Does the government need to recapitalize Irish banks?

I have a conflict of interest as I am a shareholder in AIB. I also have an interest in the other banks through the ISEQ ETF.


Bank of Ireland's results this morning suggest that they do not need additional capital. They can rebuild their capital base by not paying dividends and by cutting back on making new loans. As their existing loan book is repaid, their capital ratios will improve. So I would agree with their assessment that they do not need new capital. It is not in the shareholders' interests to raise capital when the share price is so low.

However, this calm, slow rebuilding of reserves would not be possible in the absence of the government guarantee. Without the guarantee, they would have to get additional capital to retain the confidence of the depositors.

This clamp down on new loans is not in the public interest as it will damage the economy. But as a shareholder in Bank of Ireland, my primary interest is the value of the Bank of Ireland shares. (AIB would be in a very similar position to Bank of Ireland)

Of course, it’s a vicious circle. If the banks stop new lending, the economy deteriorates further and the credit situation of the bank’s customers gets worse and worse.

I see no point at all in putting government capital into Anglo Irish Bank or the Irish Nationwide. The outlook for them is just too uncertain and they should just stop making any new loans and see how good their loan book is in the fullness of time. I don't think that there is any economic benefit to Ireland from putting tax payers' money into these banks to allow them to expand their lending outside Ireland.

Irish Life and Permanent and the EBS don’t need capital either. They can rebuild their reserves through a cut in lending. Irish Life and Permanent may find it difficult to access capital, but the government could lend it money which would be repaid in time.

So what does the government do about the economic problems caused by the freeze in new lending? In the past it set up ICC Bank and ACC Bank when lending was needed. Why not do this again? Rather than inject capital into banks with problems, the government could set up a state-owned bank which would have no legacy bad debts.

At the end of the day, the government could buy the Bank of Ireland for around €1.5 billion and use it as the vehicle for growing the lending. Or they could buy AIB for a little bit more. When the current crisis is over, they could then float them at a considerable profit.

If only it was as simple and easy as you portray ??

The key conflict is the one you have identified. The banks in their current form would not survive without the government guarantee. The government guaranteed the banks (theoretically speaking at least, although I doubt they got that far in their blind panic) to keep money moving in the economy through continued lending.

If the banks are not lending because they need to improve their capital ratios and write down their bad debts, what is the point in saving them? As you suggest, it would be better to set up new banks, let the existing ones go bust and then buy up the assets required for the new banks from the liquidator (for example, IT systems, back office and branch networks).

I also believe the banks are fundamentally understimating the severity of two things:
1. The credit crunch - the current interbank spreads are likely to be the new normal; certainly, the old normal is not going to return. Why? The old ones were based on the fact that no major banks had gone bust in the previous ten years so risk was low. Now that we have had a major risk event, that will be factored into future interbank lending, bond prices etc.
2. The credit crunch in Ireland - as I posted previously, this has not really hit yet, IMO. As you identify, the vicious circle will mean that the previously solvent customers of the banks are no longer solvent. With unemployment, the state will pay the interest portion of the loan, so it may not be too bad. With underemployment, the state will not help and this is a far more serious situation. People will have to decide which debts they can afford to pay and still put food on the table. It sound melodramatic, but one look at the money makeover section on this site shows a number of people in very serious situations with mountains of debt, negative equity, and at best static income.

No interest in any bank shares.

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Brendan

Boss, I think you have highlighted a real dilemma with the Irish solution. It appears to have saved the banks and the banking system at probably no cost to the taxpayer. But it has not saved the Irish economy, which seems to be destined to die of slow starvation of credit. Other jurisdictions have recognised that it needs rather more than saving the banks it needs encouraging them to lend. The British system starts to look good (hence the Brown Bounce).

A State greenfield operation? - nice idea - but surely unable to be up to full speed in time.

Shareholders (inc me) are only diluted AFAIK if shares are issued at lower than market price - unless of course you believe market price is way understated.

I also agree that the banks seem to understate the issue. Why else do we get bullish statements from IL&P and BoI (profits still v high, no need for capital etc.) only to be followed or preceded by heavy price falls?

Duke of Marmalade said:

It appears to have saved the banks and the banking system at probably no cost to the taxpayer.

