SME Credit and Deleveraging Targets

A number of people have asked me since I wrote this post about AIB and Bank of Ireland failing to meet their SME lending commitments whether we should have expected this outcome because of the deleveraging targets set in last year’s Financial Measures Programme (FMP) agreed with the Troika. The PLAR (Prudential Liquidity Assessment Review) element of this programme aimed at reducing the quantity of loans on the balance sheets of the domestic Irish banks. So isn’t the reduction in SME lending just a consequence of the agreement with the Troika?

The quick answers to these questions are:

1. There is no contradiction between the pillar banks meeting their SME lending commitments and also meeting the PLAR deleveraging targets agreed with the Troika.

2. AIB are going well beyond their PLAR commitments in tightening credit within Ireland and Bank of Ireland may also be but haven’t reported their loan book in a way that allows one to check.

For the longer answer, I’ll describe two aspects of this issue. First, the data from the Central Bank on stocks and flows of SME lending. Second, I’ll discus the deleveraging plans outlined in the FMP document and the evidence on the actual changes in loan books in 2011 provided in AIB and Bank of Ireland’s recent annual reports.

Stocks and Flows of SME Lending

When examining the question of whether or not banks are providing adequate amounts of lending, it is important to distinguish between stocks and flows. If you see the total stock of loans this year being the same as last year, that doesn’t mean that the bank has made no new loans. It just means that the amount of loans given out equalled the amount of loan repayments made by customers.

As I noted in the previous post, the language in AIB’s announcement of its commitment to SME loan targets made it clear that they were referring to a target for new loans.Whether a commitment to a given amount of new loans equates to an increase in the total outstanding stock of loans depends upon what fraction of existing loans are being repaid. SME loans have a relatively short average maturity, so agreeing to a given amount of new loans will be well short of agreeing to increase your balance sheet by that amount.

Thankfully, the Central Bank now provide figures to help us sift through the stocks and flows of SME lending in Ireland. They have also provided an explanatory note explaining the meaning of the various figures.

The Central Bank figures show three different “totals” for SME lending: Total SME lending, SME lending excluding financial intermediaries and SME lending excluding financial intermediaries and property-related sectors. I think the best guess as to what the €3 billion per year loan commitment likely referred to was SME lending excluding financial intermediaries.

The first tab in the spreadsheet reports outstanding amounts of Irish SME loans. In December 2011, total SME loans outstanding was €73.6 billion, SME lending excluding financial intermediaries was €61.5 billion and SME lending excluding financial intermediaries and property-related sectors was €27.3 billion.

Looking at changes in the outstanding amounts is not a good way of assessing what’s happening with SME credit. The totals can be affected by various re-classifications that change the total without new lending occurring, e.g. there was a big jump in June 2011 in property-related SME loans.

To deal with this problem, the Bank publishes a “Transactions” series which

are calculated from quarterly differences in outstanding amounts adjusted for reclassifications, other revaluations, exchange rate variations and any other changes which do not arise from transactions.

In other words, “Transactions” tells us the amount of new loans issued minus the amount of loans repaid. The Bank also publishes a “New Lending” series that does what it says on the tin. Using these two sets of figures, we can back out the amount of loan repayments that are occurring. Here are the figures for last year.

What these figures show is that the Irish banks could have made an additional €2.9 billion in loans, i.e. €6 billion in total, without increasing their total exposure to Irish SMEs. This is a market in which non-pillar banks (in particular Ulster) used to play some role but, by 2011, I suspect they would have had a fairly small involvement. So effectively these figures show that AIB and Bank of Ireland could have honoured their SME lending commitments without doing much to raise their balance sheet.

Domestic Deleveraging Targets and Outcomes

But what about the deleveraging plans? Wouldn’t even a small increase in SME loan balances have run counter to the PLAR plans? Well, no. It turns out these plans were based upon a very limited amount of deleveraging in the “core” activities of the banks such as domestic SME lending.  It is worth checking out the planned deleveraging and comparing it with what is actually happening.

Here are the three-year deleveraging targets set out in the PLAR.

