I’ll write a bit more later on the substance of the announcements today from AIB and the Department of Finance. However, I thought I’d first discuss an aspect of today’s developments that hasn’t been discussed in most of the press reports. Together with the Minister for Finance (with whom they have good reason not to disagree) AIB have “formed a view” that they need to have an extra €1.5 billion in Tier 1 capital.
Those who followed AIB and BOI’s fruitless attempts to raise equity in recent months were probably surprised to hear that rather than just announce that AIB was taking an extra €1.5 billion from the government, the bank stated that it was planning to raise these funds itself. Most media stories have focused on how AIB can achieve this by selling its minority stake in M&T, an American bank, and perhaps also selling its stake in a Polish bank.
Now here’s where it gets tricky. RTE and other media outlets have reported this as a simple story of “bank short of funds raises funds by selling assets.” The problem is folks, that plausible as this may sound, that’s not the story at all.
This is a bank that needs additional equity capital, which in banking means the value of its assets minus its liabilities. But selling an asset already accounted for on the balance sheet for cash does not change a bank’s capital one iota, it just changes the composition of its assets (now it might affect risk-weighted assets but that’s a different matter.)
To be more specific, AIB’s balance sheet (latest version available here — see page 28 of the press release) shows the value of its “Interests in Associated Undertakings” at €1.968 billion. This includes the value of its 24% stake in M&T banks in the US, which it is now thinking about selling. Apparently, AIB’s books value this stake in M&T at about €1.5 billlion.
Now bear with me, here’s where it gets interesting. One might imagine that the story here is that AIB are planning to sell their M&T stake for more than its valued at on their books. Unfortunately, the opposite is the case. M&T, like most other US banks, has seen its stock price battered (it’s down 50% relative to last September) so AIB’s stake in it is now worth about €1.4 billion. And selling the lot in one go because you’re short of funds suggests that AIB may make a bigger loss than this.
So far then, AIB’s current strategy for coming up with extra capital to cushion against losses is to sell its stake in M&T for a loss. But wait a minute, here comes the goodwill write-up to save the day.
What’s that, you say? Well, it turns out that the reason selling M&T is going to boost AIB’s equity capital is because the balance sheet also contains another line on the asset side for “Intangible Assets and Goodwill”. Apparently, AIB took a writedown on Goodwill when it orginally purchased a stake in M&T and they can reverse this when they sell the stake.
So, as the FT reports,
The bank is set to book a loss on disposal, but after adjusting for goodwill the sale will bolster the bank’s capital position.
The genesis of this goes back to early last year. Here’s a story from February of last year from the Business Post:
AIB’s in-house accountants recently estimated that selling M&T would result in a goodwill write-back to its balance sheet of almost €900 million, up from a previous estimate of approximately €450million. Chief financial officer John O’Donnell told analysts last week that the bank’s auditors had confirmed the revised approach.
Yes, folks, this is AIB’s new strategy for protecting itself against future losses. Sell their US operation at a loss, so they can write up Goodwill because their auditors reckon it’s kosher. After all, their Irish operation is notoriously well run and highly respected by the Irish public.
13 replies on “Goodwill Hunting at AIB”
Perhaps you can help with another bit of confusion.
AIB says that it and the government agree that it needs 5 billion euro. This number comes from the stress tests.
But then there’s NAMA still to come, which presumably reflects the fact that AIB will need to dump more loans into NAMA down the road.
So why didn’t the stress tests already capture this need for additional assistance?
Credit Suisse had this note out this morning:
“The two obvious assets which could be disposed of in our view are the stake in M&T and BZ WBK. The market value of both of these assets amounts to €2.2bn with minimal book capital gain on disposal due to carrying value being broadly in line with market value of the assets. However, this is equivalent to €800m (75bps) of equity tier 1 impact after taking into account RWA reduction from sale of BZ WBK and goodwill writeback on sale of M&T. We think that M&T would contribute about 45bps and BZ WBK about 30bps. We therefore find it difficult to see that asset sales alone can generate this extra capital. We see the possibility of raising further equity tier 1 from tier 1 and tier 2 debt repurchase, of which they have €6.6bn in total. For illustration purposes only, we estimate a buyback of €800m at an average price of 50% of par value and 50% take-up would generate an extra €200m of capital to top up proceeds from asset disposals.”
This leaves a €500m hole to fill, presumably by the taxpayer, meaning the government will have around a 30% stake in the equity of AIB. This is before the NAMA unwinds the rest of the mess.
Must have another look at BOIs balance sheet, wonder what’s not nailed down there..
So M&T is to be sold – but to whom? Maybe NAMA should be buying assets with a possible upside – or at least offering to buy them to create a floor price. Anybody willing to speculate on the future market value of that 22%? Canadian banks are bargain hunting and won’t be shy about bargaining a lot harder with AIB than NAMA will for half built houses.
The asset disposal will be well below Book. According to a senior executive in AIB North America, they had a buyer at $1 billion at the start of the year – due diligence was completed – but the transaction did not proceed.
Selling assets at the bottom of the market…..hmmmm? Or isit?
Why sell? A revaluation of the goodwill provisions an all acquisitions is justifiable in certain circumstances. But the impetus if it is the stress test, suggests trouble for which it appears the only remedy is cash…..
Banks exist only because they have a licence from the Minister. S/He is advised by the CB. Nationalizing banks merely removes the veil that exists between the licensee and the licensor. But it also entails direct control and responsibility. What has been found that does not require nationilization but requires a firesale? Was NAMA not supposed to deal with bad assets? When operating, and I still think it won’t get off the ground, there will be no need to sell any good asset.
