Fergus Murphy, the chief executive of Educational Building Society (EBS), was summoned to a 5pm meeting on Wednesday at the National Treasury Management Agency (NTMA) headquarters on Dublin’s Grand Canal Street.
Murphy and his team at EBS had spent the past 10 months working on the sale of the state-owned society. Recently the NTMA, which manages government investment in the banking sector, agreed to enter sale negotiations with a group of private-equity investors, led by Dublin’s Cardinal Group and including Carlyle and WL Ross, American investment funds.
The phone call from the NTMA was not unexpected. On Wednesday, Murphy separately learnt that NTMA had broken off talks with the Cardinal consortium. The news he received at the 5pm meeting was, however, a shock: EBS was to be subsumed into Allied Irish Banks.
So Murphy’s expectations about the future ownership of the EBS had gone from American private equity to state-owned, standalone bank, to an AIB subsidiary in the space of a couple of hours. But then, it was that kind of week.
Elsewhere, Irish Life & Permanent, which had avoided the worst of the financial crisis because of a lack of exposure to toxic commercial property loans, finally succumbed to the woes of the residential mortgage market.
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Irish Life, which accounts for 30% of the life and pensions market, is to be floated on the stockmarket later this year. Its beleaguered banking subsidiary, Permanent TSB (PTSB), will fall into hands of the state and faces an uncertain future.
Up to €24 billion in capital is to be pumped into AIB, Bank of Ireland, PTSB and EBS after Thursday’s stress tests delivered a savage assessment of the potential future losses on their loan books. This could bring the total state capital injections to almost €70 billion. In the words of Patrick Honohan, the governor of the Central Bank, it’s arguably “the most expensive banking bailout in history”.
There is also a plan to split the two remaining standing pillars, AIB and Bank of Ireland, into core and non-core banks. The core banks will focus on lending to business and consumers in Ireland. The non-core will deal with international business, which will be sold off or wound down over the next three years.
Almost lost as a minor footnote last week was Anglo Irish Bank’s announcement of the largest ever loss in Irish corporate history — €17.7 billion.
SO A week is a long time in banking as well as politics. When it comes to the coalition government’s election promise about sharing the €70 billion cost of Ireland’s banking bailout, however, a month seems like an eternity.
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On Thursday evening in the government press centre, the suggestion of four weeks ago that bondholders would be burnt had disappeared. Michael Noonan, the finance minister, conceded that Irish taxpayers would have to shoulder the burden alone.
“It is Frankfurt’s way or Labour’s way,” Eamon Gilmore had said during the election campaign, vowing to challenge the European Central Bank (ECB) on burning bondholders. As he stood beside Noonan on Thursday evening, Gilmore looked uneasy when reminded of his battle cry.
Fine Gael, although never quite so explicit, did little to counter the notion that the bondholders would suffer. It even threatened at the beginning of the election campaign “unilaterally” to impose losses on senior bondholders. In a banking policy document entitled Credit Where Credit is Due, launched by Noonan in February, Fine Gael floated the idea of asking Europe to help to pay the repair bill for “systemically important” banks such as Bank of Ireland and AIB.
“If other European countries have set their face against a default by Irish banks on reckless loans from banks regulated in their own jurisdictions, then they should be willing to contribute directly to the recapitalisation of Irish banks,” the document said, repeating comments made by Noonan two weeks earlier.
On Thursday, however, the finance minister admitted defeat. The only outside contribution to Ireland’s banking bailout bill will be the €5 billion already taken from junior bondholders at Anglo Irish Bank and Irish Nationwide.
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The ECB, Noonan explained, was opposed to any sort of burden sharing with senior bank bondholders, for fear of contagion spreading to other European banks. The finance minister said it was neither “reasonable nor logical” to go after senior bondholders in AIB and Bank of Ireland because those banks would need more credit from the bond markets in the years to come.
According to Noonan, a minority of the ECB’s governing council does support the idea of allowing Ireland to impose haircuts on some of the senior bank debt. Axel Weber, the outgoing governor of the German Bundesbank, supported the idea on Thursday night.
