The asset warehouse is an idea straight from structured finance. Each of the banks that the Irish government has decided are viable would sell assets to the warehouse. The warehouse would be funded with a combination of funds from investors and the ECB.
Just like all structured finance securities, the attractiveness of and cost of funding the asset warehouse will be related to the disclosure surrounding the underlying asset performance.
As has long been advocated for on this blog, the gold standard for asset-level disclosure is to report the performance of the underlying assets on an observable event basis. Examples of observable events include payments, delinquencies and defaults.
The further the disclosure of the asset warehouse moves from the gold standard the less access to and the higher the cost of funds from investors.
Given the questions surrounding the quality of the assets in the Irish banking system, to maximize the attractiveness of the asset warehouse to investors requires providing the gold standard for disclosure. Investors need to know that they can access current information on the underlying assets.
Without the gold standard for disclosure, investors have to assume that there is a reason for not disclosing the underlying performance of the assets on a current basis. This reduces their appetitive for exposure to the asset warehouse and increases their required return. This increase is ultimately paid for by the Irish taxpayers.
Another reason for offering the gold standard of disclosure is it eliminates the illiquidity premium. Moving from the gold standard of disclosure to the current industry standard of once per month disclosure, increases the cost of funding by adding an illiquidity premium. The illiquidity premium exists because investors know from the recent credit crisis that once per month reporting is not adequate to sustain an active secondary market.
The illiquidity premium is a minimum of one quarter of a percent and more likely one half of one percent annually. For the 60 billion euros asset warehouse being discussed, having once per month disclosure would cost the Irish taxpayer a minimum of 150 million euros and more likely 300 million euros per year.
Irish authorities are considering allowing the country’s debt-laden lenders to set up a company to warehouse more than 60 billion euros ($84.8 billion) of loans that would be wound down or sold over time, according to three people familiar with the matter.
Some banks have sought to convince the central bank and government officials that this would be preferable to splitting their operations into core and non-core units, which is also being weighed, said the people, who declined to be identified because the talks are private.
It would need approval from the European Central Bank, which would be the most likely initial provider of funding to a warehouse vehicle, they said.
.... Ireland agreed as part of its bailout in November to shrink its banks, as deposit outflows last year drove up their reliance on funding from the ECB. While Irish central bank Governor Patrick Honohan said the ECB wanted to accelerate deleveraging, Ireland has “put in the condition of no fire-sale losses because the state cannot afford it,” he said.
A decision on the approach to shrinking banks’ balance sheets will be made before the results of capital and liquidity stress tests are revealed on March 31.
So-called viable lenders ... need to cut their loan-to-deposit ratios to 122.5 percent, “which is acceptable to Europe,” Finance Minister Michael Noonan said March 14. The average loan-to-deposit ratio is currently about 170 percent.
... Still, a single warehouse company, or special purpose vehicle, which can be separate from the banks’ balance sheets is the “preferred and most realistic route” to deleveraging the banks, analysts including Fergal O’Leary and Michael Cummins of Glas Securities, the Dublin-based fixed-income firm, said in a note to clients on March 9.
It would be “a more robust, transparent and market-friendly vehicle, than individual SPVs set up by each bank,” it said.
... Banks’ foreign assets and some residential home-loans that are priced to track the ECB’s key rate, would most likely be transferred to any such vehicle, said three of the people.
Bank of Ireland, Allied Irish and Irish Life have more than 60 billion euros of U.K. loans.
None of the banks would own more than 50 percent of the new company, allowing them to remove it from their balance sheets, according to the people.
Assets would be transferred at book value, avoiding initial capital losses, they said. Still, they would have to be sufficiently stress-tested and the vehicle properly capitalized to convince investors that future losses will not ultimately end up back with the banks, they said.
The central bank is stress-testing against a 60 percent drop in house prices from their peak in 2007, an economic contraction and rising unemployment for this year and next.
Depositors and wholesale markets would have more confidence in funding the core banks as a result, they said, adding that this would lower lenders’ reliance on central banks.
Irish banks have already sold 72.3 billion euros of risky commercial real-estate loans in the past year to the state-run National Asset Management Agency, the nation’s so-called bad bank. The loans were sold at an average discount of 58 percent, contributing to the country’s need to inject up 46.3 billion euros into absorb soaring losses in the banks.
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