Investor enthusiasm for Irish banks belies problems
BUSINESS OPINION:It is hard to reconcile the new-found enthusiasm of international investors for the Irish banks with what we hear and read on a day-to-day basis.
The Irish banking system remains badly broken by almost every conceivable metric.
Last Friday saw the release of figures showing that the system is still heavily dependent on the European Central Bank for funds as the wider global banking system remains reluctant to lend to it or to put money on deposit.
It is also the case that the banks have yet to seriously start working through their problem personal and mortgage lending.
Credit for business remains tightly rationed at best and non-existent at worst.
So how did the Government offload €1 billion worth of investments in Bank of Ireland with such ease last week? And why is there reported to be good interest in a similar transaction involving AIB?
A big part of the reason is technical. The Government, alas, was not selling shares in the bank. It was selling its contingent convertible capital notes – or CoCos – which are a different thing entirely.
CoCos automatically convert into equity if the bank’s ratio of equity to loans falls below a certain level. However, if it doesn’t, the CoCo holders get their money back in 2016 plus 10 per cent-a-year interest.
The appetite for the CoCos signals that investors don’t think Bank of Ireland is going to run out of capital in the next three years. This is not the same thing as saying the Irish banking system is fixed or Ireland is firmly on the recovery track.
That is going to take much longer and in a way the sale of the CoCos can be seen as symptomatic of the problem, or part of the problem, which is the schizophrenic approach being adopted towards the banks.
The reason investors are comfortable about buying the Bank of Ireland CoCos is in part because they don’t believe the bank will be forced to write off so much capital that they will be triggered.
For some reason – or for a combination of reasons – the CoCo buyers have concluded that the Government will not be riding the banks too hard over the next three years to take aggressive writedowns on their mortgage books or business loans.
Funds for SMEs
And they are probably right. The announcement last week by the National Pensions Reserve Fund (NPRF) of further details of three new funds to invest in small and medium-sized enterprises certainly points in that direction.
Rather than use the banking system it owns and controls to solve this problem, the Government has chosen to incentivise Carlyle, Better Capital and BlueBay to come into the Irish market.
It may be overly pejorative to describe these entities as vulture funds, but at the same time we all know they are not here for the Gathering.
They raise their money by offering superior returns to investors and you only do that when you make superior profits. The NPRF has only given the haziest outline of how the three funds – into which it will commit up to €500 million – will work and no doubt in the fullness of time we will hear what measures have been put in place to ensure that the taxpayer and Irish businesses don’t get stuffed for the benefit of Carlyle, Better Capital and BlueBay investors.
So why has the Government thrown in the towel so to speak in terms of getting the banking system to do what it wants?
Structural problems and the lack of capacity in the system are part of it. Even with the best will in the world on the part of the banks – and it’s quite a big if – the process of restructuring them will take time. If you accept this argument, then expensive non-bank finance for small business from the likes of Carlyle is better than no finance. The issue then becomes oversight.
The other argument is that there is an overriding imperative to attract international investment into the banks in the hope of weaning them off ECB funding. Here again the view is that expensive money via the sale of CoCos to international investors is better than taxpayers’ money.
It is a somewhat tendentious argument as it risks putting the bank cart before the economic recovery horse. But at the same time it is reassuring that there is a logic to what the Government is doing. What is hard to stomach is that the out-and-out winners seem to be the financial alchemists investing in the new funds and the CoCos, who played such a part in getting us into this mess.