2009)

Brendan, when I saw that figure first I thought it was millions as well and I re-read it a few times before going off and checking out the scale of the other figures in the report.
However comments about the Big Four American banks exposure to derivatives on http://www.globalresearch.ca/index.php?context=va&aid=12053 informed my review and so I realised the figure was what it was.

[Please note I'm not standing over or promoting comments made in this article, merely referring to it to show that Derivatives figures for the Big Four American banks also seem to be dwarfing the other amounts in their balance sheets.]

yoganmahew, your comments about the contracts entered into and the models used to establish the derivatives' values summarize my concerns also.


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## thehill (18 Jun 2009)

Brendan said:


> No one knows the real value of these loans because we can't predict the future.
> 
> ...
> 
> So let's assume a 50% reduction in the value of the property. That brings it down to €11 billion. So the loss would be around €7 billion. But some of this would be secured or guaranteed by other assets, so let's say that the loss will be €5 billion.


 
Brendan, 

A layman's point if you don't mind.  You acknowledge you cannot tell the future but surely there is a point to be made that these figures are all just estimates because if €11 billion worth of property were to flow into the market over a period of the next few years this in itself would have an effect on the value of property.  An increased supply would cause the value of property in these sectors to fall.  So in the end for all the talk of politicians and economists, short of hiring people who can actually see into the future there is nobody who really knows how this mess will pan out.


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## North Star (18 Jun 2009)

The size of the derivative book can be a function of many things including trading style. An actively traded swap book would have a very large notional size but the actual risk could be very low if the positions were matched. Accepting concerns about fair value accounting etc; if you are trying to get a handle on the risk Anglo is or used to run on their interest rate trading, I would look at their VAR (Value at risk numbers). As we all know the biggest risk in their business model were credit and liquidity risks, I dont think interest rate risk was or is a significant contributor to the banks downfall.
I agree with all concerned that a new transparent business model with a higher level of regulation is required.


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## onq (18 Jun 2009)

North Star said:


> I agree with all concerned that a new transparent business model with a higher level of regulation is required.



I didn't say that.
[not in this thread anyway]

The freedom offered by a capitalist free market leads to crashes on a regular basis. Every correct judgement or business call teeters on the brink of error. The best are the best because they exist on the ragged edge. 

As anyone who's ever tried to cycle will tell you, it takes practice, but then you feel like you can do it forever, until the conditions change - tyre bursts, hit a rock or kerb, other vehicle, black ice et cetera.

Now there is no recovery from black ice, none. You go down, period. That doesn't stop people cycling though - that's human nature.



Deciding on what kind of regulation and the level of regulation is the tricky bit. Remember that Anglo was the darling of the Irish business world until it crashed, and AIB are only as exposed as they are because they chased Anglo harder than BOI did, by their own admission.

So more regulation may not be the answer.

ONQ


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## z109 (18 Jun 2009)

North Star said:


> The size of the derivative book can be a function of many things including trading style. An actively traded swap book would have a very large notional size but the actual risk could be very low if the positions were matched. Accepting concerns about fair value accounting etc; if you are trying to get a handle on the risk Anglo is or used to run on their interest rate trading, I would look at their VAR (Value at risk numbers). As we all know the biggest risk in their business model were credit and liquidity risks, I dont think interest rate risk was or is a significant contributor to the banks downfall.
> I agree with all concerned that a new transparent business model with a higher level of regulation is required.


See VaR is one of the things I have a problem with too. It is also a model! So they model the damage their models will do by using a model? Is this why they have 25 sigma events?

If you were planning in 2006 on hedging your interest rates, or better still, making money on people betting theirs three years out, what do you think would never happen? (Bear in mind that interest rates started the year at 1.25% and rose to 2.5% by the end of the year). Nobody could have seen this coming, right? Or rather, nobody in our banks or regulators or finance departments or even in our universities saw it coming.

So, while VaR might give you a warm feeling, the number of days that banks have lost more than their VaR over the last two years should give you pause for thought. The amounts about that VaR should give you more.

And that's all those of us who are concerned are talking about. Pause for thought. There is a risk there. Not a word has been said about it. The portions of the PWC report dealing with derivatives risk were not released.

We could yet see the banks, the government and the nation praying for higher interest rates, even though they would bankrupt many of us...

Oh and I agree with ONQ - the best way to enforce regulation is to enforce solvency requirements. If a bank is bust, let it go bust. Perhaps the shareholders will point their piggy eyes beyond the profit trough and wonder if the bank they own is being run in sustainable fashion. Perhaps the bondholders will demand a higher premium for the risks being taken...


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## onq (20 Jun 2009)

yoganmahew said:


> <snip>
> 
> Oh and I agree with ONQ - the best way to enforce regulation is to enforce solvency requirements. If a bank is bust, let it go bust. Perhaps the shareholders will point their piggy eyes beyond the profit trough and wonder if the bank they own is being run in sustainable fashion. Perhaps the bondholders will demand a higher premium for the risks being taken...



I didn't say that either, really - at least in this thread. 

But I wish I had, because its that kind regulation - one based on self interest - that I think will actually work.
And should Anglo go under its possible that the shock might make some people in the financial "industry" cop themselves on.

They seem to be a little shell-shocked but still apparently feeling invulnerable because they think no-one has seen the derivatives problem.
Letting Anglo "go" might be exactly the kind of treatment that's needed for the system as a whole - cutting off one irretrievably diseased limb.

Determining exactly how badly Anglo Irish is exposed to potential derivative downside should be a priority for anyone considering putting 4Bn into it
Analysing the Anglo Irish Bank derivatives issue would seem to be a necessary precursor to terminating Anglo should it be found to be a huge net negative.

FWIW

ONQ


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## z109 (20 Jun 2009)

onq said:


> I didn't say that either, really - at least in this thread.
> 
> But I wish I had, because its that kind regulation - one based on self interest - that I think will actually work.


Sorry, I was starting from your logical conclusion


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## onq (21 Jun 2009)

yoganmahew said:


> Sorry, I was starting from your logical conclusion



If only we could get the Government to do that, we might work backwards to a solution. 

;-)


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