Noonan still hopes that the ECB’s policy may change when it comes to the €7 billion of senior unguaranteed debt left in Anglo and Irish Nationwide. But he has conceded that the decision is out of his hands. “[Opinion] in Europe is changing all the time,” he said. “At one time, burning [junior] bondholders was not on the cards in Europe. Now, it is. Some in the ECB governing council now favour burden sharing with senior bondholders, but it is not the majority opinion. We won’t go there without it.”
Fianna Fail engaged in predictable schadenfreude at the apparent U-turn in Fine Gael policy last week. The only “burning” that had taken place in relation to the banks, it said, was of Fine Gael’s and Labour’s election promises.
“There was a lot of rhetoric on banking policy,” said Michael McGrath, a Fianna Fail TD. “We saw a dramatic and humiliating climbdown when the government were faced with the attitude of the ECB.”
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McGrath, along with the Sinn Fein finance spokesman Pearse Doherty, also pointed out that the commitment to establish a state Strategic Investment Bank, contained in the Programme for Government, wasn’t mentioned by Noonan on Thursday. Nor was the €60 billion medium-term liquidity programme that was supposed to be on the way from the ECB.
“They have magically disappeared,” McGrath said. “We are not convinced of the strategic bank’s merits, anyway. How would it attract sufficient funds?”
Dermot O’Leary, the chief economist of Goodbody Stockbrokers, believes the investment bank could make things worse, sucking deposits away from the main banks, who desperately need the cash.
Labour says the new investment bank is still a possibility, and there is likely to be an update on it in the jobs budget, due by mid-June. Government sources conceded, however, that the coalition partners had yet to reach agreement on where the money would come from to set it up. Labour originally wanted to tap the National Pension Reserve Fund, while Fine Gael preferred using the proceeds of state assets. A compromise may be difficult to find.
As his predecessor Brian Lenihan discovered when he sought leeway from the ECB, Noonan is finding that Ireland has few options when it comes to sorting out the bill for our delinquent banks. Reality has bitten hard for the country’s new political leaders.
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THE new plan sacrifices choice and competition in the banking market, for both consumers and business. Larry Broderick, the general secretary of the Irish Bank Officials’ Association, estimates that the re-organisation may have an impact on up to 6,000 job losses in the sector.
The massive infusion of capital will also fatten up AIB and Bank of Ireland, possibly for sale to foreign owners. So will any of this help to stimulate economic recovery?
The redrawing of the Irish banking sector, and its reduction from six institutions to two-and-a-bit banks (the bit being PTSB), has its genesis in the international rescue plan for Ireland signed in November.
The bailout troika of the ECB, the International Monetary Fund and the European Union demanded that Anglo and Irish Nationwide be wound up. It also required that the Irish banking system be reduced in size, and return to traditional funding, with its quantum of loans more closely tracking the size of its deposit base. It is this drive to shrink the system that is shaping the new banking structure. The magic number is that a bank’s loans should not exceed 122.5% of deposits. The total loans within the domestic banks at the end of December 2010 was €282 billion. Deposits amounted to just €157 billion: a ratio of 179%.
To get the loan-to-deposit ratio down to 122.5%, and reduce reliance on ECB funding, the banks have to shrink their loan books. Shedding the vast bulk of international loans by the end of 2013 has become a priority, and the process has already started.
This week, Bank of Ireland will offer for sale Burdale, a specialist UK lender which has about €1 billion of loans. AIB will try to sell its UK business, which lends to small firms. All the banks are expected to lose money as they sell loans into a distressed international banking market.
The shrinking of the banking sector has clear downsides, however. Many business owners fear a return to the 1980s when AIB and Bank of Ireland dominated the market.
“The banks will be so scared in the next few years that they won’t lend to anybody — it will be the same thing all over again,” said John Teeling, the chairman of Cooley Distillery, a whiskey maker. “I am totally depressed about the whole banking situation. There is no effective banking system offering liquidity to the Irish market for businesses.”
