Annus horribilis for Irish banks

With each passing month things got worse for Irish banks and their handling of the crisis often did not go down well with the public or the Government, writes SIMON CARSWELL, Finance Correspondent

THE GOVERNMENT may have restarted the oxygen of funding to the banking sector with the emergency State guarantee in September 2008, but fears that the banks had potentially fatal levels of capital to protect against rising losses lingered as 2009 began.

Just before Christmas 2008, the third largest domestic lender, Anglo Irish Bank, revealed that former chief executive Seán FitzPatrick had hidden loans of up to €122 million over eight years. The scandal forced out FitzPatrick as chairman and then David Drumm, his successor as chief executive.

The year started with another emerging crisis and ended with all but one of the six domestic lenders still desperately low on capital and the sector facing a much greater level of State ownership in 2010.

JANUARY

Anglo’s finance director Willie McAteer, the bank’s third in command, followed FitzPatrick and Drumm out the door in early January.

The Irish banking crisis was three months old at this stage, yet the three Anglo executives were the only bankers to have resigned.

It emerged that the Financial Regulator knew of FitzPatrick’s loans that he had been temporarily hiding in Irish Nationwide Building Society (INBS) over the years.

The loans were detailed in the bank’s quarterly reports to the regulator. The regulator’s chief executive Pat Neary – already under pressure for his repeated assurances throughout 2008 that the Irish banks were adequately capitalised – announced his departure.

By the late evening of Thursday, January 15th, the strain on Anglo became too great and the Government was forced to take the bank into full State ownership, blaming the “serious reputational damage to the bank” caused by the controversy over FitzPatrick’s loans.

Brian Goggin said he would step down as Bank of Ireland chief executive in the summer after the bank decided to accept a State capital bailout and due to the bank’s collapsing share price. His departure was expedited after he proclaimed to RTÉ that, following a voluntary pay cut, he would earn “less than €2 million” for the current financial year.

FEBRUARY

The nationalisation of Anglo spooked investors creating uncertainty that the Government may have to take over other banks.

Further controversies came thick and heavy as it emerged that Irish Life Permanent (ILP) had moved deposits of €7.45 billion into Anglo for several days over the latter bank’s previous September 30th financial year end.

The deposits falsely flattered Anglo’s balance sheet at a time of severe volatility and made the bank appear much stronger than it was on a day when investors were closely scrutinising its books.

Anglo claimed the lodgements were customer deposits, while ILP argued they were inter-bank deposits backed by funds originating from Anglo. This is now the subject of investigations by the Garda and the Director of Corporate Enforcement Paul Appleby.

ILP had argued that the move had been encouraged by the Financial Regulator and the Central Bank as part of a “green jersey agenda” to encourage Irish banks to support one another through the liquidity crisis of 2008.

The regulator said that it was unaware of the precise nature of the arrangements in advance and that, while it would have encouraged interbanking lending, it could not support the nature of the transfers, which masked Anglo’s heavy losses of customer deposits. It emerged that the regulator became aware of the transactions a month after they took place, but failed to raise any issue until mid-January.

Despite differing accounts over who knew what and when, ILP chairwoman Gillian Bowler admitted the deposits were “wrong” and regretted that they had happened. ILP’s board met and accepted the resignations of finance director Peter Fitzpatrick and head of treasury David Gantly, and later chief executive Denis Casey.

By this stage, three Irish bank chief executives had resigned.

During the same week, the Government announced a revision of its pre-Christmas recapitalisation plan, saying it would inject €3.5 billion each into Allied Irish Banks (AIB) and Bank of Ireland, for 25 per cent preference share stakes.

Soon afterwards, Minister for Finance Brian Lenihan sought to remove the banks’ most toxic loans – the €60 billion in loans to developers against which banks were taking heavy losses. The Government enlisted economist Peter Bacon to devise a “bad bank” plan to cleanse the lenders.

