A year spent losing banks and billions

BANKING: THE YEAR started with six Irish banks, all struggling, and ended with four banks, still struggling. Two have been deemed "pillar" banks by the Government – Bank of Ireland and Allied Irish Banks.

A third will be wound down – Irish Bank Resolution Corporation, the merged bank made up of what remains of the two most toxic banks, Anglo Irish Bank and Irish Nationwide Building Society.

The fourth bank, Irish Life and Permanent, faces an uncertain future as the Government has abandoned plans to sell Irish Life due to market turmoil over the euro crisis and there is uncertainty over the future of the company’s banking division, Permanent TSB.

As 2011 draws to a close, Anglo Irish Bank, Irish Nationwide and EBS building society have been fully nationalised, while Allied Irish Banks and Irish Life and Permanent had been effectively nationalised with the State owning more than 99 per cent of each.

Bank of Ireland will end the year as the only Irish bank among the six lenders in existence at the outset of the crisis that has avoided Government control.

This is a result of the Government’s decision last July to sell a 35 per cent shareholding in the bank to a group of private investors, led by Canadian company Fairfax Financial, for €1.1 billion.

This reduced the State’s shareholding to 15 per cent, despite an injection of €4.2 billion in public funds into the bank since 2009.

The year began with the last government waiting to find out how much would need to be pumped into the banks to over-capitalise them under the November 2010 bailout agreement reached with the EU Commission and the International Monetary Fund.

By the time these emergency lenders to the State had arrived in Dublin, the cost of the banking bailouts had reached €46 billion.

This was the estimate set by the Central Bank in September 2010 after it became clear that the National Asset Management Agency was applying an average haircut of 58 per cent to €74 billion worth of property loans it acquired from five banks, inflicting massive losses on them.

Despite opposition from the Central Bank on the scale of the further recapitalisation required, the European Central Bank dictated what action was needed under the terms of the bailout – Frankfurt ordered that banks had to be stuffed with capital to reassure the financial markets that they had enough in reserve to cover any potential losses.

For the second annual round of stress tests in March 2011, the Central Bank hired outside consultants – Blackrock, the world’s biggest asset manager; Barclays Capital and Boston Consulting – at a cost of €30 million to put the banks through the ringer and to reassure the disbelieving markets.

Unlike the previous year, the banks were not just tested for capital requirements to cover potential losses, including possible deficits materialising from rising losses on residential mortgages. The Central Bank also assessed how much by way of loans and other assets they would need to shed in a so-called “deleveraging” of their balance sheets. This was to wean them off funding from both the European and Irish Central Bank – the reason why the ECB pressurised the then minister for finance Brian Lenihan to accept a bailout.

As the two-year run of corporate deposits on the Irish banks slowed in the final months of 2010, the central banks in Frankfurt and Dublin had covered the shortfall.

By the end of 2010 the six guaranteed banks had drawn €91 billion from the ECB and a further €51 billion from the Irish Central Bank through emergency loans or “exceptional liquidity assistance”, to give the credit line its technical name. Most of the €51 billion had been loaned to Anglo Irish Bank.

Patrick Honohan, the governor of the Central Bank, and Matthew Elderfield, the deputy governor in charge of financial regulation at the Central Bank, announced how much more the Irish banks would require at the end of March 2011.

The Prudential Capital Assessment Review – or PCar stress test – put the figure at €24 billion. This took account of expected losses over the three years to the end of 2013 and included €5.3 billion of possible but unlikely losses in the years after 2013.

The Prudential Liquidity Assessment Review, or PLar test, estimated the cost of selling €73 billion in excess loans and other assets to “right-size” the banks.

This was on top of the €74 billion of loans which Nama was taking out of the banks at a heavy cost.

The combined sum put a figure on just how broken the funding models of the banks were.

The Central Bank said the four Irish banks left after Anglo and Irish Nationwide had loans of €255.6 billion and €142.1 billion in deposits at the end of 2010. This represented a loans-to-deposits ratio of 180 per cent. A new target of 122.5 per cent was set to be achieved by the end of 2013.

The additional €24 billion capital bill required at the four banks included a further €13 billion for AIB, €5.2 billion for Bank of Ireland, €1.5 billion for EBS and €4 billion for Irish Life and Permanent, for which it meant the effective nationalisation of that bank.