Perhaps all the banks will be asked to dispose of all such assets? Perhaps waiting will reduce the value of them even more?
This is a good sign then, given that nearly every bank that took on growth also over expanded over the last two decades. There is going to be an even greater reduction of capital in all of those banks. Disposing of them now means not competing for capital through the need to fund NAMA and represents a logical clearing of the decks and suggests some thought behind the process.
@ Frank Galton
Confusion always exists where lies are being spun…
Stress tests mean anything the CB wants. With NAMA, it should be the answer to the problem, with whatever secret stress tests enabling a measure both of value and of identification of dubious assets. Or do they mean that their cash flow is so poor that default is possible within months? Note how all the US banks are profitable, yet still need Tarp funds….. accountants are sometimes painting and decorating experts. Or very adept at applying lipstick on pigs!
[…] The Irish Economy « Goodwill Hunting at AIB […]
I read in the aftermath of the Citigroup results last week that $2.5bn of their $1.6bn profit was profit from the proceeds of debt repurchase at a discount. This was using a new accounting policy from 2007 that allows unrealised gains to be recognised in the p&l of the banks. Conversely, if the debt regains value, the bank must recognise this as a charge to the p&l.
I was greatly disturbed by this development coupled with the revised mark to market accounting policies adopted recently. It seems that accounting wizardry is back in fashion (did it ever go away even since Enron).
Yesterday, AIB made some remarks about debt repurchase. Should I be worried that AIB are going to try to pull the wool over the eyes of the government with some new fancy policies to paper over the cracks?
Finally, AIB have not had pay cuts and the 7 over performing departments have been awarded bonuses (not yet been paid – but no word that they will not be paid) when are these guys going to pay?
Basically, as i understand it, if they buy back the AIB perpetual paper, which is classified as Tier 1 capital, the situation evolves like this – the paper is still valued at 100 on their books as a liability, but trades in the market at say 30 cents. They go in and tender at 45 cents on an issue. Paper holders receive a 50% profit on the tender vs market price, and the Bank gets to close off the liability at 45 vs book value of 100, creating 55 profit which is then becomes fresh and real capital. Its not a accountancy trick, more an issue of being able to use the distressed market values of bank bonds in your own favour for a change. Obviously if people thought they were going to do this on a huge scale, it would see the bonds bid up, but they’ll likely choose very specific issues to do it on. I’m currently a holder as of today of a very small amount of 2049 AIB paper at 30 cents. It yields c.20% on the discounte purchase price, so even if this doesn’t get tendered for immediately, the risk reward payoff is attractive. Expect this sort of thing to happen with a lot of banks over the next year.
Thanks Owen. I realise now that the original post didn’t make it clear enough that I was only focusing on the effect of the M&T sale (I have edited the post now to reflect that) and as far as I am concerned that is a pure accounting gimmick.
Buying back debt at a discount is a slightly different matter. I agree that we’ll see a lot of this kind of thing over the next year.
However, I think you might be slightly off in your example. I don’t think buying preferred prefs at a discount changes Tier 1 capital at all—at the end of the day there’s still 100 units of Tier 1 capital in your example. It just changes the distribution within Tier 1 towards having more core Tier 1.
I can’t claim to know but I suspect that what they are planning to buy back at a discount are what are listed as “subordinated perpetual loan capital” (692 million as of December) which are junior to perpetual prefs and the only type of debt not covered by the guarantee. Buying this stuff at a discount does not change total regulatory capital but does lead to more Tier 1 and less Tier 2.
However, since this kind of undated subordinated debt wasn’t covered by the state guarantee, that kind of transaction wouldn’t really give the banks any greater cushion in relation to when they would have to call on the guarantee. So I still think that would be a bit gimmicky.
The AIB move might be criticized on minor points but seems a reasonable move to make. So I think that they should be appluaded for a good decision.
Given stress tests indicate too little AIB equity capital it needs to shrink its balance sheet, increase equity capital, or lower the riskiness of the balance sheet (either or both sides of the balance sheet). Ignoring forex risk the common shares on US-domiciled banks have per annum volatility of 30-40% so if AIB uses a reasonable market valuation this is the per annum volatility-risk attached to this asset — much of it is highly correlated with the risks in the other assets in its portfolio. Replacing this US common share asset with a cash asset (volatility near zero, plus perfect liquidity) is a good idea in the circumstances unless the price received is a distress-sale price. By broadcasting its plan and taking time to complete the transaction it should get a reasonable auction-type price not a hasty distress-sale price.
Once it has cash it can use it to shrink the liability side of the balance sheet and raise % equity capital.
The same old same old. Let’s talk about accounting issues as if they were the same as actually having a banking strategy and the talent to execute it. Does selling M&T and the Polish bank really make sense. Do they add value to this mess or subtract from it. Will they make money in the future or heavens forbid this month? Or are they just stupid mistakes of the past. And even if they are stupid mistakes from the past that’s water under the bridge. What is their future prospect? The real question is simply – How is AIB planning to make money in the future? Is it a viable business? If the answer to those question are no, then the playing with M&T and other accounting junk is beyond pointless. But certainly within the scope of AIB’s management talent.
[…] From the point of view of AIB management, however, this debt buyback is the main step that they could take to boost their core equity capital by €1.5 billion as ordered by the Minister for Finance. So it might not really be that great a deal for AIB shareholders or for the taxpayer, but it lets AIB management live to fight another day. (The rest of the money might be made up by the great AmericanPolish bank Goodwill boondoggle.) […]
[…] valued at on the balance sheet according to Note 35. So not much gain there. However, as I noted last year, AIB’s accountants tell them that they can write up their goodwill because of this […]