'Horrifying' understates dire plight of Irish banks


ANALYSIS:The haircuts announced on Nama D-Day reveal exactly how starved of capital our banking institutes have become, writes SIMON CARSWELL

THE BANKING solution unveiled by the Government and the Financial Regulator confirms what most have suspected since the financial crisis peaked in September 2008 – the banks cannot make it on their own as the capital holes in their books are just too deep.

Minister for Finance Brian Lenihan and the Financial Regulator revealed that the five institutions participating in the National Asset Management Agency (Nama) would need to boost their core cash reserves by €21.8 billion and possibly by €10 billion more.

Lenihan described the losses incurred by the country’s banking system as “horrifying” but this hardly goes far enough.

While these figure are shocking, the most startling detail provided by the Minister was that the State-owned Anglo Irish Bank may require a further €10 billion in capital on top of the €4 billion invested last year and the €8.3 billion he is pumping in this week.

This would bring the bailout at Anglo to €22.3 billion – almost one-third of its loans – and will intensify the debate over whether the Government should keep it open.

The €10 billion would bring the cost of keeping Anglo open beyond the €18 billion to €22 billion parameters provided by the bank last week as the capital cost of winding the bank down over 10 years.

The Minister said that winding the bank down over 10 years would expose the State to a further €30 billion in funding.

The extra €10 billion arose because Anglo had factored in a haircut of 28 per cent on its €36 billion Nama-bound loans and it only learned yesterday morning that the agency was applying a discount of 50 per cent to the first loans and they applied across the board.

This accounted for €7 billion of the additional €10 billion, with the remainder being capital for its planned new bank.

However, given that Lenihan pre-sold the series of announcements yesterday as a “once-and-for-all” solution aimed at drawing a line in the sand, this potential liability to the State will not inspire confidence in taxpayers who are picking up the tab.

The “big bang” recapitalisation programme which had been billed as definitive and final was also less definitive and less final for the country’s two largest banks, Allied Irish Banks (AIB) and Bank of Ireland.

The Minister said that AIB would need “at least” €7.4 billion more capital and Bank of Ireland €2.7 billion or €10 billion in total before the end of this year.

Lenihan’s comments on both banks confirmed what many had suspected for some time – AIB is in a far deeper hole than its rival.

The Government doesn’t expect to have to make any additional investment into Bank of Ireland, and Lenihan said that he expected the State to remain a minority shareholder in the bank and that it had “a strong future”.

The future is not so rosy for AIB. The country’s largest bank is sliding towards majority State control given the capital shortfall it faces.

In addition to this, the Government will have to invest €2.6 billion in Irish Nationwide and €875 million in EBS, bringing the country’s only two standalone building societies fully under the ownership of the State.

So, all told, out of the four domestic banks and two building societies, the State will take control of two and is likely to effectively nationalise AIB before the year is out if it cannot fill its hefty capital deficit by year-end.

The Government has already pumped €11 billion into the banks and it looks likely that it will pump a further €15 billion or so out of the €21.8 billion required across the five participants in Nama.

This, of course, does not include the whopping €10 billion additional bill hanging over Anglo.

The discounts or so-called “haircuts” applying to the first loans into Nama in part explain why the banks need so much capital.

Nama is applying well in excess of the 30 per cent average discount estimated by Lenihan last September. Only Bank of Ireland, the least worse-off lender which is taking a 35 per cent haircut on the first Nama-bound loans owing by the 10 biggest borrowers, comes close to this.

The purpose of yesterday’s “big bang” announcement was as much, if not more, about sending a strong signal to international investors that the State was taking necessary but tough measures regardless of the head-spinning costs involved.

But will it all work?

The Government must ensure that taxpayers are getting a bang for their buck, both in terms of securing a foreseeable return on their massive investment and seeing tangible evidence that the institutions have emerged from their zombie state and are actually lending to customers again.

The real test will be to see the availability of credit to the viable and profitable businesses that have been suffocated by the banks’ “self-help” attempts to fix their own problems by hoarding capital.

The aim of the recapitalisation plan was as much to prevent this happening, injecting not just enough capital to meet expected losses but to bullet-proof the institutions against further heavy losses beyond their development books into mortgages, personal loans and borrowings across businesses.

As much as the banks have a capital problem, they also face huge difficulties in reducing their high borrowing costs and being able to access funding without State support or using the hugely-expensive extended Government guarantee.

The domestic banks have about €25 billion in borrowing to pay off before the blanket guarantee expires at the end of September.

Demanding that the banks generate a further €21.8 billion in cash to sit in their reserves should instill confidence within the international investment community.

And given the €200 billion gap between home deposits and loans across the €380 billion domestic bank loan books, the fears of international investors must be soothed as the Government cannot afford to fund the difference.

Mr Lenihan has followed the DIY repair manual that has been well worn by various countries when banks collapse – guarantee them, recapitalise them and purge them of their most toxic loans.

However, the latter two measures have taken far longer in Ireland than in other countries.

The International Monetary Fund warned Mr Lenihan last April that Nama would not lead to a significant increase in lending.

What Nama has started doing with the transfer of about €1 billion in toxic property development loans from Irish Nationwide and EBS building society on Monday is crystallising the full scale of the losses that the banks on their own have failed to recognise for more than a year, primarily due to the horrendous losses facing them.

While Nama is the trigger, recapitalisation is the bullet and the target objective is to kill off any doubt that the institutions will require further capital. Again, the uncertainty surrounding the full and final capital bill at Anglo will do little to encourage investors to pile into the other Irish banks.

The regulator is setting the core equity ratio – the key gauge of a bank’s reserves to meet unexpected losses – to 7 per cent at the end of this year. In other words, the regulator wants the banks to reach the point where they have €7 in reserve for every €100 out on loan.

The difficulty for the banks is that this is the minimum expected of banks in the international market. The difficulty is that large international banks such as Dutch giant Rabobank and UK bank HSBC hold well above this level.

So, put another way, yesterday’s recapitalisation plan will in time return the two big banks to par, but it could take much longer for the institutions to reach a position of strength. The banks will remain cautious on their new lending through the remainder of the recession.

It will be some time before the State is able to recover even a fraction of an investment in the banking sector that looks set to rise above the €26 billion mark and possibly higher if Anglo remains an unquantifiable black hole and AIB cannot raise sufficient cash privately.

And this is before even considering a return on the €50 billion being invested in Nama to buy the institutions’ most toxic loans.

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