Property's spoils ruined mighty AIB

ANALYSIS:Three reports take an unflinching look at how events took such a disastrous turn for a giant of Irish banking

JUNIOR BANKERS were always taught they should only lend money they believed they could get back. This traditional rule of banking was forgotten at the Irish banks as the hubris of the property boom took hold.

An Allied Irish Banks executive put it succinctly in one of three reports commissioned by the bank – none of which have been published – to understand what went wrong at AIB. The 2010 report by the bank’s then chief credit officer Joe O’Connor looked in particular at the Republic of Ireland (ROI) division that was responsible for most of the bank’s cost to the State of close to €20 billion. “In short, the main thrust of the business in ROI was to focus on volume/market-share written loan origination,” he said. “This was achieved by growing property advances and related income in an unbalanced manner, and thus flouting enduring principles of banking.”

The €29.3 billion drain on the State that was Anglo Irish Bank eclipses the €20 billion cost of nationalised AIB. The bigger cost at Anglo, combined with the nefarious discoveries at that bank unrelated to property lending, has meant AIB’s uglier sister has attracted far greater attention and public ire.

However, based on a bad lending league table and the level of losses, if Anglo was toxic, then AIB could aptly be described as septic.

The public is still largely in the dark on any forensic analysis of the monumental errors that took place at AIB – once Ireland’s biggest bank and now 99.8 per cent State-owned – for which the public is paying so heavy a price.

The heavy losses are playing no small part in the dramatic downsizing of the bank, which yesterday confirmed about 2,500 redundancies among its 15,000-strong workforce.

The three unpublished reports into past practices at AIB, seen by The Irish Times, pull back the curtain on the failures at the bank.

O’Connor’s analysis and the later reports by London-based consultant Michael Foot from the Promontory Financial Group and accountants Deloitte reveal what went wrong with AIB’s lending, notably in the ROI division.

This was the sector that dealt with developers who accounted for most of the €17 billion in bad debt provisions at AIB taken in the three and a half years to the end of June 2011.

In April 2009, the bank’s then chief risk officer Nick Treble (now head of the bank’s UK “non-core” business) offered the first internal analysis of how AIB imploded. In his report,

Why the Credit Crisis hit AIB so Hard

, he summarised what had happened in three points:

* bad analysis of the Irish housing market;

* bad judgment on exposures to major developers whom AIB believed could not fail;

* bad luck due to the global financial crisis.

THE O’CONNOR REPORT

Former chief executive Eugene Sheehy’s successor Colm Doherty asked Joe O’Connor to dig deeper into the bank’s failures, and he reported back in June 2010.

O’Connor had been Doherty’s chief credit officer in capital markets before he was promoted to group chief credit officer following Doherty’s elevation to the role of AIB group managing director in November 2009. (Both men have since left the bank.)

O’Connor was an appropriate candidate to carry out this kind of exercise. The mounting losses at the ROI division were in stark contrast to the performance of capital markets which remained profitable during the crisis.

A notable difference in loan approvals between the divisions was that the chief credit officer in ROI didn’t report directly to the group chief credit officer but to the head of the division; in capital markets, they did report directly to the group chief credit officer.

The figures in O’Connor’s report tell the full story. The spoils of the property market lured the mighty AIB into a heavy concentration that felled it.The loan book increased by €76 billion between 2002 and 2008, when the percentage of property loans as a proportion of overall loans went from 18 per cent to 37 per cent.

This was greater than at rival Bank of Ireland, which has taken less public cash (€4.2 billion) and avoided State control (see table). Bank of Ireland was also more conservative in the scale of lending to big borrowers.

By 2009, property loans accounted for €49 billion of AIB’s €134 billion loan book, and of that €49 billion, 46 per cent or €22 billion was concentrated in land and development – the highest risk loans on its books. This was well in excess of the bank’s peers, O’Connor said. Within the €22 billion land and development book, loans in ROI accounted for €17 billion, or 77 per cent of that book.

Like Anglo, AIB was concentrated on a small number of big borrowers. The top 50 borrowers accounted for €16 billion of loans, of which €13.5 billion was property. ROI property loans accounted for 62.5 per cent of the top 50, or loans of €10 billion.

Among the big developer borrowers were Liam Carroll, Ray Grehan and David Daly.

Incredibly, even after the market had turned, the ROI division kept lending out on property. O’Connor said ROI property loans grew by 8 per cent in 2008; the capital markets property book contracted by 6 per cent.

