Icelandic Banks – The Fall Out
Mark Horsfield, Director London Division
13th May 2009
Arlingclose Limited 6/7 Hatton Garden London EC1N 8AD Telephone +44 (0) 20 7831 3114 Fax +44 (0) 20 7831 3178 www.arlingclose.com
Registered Office Barclays Bank Chambers Stratford-upon-Avon CV37 6AH Registered in England No 2853836 Regulated by the Financial Services Authority No 417722
Arlingclose Limited provides independent advice
History
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Arlingclose – CIPFA London Division Icelandic Banks – The Fall Out
Before the Crunch
Source: Bloomberg
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Arlingclose – CIPFA London Division Icelandic Banks – The Fall Out
The Credit Crunch – up to 11th May 2009
Source: Bloomberg
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Arlingclose – CIPFA London Division Icelandic Banks – The Fall Out
Arlingclose investment advice to clients before and during the credit crunch
Before
• Credit advice does not blindly follow the credit rating agencies
• Advised clients to remove Icelandic institutions (and subsidiaries) from lending lists in Spring 2006
• Advised clients to invest with counterparties with higher credit ratings (AA- minimum long term/F1+ short
term) upon early signs of distress in money and credit markets – July 2007
• Developed and issued direct dealing list of counterparties with higher credit ratings
• Held discussions with DMO and advised clients to reactivate/open DMADF accounts – July/August 2007
During i.e. from August 2007 to date
• Advised clients to adopt cautious stance and strategy focus must demonstrably be towards capital
preservation
• Meeting with Icelandic Bank, December 2007 – “avoid” view reaffirmed
• Advised clients not to invest in any banks or building societies on 29th September 2008
• Advise clients not to invest in Ireland’s banks despite guarantee
• Continue to advise clients to utilise DMADF, banks and building societies with minimum AA-/F1+ ratings
plus access to UK Credit Guarantee Scheme, spread of money market funds, and AAA rated bonds
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Fall Out
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Arlingclose – CIPFA London Division Icelandic Banks – The Fall Out
A tale of three weeks in 2008
Cash-rich councils are being insulated from the impact of rising
costs thanks to an increase in lending rates fuelled by the
Lehman Brothers crash 18th September 2008
As many as 20 local councils are reported to have been caught
up in the collapse of Iceland's banks and several could lose
millions of pounds 9th October 2008
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Arlingclose – CIPFA London Division Icelandic Banks – The Fall Out
Scrutiny and response
Communities & Local Government Select Committee
House of Commons
Inquiry into Local Government Investments.
Report due in days
Audit Commission National Report: Risk and return:
English local authorities and the Icelandic banks.
Intention to revise TM Code and Guidance Notes.
TM Panel Bulletin Released.
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Arlingclose – CIPFA London Division Icelandic Banks – The Fall Out
Key factors from our perspective – yet to be addressed?
• Independent advice not information transfer
• Automated process focusing on a single source of information to assess credit
risk is simply not good enough
• If in doubt do not invest – use the DMADF
• Reliance on luck was not – and will never be - an option
• Establish a strategy that meets your Authority’s risk appetite
• Be prepared to change tack quickly
• Central Government could help more – i.e. PWLB rates, Investment Regulations
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Debt
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Arlingclose – CIPFA London Division Icelandic Banks – The Fall Out
Some Debt Statistics
31/03/2003 31/03/2004 31/03/2005 31/03/2006 31/03/2007
England & Wales 41,804 41,533 43,303 49,728 53,188
Scotland 8,805 8,575 8,646 9,363 9,389
Great Britain 50,609 50,108 51,949 59,091 62,577
% Growth 31/03/2003 31/03/2004 31/03/2005 31/03/2006 31/03/2007
England & Wales 0% -1% 4% 15% 7%
Scotland -10% -3% 1% 8% 0%
Great Britain -2% -1% 4% 14% 6%
UK Interest Rates
10
9
8
7
6
Rate
5
4
3
2
1
0
Jul-92
Jul-93
Jul-94
Jul-95
Jul-96
Jul-97
Jul-98
Jul-99
Jul-00
Jul-01
Jul-02
Jul-03
Jul-04
Jul-05
Jul-06
Jul-07
Jul-08
Jul-09
Jan-92
Jan-93
Jan-94
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Date
10 yr Gilt yield Repo Rate Projected 10 yr Gilt yield Projected Repo Rate
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Arlingclose – CIPFA London Division Icelandic Banks – The Fall Out
Conclusions: Icelandic Banks – The Fall Out
• Risk – small word but with big implications.