Dr Michael Walsh resigned as Irish Nationwide Building Society (INBS) chairman on February 17th as further revelations emerged about FitzPatrick’s “bed and breakfast” loan arrangement to hide his borrowings at Anglo.

Anglo’s long-awaited annual report for the year to September 30th, 2008 – when the bank teetered on the brink – was published late the following Friday with a report by accountants PricewaterhouseCoopers (PwC). They provided fascinating details into the bank’s financial position the previous autumn and its wild lending.

The PwC report showed just how close Anglo was to going bust.

Anglo had lost €10 billion in deposits in September 2008 and was facing a negative cash position of €12 billion by mid-October. The heavily edited report found that the bank had very large exposures – about 15 customers with loans of more than €500 million each.

It was a case of a having far too many eggs in a very fragile basket.

The bank also said in its annual report that it would have to write off €300 million in loans provided to 10 long-standing customers who had purchased a 10 per cent stake in the bank during the summer of 2008 to prop up the share price.

The so-called “Golden Circle” transaction, known within Anglo as the Maple transaction, arose after businessman Seán Quinn decided to convert an indirect 25 per cent stake in the bank into a direct shareholding of only 15 per cent. This left an overhang of 10 per cent of the bank’s shares, which, if left to the open market, would lead to the stock plummeting, sounding alarm bells about the stability of Anglo.

The secret share deal is the third strand of the official inquiries taking place at Anglo.

At the end of the month Richie Boucher, an internal candidate and former head of Bank of Ireland’s Irish retail operations, was appointed to succeed Goggin.

The appointment drew criticism from several quarters, including financier Dermot Desmond, who said that a person who helped create the bank’s problems should not be charged with solving them.

MARCH

As bank shares fell to record lows, Lenihan issued assurances that outflows of deposits at the two main banks was nothing to worry about. This did little to ease the growing pressure on the banks’ funding as the system came under a level of stress last experienced the previous September.

This had a knock-on effect, driving up the Government’s borrowing costs to the most expensive level recorded in a decade compared with German debt.

The month started with troubling 2008 annual results from the State’s largest bank, AIB. Heavy write-downs on Irish development loans forced the bank’s Irish operation into its first loss since the bank was established in 1966.

Chief executive Eugene Sheehy refused to resign, saying that he planned to lead AIB through the crisis. He said that the bank had believed there would be “a soft landing” in the economy.

AIB said it could write off €8.5 billion on bad loans over three years and, with the €3.5 billion taxpayer bailout, would still have enough capital to survive the recession.

The crisis claimed more casualties as the chairman and finance director of the Educational Building Society (EBS) resigned after the customer-owned lender, a minnow in property development lending, made a loss of €38 million for 2008 as a result of these loans.

Three days later, the Government committee on bankers’ pay, dropped another bombshell. Michael Fingleton, the chief executive of INBS, the State’s other building society, had been paid a €1 million bonus in November 2008, just weeks after the society secured protection under the State guarantee.

Fingleton said that he was contractually entitled to the bonus which had been agreed in early 2008. It subsequently emerged that he was also the sole beneficiary of a €27 million pension.

By late March, the Government had taken Peter Bacon’s advice and started preparations to establish a bad loans agency to cleanse the banks of their toxic assets.

APRIL

The mounting pressure on Fingleton became too much and he agreed to step down, promising to repay his bonus to INBS. As the year comes to a close, the society has to yet to be repaid.

Fingleton became the fourth bank chief executive to step down; only Eugene Sheehy at AIB and Fergus Murphy at EBS remained.

The Government’s emergency budget of April 7th was dominated by the establishment of the National Asset Management Agency (Nama) which would buy up to €90 billion in development and associated loans at a discount.

Dr Bacon said this would remove uncertainty about the banks’ capital requirements, while Lenihan said the economy could not sustain banks postponing losses on property loans.

The Minister refused to say how much the Government would pay for the loans but that, if the purchases led to losses and the banks needed more capital, the State would take majority stakes.

