Different roads to bank capital

Both private equity funds and a domestic investment group are looking at the banks, writes Simon Carswell

IF IRISH bank shares are valuing the institutions at about a fifth of their book value - and groups of US private equity firms and Middle Eastern funds are eyeing up possible investments - why shouldn't existing shareholders be keen to invest as well?

This is the argument that a domestic institutional investment group, a consortium composed mostly of existing shareholders in the banks, has put forward to explain to other potential investors the benefits of participating in the recapitalisation of the Irish banks.

The debate now raging in banking circles is no longer about whether the banks need capital, but where it should come from.

Minister for Finance Brian Lenihan last week encouraged the six guaranteed banks and building societies to raise additional capital privately, and signalled for the first time that the State may co-invest.

Private investors circling the banks include the Irish-led Mallabraca consortium, which is backed by US private equity firms JC Flowers, Carlyle and two Middle Eastern funds.

Texas Pacific Group and Kohlberg Kravis Roberts are also considering investments in the banks. These three groups, and UK private equity firm Apax Partners are in talks with Bank of Ireland about a possible investment.

Private equity firms have also approached other banks.

Mr Lenihan last week encouraged the Irish financial institutions that were in talks with potential investors "to progress these discussions". He said he would examine proposals for State co-investment with private interests on a case-by-case basis.

Against this backdrop, the institutional investment group, which was initially co-ordinated by the Irish Association of Investment Managers (IAIM) but which is now advised by a team from Deutsche Bank, is busy drumming up support by explaining its interest.

The fund managers' group, which is led by AIB Investment Managers, Irish Life Investment Managers and Bank of Ireland Asset Management, wants to ensure that existing shareholders are not diluted in any recapitalisation and that they have a chance to participate in any such investment.

It wants a "seat at the table" on any discussions about the recapitalisation of the banks, and is seeking a "mechanism" to make "institutional capital" more proactive.

The emergence of the group has pitted the interests of the existing shareholders against those of the private equity firms. The group believes its own involvement in any recapitalisation will exclude private equity players as these firms will likely want a controlling interest for their investment.

It's thought that the group could create a fund of €2 billion that could be invested in the banks and matched by a similar-sized investment from the Government.

Mr Lenihan has said that "in certain circumstances it would be appropriate" for the State to consider investing in the banks, possibly using the National Pension Reserve Fund, which is holding cash of €1.5 billion.

Mallabraca has a war chest of €5 billion to invest but has cash-rich sources to offer more.

Analysts believe the banks need to raise anywhere between €5 billion and €15 billion in additional capital, depending on how depleted their existing capital is after absorbing higher-loan losses.

Anglo Irish Bank said on Wednesday that it would still make profits of about €700 million a year over the next three years and grow its capital base, despite writing off €700 million in loans - about 1 per cent of its loan - in each of those years.

David Drumm, Anglo's chief executive, said the bank had not yet made a decision on whether it would seek to raise capital more quickly from external sources.

"We would be very cognisant in any additional capital that we would bring in that it would have the interests of our existing shareholders at heart and that means what we are paying for it, the terms of it, and, indeed, whether it's coming from existing shareholders or not."

This will appeal to the fund managers' group, which sees value for Irish investors and existing shareholders by taking stakes in the banks before private equity firms.

At a briefing for the Irish Association of Pension Funds on Tuesday, Deutsche Bank warned that private equity firms would be "unwilling to grant free options to existing shareholders" and would seek "an element of control" through investments with or without voting control.

In its presentation Deutsche Bank said private equity firms had made "superior returns" of between 25 and 80 per cent a year from their investments in distressed banks.

It highlighted JC Flowers' investment in Shinsei (Long-Term Credit Bank) in Japan, Lone Star's stake in Tokyo Sowa Bank and Warburg Pincus in US bank Mellon as examples. It estimated that the banks increased in value by 800 to 1,400 per cent.

The bank advisers also pointed to the Middle Eastern investment in British bank Barclays, in which existing shareholders were offered £1.5 billion of "mandatorily convertible notes" (MCNs), which they can only convert into ordinary shares by June 2009.

Deutsche Bank advised that existing shareholders in the British banks didn't have an opportunity to participate in recapitalisations, and has warned Irish bank shareholders not to suffer the same fate.

Mallabraca has signalled that it would be willing to allow existing shareholders to participate in a rights issue at a later date but it's not clear whether it would want existing shareholders to co-invest up front in any recapitalisation.

Both sides are still setting out their stalls. At the very least, the banks have more than one source from which to tap more capital, though the cost, amount available and consequences of either side investing will vary significantly.

Governments and banks

Capital investments by governments in banks

Ireland..............nil

Spain................nil

Sweden...........€1.5bn

Switzerland......€4bn

Greece............€5bn

Austria............€15bn

Netherlands....€20bn

Italy...............€20bn

France...........€40bn

UK................€57bn

Germany........€70-80bn