Explaining the ptsb stress tests

[Brendan Burgess]

I have read the documents and find them hard to understand. Is this about right?

The CET1 Ratio (Common Equity Tier 1) at 31 Dec 2013, according to ptsb was |13.13% |€2.2 billion
However, the Asset Quality Review reduced this to| 12.84%
The required level of capital is|8%

In other words, the ECB is happy that the provisions in ptsb's accounts are realistic and it has plenty of capital at the moment.


Next, the ECB stress tests the capital. If the current economic forecasts are right, what will happen ptsb's capital?

The baseline scenario reduces the capital to| 8.82% |€1.5 billion
The required level of capital is |8%

So in the event of the baseline scenario, ptsb will lose a further €700m, thus reducing its capital to €1.5 billion which is still enough.

Now, what happens if the adverse scenario occurs?

In the event of an adverse scenario, the capital is reduced to| 0.97%|€162 million
The capital required is |5.5%|€921
So ptsb is short| 4.53%|€855m

(I have estimated some of the monetary amounts from the percentages, which is why they are not reconciling, but the overall picture is about right)

If the adverse scenario transpires, ptsb will lose almost €2 billion of its capital.

 

[Brendan Burgess]

So what is the "adverse economic scenario" in which ptsb will be short of capital?

The adverse scenario, designed by the ESRB, reflects the systemic risks that are currently assessed as representing the most pertinent threats to the stability of the EU banking sector:

(i) an increase in global bond yields amplified by an abrupt reversal in risk assessment, especially towards emerging market economies;

(ii) a further deterioration of credit quality in countries with feeble demand;

(iii) stalling policy reforms jeopardising confidence in the sustainability of public finances; and
(iv) the lack of necessary bank balance sheet repair to maintain affordable market funding.


The negative impact of the shocks, which include also stress in the commercial real estate sector, as well as a foreign exchange shock in Central and Eastern Europe, is substantially global. In the EU, the scenario leads overall to a cumulative deviation of EU GDP from its baseline level by -2.2% in 2014, by -5.6% in 2015, and -7.0% in 2016. The EU unemployment is higher than its baseline level, by 0.6 percentage points in 2014, by 1.9 percentage points in 2015 and by 2.9 percentage points in 2016.


For most advanced economies, including Japan and the US, the scenario results in a negative response of GDP ranging between 5-6 per cent in cumulative terms compared to the baseline.

 

[Brendan Burgess]

I presume that the adverse economic scenario is adapted to Ireland's expected and adverse economic scenario? In other words, the adverse scenario should include house prices falling by, say, 30%.

Brendan

 

[Brendan Burgess]

There is an excellent summary by Joseph Ryan on Irish Economy.ie

http://www.irisheconomy.ie/index.php/2014/10/26/results-of-comprehensive-assessment/#comment-1631558

PTSB has a CET1 (Common Equity Tier One Ratio) of 12.8%, where 8% is the required minimum. A good result in most peoples book.


Yet the adverse test scenario, leaves PTSB with only a 1% CET1 Ratio, for what appears to be a further impairment loss of 1.3 billion, and additional pre-impairment operating losses of almost 882 million. Whatever about impairment losses, pre-impairment losses of almost one billion seem outlandish.


In order to insure against this doomsday scenario, the government intends, apparently, to fire-sale whatever value is left in PTSB, plus its investment so far including the €400 million COCO bond. It seems a nonsensical and ludicrous cost of a contingency repair.


In addition, if the adverse scenario does actually happen, is it not better for the government to be the arbitrator of what happens to the €30 billion in assets that the PTSB now has, rather than having empty pockets and empty hand and being told;
‘The assets are none of your business just pay the liabilities (mostly ICB/ECB), like the last time’.

 

[Duke of Marmalade]

The assets are none of your business just pay the liabilities (mostly ICB/ECB), like the last time’.

What is Joseph ranting about? When did the Irish government take on the liabilities of a bank but leave its assets?

As to selling at firesale prices, the value of Irish banking equity is at historic highs. Bank of Ireland has a market cap of €10bn of which the government holds €2bn. AIB has a market cap of €55bn of which all but 0.1bn belongs to the government. Now's the time to sell when asset prices are so high.

 

[Brendan Burgess]

Hi Duke

I think that this bit is a good summary. It is a good result, although it's being portrayed as a failure by the media.

PTSB has a CET1 (Common Equity Tier One Ratio) of 12.8%, where 8% is the required minimum. A good result in most peoples book.