Note that AIB were actually supposed to increase their core loans by €1.5 billion by the end of 2013. AIB have since been merged with EBS who were supposed to reduce core loans by €2.6 billion but this still amounts to a very small combined reduction of €1.1 billion over three years. Bank of Ireland were supposed to reduce core lending by €2.6 billion by 2013. There can be little doubt that the banks could have absorbed the small increase in SME lending required by their public commitments and still meet these deleveraging targets.

What is actually happening with core lending? AIB helpfully provided a table describing core and non-core lending on page 34 of their annual report. The table shows that, once you subtract off the additional €13.6 billion from taking over EBS, core loans at AIB have declined by €2 billion. You can also work out from information in the report and EBS’s 2010 annual report that the EBS total is €0.2 billion lower than their end 2010 figure, so the combined AIB-EBS reduction in core loans in 2011 is €2.2 billion, which is twice as large as was agreed to as part of the PLAR over the three-year period 2011-2013.

AIB’s report doesn’t split out SME lending in the same way as the Central Bank statistics. However, page 83 of their report does tells us that there has been a reduction of €1.3 billion, from €17.6 billion at end-2010 to €16.3 billion at end-2011, in a non-property-lending category labelled “SME\Commercial”. These figures suggest that AIB likely accounts for the majority of the €1.7 billion reduction in 2011 in non-financial-intermediary non-property SME lending recorded by the Central Bank. And remember this is a wholly state-owned financial institution.

What about Bank of Ireland? Unhelpfully, their preliminary statement for 2011 fails to report their loan book in a way that is compatible with the core\non-core targets set by the PLAR.  However, it does report a table (on page 49) that shows a small increase in 2011 in “Republic of Ireland non-property SME loans” of €342 million. Elsewhere though, a category labelled “non-property corporate” lending was reduced by €4.5 billion and “property and construction investment” was reduced by €3 billion.

From these figures, it also seems likely that Bank of Ireland is also over-shooting its PLAR target of fairly modest reduction in core lending and thus tightening domestic credit more than had been planned. It would be helpful if the Minister for Finance would request that Bank of Ireland provide an update on where they stood at the end of 2011 in relation to their core lending relative to the targets set in the PLAR.

Irish Banks Are Not Meeting Their SME Lending Commitments

During my appearance on the Vincent Browne show a few weeks ago, government TD Damien English told me that the Irish banks were meeting their lending targets to SMEs. It’s hard to follow all the news that comes out on the Irish economy so I wasn’t sure what Damien was talking about but I did express skepticism about this claim based on figures from this IMF report (page 13) showing the banks deleveraging core assets faster than had been planned in the PCAR\PLAR document.

Anyway, I did some work today to check what’s going on. You may recall that in 2010, AIB and Bank of Ireland both committed themselves to €3 billion in …. well in what? That’s a good place to start. Bank of Ireland’s document was fairly vague. The only mention of the €3 billion figure in the announcement was this

Bank of Ireland is committed to providing a minimum of €3bn in lending to viable SMEs each year for 2010 and 2011.

Now banking is a sufficiently complicated business that this could mean anything. It could stretch from an addition €3 billion of loans on the balance sheet, to issuing €3 billion in new loans while some old loans are repaid, or perhaps something else. AIB’s announcement, however, was clearer. It committed itself to

Make available €3bn in new or additional credit to SMEs, including specific working capital support, in both 2010 and 2011.

Since we can presume that both banks had to agree to the same type of commitments, this statement told us that the banks were agreeing to make new loans to customers (featuring “additional credit”).

One thing that the €3 billion commitment clearly did not refer to was restructuring existing loans, as this counts as neither new credit nor additional credit. Indeed, elsewhere in AIB’s document setting out its commitment, the bank makes it clear that they do not think restructuring loans counts as new lending:

AIB is already providing considerable lending support to SMEs in both new lending and in the re-scheduling and restructuring of their existing borrowings

Note “new lending” and “re-scheduling and restructuring” — if the bank thought restructuring was new lending they would not have added the second half of this sentence.

Ok, that’s what the commitment was. Let’s find out how much new lending there has been. Since June 2011, the Central Bank has been publishing figures for SME credit in Ireland, including data on Gross New Lending defined as follows.