• Joined up treasury management strategies in focus – the appetite for external
borrowing is muted (except in 11 Downing Street).
• Local authorities access to the PWLB provides an effective insulation from the
credit crunch as far as access to borrowing is concerned.
• Nevertheless, banks like local authorities as counterparties and are reasonably
keen to lend provided the terms are right.
• We prefer to see our clients have control of their debt portfolios.
• Treasury management “industry” is at the crossroads.
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Appendix
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Arlingclose – CIPFA London Division Icelandic Banks – The Fall Out
Credit Risk
Rating definitions
Minimum ratings: Long term A, Short Term F1 (Fitch)(or equivalent)
Definition:
A: High credit quality. 'A' ratings denote expectations of low credit risk. The
capacity for payment of financial commitments is considered strong. This
capacity may, nevertheless, be more vulnerable to changes in
circumstances or in economic conditions than is the case for higher
ratings.
F1: Short-term : Highest credit quality. Indicates the strongest capacity for
timely payment of financial commitments.
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Arlingclose – CIPFA London Division Icelandic Banks – The Fall Out
Credit Risk
Rating definitions
Early response to warning signs and migrate up credit ladder: Long term AA,
Short Term F1+
Definition:
AA: Very high credit quality. 'AA' ratings denote expectations of very low
credit risk. They indicate very strong capacity for payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.
F1+: Short-term: Highest credit quality. Indicates the strongest capacity for
timely payment of financial commitments; the "+" denotes any
exceptionally strong credit feature.
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Arlingclose – CIPFA London Division Icelandic Banks – The Fall Out
How real is Credit and Counterparty Risk?
2008
• Merrill Lynch believes that the banks should be rated
• £954m invested by 127 UK Local Authorities in Icelandic
"BBB" instead of "A”, … because of their heavy
Banks in October 2008
reliance on short term financing there is
considerable uncertainty as to whether or not the
• ‘But now Iceland’s economy is in trouble. Interest rates are
Icelandic economy will land softly when the current
soaring — rising to 11.5% last week — and the stock market
boom draws to a close and market perceptions
and the currency are sliding amid warnings that the country
change. says’ – Bloomberg, 21/07/06
is facing a debt crisis’ - The Sunday Times, 02/04/06
• ‘Another day of turmoil in the Icelandic markets’ -
• ‘British firms face chill as Iceland crumbles’– Icelandic
Iceland Review Online, 03/09/06
raiders have bought large stakes in UK firms. With their
economy now in trouble, will they be forced to bale out?’ -
• ‘Moody’s blasted for giving Icelandic banks top
The Sunday Times, 02/04/06
rating’ – Bloomberg, 26/02/07
• ‘Kaupthing is ‘vulnerable’ on Refinancing Needs, Merrill
• ‘Is Iceland headed for meltdown?’ – The Telegraph,
says’– Bloomberg , 21/07/06
05/02/08
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Arlingclose – CIPFA London Division Icelandic Banks – The Fall Out
Building Societies – ranked by Asset Size
Rank Building Society Assets at April 09 Current Position
1 Nationwide incorporating £178,482m + £4,964m Merged with Cheshire and Derbyshire BS in
Cheshire , Derbyshire and + £7,090m + £3,309m December 2008, and Dunfermline BS in
Dunfermline Building Societies March 2009
2 Britannia £32,377m Due to merge with Co-op Financial Services
3 Yorkshire incorporating Barnsley £23,137m + £376m Merged with Barnsley BS on 31.12.08
Building Society following Barnsley BS £10m investment in
Icelandic banks
4 Coventry £14,908m
5 Chelsea incorporating Catholic £13,017m + £44m Merged with Catholic BS on 31.12.08
Building Society
6 Skipton £11,967m + £2,876m Merged with Scarborough BS due to
“difficult trading conditions” from poor
lending decisions by Scarborough BS
7 Leeds £9,199m
8 West Bromwich £8,651m
9 Principality £5,286m
10 Newcastle £4,699m
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Arlingclose – CIPFA London Division Icelandic Banks – The Fall Out
PWLB Maturity New Loan Rates 1st April 2007 to date
6.00
FY 2008/09
5.50
5.00
4.50
4.00
3.50
3.00
2.50
2.00
5 10 15 20 25 30 40 50 Source PWLB
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Arlingclose – CIPFA London Division Icelandic Banks – The Fall Out
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