How it all went wrong for Tiarnan O'Mahoney's ISTC


The credit crisis has left Irish lender ISTC with estimated liabilities of €871 million last year, writes Simon Carswell, Finance Correspondent 

ONE LAWYER said the balance sheet looked like that of a small shop until you noticed that the three zeros at the top of the page indicated the losses involved were hundreds of millions, not hundreds of thousands.

The cash lost in the investment disaster that is Dublin specialist lender International Securities Trading Corporation (ISTC) is unprecedented on an Irish scale - it's the largest ever Irish corporate cash loss.

Here was a small Irish firm, flush with hundreds of millions invested by wealthy Irish high rollers and institutional investors, playing with the big boys of international banking.

However, the credit crunch changed the game completely and ISTC was up-ended by a series of hard, unexpected tackles.

International banks, bondholders and investors have been left nursing losses of €820 million.

One group of creditors - bank lenders and trade creditors, who had the voting power to decide on the company's future - agreed on Tuesday to a rescue plan in which they will write off €388.5 million so the firm can continue as a going concern.

They clearly felt being paid 12 cent for every euro owed was better than the nine cent in the euro on offer in the event of the total collapse of the business.

The company hopes to move fast. It will ask the High Court next week to give its blessing to the rescue plan and, with the sanction of the Competition Authority, ISTC will be sold to British investment bank Collins Stewart for €5 million, a mere molehill to ISTC's debt mountain.

Creditors and shareholders will be given a chance to reinvest in a convertible loan note which the company hopes will raise €2 million in further funding.

It will be interesting to see if any of them are willing to put down fresh chips. Their return to the table would say a lot about their belief in the company and its founder, former Anglo Irish Bank chief operating officer Tiarnan O'Mahoney.

Remarkably, some of the bank lenders have "conditionally expressed a willingness to consider" advancing new loans to ISTC on the condition that the company would take some assets back on its balance sheet, according to the report on the rescue plan devised by the company's examiner, insolvency specialist John McStay.

Evidently the banks believe the company's model is still sound.

However, it's no surprise to see McStay point out in his report that the company would not accept any exposure to margin calls under the terms of any new loans.

It was a series of margin calls last autumn that blew ISTC on to the rocks. The credit crisis left the firm with estimated liabilities of €871 million in late November. These were substantial debts, particularly for a business that employed just 18 people.

Trying to understand ISTC's business is as confusing as it is hard to fathom the scale of company's losses.

ISTC saw an opportunity to make money in the business of bank capital. Banks need money to keep them in the business of providing loans and Tiarnan O'Mahoney spotted a niche, setting ISTC up as what was essentially a bank's bank.

ISTC's model was based around the cornerstone of commercial banking - "buy to hold" lending. The firm borrowed money from banks and lent it on to other banks. Its lending margin was created by investing in certain assets, debt instruments, that yielded a higher return than regular borrowings.

The assets were registered in the name of lending banks but held on ISTC's books, showing the loan to the borrowing banks as an asset of the company and the debt to the lending banks as a liability.

All the company had to do was manage the assets and related credit risks, and it could create and exploit the lending margin. So long as the assets were throwing off cash, ISTC could make profits. And it did. In the six months to March 15th, 2007, ISTC made a profit of €6.8 million.

By last September the company had a cash pile of €160 million and was expecting to announce more profits for its 2007 financial year. Then the credit crunch struck and some of the assets securing ISTC's loans of €2.9 billion to 140 bank customers in 22 countries were downgraded in value.

This brought the roof down. When the assets fell below an agreed percentage of the money borrowed by ISTC, the lending bank could call on the company to make up the shortfall - the dreaded margin call. This sent ISTC's debts spiralling and forced the company to seek High Court protection.

Lending banks could then sell assets held by ISTC registered in their names at heavily reduced prices. They managed to recoup all but €435.6 million, which became a debt on ISTC's books.

At a meeting of ISTC's bankers last Tuesday to vote on the rescue plan, one creditor was particularly unhappy that no manager had been appointed to sell the €18 million worth of assets remaining on the company's books. Among these are some of the SIV (or structured investment vehicle) notes that have been contaminated by the rippling effect of the US sub-prime home loans crisis.

The company will want to avoid a firesale of these remaining assets as there are few buyers out there for such toxic assets. If sold now, they will go for knockdown prices, far less than their potential.

Now the company appears to have been saved, questions will be asked, particularly by the Irish Financial Services Regulatory Authority, on how 125 retail investors and about a dozen credit unions came to invest in International Securities Trading Corporation bonds and ended up next to the big boys of international banking on a list of losses topping €800 million.