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Au contraire mon ami! The cost to the Irish state of issuing debt has risen considerably. All that has happened is that the banking risks have been transferred from one counterparty to another. Everyone knows that the guarantee is a bluff because the Irish state cannot afford to pay out on this. In the end the banks will probably have to be recapitalised and this will cost the taxpayer even more. The most recent state bond issue (€4bn) had to offer buyers 0.25% over average European gov. bond yields in order to get them to buy it. Irish state debt is priced about 1.2% above that of Germany. This is an expensive guarantee.

Duke of Marmalade said:

Shareholders (inc me) are only diluted AFAIK if shares are issued at lower than market price - unless of course you believe market price is way understated.

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As an existing shareholder you will be granted the right to subscribe for new shares at the same price as everyone else (assuming that the banks issue new ordinary shares). You are only diluted if you don't take up your 'rights' to the new shares. In any event, as an Irish taxpayer you will end probably up owning the banks anyway because it is highly unlikely that that banks will be able to persuade institutional shareholders to buy more shares.

I don't believe the public are being allowed see the full picture.
In July the Dail finance committee were being told all was sunny in the garden, come Sept and emergency bail out is required to stop the collapse of the entire sector.
I don't have access to figures, but I suspect provisions for bad-debts will prove to be woefully inadequate.

Brendan said:

Bank of Ireland's results this morning suggest that they do not need additional capital. They can rebuild their capital base by not paying dividends and by cutting back on making new loans. As their existing loan book is repaid, their capital ratios will improve. So I would agree with their assessment that they do not need new capital. It is not in the shareholders' interests to raise capital when the share price is so low.

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Can I discuss individual shares here? Dresdner reckon that BOI will need at least €1.1bn euros in additional capital (and possibly up to €1.6bn). Scrapping their dividend will save them €630m but this is not enough. Their Tier 1 equity capital is about 6.3% whereas the new international norm is over 8% (at an absolute minimum). This is still too low. If their loan losses are anything like the market suspects then they do need new capital.

Brendan said:

I see no point at all in putting government capital into Anglo Irish Bank or the Irish Nationwide. The outlook for them is just too uncertain and they should just stop making any new loans and see how good their loan book is in the fullness of time. I don't think that there is any economic benefit to Ireland from putting tax payers' money into these banks to allow them to expand their lending outside Ireland.

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Why does BOI deserve help and not Anglo? Anglo's capital ratios are better than BOI or AIB. Moreover, judging by cost/income ratios Anglo is twice as efficient and profitable as its larger peers.

Brendan said:

At the end of the day, the government could buy the Bank of Ireland for around €1.5 billion and use it as the vehicle for growing the lending. Or they could buy AIB for a little bit more. When the current crisis is over, they could then float them at a considerable profit.

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Why should the government pay anything for these banks given that they only reason that their shares are not worthless is the existence of the state guarantee? If (as I believe) BOI, AIB and Anglo (perhaps even IL&P) all need to be recapitalised then the curreny equity value of the banks is a lot lower than the stockmarket implies. Since the government has saved these institutions why should it reward their shareholders at the taxpayers expense?

Brendan said:

It is not in the shareholders' interests to raise capital when the share price is so low.
..This clamp down on new loans is not in the public interest as it will damage the economy. But as a shareholder in Bank of Ireland, my primary interest is the value of the Bank of Ireland shares.
..Of course, it’s a vicious circle. If the banks stop new lending, the economy deteriorates further and the credit situation of the bank’s customers gets worse and worse.

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The directors of the banks are trying to convince their shareholders that it is in their interest not to recapitalise, when in reality it is not in the directors interest. They will be out of a job if the government has to recapitalise the banks, which is why they have been so reluctant to write down the value of their assets to reflect reality. If they get their way we will be left with zombie banks with no money to lend whilst they wait for likes of the developments in ballsbridge to be eventually built and sold to restore their capital base.
Instead, a write off of the bad debts and subsequent recapitalisation would provide funds to be lent to successful businesses that would help restore the economy and generate profits for the banks in the future. Its the choice of whether to follow the Scandinavian (short term pain for long term gain) or Japanese (long term pain followed by more long term pain) model. As a rough guide to which is the better course, if the Irish bank directors are recommending once thing, then we should be doing the opposite!

JohnBoy said:

Why does BOI deserve help and not Anglo?

