Wait for banking revival far from over

ANALYSIS:The private sector vote of approval for Bank of Ireland is a boost but Irish banks still have huge hill to climb.

WHERE ONCE there were six, now there are three – and two of those are wards of the Irish State.

Allied Irish Banks and Irish Life and Permanent have been effectively nationalised following a shareholder vote and a High Court order respectively this week.

The already nationalised EBS building society was shoe-horned into AIB at the start of this month.

Anglo Irish Bank and Irish Nationwide Building Society – the most toxic of the Irish lenders – were merged on July 1st and will be closed down over 10 years under the name, Irish Bank Resolution Corporation (IBRC).

And then there is Bank of Ireland, out on its own as the only Irish bank to have escaped the clutches of Government control following the conclusion of an early-morning deal with a group of private investors last Monday.

It has been a frenetic week in Irish banking as the Government and the banks finalised their €24 billion recapitalisation as laid down under the terms of the European Union and International Monetary Fund bailout ahead of a deadline of July 31st, this Sunday, to reach over-capitalisation.

The aim of the exercise was to restore confidence in the shattered banking system within the international markets. Has it worked? For Bank of Ireland – possibly. For the others – not yet.

The week started with the deal brokered by the Government with a group of North American investors (with some small Irish players in their midst) to inject €1.123 billion into Bank of Ireland.

This limited the State’s shareholding to a minority stake thereby enabling chief executive Richie Boucher and his management team to avoid joining the other five in State hands and the Government to avoid the virtual nationalisation of the banks.

The deal was portrayed as a fillip for the State. Things were not so rosy at the other “pillar” bank.

The announcement from the virtually-nationalised AIB yesterday afternoon that it had taken a State “capital contribution” of €6.054 billion for “no consideration” shows just how the fortunes of the two banks have diverged widely.

It made no sense for the Government to tie up a further €6 billion in shares in a bank in which it already held a 99.8 per cent stake.

The Bank of Ireland deal with the North American investors is important for two reasons – one financial and the other symbolic.

The €1.123 billion private investment means that the Government does not have to borrow at still costly interest rates from the EU or IMF to recapitalise the banks.

The latest banking bill is covered by the €17.5 billion earmarked from the National Pension Reserve Fund and State’s cash balances in the EU-IMF bailout deal.

This is as a result of the €5 billion saved from forcing losses on junior bondholders and the deal with the Bank of Ireland investors which reduce the €24 billion recapitalisation bill that bit further.

The fact that “value investors” such as Fairfax Financial from Toronto, Wilbur Ross from New York, Fidelity Investments from Boston, and Capital Group and Kennedy Wilson from Los Angeles see a potential return in Bank of Ireland sends out a signal that Ireland is no longer toxic.

But this doesn’t mean that the Irish banks are fixed – far from it.

Pumping the banks with capital was only ever going to be the first part of a very long repair job.

The Irish banks are still heavily reliant on European Central Bank and Central Bank funding.

AIB said at its half-year results on Monday that it had cleared the last of its emergency loans at the Irish Central Bank in April but it still has €28 billion – about a quarter of its funding – in loans from the European Central Bank.

All told, the Irish banks are in hock to the Frankfurt-based bank and the Irish Central Bank to the tune of about €158 billion, a sign of a dysfunctional banking system.

Like the challenge the Government faces with the public finances, the only real way to cut borrowings is to ensure you don’t have a requirement to borrow.

For the State, this means cutting spending and increasing taxes; for the banks, it means reducing their loans and raising more deposits so they can become self-sufficient again on their traditional lifeblood, customer funding.

AIB gave a progress report on its deleveraging of loans when it published half-year results last Monday. The bank said it had reduced its “non-core” loans from €25 billion at the end of last year to €16.8 billion at the end of June.

Most of the deleveraging across the three remaining banks has so far involved overseas assets, which are much easier to offload. Irish assets are far too distressed and only attract firesale prices.

More than half of the €72.6 billion of loans and other assets which have to be deleveraged across AIB, Bank of Ireland and Irish Life and Permanent are foreign assets, mostly UK mortgages. Bank of Ireland has a UK mortgage book of €32 billion and Irish Life and Permanent has €7.5 billion, to which British lender Northern Rock has been linked as a potential buyer of these assets.

The troika of the European Central Bank, the European Commission and the IMF have acknowledged that the deleveraging of the banks will be a difficult process to meet by the end of 2013 deadline.

The focus on asset sales has so far been in the US where AIB and Bank of Ireland have sold commercial property assets and Anglo is selling loans of $10 billion.

The deleveraging will help to pay down debt due to the European Central Bank as will payments from the National Asset Management Agency to the banks on bonds issued as payment for the €72.3 billion of property, land and development loans already deleveraged from the banks.

Nama said at the publication of its 2010 annual report yesterday that it had paid more than €1 billion of debt due to the banks on its bonds and that its cash balances had reached €1.4 billion this week.

The agency has a target set by the last government and the troika to generate €7.5 billion of cash to pay off 25 per cent of its €30 billion debts by the end of 2013. Like the banks, Nama has concentrated on selling assets where there is a market – overseas. Out of €3.9 billion in sales approved by the agency, 80 per cent were on assets outside Ireland. It admitted making losses on Irish asset sales.

Given that 39 per cent of assets at Nama are outside Ireland, the agency will eventually have a rump of Irish properties to offload and unless there is a recovery in the market this could knock its debt reduction plan off course.

This, in turn, will put pressure on the banks’ plans to reduce their borrowings at the ECB over time.

The end of the bank recapitalisation process this week marks the fifth in a series of bailouts for the banks over the past 30 months.

Given the severity of the Central Bank stress tests in March and the fact that the banks have some of the highest capital levels in Europe, this should be enough.

Bank of Ireland’s successful capital-raising from the private sector was a unique win for an Irish bank in the three-year crisis.

But the banks cannot borrow in the open markets and are still heavily reliant on the guarantee of a Government whose credit rating stands at junk status. They will be remain reliant on the central bankers in Frankfurt and Dame Street to bankroll their businesses for some time yet.

While Bank of Ireland might have found support from parties other than the State – and this offers some hope – the banks are far from out of the woods.

The Irish banks how it stands now

Bank of Ireland – majority privately owned; State shareholding – 15.1 per cent (only Irish bank to avoid Government control). 

Allied Irish Banks – nationalised; State shareholding – 99.8 per cent. 

EBS building society – nationalised; merged into Allied Irish Banks. 

Irish Life and Permanent – nationalised; State shareholding – 99 per cent-plus. 

Anglo Irish Bank and Irish Nationwide Building Society – nationalised; merged; renamed Irish Bank Resolution Corporation; to be closed over time.