Patrick Honohan on Bank Rescue Package

Today’s Sunday Business Post carries this article:   “Bank Rescue Package: More To Come“.

(May be helpful in thinking about Karl’s previous post.)

4 replies on “Patrick Honohan on Bank Rescue Package”

in reference to the article: the shares won’t rise because it will take greater than 8% profit for them to see any value! the preference shares remove any incentive to invest in the banks -as dividend is gone- and capital gains are not likely given the wordwide economic outlook, expecting shares to rise based on a lifeline is like expecting a person to return to professional sports after a lung transplant, the capital injection merely gives the banks a better shot at getting through it doesn’t make it an attractive investment proposition.

The upside is that the prices are so low they won’t attract the same level of short sellers as previous

One question I have is this: can banks raise money currently for less than 8%? because if so then it may have been better to do so on the open market. The state (or banks themselves) could buy CDS on the debt, bundle & underwrite these making them assignable to the creditors who lend the banks the money. So if you lend the bank money the state will hold CDS on the banks on your behalf as security for the loan.

This would be a market based solution. the NPRF would be left as a liquidity pool just in case. (so if things get worse we don’t -as a nation- have to borrow more)

eg: if the banks could borrow at 3-4% and CDS was 300bps then the net 7% would be cheaper to the banks than 8% payment to the state.

Karl – would you lend money at the effective risk free rate to irish banks right now? if so, I have a bridge in brooklyn that I need to offload….

The problem is that the banks can’t just borrow the money they need. They could if they wanted borrow money, because of the guarantee, but that borrowed money wouldn’t help their situation. Credit’s not the issue. They need what’s called ‘equity’ or (more broadly) ‘tier 1’ capital to cover bad debts that are very likely to occur in the future. If you don’t have enough capital to cover your potential bad debts, it means that you can’t go forward, because you can’t really afford to be in the business anymore and making further loans would be reckless.

It isn’t a question of having enough cash – the banks can get cash or credit alright. The issue is that the banks have unrealised losses (loans that are going bad) and they need to be able to show the regulator that they can afford to lose the money.

If they can’t show that, by showing they have equity investment or failing that this tier-one stuff, then they can’t go on. Any further credit they draw down is basically reckless, because they aren’t going to have enough profits to pay back that credit.

This is like being in Atlantic City. You’ve got a credit facility and you might even have a friend who will lend you some chips. But at a certain point, you’ve bet and lost as much as your assets are worth. You could keep on playing, but it would just be reckless. You might well be able to trade out of your position if you keep playing with credit, but you probably won’t. It is time to either find some new risk capital or to leave the table.

In practice, a bank can’t keep playing hands (giving out new loans) because the regulator is looking over the bank’s shoulder, making sure it has assets to cover the bets it is making.

From the investor’s perspective, equity or tier one capital is risk capital. It is a highly ‘leveraged’ investment. What this means in practice is that if anything goes wrong, all the other creditors (depositors, bondholders, the taxman, the employees, the property owners, the electric bill) have to be paid before the equity investor gets paid.

CDS’s are about debt, not equity. What you are talking about is for someone to give you insurance on what the AIB or BoI stock price will be. This insurance is simply not available. (Well, strictly speaking, it might be available in the form of a put option, but it would be expensive, probably many times the cost of the underlying share. The option agreement (or any other kind of ‘insurance’ would probably be illegal and void under the ban on short-selling, because the seller of the option would effectively be betting against the success of the underlying share. It would also be difficult to even find anybody creditworthy enough to offer this type of option in the current financial situation.)

Realistically, the 8 percent coupon (or dividend or whatever they like to call it) on the preference shares is just nominal. In my view, it is inconceivable that this is going to get paid. If things go well, the money will be needed to finance new loans. If things go badly, it will be needed to just keep the doors open.

Then, apart from the fact that, at a very basic level, it’s needed to ‘keep the doors open’, how will this package help at all?

From what i’ve seen the Minister sidetracked the issue of where his €7bn estimate came from, and given that the banks aren’t being upfront with their bad debt predictions/estimates, how can this capital injection help?

Isn’t what this country needs a fundamantal change in how the banks are set up and run, and not capitalisation that will be like a drop in the ocean?

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