This component details the amount of new credit facilities drawn-down during the quarter by SME counterparties, i.e. where this credit facility was not part of the outstanding amount of credit advanced at the end of the previous quarter. Gross new lending is defined in such a way as to exclude renegotiations or restructuring of existing loans.

The latest figures are available here.

Over 2010, total gross new lending to SMEs from all banks in Ireland, not just AIB and Bank of Ireland, was €3.1 billion. For 2011, the figure was €4.3 billion. Total new lending to SMEs excluding lending to financial intermediaries (which I’m guessing is closer to what the commitments actually referred to) was €3.0 billion in 2010 and €3.1 billion in 2011. Whatever way you look at, without knowing how much the non-pillar banks loaned out over the past few years, it is clear that AIB and Bank of Ireland have not met their commitments to together make €6 billion in new loans to SMEs.

Given these figures from the Central Bank, why would Damien English think that the banks have met their target? The answer is likely to be that John Trethowen of the Credit Review Office has declared that the banks met their targets in 2011. Here‘s his latest report from February 2012

I am pleased to advise that AIB and BoI have both achieved their €3bn on loan sanctions.

And here‘s the Irish Times reporting this happy outcome.

Now how can Trethowen think that the targets for new lending have been met when the statistics show that they haven’t? The answer is that, contrary to the original commitments, Trethowen is counting loans that have been restructured:

The €3bn targets achieved in 2011 has a majority of restructured sanctions

It’s interesting to see the evolution over time in Mr. Trethowen’s discussion of these targets. Here‘s his first report, from June 2010. The only mention of targets is a mention of his role in

ensuring the two banks have plans in place to achieve the €3bn p.a. new lending targets over the next two years.

Here‘s his second Report from November 2010. This report mentions that the €3 billion targets being achieved wouldn’t necessarily see balance sheet expansion of the same amount because of a number of factors such as loan repayments. One factor that is mentioned is

‘Old new Lending’ being the restructuring of overdraft lending already on the balance sheets.

The inverted commas are Mr. Trethowen’s, not mine. It looks as though at this point, he doesn’t view restructuring as genuine “new lending”.

By his third report in February 2011, Mr. Trethowen has begun to state that restructuring loans counts towards meeting the targets:

The Minster’s target for new sanctioned lending of €3bn by each of the banks is in line to be achieved by April 2011. This may appear contradictory to the comments elsewhere in this report on balance sheet contractions. The explanation is that much of this sanctioning activity is in debt restructuring to assist many businesses to survive. I have asked both banks to report the amount of ‘New’ money being sanctioned, and they are presently both amending their systems to provide this information.

The target has apparently now shifted from the fairly clear “new or additional credit” to “new sanctioned lending … including debt restructuring”.

By his fifth report in August 2011, Mr. Trethowen had taken an Orwellian turn and started chastising people for actually expecting the banks to keep their promise in relation to new credit:

Until the demand for credit is fully understood there is little point in some commentators being fixated on the amount of New Credit as opposed to restructuring sanctions. It is obviously impossible to grow New Credit in an economy where such credit is not being demanded.

This may have been a rhetorical over-reach for Mr. Trethowen as in his next report in November 2011, he seems to have re-discovered (perhaps via a clip around the ear from someone in government) that new lending is sort of the point of the whole loan commitment thing:

Whilst I have not subscribed to the disparaging of the restructured financing element of how these targets have been achieved to date, I do however accept that a focus should now be brought onto the ‘New Money’ element to reflect and support the prospects for a continuing economic recovery in 2012.

And in his latest report he notes

There is growing interest in the level of new money: restructured money in these sanction figures. I fully accept that restructuring, while important, will not drive growth and the Government would like to see a sharper focus on the element of ‘new’ money sanctioned and drawn in the quarters ahead, and this is reinforced in our meetings with the Pillar Banks.

So there’s a growing interest in finding out how many new loans the banks are actually making given that they had both promised to make €3 billion a year in new loans? Funny that.

Since the Central Bank now collect and publish statistics on new lending to SMEs, one hopes that Mr. Trethowen won’t find it too difficult to obtain this “sharper focus” on new lending. One would also hope that members of the media might remind the government and Mr. Trethowen that spinning about targets met isn’t really the same thing as meeting the targets that were actually set.