And this bit seems to highlight that the adverse scenario is an outlandish test. I don't fully understand it, but it does seem to me that potential future losses of ptsb are not €2 billion, except in an extraordinarily adverse situation.

It has €4 billion of provisions against €29 billion of mortgages. It also has €2 billion of capital.

Yet the adverse test scenario, leaves PTSB with only a 1% CET1 Ratio, for what appears to be a further impairment loss of 1.3 billion, and additional pre-impairment operating losses of almost 882 million. Whatever about impairment losses, pre-impairment losses of almost one billion seem outlandish.

Is the following not correct as well? We have a well capitalised lender, ptsb. There is an adverse scenario in which its capital will be reduced to 1%. But we are going to have to sell a stake now in case that adverse scenario unfolds. As the main shareholder is the Irish state, if the scenario unfolds, they could fund it then.

As this is not allowed, the Irish state should simply cough up the €200m in capital required. It will get it back when it sells the bank.

In order to insure against this doomsday scenario, the government intends, apparently, to fire-sale whatever value is left in PTSB, plus its investment so far including the €400 million COCO bond. It seems a nonsensical and ludicrous cost of a contingency repair.

I don't follow this and it's not correct.

In addition, if the adverse scenario does actually happen, is it not better for the government to be the arbitrator of what happens to the €30 billion in assets that the PTSB now has, rather than having empty pockets and empty hand and being told; ‘The assets are none of your business just pay the liabilities (mostly ICB/ECB), like the last time’.

It has €20 billion in customer deposits, €7 billion in wholesale funding and only €6 billion from the ECB/ICB which is only 18% of total funding.

I think what he is saying about the state being the arbitrator is that if the adverse scenario happens and the government owns 100% of the company, it can decide to capitalise it further or sell the loans to someone else, e.g. the State owned AIB. If a significant part of ptsb is owned by shareholders, they can't really do that.

 

[Brendan Burgess]

As to selling at firesale prices, the value of Irish banking equity is at historic highs. Bank of Ireland has a market cap of €10bn of which the government holds €2bn. AIB has a market cap of €55bn of which all but 0.1bn belongs to the government. Now's the time to sell when asset prices are so high.

The AIB share price is artificial and meaningless and so the market cap is meaningless.

ptsb's market cap is €2.5 billion - roughly the same as the state put into it.

If someone wants to invest €1 billion for a 30% stake, that would be fine. But I am sure that investors are thinking in terms of paying €500m and getting 50% of the equity.

 

[Duke of Marmalade]

The AIB share price is artificial and meaningless and so the market cap is meaningless.

ptsb's market cap is €2.5 billion - roughly the same as the state put into it.

If someone wants to invest €1 billion for a 30% stake, that would be fine. But I am sure that investors are thinking in terms of paying €500m and getting 50% of the equity.

Agreed. Obviously the €200M or whatever seems small beer and the government could easily take on the burden itself. But the long term objective is to privatise the banks once more so on principle they might just try the water with ptsb. I doubt whether they will be suckered in the way suggested by JR.

(I was tongue in cheek on the AIB capitalisation but let's not discuss further - probably already in breach of AAM protocol.)

 

[Brendan Burgess]

Agreed. Obviously the €200M or whatever seems small beer and the government could easily take on the burden itself. But the long term objective is to privatise the banks once more so on principle they might just try the water with ptsb. I doubt whether they will be suckered in the way suggested by JR.

I think that they might well be suckered in. They have this ideological/political position that they do not want to put any more money into the Irish banks. If they put in the €200m they will get criticised, so it might be easier to sell a lump of it at a bargain price.

(I was tongue in cheek on the AIB capitalisation but let's not discuss further - probably already in breach of AAM protocol.)

I thought that we had made an exception on AIB's share price as it was so ludicrous, but I can't find the post. Maybe I moderated myself.

The objective of the ban on share price discussion is to prevent the meaningless hot air analysis often seen on websites. In the context of the state selling ptsb, it's appropriate to make an exception.

 

[Brendan Burgess]

Michael McGrath does want to see a stake in ptsb sold too cheaply either.

[broken link removed]

If additional equity capital is required there is likely to be interest from private equity investors. Their sole motivation will be to buy at the lowest possible price and maximise their potential future profit as we saw in the case of Bank of Ireland. The Irish public have put a considerable amount of money in to Permanent TSB at this stage. It would be unacceptable if the state’s holding was sold down at bargain basement prices. The government should seek to maximise the value of the brand and if necessary be willing to maintain the state’s holding so that it is in a position to benefit from future upturn in the bank’s value. Private equity investment is welcome but not at any price.

Brendan