Super Tuesday turned out not to be so super at giving us a better picture of what’s going to happen to AIB. Indeed, I’ve been puzzling over some aspects of the announcements and coming up with a decent picture of what’s likely to happen requires a fair few calculations and assumptions. But here goes. I’ll break this up into two bits. Capital requirements and NAMA transfers first and then asset disposals second.
Capital Requirements and NAMA Transfers
Let’s take the capital requirements for starters. AIB Group’s risk-weighted assets (RWA) was €120 billion at the end of 2009. The NAMA-bound assets (originally worth €23 billion) have been held on NAMA’s balance sheet at a value of €19 billion.
It looks like this wasn’t a very accurate estimate and that there was still a lot of risk involved when this estimate was arrived at. However, it also looks as though the NAMA-bound assets have been given a relatively low risk weight on the AIB balance sheet. Why do I say this? Well, if they had a risk weight of one, then the bank would only have RWA of €101 billion after the assets were transferred. If this was the case, then the bank would then need to have €7 billion in equity capital.
However, the Central Bank’s Prudential Capital Assessment Review states that AIB requires “An additional €7.396 bn of equity capital to meet the base case target of 7% equity, before taking account of projected asset disposals.” Because more than €7 billion in equity needs to be added, this means that the projected post-transfer RWA has to be higher than €101 billion and thus that the removal of the €19 billion is NAMA-bound assets isn’t subtracting €19 billion from RWA.
I think it’s safe to operate under the assumption that the Central Bank is projecting that AIB will still be left with a small amount of equity capital after the NAMA transfers and other write-downs. If, for instance, the bank is projected to be left with equity capital of €500 million, then the Central Bank is requiring total equity of €7.9 billion, implying an RWA of €112 billion (=7.9 / .07).
I looked through AIB’s annual report for some confirmation of the limited contribution to RWA of the NAMA assets as of December 2009 and didn’t find anything (that doesn’t mean it’s not there—it’s a 324 page report.) If any of our commenters can confirm this, let me know. (Commenter Brian Woods 2 suggests that because there are end-2010 requirements, the RWA estimate involves some growth in lending. This sounds like a plausible answer. The main point here is that I’m not going to work from an RWA of €101 because that’s clearly wrong.)
The idea that AIB is left with a very small equity cushion also emerges if one works from the assumption that the first-tranche discount of 43% is expected to be applied across the board to AIB’s assets (we don’t know if this is going to happen, I’m just describing an assumption). This would imply a total haircut of €9.9 billion. The Bank has already made provisions for €4.2 billion of these losses, so this would trigger an additional €5.7 billion in losses. In addition, the Central Bank is asking the bank to make further provisions for “foreseeable losses” on its non-NAMA loan book.
Given that AIB’s starting position is that it has €6 billion in equity, this might appear to wipe out its equity capital. However, it’s been brought to my attention that my earlier comments on this issue neglected the fact that the bank will be able to get some tax back after it declares these huge losses. All told, then, it looks like the bank will be starting from a positive, but very small, level of equity capital. My suspicion is that the estimates of the pricing have been set to achieve this outcome whereby the bank is not quite insolvent.
So that’s the picture of what’s required in the absence of asset disposal sorted, sort of. Now let’s look at asset disposals. AIB’s Polish and UK operations are integrated into the banks consolidated balance sheet, with the UK outfit contributing €21 billion to RWA and the Polish bank contributing €10 billion.
Starting from my guesstimate of a post-NAMA-transfer RWA of €112 billion, these asset disposals would reduce RWA to €81 billion. The bank would then need total equity of €5.7 billion. Assuming a starting equity of €0.5 billion, this requires new equity of €5.2 billion rather than €7.4 billion. Much of the media coverage of this issue will discuss this point as though the bank “raises” €2.2 billion this way but, of course, it doesn’t raise any capital. Rather, it’s the “honey, I shrunk the bank” approach to making existing capital give a higher equity ratio.
So where’s this €5.2 billion going to come from? The plan is to raise it by selling the stakes in its foreign banks for more than their current valuations on their balance sheets.
Let’s take them in turn, starting with the “jewel in the crown” as the financial journalists like to say, the banks 70% stake in Polish bank BZWBK. Note 39 of AIB’s annual report indicates that this share is held on the bank’s balance sheet at about €1.4 billion. However BZWBK’s stock has been a star performer over the past year and with a market cap of €5.1 billion zlotys and an exchange rate of 1 zloty = 0.26 euro, AIB’s stake is now worth €2.6 billion on paper.
I suspect that this is what the Brian Carey of the Sunday Times was referring to today when he wrote that disposal of the BZW stake would “raise up to €3 billion”. However, you don’t get to take in this money and then also keep the valuation of the stake in the bank as an asset on the balance sheet. So, by my calculations, at current stock prices this would constitute a gain of €1.2 billion if realised.
Then there’s the 22.7% stake in US bank M&T. The current market cap of M&T is $9.4 billion, which with an exchange rate of $1 = €0.74, values AIB’s stake at €1.6 billion, which is more than the €1.282 billion that it is currently 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 sale. Commenter Tull McAdoo places this at €700 million, so let’s go with that.
These figures suggest gains of €2 billion from the Polish and US asset disposals if the current market values were realised. But disposing of a large block of shares often requires having to sell at a discount. Also, the UK unit is loss making, so while selling this reduces RWA, it may require taking a loss on the balance sheet.
The Bottom Line
Is that I’m having a hard time seeing the bank raise more than €2 billion from asset disposals and it may be a good bit less. (There are other uncertainties–I don’t claim to be an expert in the prognosis for the Polish stock market.) So meeting the €5.2 billion target for equity may require an almost full conversion of the state preference shares (and perhaps also the issuance of new government ordinary and/or preference shares to meet the 8 percent “core Tier 1” requirement.)
One might imagine at this point that if the bank has shareholder equity of €2.2 billion, that a conversion of preference shares would give the government a 56% stake (3.2/5.7). But what actually matters for the ownership stake is what fraction of the bank €3.5 billion would buy at the prevailing share prices at conversion. With further losses to come that are most likely above Central Bank’s “foreseeable losses”, this bank is likely to continue to trade at a discount to book equity. Furthermore, AIB is highly unlikely to be able to pay out on the govenment’s preference shares in May, so this will be a €250 million ordinary share stake will pass to the government. (Again, thanks to Tull for this point, which I had omitted.)
So, that’s my take: AIB heading for seventy to eighty percent state ownership unless some pretty serious rabbits are pulled out of hats.
I’d note that this is a particularly numbers and assumptions intensive post, so I’ll happily take corrections on any of the calculations above.