The Department of Finance insists that the deleveraging will allow the twin-pillar banks to focus on lending. There are plans to set targets for lending to different sectors, from hotels to agriculture and mortgage lending. Ireland’s Central Bank estimates the demand for credit over the next three years at €16.5 billion. The Department of Finance says that the two remaining banks will have up to €30 billion to lend. Raymond Coyle, the owner of Tayto Foods, said: “It is back to the 1980s, surely, but if you have two banks lending rather than four not lending, then that has to be better, doesn’t it?”
Smaller and fewer banks will mean fewer jobs. Broderick hopes to meet Noonan this week. “We understand the EBS [merger] came as a surprise to AIB,” he said. “We have no idea exactly how many jobs will go as a result. The first indications may emerge with their results on April 12. “We will not co-operate with anything until somebody tells us what’s going on.”
The least that up to €24 billion of taxpayers’ money should buy is some certainty. The stress-testing of loan books and deleveraging is designed to clean up the banks and to borrow again.
GIVEN the prospect of less competition, job losses and no apparent change to how the banks operate, are we paying too much for this bailout? Is the taxpayer going to drown in the debt?
The answer is not yet. The vast bulk of the cash pumped into the bank rescue has come from our cash resources. Last week’s €24 billion only added €2 billion to the government’s debt-funding requirements. About €17.5 billion will come from the National Pension Reserve Fund, and more from cash reserves.
What Ireland and the ECB need to help to end this crisis is growth. A return to banking normality, even if it is in three years’ time, should help.
On Friday, Standard & Poor’s downgraded Ireland’s sovereign credit rating, but only by one notch from A- to BBB+ and crucially gave Ireland “a stable rating”.
“That was a vote of confidence,” said Padhraic Garvey, debt strategist with ING, a Dutch bank. “Ireland needs a sustained run of good news. The banking story is only a part of it. The macroeconomic numbers will also have an impact.”
But some people have made up their minds. Nouriel Roubini, professor of economics at New York University, said: “I’m not sure that it’s going to be enough and putting all the losses of the banks on the balance sheet of the government and eventually breaking the back of the government ... it’s not the right solution.”
The upheaval will continue over the next fortnight, when the banks rush out their annual results, and the findings of the government-commissioned investigation into the collapse by Peter Nyberg, a Finnish banking expert, are released.
Matthew Elderfield, the Financial Regulator, will shortly write to all current bank directors alerting them to upcoming fitness and probity tests. “What you will see is a stress testing of the bank boards,” said a senior Department of Finance official.
And so, almost a year after Lenihan drew a banking line in the sand, the new government has announced a “radical restructuring”. Noonan’s strategy envisages AIB and Bank of Ireland as the twin pillars of a healthy banking system, one that can deliver up to €30 billion in new lending to productive areas of the economy. But the same question lingers: will it work?
Within two months of Lenihan’s line drawing, Greece was forced to seek a sovereign bailout, triggering events that led Ireland down the same path. The biggest test of Noonan’s plan to “return the banking system to long-term viability and profitability” and to “break the vicious cycle of the massive dependence of the banks on the state” may well be its ability to withstand external shocks.
Additional reporting: Niall Brady
For full view of graphic, revealing the sums spent on the banking bailouts click here
Return to bond markets ‘a year away’
Some believe the Irish banks’ re-entry into the bond markets could still be a year away, writes Niall Brady.
“Stress tests only count for so much,” said Theo Phanos, founder of Trafalgar Asset Management. “Investors need to see several quarters of stable macroeconomic performance, including GDP growth, fiscal discipline and stable earnings.”
But there is some talk that Bank of Ireland, if it can raise the €5 billion it needs at least partly from private sources, might be able to tap international money markets before the end of the year. But the return to normality will generally be a long, slow process for Irish banks.
“My experience of the bond market is that you go down in the elevator, but you have to come back up the stairs,” said a Dublin banker.
This means the European Central Bank (ECB) will continue to fund the Irish banking system and dictate how the country runs its banks. There was speculation that it would offer Irish banks a medium-term fund facility, which would have boosted market confidence but the proposal met resistance at the highest European levels.
It looks like short-term funding, which has to be confirmed every two weeks, will be extended on a medium-term basis. Crucially for the banks, though, the ECB has agreed to loosen its terms of lending, and specifically how it values collateral it receives in return for loans. Dependence on the ECB will be reduced, however, only when the banks have been through a deleveraging process.
