State may play cupid for banks

The Bill setting up the bank guarantee will hasten mergers and acquisitions, writes Simon Carswell, Finance Correspondent

THE CREDIT crunch has turned the financial world on its head. Merger and acquisition options among Irish banks previously thought unthinkable - or impossible for competition reasons - are now firmly on the table in a bid to further safeguard the stability of the Irish banking system.

The legislation underpinning the State's estimated €485 billion guarantee covering the six Irish-owned institutions and four foreign-owned Irish banking groups has steadied the cash-starved Irish banking system but more concrete foundations need to be laid.

So far Ireland has seen none of the nationalisations or takeovers that have taken place among banks across Europe.

The Bill setting up the guarantee creates a blueprint and will hasten consolidation.

It confers on Minister for Finance Brian Lenihan wide-ranging powers, among them an ability to set aside competition law to allow mergers over the next two years if deemed necessary to protect the system.

Officials from the Department of Finance, Central Bank and the Irish Financial Services Regulatory Authority - with outside advisers - have, over recent weeks, been casting their eyes around the dancehall of Irish banking, seeing who can be matched with whom.

The guarantee is regarded as only the first step in fixing the problem. Officials have been drawing up proposals to match or break up institutions, perhaps with the involvement of international players, in an effort to create four or five strong Irish banks that can weather any future storm blowing in from overseas.

Mr Lenihan can now act as both match-maker and marriage registrar, aligning Irish institutions.

The sector could see the biggest wave of consolidation since 1966 when Allied Irish Banks (AIB) was formed in a merger of three banks.

Consolidation is possible, say analysts, though foreign takeovers are unlikely as Mr Lenihan has said the guarantee would lapse in the event of such a takeover.

Cash-rich Spanish bank Santander has been linked to AIB and Bank of Ireland, but then it has also been linked as a white knight to most struggling British banks.

An overseas sovereign wealth fund could solve a problem. The opportunity of picking up a "bargain basement" Irish bank, especially if the guarantee was extended to overseas takeovers, could also attract a large international private equity player.

ANGLO AND IRISH NATIONWIDE

The most obvious and pressing targets are Anglo Irish Bank and Irish Nationwide Building Society (INBS) - which have the heaviest exposures to the declining commercial property sector. Both would be very reluctant and somewhat chastened brides.

The two biggest banks, AIB and Bank of Ireland, would be equally reluctant grooms for either Anglo or INBS, as they would prefer to remain single to resolve their own issues before taking on larger commitments, but they may be called upon to do so by Government.

AIB and Bank of Ireland would "take them on later with a better risk/reward balance", said one senior banker.

Another potential suitor for Anglo Irish could be Ulster Bank, the third largest Irish retail bank.

Ulster Bank already has a large exposure to the Irish property market and is now covered by the Government's guarantee scheme.

It is part of a massive group in the UK bank RBS, which has its own constraints, but the offer of an injection of fresh capital from Mr Lenihan could encourage Ulster to consider a proposal.

A break-up of Anglo Irish between AIB and Bank of Ireland - coupled with the sale of its overseas loans - is considered "a last resort", however.

The more likely option is to back Anglo into AIB or Bank of Ireland, creating a "steady" entity where Anglo's business could be sold off over the medium-term when market appetite returns.

One possible marriage emerged last month when Anglo considered a takeover of INBS but only with support from the Government. This seems improbable now as senior Irish bank executives see Anglo Irish only as a bride, not a groom, given its vulnerability.

IRISH LIFE PERMANENT

Sebastian Orsi, analyst at stockbroking firm Merrion, said in a report this week: "Amongst the larger players, a merger of Anglo and ILP would create a third large domestic banking franchise, diluting Anglo's concentrated commercial property exposure, without resulting in major redundancies. However, it would not address capital or liquidity issues."

A fresh injection of capital could be offered as a reward by Government to encourage minds to meet and institutions to merge in an effort to strengthen the system from further international shocks.

NCB Stockbrokers said in a report this week that it seems certain that the Government will use the powers created in the guarantee Bill "to orchestrate consolidation among the six banks whose deposits are guaranteed. The aim will be to create an industry that is stronger and better able to withstand the buffeting the banks will take in the next few years."

The stockbrokers said the banking sector will see "the smaller players absorbed by the larger banks and believe it possible that Irish Life Permanent will merge with BoI or AIB".

NCB added that the Government was the "only investor in town", and Mr Lenihan will have to follow the lead of the UK government, which appears willing to underwrite stakes in the banks.

"We believe that this will inevitably lead to the Irish Government taking meaningful stakes in their banks. We believe that such investments may coincide with some consolidation activity," said the firm.

ILP would fight to remain independent and ward off any attempt by the Government at "nation-building" within the sector, say industry sources.

The company has said it can access capital of up to €1 billion from Irish Life to protect itself for the future and its short-term funding problems have been solved by the guarantee.

While it has no exposure to developers or builders, its high loans-to-deposits ratio and heavy reliance on the frozen wholesale markets leaves it vulnerable to future surprises.

ILP would regard the break-up of the company as "an absolute last resort", the industry sources said. And although it would admit that it has its challenges, the company is "a more manageable problem" than some of the other difficulties in the market.

Bank of Ireland has been linked with ILP. Such a merger would join the two largest life and pensions companies as well as the two largest mortgage lenders, which may create headaches even with the competition rule-book pushed to one side. This marriage remains a possibility, though it would involve significant redundancies.

One option given credence by some sources could see Irish Life remain independent with the bank, Permanent TSB, sold to facilitate this deal. The State's largest bank AIB, regarded as "under-weight" in the mortgage market for its size, could take over Permanent TSB. This would give it a share of more than 35 per cent of that market. Ulster Bank may be interested for similar reasons.

Under normal circumstances such a deal would be thwarted by competition fears but it could be acceptable in the current climate.

Bank of Scotland (Ireland), supported by HBOS, its large UK parent (albeit one with its own difficulties) and even cash-rich Dutch giant Rabobank, which owns ACC Bank, could see value in Irish Life selling their own life and pensions products. Rabo could see this as an opportunity to become further embedded in the Irish market.

AIB and Aviva/Hibernian, which work closely through their joint ownership of Ark Life, could also swallow up Irish Life, but again competition issues may be too great here.

Danish-owned NIB has just launched its own life and pensions business Danica. A takeover of Irish Life would give NIB Ireland's largest player in this market.

EBS BUILDING SOCIETY

It's harder to predict the future at EBS building society. There is an argument in recessionary times for a strong mutual society that could offer more affordable, less profit-driven mortgages.

It could be further strengthened by backing INBS into EBS, but only with substantial State support to protect it from INBS's heavy commercial property exposure.

This marriage would preserve "a mutual offering" in Ireland, said one source, and take out a highly-vulnerable lender INBS.

However, EBS chief executive Fergus Murphy would have a fight on his hands, squaring such a transaction with some of the building society's more outspoken members and veteran INBS chief executive Michael Fingleton.

Failing that, AIB, which made a takeover approach for EBS in late 2006 and is a long-time admirer of the society, could easily rekindle its interest, giving the bank a share of the Irish mortgage market that is more representative of its size.

EXCEPTIONAL TIMES

The removal of normal competition rules in the bank guarantee legislation will give Mr Lenihan and his officials a two-year opportunity to remould the Irish banking system, reducing future risk to the entire system.

Competition Authority chairman Bill Prasifka said the guarantee Bill created "an exception in exceptional circumstances".

"Where we are talking about financial stability and the health of the economy, it is rather understandable that some transactions have to be handled at the discretion of the Minister," he said.

Irish banks are living in a whole new world. Expect the unexpected.