Viking accounting

Just before last weekend’s election, the FME (Iceland’s Financial Supervisory Authority) received two reports on the health of to “New” banks (New Kaupthing, NBI and Íslandsbanki), one from accountant Deloitte and the other from management consultants Oliver Wyman. The reports have not been made public, but were leaked to Morgunblaðið, whose article has been translated by Anya. Apparently, 40% of the assets of the new banks are “non-performing”: ie, they consist of loans which are not being paid back.

While 40% of worthless assets may seem a lot, it is actually far less than the FME's initial estimates. These were not made public either, although we know some details thanks to the IMF. The FME wanted to write off 66% of Kaupthing’s Icelandic loan book and 50% of Landsbanki’s (later upped to 55%). The FME didn’t dare give an exact figure for Glitnir, but crossing the FME's figures with Glitnir's 2008Q2 financial statement suggests that they were working on a 75% write-off! “We do not intend to pay the debts of banks that have been a little heedless” toned central bank chairman and former Prime Minister Davíð Oddsson on 7 October, in comments that are widely suspected of having prompted the UK government to freeze the British assets of Landsbanki. For a while, it appeared that the Icelandic authorities didn’t expect individual Icelanders and Icelandic companies to pay their debts either.

Icelanders built up household debts of more than twice their disposable income in a credit frenzy fuelled by their banks’ foreign borrowings, making Americans, with household debts of “only” 134% of disposable income, seem positively virtuous in comparison. Iceland’s companies went even further: corporate debt is more than three times GDP, compared to 77% in the eurozone. An old British adage runs that if you owe the bank a thousand pounds you have a problem, but if you owe the bank a million pounds then the bank has a problem. If so, Iceland’s new banks have a very big problem.

The new banks were set up to take on the assets and liabilities in Iceland, and the assets (mostly loans) far outweigh the liabilities (mostly deposits), at least in book value. But how much are those assets actually worth? The question is doubly important because the new banks have to compensate their predecessors for the net value of the assets. That money will then help pay the old banks’ overseas creditors. The larger the provisions, the lower the net value of the new banks’ assets and the less they will have to pay out to their predecessors. The FME’s provisions amounted to a 4000 billion krónur loss for the foreign creditors of the old banks; the leaked report would put these provisions at nearer 2500 billion krónur. The difference – roughly the size of Iceland's GDP – would have to made up in part by increasing the capital of the new banks.

The valuation of the assets of the new banks was supposed to be completed with ninety days: it has dragged on for more than twice as long. Yet it is absolutely fundamental to any recovery plan for the Icelandic economy. Until the initial balance sheet is known, there can be no capital injection into the new banks, no restructuring of loans, and no sale of assets to pay off the debts. One can only hope that the new government will move swiftly to publish the relevant parts of the reports after the holiday weekend: to do so might be politically painful within Iceland, but it is essential for regaining Iceland's international credibility.

***UPDATE*** (Saturday 2 May)
See also this press release from the Ministry of Business Affairs and this article in today's Iceland Review.