AIB reluctantly accepted that the State’s €3.5 billion would not be enough to absorb future losses and agreed to raise a further €1.5 billion after a more severe stress test by the Government.

The admission spelt the end for AIB’s three most senior bankers. After surviving seven months of the crisis, AIB chairman Dermot Gleeson, chief executive Eugene Sheehy and finance chief John O’Donnell agreed to stand down.

The bank had stubbornly resisted State aid and then twice increased the capital that it needed, all the time refusing to contemplate management changes until large shareholders threatened to withdraw support.

MAY

Two weeks later, their humiliation was complete when a shareholder hurled two eggs at Gleeson and Sheehy as the bank sought investor approval for the State’s €3.5 billion recapitalisation.

Bank of Ireland governor Richard Burrows became the fifth bank chairman to step down, saying that accountability “must be taken at the top” after the bank upped its estimate for long-term loan losses to €6 billion and due to the plummeting stock.

ILP’s Gillian Bowler, the only surviving chairwoman across the six domestic financial institutions, refused to stand down, proclaiming herself to be a fighter not a quitter. She outlined to shareholders that the company intended to restructure itself so it could offload its loss-making bank, Permanent TSB, in an anticipated consolidation of the banking sector.

Dr Michael Somers, head of the National Treasury Management Agency, under whose roof Nama will operate, caused quite a stir in mid-May when told the Committee of Public Accounts (PAC) that he knew very little about how the agency would operate and that the Government was facing “an appalling dilemma”. He warned that Nama could be “a bonanza” for lawyers.

The publication of Anglo Irish Bank’s half-year results at the end of the month showed the scale of the problem. The bank posted €4.1 billion in losses, the largest in Irish corporate history, wiping out the bank’s capital reserves. The Government agreed to a €4 billion State bailout, while the bank hinted at further future losses and more demands for State capital.

JUNE

New recruits were brought in to steer the Irish banks. Former Bank of Ireland chief executive Pat Molloy joined the bank as governor. Gerry McGinn, formerly head of Goodbody Stockbrokers in Northern Ireland, replaced Fingleton as chief executive of Irish Nationwide and Irish Life’s chief executive Kevin Murphy stepped up to take the helm at ILP.

JULY & AUGUST

By the start of July, Bank of Ireland warned that operating profits (before heavy loan losses) were under pressure due to higher funding costs.

Permanent TSB tried to offset this by increasing the standard variable rate on 50,000 mortgages. The ensuing uproar scared other lenders off repeating the trick.

The heavy losses from the collapsing property sector began to hit home as developer Liam Carroll became the first mega borrower to seek protection for his heavily indebted companies.

After a marathon legal battle and two failed bids for protection in the High Court and Supreme Court, the group collapsed under debts of €1.3 billion in October.

The case showed the scale of the writedowns facing the banks and posed a huge dilemma for Nama.

Late in July, the Government published the draft Nama legislation but omitted the key detail of how much the State would pay on the loans. The Bill said the Government would buy some loans at a “long-term economic value” above the market value as the properties backing the loans had no buyers in the current distressed market.

SEPTEMBER

More than five months after announcing Nama, the Government finally disclosed on September 16th that it would buy property and associated loans of €77 billion from the banks at a cost of €54 billion, representing an average discount or “haircut” of 30 per cent across the five participating lenders.

This represented an overpayment of €7 billion to account for the “long-term economic value” as the market value of the properties backing the loans was €47 billion.

The plan was to withhold €2.7 billion of the €54 billion from the banks so as to share the risk between the banks and the State.

The Government said that Nama would buy €28 billion in loans from Anglo, €24 billion from AIB, €16 billion from Bank of Ireland, €8 billion from INBS and €1 billion from EBS. For INBS, it would mean the loss of 80 per cent of its loans, putting its future as an independent institution in jeopardy.

AIB said it would now raise €2 billion in extra capital over the next 12 to 18 months, while Bank of Ireland said the discount on its Nama loans would be significantly less than the 30 per cent average.

