How to recapitalize the Irish banks

Sheltering under the Irish Government’s guarantee, the Irish banks have survived massive falls in their share prices.

In each case the current market price is less than 10 per cent of its peak — 2 per cent in the case of Anglo Irish Bank.  Value to book ratio (using the last annual accounts) varies between one fifth and one sixteenth.

Time to recapitalize, then, I would guess.  When the regulator finally decides to require them to increase their capital (not least to reflect the large foreseen losses of the “incurred but not reported” type), the Government will have to be ready to participate.  But how?

For some ideas and a cautionary comment by an academic scribbler, see today’s Irish Times:

6 replies on “How to recapitalize the Irish banks”

An open factor in the re-capitalisation debate is the apparent preference for the banking sector to consolidate. Presumably, the intent is that stronger banks take over weaker entities. If this is the case, a stronger bank should be willing to do this voluntarily to the extent it can acquire the weaker bank(s) at a viable price and believes it can do a better job in recovering value from troubled assets. However, it is not clear whether there is much to be gained from inducing mergers between a set of banks that may be all troubled. Moreover, acquisitions may only be feasible if the government underwrites the scale of potential losses to protect the acquirer from downside risk. It would be interesting to see a more explicit case made why mergers are such a good idea.

Good article Patrick.

While I agree that the government should take a very active role in the recapitalization of the banks I think we need to be very careful of continuing the guarantee for all banks indefinitely. This may we need to surrender some of the money that could be made in the future.

However, if any of these banks fail while the guarantee is in operation Ireland Inc is finished. There is no way we can would be able to borrow the cash needed to cover this.
Our credit default swap spread is widening at an alarming pace, up over 115% in the last month. The largest increase worldwode and now only Greece the EU is considered more likely to default.

I don’t think any private investor, trader, company CEO or government should make a bet so big that if it goes wrong it is game over.

The guarantee may have been free to give out but it could be very expensive in the long run.
Ireland is in very dangerous territory, one wrong decision or twist could have disastrous consequences for years to come.

Commercial logic is not really a factor in these discussions. I believe that there are a couple of reasons why banking mergers might seem like a good idea to some.

1) The state cannot afford to underwrite the losses of the entire banking system, neither can it afford to recapitalise every Irish bank. The state tied its own hands with the banking guarantee and mergers are a way of wriggling out of the obligation to stand behind all the banks. Therefore, private capital needs to share the burden. If this means that shareholders of the acquiree get sacrificed then so be it. Mergers would also offer a ‘legitimate’ reason for the acquiring bank to seek additional capital and surprisingly there appears to be some private sector interest in the Irish banks so the taxpayer may not be on the hook for all of the cost (just most of it!).

2) Philip Lane is probably correct in suggesting that all of our banks may be troubled. Indeed, they are all potentially troubled for the same reason – over exposure to property lending. I do not think that it is in the interests of any of the Irish banks to see a domestic rival fail as this would inevitably lead to a downward repricing of a large array of their assets as the loan book of the stricken bank is unwound. It seems to me that the banks would rather risk a long slow death rather than try and accept the large wrtiedowns that many think are inevitable.

Patrick writes, “The banks themselves have made public forecasts of these likely future losses going well beyond what is provided for in their official accounts. These forecasts imply that they are undercapitalised on any commonsense interpretation of the facts.”
I must have missed that because I thought the banks were giving loan impairment guidance in a range that implies that they don’t need more capital. Markets clearly don’t believe the banks’ NPL projections.
Isn’t the worry that we do a Japan on it? There, the banks during the 1990s started with projections about what annual operating profits they would make. NPLs charges were then set at a level a bit below these profits so that capital was not eroded. Banking regulators turned a blind eye. But since de factor NPLs were much greater than actual write-offs, banks were evergreening de facto bankrupt borrowers. The effect of such banking practices was that problems in the property market were never resolved. The rest is history.

I agree with Alan that evergreening (especially of developers’ loans) and complacent accounting procedures is a huge risk and seems to be what we are slipping into.

My purpose in highlighting the magnitude of the loan loss projections that the banks have been making is to stress that — even through what are probably over-optimistic lenses — these losses are huge.

For example, Anglo Irish has projected a range of loan-loss provisions required over the next three years totalling well over €2 billion. If even that sum was brought to book now it would halve reported shareholders funds which would then be less than 2 per cent of total assets.

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