Sunday 25 March 2018

Emmet Oliver: Markets will push Merkel and Sarkozy to address real issues

The wrong solutions for the wrong set of problems is the best way to sum up the package unveiled in Paris by France and Germany this week.

But looked at in a certain way, it may represent the last roll of the dice before Germany finally accepts that harmonising corporation tax and taxing share transactions are a waste of political energy.

The concentration should be on restoring confidence for those who buy the debt of European countries.

With pressure from her own coalition partners on one side, and a rampant opposition on the other side, German Chancellor Angela Merkel is increasingly not prepared to accept two core demands from peripheral Europe (a fast-growing category now starting to encompass Italy). These are: an expansion of the rescue fund, and/or an examination of the idea of eurobonds.

Instead Merkel and President Nicolas Sarkozy believe they can leisurely transition towards these bigger concepts over many years, essentially moving at a pace of their choosing.

How wrong they are likely to be. Unfortunately, it's not possible to tell the markets to go on vacation for five years.

Despite a second bailout for Greece, a shoring up of the European Financial Stability Facility (EFSF) and, for now, an affirmation of France's AAA rating, events are moving far quicker than Sarkozy or Merkel seem to realise.

Italy, for instance, is due to hold a schedule auction by the end of this month -- any postponement of this event is likely to send shivers through the wider European bond market.

There is also the issue of how long the ECB is prepared to keep buying Italian and Spanish bonds before it shouts stop.

Events from last year, when Ireland was under pressure, tell us that the ECB does eventually run out of patience, and does eventually transfer the problem back to the politicians and the International Monetery Fund.


There is also likely to be a conveyor belt of writedowns from banks on their Greek government bonds, putting banks holding Irish, Portuguese and Spanish bonds on edge, as they worry about their own capital levels.

All of these are pressing events impacting on the bond market now.

They are probably only solved by the issuing of eurobonds, particularly at a time when international buyers are looking to diversify away from US Treasury bonds.

President Sarkozy said on Tuesday he could one day "imagine'' a system of eurobonds being created, but now was not the time.

But he may not be the man to make that decision. Time is not something in the gift of either Sarkozy or his German counterpart.

Banks still addicted a year later, running up a €155bn tab

As Ireland approaches the first anniversary of the IMF/EU bailout deal, one wonders how the success or failure of the plan will be assessed.

Clearly, getting Irish bond yields down was important. In that context some progress has been made but lots more needs to be done by the likes of Ajai Chopra of the IMF.

One of the vital pledges lenders and borrowers made in December was to end the addiction of Irish banks to central bank funding, through a deleveraging plan and shrinkage of balance sheets.

On that front, the plan has made less progress. Yes, central bank assistance to Irish banks has fallen from last November's peak but it still remains at a tear-inducing €155bn.

Reducing this figure -- split between the Irish Central Bank and the ECB -- based on the current rate of progress, arguably could take years, potentially even a decade. It is a frightening level of dependency that highlights a key problem for the banks.

The institutions want to attract deposits so that central bank funding can be repaid, but they cannot attract deposits because they have such a large dependence on the central bank, which frightens away risk-averse corporate treasurers.


Also, because so much of the money has come from the ECB, which is lending €533bn to European banks in total, there is a tendency to think of the liquidity as a type of generational loan that will be wrote off by some creative ECB accountant long after the crisis has passed.

That may well be what happens. However, ongoing addiction to funding does make it difficult for the pillar banks to present themselves to the outside world as "normal'', post-crisis banks entitled to borrow money at what are called normalised rates in the markets.

CRH's prudence has an upside for investors

For the small band of investors who still play the Irish stock exchange and the Irish stock exchange alone, CRH represents a throwback to a happier time when Irish stocks actually paid a dividend.

With the banking sector all but nationalised and hence no dividends, and Ryanair sticking to its long established policy of not paying a regular dividend (it does make occasional special dividend payouts), the Irish market is something of a barren wasteland for those shareholders interested in a proper yield on their investments.

The loss, for a few years, of any dividend from Smurfit Kappa was a body blow for those holding a broad basket of Irish stocks and many other staples, like Kerry, are still paying out, but the yields are relatively modest.

CRH, which pays out over 5pc of the value of the share price each year, is something of the last redoubt in terms of giving investors a return beyond just capital appreciation (another is Irish Continental Group).

The crucial message in this week's results from the company, Ireland's largest, is that the dividend can be maintained as long as the company maintains its current course which is to be conservative on acquisitions (no "splurging'' as CEO Myles Lee described it), conservative on leverage and conservative on costs.

Of course, this prudence will not necessarily help the company to jump-start the share price. Analysts are of the view that CRH does not have enough exposure to faster-growing economies, although this week Mr Lee assured shareholders that Russia and China were targets for expansion.

The former seems a curious choice economically, while the latter appears the right move, albeit there are serious concerns about a real-estate bubble there.

Either way, it appears CRH can choose one of two paths, but not both.

It either maintains a solid plodding profile and waits for recoveries in the US and Europe and maintains the dividend, or it refashions its business into an emerging markets play, stretches its balance sheet a little more and puts the dividend payout under review.

Irish investors and pension funds, nursing huge losses on other stocks, will probably hope it opts for the former, at least for now.

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