This was the main story of the 2011 stress tests: a fifth Irish institution falling into State control.

Given that Bank of Ireland had already tapped shareholders for €3.5 billion in a rights issue in June 2010, everyone (except the bank and some within Government circles) expected that institution to fall into State hands too.

But the bank’s chief executive Richie Boucher, an executive director since before the crisis, came out fighting, arguing that State control was “not inevitable”.

Coinciding with the stress test results, the new Minister for Finance Michael Noonan and the Fine Gael-Labour Government voted into power that month announced a wide-ranging restructuring of the banking sector.

Plans to sell State-owned EBS (building society) to a consortium of investors led by Dublin-based Cardinal Capital Group were abandoned and Noonan said that EBS would instead be merged into AIB to form one of two “pillar” banks; the other was Bank of Ireland.

Irish Life and Permanent would be broken up and Irish Life sold to raise some of the €4 billion cost of recapitalising Permanent TSB.

Bank of Ireland moved quickly to raise capital by tapping shareholders again, this time for almost €2 billion, and inflicting losses on subordinated bondholders, generating a further €2 billion.

The Minister used the emergency legislative banking powers introduced in December 2010 by his predecessor, to force heavy losses on AIB subordinated bondholders. Despite legal challenges from two of the bondholders, €2 billion was raised by forcing losses on this class of lenders to the bank.

All told, the Government reduced the €70 billion bill for bailing out the banks by about €6 billion by forcing losses on the bank subordinated bondholders.

The ECB overruled any “burden-sharing” with any senior bondholders at Anglo Irish Bank or Irish Nationwide, fearing the effect it may have on the funding of the Irish banking system and indeed the wider European banks.

As a result there was much controversy in November when IBRC paid $1 billion (€720 million) to senior bondholders, repaying in full mostly distressed debt investors who took a punt by buying the bonds when they traded at deep discounts over concerns about the Government’s plans for them.

Instead the Government abandoned efforts to burn senior bondholders in the face of heavy opposition from the ECB in favour of lobbying the EU authorities for permission to park the €31 billion of promissory notes or IOUs being used to bail out Anglo in either one of the European bailout funds.

The aim of the plan is to reduce the €17 billion long-term interest costs of paying for the promissory notes.

The investment of €1.1 billion by Fairfax and fellow North American investors, New York billionaire Wilbur Ross, LA-based Capital Research, Kennedy Wilson, and Fidelity Investments had put the cost of the banking bailouts at €63 billion by the end of the year.

While it appeared that the long-awaited line had finally been drawn under the cost of the banking crisis, the source of new deposits to improve their funding remains a long way off.

By the end of the year, the Irish banks were still reliant on funding from the European and Irish Central Banks to the tune of more than €100 billion. This was despite the banks enjoying some progress on the deleveraging of assets, notably commercial property loans in the UK and the US.

However, as European banks rush to recapitalise, this will increase the amount of assets being dumped on the markets, which could reduce the price of unwanted Irish bank assets.

Another area where there is still no final closure is the suitability of the surviving pre-crisis bankers and whether they should be allowed to hold on to their jobs.

Richie Boucher, the chief executive of Bank of Ireland, is the most prominent of the long-serving bank directors to face the Central Bank’s new fitness and probity tests next year. The regulator has told the banks that any director who intends to remain on after the start of 2012 must pass these tests.

Boucher received very public support from the new investors in Bank of Ireland which complicates matters for the Government, who sold the investors their stake in the bank, and the Central Bank.

Bank of Ireland directors Des Crowley and Denis Donovan stood down from the court or board of the bank during the year but hold on to their executive roles.

Over at AIB, the long-awaited appointment of a chief executive – a post that had been vacant since the departure of Colm Doherty in November 2010 – was made.

Dubliner David Duffy, who had spent most of his career working overseas, was appointed and agreed, after much to-ing and fro-ing by the bank, to the Government’s €500,000 bankers’ pay cap.

Like his counterpart at Bank of Ireland, he faces tough challenges in 2012 at AIB as it identifies the 2,000 staff to be made redundant and aims to attract investors to reduce the State’s shareholding.

The objective for 2012 will be to try to reduce the State’s involvement in the banking sector and to get the banks funding themselves without the support of the Government and the central banks. However, both objectives will be next to impossible if the euro crisis continues to deteriorate.