When banks return to the bond markets, the cost of funds will still be high. As a result, so will the cost of borrowings for Irish consumers and businesses.
The reduction in the number of Irish banks is happening just as foreign banks retreat. Bank of Scotland has shut up shop, and National Irish Bank (NIB) has closed branches and is to concentrate more on corporate and multinational businesses.
Those foreign-owned banks that remain, including Ulster Bank, the number three player in the market, are dormant in some areas of the market, especially mortgage lending. But Ann Fitzgerald, chief executive of the National Consumer Agency, insists: “I don’t accept that these institutions [Ulster and NIB] are interested only in deposits.”
Brendan Burgess, of Askaboutmoney.com, a personal finance website, says that competition must take a back seat if the system is to be repaired. “Part of the reason for our problems is that there was too much competition in lending and, as a result, the banks have been wrecked by cheap tracker mortgages,” he said.
“Our problems are bigger than competition, but the government should act now to ensure that competition is restored when the market returns to normal.”
It’s tough in the desert, but it could get tougher here
The car peels slowly off the main road and turns into Ishani Ridge, an estate of spacious bungalows, all painted bright yellow with shuttered garages in a blinding white, writes Brian Carey.
The houses are all unoccupied; mounds of gravel are heaped on scrub-infested gardens. Bright white pavements and asphalted cul-de-sacs stretch into empty desert. Cylindrical sewage pipe segments are stranded overground; fire hydrants are covered in black plastic.
The car driver heaves a giant sigh, and after six minutes, the YouTube tour is over. This is Pahrump, Nevada — but it could be Leitrim.
Perhaps the most controversial element of the stress tests of Irish banks, which last week prompted fresh demands for a capital injection of up to €24 billion, was the hiring of BlackRock Solutions. The company is part of one of the world’s largest investment companies, and has an international reputation in analysing investment risk.
But the firm — one of 10 consultants, accountants and law firms hired to help with the Central Bank of Ireland review — has irked local bankers by using American property experience to assess Irish loan books.
For example, BlackRock used the property collapse in Nevada as a template for Ireland. It also projected losses in a scenario that envisaged 45,000 repossessions over the next three years. There were fewer than 400 in Ireland last year.
The firm assessed mortgages to estimate the potential for losses over the whole life time of the mortgage, not just the three years of the review.
Such rigorous, and what many bankers see as excessive, stress testing, is designed to convince the markets that Irish banks will be capitalised sufficiently to withstand the harshest of economic environments.
The stress testing is just one element. Irish banks will also be capitalised to keep reserves that are proportionately much higher than other banks in Europe.
Even after that, the Central Bank of Ireland on Wednesday decided to add an extra buffer to cover losses on loans that are “not evident now” but might be “embryonic” in the loan books. Such a loading of capital into the banks, and the use of 10 sets of outside advisers and two peer reviewers from the central banks of Italy and France, are essentially designed to bomb-proof the review.
The hope is that this will dispel any doubt that the Irish banks and their regulators are hiding problem loans.
As Patrick Honohan, the Central Bank of Ireland governor, stressed, BlackRock’s assessment is not a prediction and the capital raised by the banks may never be used.
It is designed to instil confidence and prevent the devastating kind of outflow of deposits that struck the sector last year.
If these allowances are far too high, and the banks end up with too much capital, Honohan says, it will be the shareholder, largely the state, that will benefit.
Are we fattening up the banks for sale? If they become too fat, and the market says they have more capital than they need, the excess should be reflected in any sale price, Honohan said.
Harsh as they are, the BlackRock stress scenarios are not the most severe assessments made on Irish loan books.
The new Anglo Irish Bank management, which was not part of the review, assessed its books based on a worst-case scenario that was far worse. The loss rate on its personal loans would be a massive 68%, compared with 29.8% at the worst of the banks under review, Allied Irish Banks, Bank of Ireland, Permanent TSB and the Educational Building Society.
It is doubtful that the potential loss rates of Anglo’s high-roller personal clients would even be repeated in somewhere such as Nevada.