O’Connor attributed the failures in the ROI division to a litany of errors. There was “sporadic” analysis by the risk and credit units of the concentration in property, and their recommendations were “often bland, ambiguous and difficult to measure or achieve”.

Credit policies and guidelines failed to provide appropriate controls. There were shortcomings in the skills and experience of staff dealing with property loans. A culture of strong earnings growth became “embedded” within the ROI division and moved the business “up the risk curve”. There was also a culture of “little individual accountability” in some areas and “few escalation procedures”.

Loans were priced at levels that did not reflect the risks the bank was taking on.

The “perfection” of security to support the loans was not always achieved, he said, and there was poor oversight of individual cases.

Large exposures to major borrowers “grew disproportionately”, wrote O’Connor.He said the group chief credit officer who oversaw major lending decisions was not on the bank’s overall executive team. He also noted management of staff loans was not handled by one unit, and the division that dealt with staff business at AIB only handled about 65 per cent of the employees’ business with the bank.

He found there was “ineffective separation” of loan origination and approval in many areas– those who presented the loan applications were also involved in approving them.

THE PROMONTORY REPORT

AIB’s problems were traced all the way back to Sheehy’s predecessor as chief executive, Michael Buckley, by consultant Michael Foot of Promontory for his January 2011 report.

He cited Buckley’s comments in 2003 that smaller rival Anglo had joined AIB for breakfast, but was now eating its lunch. AIB subsequently became “significantly more aggressive between 2005 and 2008”, said Foot.

He found considerable reluctance among senior management to give any priority to robust governance and risk practices, despite the John Rusnak rogue trading and Faldor tax evasion scandals of earlier years.

“In the ROI division of AIB it should have concerned them (but clearly did not) that they were also accepting and signing off on frequent and major breaches of lending policies. These breaches collectively were on a scale we have rarely encountered,” said Foot.

There was little regard given to the quality of and training for staff managing loans when the ROI division was growing fast, he wrote.

“The result was that during perhaps the most critical period of aggressive and risky lending, large numbers of these loans were being made by staff without the basic cash flow analysis and other skills needed to make a proper assessment of the risks involved.”

Foot criticised the board and senior management at the bank for creating a “silo mentality” across the bank where senior executives in the ROI division set pricing on loans to pursue growth “without due regard to the risks”.

“Insufficient attention was given to proper process of credit generation and review, with seemingly little reference to or challenge from group,” said the report.

Foot said AIB’s non-executive board members were until late in 2008 “perhaps too willing to accept management explanations” – for example, on the extent of possible loan losses on “customer restitution cases”. They had also received poor information, he said.

“The board knew much less than senior management about the state of affairs within the bank, especially the ROI division, where the damaging results of the governance weaknesses eventually proved to be by far the greatest,” said the report.

“This was partly because of the difficulty of obtaining timely and accurate data, a problem that has been vigorously tackled in the last 12-18 months but which still causes problems today [January 2011].”

Many large borrower cases came before the directors, as any time a lending limit for a big borrower was breached it went to the overall board. A subcommittee of the board was then convened to approve an increased limit.

Developer Liam Carroll was among the notable clients to have breaches of limits approved by a board subcommittee, as his loans soared to and past the €1 billion mark.

More generally, Foot found dissent was not appreciated in the AIB boardroom.

“The board also prized consensus, which may have made it more difficult for those who were uneasy to speak out,” he wrote.

THE DELOITTE REPORT

The report by accountants Deloitte laid much of the blame for the problems on the board and executive management based on its analysis of the culture and “tone at the top”.

They had “not sufficiently emphasised the importance of a robust credit risk management framework” and there was “no explicit group risk appetite or tolerance articulated by the board or executive management”.

The structure of the bank was based around the performance of the individual divisions and not on an overall group management.

Deloitte said management of lending risk was not uniform across the bank and deficiencies existed at group level and in the ROI division. Major shortcomings were identified in this division, which had “an under-developed set of policies and guidance, and adherence to policy was not monitored in a systemic way”. Case reviews were not robust enough, management information was inadequate and data captured originally on new loans was poor.

Reviews of loans were not generally performed on an annual basis, as the only requirement was for three-year reviews. This remained the case until late in 2009.

Both the Deloitte and Promontory reports noted major improvements in the management of lending risks from the end of 2009 but by this stage it was too little too late for AIB.

The loan book increased by €76 billion between 2002 and 2008, when the percentage of property loans as a proportion of overall loans went from 18 per cent to 37 per cent