September marked the arrival of a new chief executive at Anglo,Australian banker Mike Aynsley, to repair the broken bank.

The Government appointed academic and banking expert Dr Patrick Honohan as governor of the Central Bank to replace John Hurley. The appointment broke a long tradition of installing a senior civil servant to head up the bank.

OCTOBER

The Government appointed Bermuda banking regulator, Matthew Elderfield, to the head of financial supervision, a new role within a reformed Central Bank Commission, which would remerge the old Central Bank and Financial Regulator under the same roof.

The Government issued a draft business plan saying the National Asset Management Agency would turn a profit of €5.5 billion by 2020 with a 10 per cent rise in property values after previously saying it would break even.

NOVEMBER

Bank of Ireland and AIB submitted five-year restructuring plans to the European Commission under the terms of the State’s €7 billion recapitalisation.

Both saw their share prices slump after a brief rally to the middle of September as the property valuations on loans heading into Nama weighed heavily on the banks.

At the end of the month, Bank of Ireland revised upwards an earlier estimate, saying the Nama haircut on its loans “should not be greater than” the 30 per cent average. The bank said that it would not need further State capital, to the surprise of many in the market.

AIB was rocked by yet more controversy during the month when it decided to appoint insider Colm Doherty, head of AIB’s capital markets division, as managing director – a new title created as a compromise when the bank could not find a suitable external candidate, the Government’s preferred option.

Mr Lenihan was furious when the bank subsequently proposed maintaining Mr Doherty on his current annual salary of €633,000, above the Government’s €500,000 pay cap. The bank quickly backed down.

Anglo said that it would create a good-bank/bad-bank post-Nama as this was the cheapest option facing the State, far cheaper than liquidating the bank, a route favoured by many members of the public.

The Government’s repair work on the banking sector moved on to the two smallest lenders, EBS and INBS, during November.

With the lenders preparing to sell a combined €9 billion in loans to Nama, Lenihan encouraged both institutions to engage in merger discussions given that both would require substantial sums of State capital to fix them.

DECEMBER

The clean out of second-tier senior executives at Anglo began this month with the Minister for Finance pledging that any former or current managers at the bank who were in default on outstanding loans would be pursued.

By Christmas, Anglo chief Mike Aynsley had filled nine of 10 positions on his new management team with five insiders and four outsiders.

The bank also began its court action against Mr Drumm to recoup loans of €8.3 million.

ILP shareholders voted for a restructuring that would facilitate a quick disposal of Permanent TSB. AIB’s shareholders agreed to participate in Nama.

Irish Nationwide and EBS secured approval from their members to take up to €2.4 billion in capital from the Government in return for issuing controlling stakes to the Government.

This paves the way for the Government taking a stake of up to 90 per cent in the enlarged EBS-INBS mutual, but the jury was still out at year end as to whether Permanent TSB would be added to create a “third force” in domestic banking to rival AIB and Bank of Ireland.

Central Bank governor Patrick Honohan called for a 9-11 style inquiry into the causes of the banking crisis, which brought a cool response from Government.

By the end of the year, the Government’s running total on bank capital injections stood at €11 billion with up to €2.4 billion more sought by the building societies.

Merrion Stockbrokers estimated that AIB and Bank of Ireland would require an additional €7.2 billion, though some of this may come from private investors and asset sales.

Anglo will need several billion more to cover further losses and to fund its restructuring, if approved by the EU.

In the week before Christmas, the Government finally unveiled the board of Nama, which will be chaired by former Revenue chairman Frank Daly and feature among others retiring IMF executive Steven Seelig, who, in correspondence ahead of the Nama legislation, memorably commended the wording of the definition of “long-term economic value” on bank loans as “masterful” in being “sufficiently specific” and “sufficiently vague” to allow “appropriate flexibility”.

The Irish banking system is set for radical change through 2010 and the State will fund the reshaping, a bill that could amount to €20 billion and possibly more.

This is before the €54 billion Nama plan and the long-term sweating of bad assets that are currently worth €47 billion at most.