Government forced into action


The Government has been forced to set a final cost on the bank bailouts to address the crumbling financial credibility of the State, writes SIMON CARSWELL, Finance Correspondent

The cost to the State of the banking bailouts is heading to €45 billion with the potential that this would rise to €50 billion if losses deteriorate even further at Anglo Irish Bank under very severe, worst-case losses where the property market does not recover for 10 years.

The massive costs – outlined today in statements from the Central Bank and Minister for Finance Brian Lenihan – reflect the severity of the Irish banking crisis. The Government bailouts amount to about a third of the State’s economic output, which does not include the cost of funding or potential losses at the National Asset Management Agency.

The repeated increases in the banking bailout costs since the Government blanket bank guarantee in September 2008 has shaken the financial credibility of the State and the mounting cost of State-owned Anglo in particular has driven up Government borrowing costs.

The purpose of today’s early morning pre-market announcements was to show, once and for all, how much the Irish banks are going to cost the State. Now the Government must prove to the international markets that it can cover the cost with the public finances in a dire state.

The financial markets, in which the Government borrows heavily to fill the €20 billion hole in the public finances, will want assurances that the bank bailout costs won’t rise beyond than €45 billion or even beyond the €50 billion including Anglo’s worst-case scenario.

The catalyst for the further bank bailouts announced today is the higher-than-expected discounts applied by Nama on the first two tranches of loans purchased from five participating lenders. The State loans agency, established last year to take out the most toxic loans out of the banks, has been paying the banks less and less for the loans.

Anglo Irish Bank, the most toxic bank, will require €29.3 billion from the State but possibly up to €34.3 billion if commercial property values 65 per cent and do not recover until 2020 or if prices drop 70 per cent and only recover to 57 per cent of their peak value by 2020.

As the cost of the bailout rises, the prospect of the Government taking a majority shareholding of the country’s largest bank, Allied Irish Banks, possibly more than 90 per cent, and control of a fourth Irish financial institution is now inevitable.

AIB was already facing an uphill battle trying to raise €7.4 billion by the end of the year. This was a massive challenge on the initial 42 per cent haircut on the first Nama loan transfers last March given that the bank had a market value of just €600 million.

The Central Bank said today said that the bank requires a further €3 billion on the expectation that the remaining Nama-bound loans face a discount of 60 per cent. Effective nationalisation is now a foregone conclusion given the bank’s dwindling share price.

Of the €10.4 billion total, the Central Bank expects the State to contribute up to €3 billion in additional capital on top of the €3.5 billion invested in the bank last year.

The higher capital bill brought a severe reaction from AIB, which announced the resignation of its managing director Colm Doherty and executive chairman Dan O’Connor.

The cost of Bank of Ireland and EBS building society is not rising but the bailout of Irish Nationwide is doubling to €5.4 billion. The sixth domestic financial institution, Irish Life & Permanent, is not affected as it avoided development lending and is not involved in Nama.

The spiralling costs must raise the possibility that the Government should seek to share the bank losses with their bondholders who chose to lend to the institutions to fund their boom-time lending frenzy.

Mr Lenihan said that the Government would seek to share the burden with subordinated debt holders – investors who lent to the banks for a risk premium – at Anglo Irish Bank, which amounts to €2.4 billion, and Irish Nationwide Building Society. However, this is pocket change in the context of a bank bailout now standing at €45 billion.

The Minister has ruled out any possibility on the contentious issue of share losses with senior bondholders who have provided far greater loans to the banks, fearing the knock-on effect this would have on the borrowing ability of the Government and the State-backed banks.

In a bid to calm market fears that the bailout won’t drag on, Mr Lenihan is accelerating the loan transfers to Nama. He said that the agency would buy all the targeted development and related loans by the end of the year, ahead of the European Commission’s February deadline, to speed up the process.

To this end, the Minister is increasing the threshold on the individual development loans to be transferred from the country’s two biggest banks, AIB and Bank of Ireland, to Nama to €20 million from €5 million. This means that 650 small borrowers will now remain at the banks and the total loans to be acquired from Nama will drop by €6.6 billion from €81 billion.

Mr Lenihan said the Exchequer deficit would be around 32 per cent of GDP but that he was still hopeful that Ireland would reduce its deficit to 3 per cent of GDP by 2013.

All eyes will be on the reaction of the financial markets where investors who lend to the Government and the banks will want to know that the banking bailouts do not rise further and that the financial system does not collapse further into State hands.