Banks braced for mergers that will strengthen sector

ANALYSIS:MEETINGS BETWEEN Minister for Finance Brian Lenihan and the heads of the guaranteed banks and building societies this week - and the circling of the banks by various private investors - have sparked a frenzy of debate about possible mergers in the banking sector, writes SIMON CARSWELL, Finance Correspondent.

There is no doubt that the Government views consolidation as part of a three-pronged approach to the safeguarding of the banking system from future shocks.

Step one involved the guarantee on September 30th, stopping the flood of deposits out of the Irish banks and building societies.

Step two will involve the recapitalisation of the banks. This looks likely to come from private investors, as the Government has repeatedly said State investment in the banks was "a last resort".

Step three involves mergers.

The arrival of international private equity firms in Dublin, including the likes of cash-rich US investment companies JC Flowers and the Carlyle Group in the Irish-organised Mallabraca consortium, means the Government may not need to dig deep into its pockets to inject fresh capital into the banks, which can absorb higher loan losses through the recession.

The consortium is named after a townland (spelt Maulabracka) in Co Cork near Dunmanway, the birthplace of Sam Maguire, after whom the GAA All-Ireland football trophy is named. However, it includes sovereign wealth funds - massive pools of state-controlled cash - coming from much further afield in the Middle East.

Sources suggest that the financial fire-power of JC Flowers and the Carlyle Group gives the consortium sufficient cash to take a stake in Bank of Ireland or in a merged group comprising Bank of Ireland and Irish Life & Permanent. The consortium is eyeing up both banks and is even believed to be interested in taking a stake in Anglo Irish Bank as a potential sweetener for the Government in a succession of transactions.

However, this depends on the appetite of Government and Anglo Irish. The top prize for Mallabraca is Bank of Ireland and Irish Life & Permanent, but especially the latter's valuable life insurance business. Taking a stake in a merged entity comprising the two banks would give the consortium a massive share of Irish financial services. Bank of Ireland confirmed yesterday it had received "unsolicited approaches" from bidders.

Private equity firm Texas Pacific Group is also believed to be circling a number of Irish financial institutions with a view to taking an equity stake and injecting capital in one or a number of Irish banks, though it appears to be seeking a less significant interest than the Mallabraca consortium.

The spectre of consolidation follows meetings between the six guaranteed institutions and Mr Lenihan in which he asked them to reflect on "structural" changes in the banking market. He is essentially asking them to consider - in a process of inward rather than Government-led reflection - mergers that might strengthen their businesses and the banking sector, and to come back to meet him again next week.

The Government is thought to be favourably disposed towards mergers, though it will be scrutinising the approaches of private equity consortiums, their plans to take stakes in a bank and whether they will involve significant job cuts.

Mr Lenihan has also received strong legal advice and is careful to show that he is not forcing the banks into a consolidation process that could run contrary to the interests of shareholders.

A senior lawyer from Dublin law firm Arthur Cox is believed to have sat in on the meetings between the Minister and the bank executives on Thursday.

This is more a process of gentle persuasion and reflection on the banking sector than a process of hammering six financial institutions into two enlarged banks based around the main players - AIB and Bank of Ireland. That is unlikely, as the Government seems keen for some form of mutual building society to remain.

Anglo Irish dispelled the concerns of staff yesterday. Chief executive David Drumm said in an internal e-mail to staff he wanted to assure them the bank would "continue as a successful and independent business bank providing a key and competitive offering".

The bank has also said as much in the revised business plan that it submitted to the financial regulator on Thursday. All the guaranteed banks have submitted revised plans to the regulator showing how they intend to reduce the risks facing them so the State guarantee will not be called upon.

Irish Life & Permanent is believed to have outlined in its own business plan that it was in talks with EBS building society about how the two institutions "might work together". EBS is also in talks about potential takeover by Dutch banking giant Rabobank.

All the while, Irish bank shares continue to languish amid lingering concerns about the need for capital, whether they can raise it privately and how it may dilute the interests of their shareholders.