Providing answers to questions about the capitalisation

Providing answers to questions about the capitalisation

What is recapitalisation?

Minister for Finance Brian Lenihan has said that the Government is injecting €3.5 billion each into the State’s two biggest banks, Allied Irish Banks (AIB) and Bank of Ireland. This is to increase the level of capital, which is essentially cash reserves, to absorb future losses on loans.

Where is the money coming from?

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The Government is using €4 billion from the National Pension Reserve Fund, which was valued at €16.4 billion at the end of last year, and a further €3 billion will be provided by “frontloading” the Exchequer’s contributions to the fund for 2009 and 2010. The pension fund was set up to pay for the State’s future social welfare and public pensions bill.

Is the investment necessary?

Governments around the world have been forced to invest cash into banks in a bid to shore up capital because losses on bank loans are expected to spiral as the global economic crisis worsens and institutions have been unable to source investments privately due to the international banking crisis.

The Government guaranteed the liabilities of the Irish banks on September 30th, but other countries have gone much further to protect their banking systems by investing cash in their banks. Ireland has nationalised Anglo Irish Bank but has not as yet invested any money in AIB or Bank of Ireland.

Both banks are expected to make losses in the coming years as they write off so-called toxic assets, which are primarily property and development loans totalling €36 billion at the two banks.

Stockbroker Davy said last week it expects AIB and B of I to write off a total of more than €10 billion in loan losses over the next three years and to make combined losses totalling €1.8 billion in the second and third years.

Is this the first attempt to recapitalise AIB and Bank of Ireland?

No, the Government announced plans to invest €2 billion in each bank and pledge to underwrite a further €1 billion in new shares that the banks could not sell privately to investors. This plan was shelved following the nationalisation of Anglo Irish in the middle of last month.

What are the terms of the investment?

The Government is taking preference shares in the banks in return for the €7 billion recapitalisation but it is not taking an equity stake or ordinary shares in the deal. Preference shares means that the Government will be paid dividends ahead of ordinary shareholders, despite all banks cancelling dividends to shore up capital in anticipation of higher loan losses.

The Government is charging interest – a coupon – of 8 per cent on the investment, which means the State will receive €560 million in annual payments, or €280 million from each bank. Under the deal, the Government is receiving legal warrants entitling it to buy a 25 per cent stake or ordinary shareholding in each bank in five years’ time at their current low share prices.

What about existing shareholders?

However, in an bid to incentivise the banks to raise further capital privately and repay the Government some of its money back earlier, the bank can reduce the potential stake the State can take to 15 per cent if each institution repays €1.5 billion of the €3.5 billion within the first year. This would also reduce the effect of diluting the value of existing shareholders’s investments in the banks. These shareholders have already lost substantial sums of money due to the 95 per cent fall in the value of the shares from their peak two years ago.

Will the Government control the banks?

The Government will have 25 per cent of the votes in management decisions, which will give the Minister for Finance a strong position in negotiations and powers to block mergers between the banks and other institutions. It will be entitled to appoint four directors, a quarter of the boards at each of the banks.

What about bankers’ pay?

Pay to senior bank executives will be reduced by at least a third.

No performance bonuses will be paid to these executives and no salary increases will be made for 2008 or 2009.

What does it mean for mortgage holders?

A moratorium has been agreed with the two banks preventing them from taking legal action for a year after mortgage holders fall into arrears on their accounts.

This relief measure was introduced as home repossessions are expected to increase in line with rising unemployment levels.

What does it mean for business?

A business lending code has also been agreed with the banks which will allow the Government to assess why certain companies are not being approved for loans. The two banks have also agreed to increase their loans to small businesses by 10 per cent.

Will the recapitalisation scheme work and will €7 billion be enough for the two banks?

This is the big question facing the Government. Most analysts and bank commentators believe

that each bank needs at least €5 billion with some saying substantially more, as the domestic recession and international financial crisis continue to deteriorate.

The belief is that the Government needs to remove toxic assets, namely property and development loans, from the banks, as the losses on these loans will continue to rise.

There are proposals at EU level to create a combination of a bad bank and a insurance scheme that could remove these assets from the balance sheets, freeing up the banks to lend more.

Mr Lenihan has only said that he is considering such proposals.

Simon Carswell

Simon Carswell

Simon Carswell is News Editor of The Irish Times