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Because Anglo is essential a property developers bank with a small role in the woder economy, and keeping it on life support will cost more than letting it collapse would have. It was a big mistake to guarantee all the banks and imo the govt panicked and were more worried about percieved damage to our international reputation by having a bank here go bust.

JohnBoy said:

Why should the government pay anything for these banks given that they only reason that their shares are not worthless is the existence of the state guarantee?

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If the banks don't agree to recapitalisation then the government should use this leverage to force them.

webtax said:

Because Anglo is essential a property developers bank with a small role in the woder economy, and keeping it on life support will cost more than letting it collapse would have. It was a big mistake to guarantee all the banks and imo the govt panicked and were more worried about percieved damage to our international reputation by having a bank here go bust.

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I agree with everything you have said apart from the above. The recent boom in Ireland has left the economy critically over-dependent on the construction industry. By letting any of the banks go you would have critically damaged the rest because they are all deep in property lending. If Anglo were to be cut loose from the state guarantee then the rest of the banks would have swiftly found out what the true value of their property assets was worth and this is probably not a problem that the Irish state is ready to face. The majority of the Irish populace is still happily clueless as to the real state of the banking system. It is only because of our membership of the euro that the IMF is not involved at this stage.

Also, the government would have to decide which banks to save and which banks to sacrifice. How would they justify these decisions?

Hi JohnBoy

Anglo and Irish Nationwide can be just slowly wound down without adding any additional capital. No one knows the true state of these banks. After a few years the position will be a lot clearer and they may require government cash to meet the guarantees or they might turn out to be very solvent, profitable companies and can be let grow again.

The economy can't afford to allow Bank of Ireland or AIB to be slowly wound down.

Brendan

JohnBoy said:

If Anglo were to be cut loose from the state guarantee then the rest of the banks would have swiftly found out what the true value of their property assets was worth and this is probably not a problem that the Irish state is ready to face.

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The problem with saving anglo/inbs is that the credit markets are well aware of the true value of their property assets which is why the spread Ireland is paying on its debt has been rising - the banks problems are now Irelands problems. If the worst banks were let go bust the government could have picked them up for free and used them to provide funding to the businesses that are actually capable of delivering a return to the economy.

Brendan's right on AIB & BOI.

Of course government needs to capitalise some banks and will have to do so. The fight back by AIB IL&P and BOI is to be expected. They are saying they are profitable, don’t need new capital and will deleverage, cut costs and dividends to shore up damaged capital bases. Current shareholders are to be left swinging in the wind nursing losses they will never recover. The upside will be saved for new shareholders – those with the dosh and dare to take a punt.

The notion of state bank is just that a notion – both ICC and ACC were only ever minnows starved for capital by a reluctant shareholder which is why they were sold off.

We are seeing a stand off between less than contrite corporate Ireland with its old boy network and a weakened government. Whatever about state finances what is really at issue here is the quite remarkable collapse of Fianna Fail credibility resulting from its responsibility for the boom to bust property market and an all too obvious leadership deficit.

Whilst one of the prescriptions in any turnaround is firing corporate CEO’s and their senior management teams it equally applies to government.

Government will capitalise some banks – but not this government and by the time the new one doe’s, bankers will have deepened the recession.

Meanwhile here’s a prediction. AIB gets IL&P (the P bit), BOI gets EBS and Anglo & INBS are left as zombies. Reason: there are only two banks that really matter, AIB & BOI. All the others business models are knackered.

As far as the Ulster, NIB and BOSI are concerned, their parents are also focussed on deleveraging where internal capital to finance foreign (Irish) lending is a rare as hens teeth. Finally I thought BOSI’s gimmick in advertising competitive advantage in its non-Irish government guarantee status was rather stupid given its property, mortgage and asset finance exposure(cars, boats and helicopters)

Brendan said:

Hi JohnBoy

Anglo and Irish Nationwide can be just slowly wound down without adding any additional capital. No one knows the true state of these banks. After a few years the position will be a lot clearer and they may require government cash to meet the guarantees or they might turn out to be very solvent, profitable companies and can be let grow again.

The economy can't afford to allow Bank of Ireland or AIB to be slowly wound down.

Brendan

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No one knows the true state of any of the Irish banks!

You say that the economy cannot afford to allow either of the big two to be wound down slowly but since no one trusts their balance sheets this is what is happening already. The economy is going to be starved of credit. In their current form, there is no future for the Irish banks outside the government guarantee. If the government does not force disclosure then the guarantee will just have to be extended and what funding the banks do manage to raise will be done at the taxpayers expense.

The notion of state bank is just that a notion – both ICC and ACC were only ever minnows starved for capital by a reluctant shareholder which is why they were sold off.

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As a shareholder in AIB, I would prefer if AIB was not recapitalized.

As a citizen and tax payer, I think that the government should take over AIB and/or Bank of Ireland. It should then sell off their overseas assets. They could then start lending in Ireland again. And when the economy and markets recover, they could float them.

This way, they keep the same downside as they have at the moment, but they get the upside of owning a potentially very valuable bank.

The market capitalization of AIB this morning is only €2.6 billion. Bank of Ireland is €1.2 billion. So they can own the critical parts of the banking business in Ireland for under €4 billion. That is less than 1% of what people reckon the state guarantee is.

So "the notion of a state bank" is very achievable.

I don't see much point in injecting capital in the Irish banks at the moment as they might just use it to free up their lending in their overseas subsidiaries which have much more profit potential.

Brendan

Brendan said:

As a shareholder in AIB, I would prefer if AIB was not recapitalized.

As a citizen and tax payer, I think that the government should take over AIB and/or Bank of Ireland. It should then sell off their overseas assets. They could then start lending in Ireland again. And when the economy and markets recover, they could float them.

This way, they keep the same downside as they have at the moment, but they get the upside of owning a potentially very valuable bank.

The market capitalization of AIB this morning is only €2.6 billion. Bank of Ireland is €1.2 billion. So they can own the critical parts of the banking business in Ireland for under €4 billion. That is less than 1% of what people reckon the state guarantee is.

So "the notion of a state bank" is very achievable.

I don't see much point in injecting capital in the Irish banks at the moment as they might just use it to free up their lending in their overseas subsidiaries which have much more profit potential.

Brendan

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I would disagree that the government needs to pay anything for these banks. I would submit to you that the equity value is worthless as their bad debts probably outstrip the current equity base of the quoted banks. Moreover, they cannot fund themselves without state help. BOI alone has €11bn maturing next year and would go bust without the backstop provided by the Irish taxpayer.

AIB has some attractive overseas assets but will not get great prices in the current market. All BOI has is a UK mortgage operation that has made a lot of BTL and self-cert loans - you will probably only get a distressed price for this.

If the government were to nationalise the two main banks then I reckon that they should wipe out the shareholders like the UK government did with Northern Rock. Equity capital, after all, is risk capital.

If the government were to pay current market levels for the two main banks they would probably find that they would need (at the absolute minimum) to stump up that amount again to cover loan losses. Indeed, I have seen figures of €20bn/€30bn suggested by some buy-side analysts as the total bad debt total for the boom (this includes everything - commercial, residential, credit cards, car loans etc).

However logial it would be to punish shareholders, who after all, have probably benefitted via dividends throughout the boom years, I suspect that it will not happen. I doubt that the government has the determination to do this so there will be a compromise solution which will arguably cost the taxpayer more in the end.

I would submit to you that the equity value is worthless as their bad debts probably outstrip the current equity base of the quoted banks.

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No. There is equity value in any company which is not obviously insolvent.

You, and many others, feel that AIB and BoI are insolvent. I don't think that they are. They have serious problems. They have loans to property developers which are currently very difficult to value. That does not mean that they are worthless forever.

But most of their loan book is performing. People are repaying their loans. As well as this, the banks have an ongoing profitable business.

But, as a taxpayer, it would make sense for the government to buy out Bank of Ireland and AIB, so that when they do recover, the government would get a great windfall.

As a shareholder, I would prefer to wait to see if my shares recover.

Brendan

Duke of Marmalade said:

needing capital is not the same as being insolvent or worthless

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Eh, in what way?

Since it's an awful time to raise capital, why would they need to raise capital if they, eh, didn't have to raise capital (in order to stave off insolvency).

Yog, bank capital is the reserve against the (hopefully) remote possibility of insolvency. Needing more capital means that possibility is less remote it does not mean it is a certainty.

I fear that Ireland is facing a perfect storm. We should not underestimate the effect of this big fall in sterling. The old punt is now worth £1.09. This was regarded as disasterous back in the 90s but at least we could do somethin' about it then. And what if Obamanation scares away the multinationals? And heaven forbid we reject Lisbon again.