Tuesday 28 March 2017

In Focus: EU delay on bank plans threatens to scupper Lenihan's key speech

The spooked EU Commission won't let the banks get away with much in their restructuring plans, say experts

Joe Brennan

IT took Brian Lenihan almost a year to crack. But his officials knew that if they were to get NAMA finally over the line in Brussels last month, they would have to concede that the project was a form of state aid.

The admission was what Joaquin Almunia, the new EU competition commissioner, needed to hear before finally signing off on the 'bad bank' plan at the end of February.

But it was enough to prompt his mandarins to take a more onerous approach to the restructuring plans of Ireland's bailed-out banks, Allied Irish Banks, Bank of Ireland and Anglo Irish Bank.

The new EU commission team, voted in two months' ago, have been badly spooked by the fiscal crisis in Greece and this, in-turn, has influenced their views of the restructuring plans.

"The whole tone from Brussels is very different to what it was even six weeks ago. All bets are off regarding what the EU would let the banks get away with in the restructuring plans," said a well-informed source.

Another source said: "It's clear the various arms of the EU individually had a lot of information on Greece's problem, but this was never pieced together before the crisis erupted. With the Irish restructuring plans seen as a test case for the new Commission, they are particularly keen to have a coordinated and rigorous approach. The Irish verdicts could set a precedent."

Heavy lifting

Bank of Ireland thought it had done all the heavy lifting before filing its viability plan last September, having decided early last year to run down its €32bn UK broker-sourced mortgage book and €5bn of international corporate loans.

However, the Irish Independent has learned that Brussels has indicated it is looking to extract more pain with its focus now on BoI's UK assets. It is not clear whether the EU is looking for the bank to either sell the UK mortgage book, its business banking operations or its joint venture with the UK Post Office.

AIB is also believed to have pitched the sale of its 23pc stake in US bank M&T as well as its UK business banking operations. But the bank fears the EU will force it to sell its 70pc-owned Polish unit Bank Zachodni WBK, which may put off any strategic investor in the group, or dampen market appetite for a likely 'rights issue' this year.

Uncertainty about the outcome of the Brussels review has resulted in a big blank space in a working draft of Lenihan's upcoming state-of-the-nation address on the future of Irish banking.

The 'big bank' announcement, slated for the middle of next week, could turn out to be something of a damp squib. However, it will be clear by then what the initial haircuts will be on the loans the banks are transferring to the National Asset Management Agency. This will then force the quoted banks, AIB and BoI, to issue stock exchange announcements where they will be expected to give updated guidance on their overall discounts.

Discount

Anecdotal evidence points to the industry-wide discount moving well above the 30pc outlined by Lenihan last September. It is now likely to be in the region of 35pc.

There's another gaping hole developing in the outcome of the stress-testing of banks' non-NAMA loans -- focusing particularly on their mortgage books and property and development portfolios. These are the loans that will not make it into the State's 'bad bank'.

The results of the stress test -- and the NAMA discounts -- will feed into how much capital the banks will be required to raise.

In his debut speech, the newly appointed Financial Regulator Matthew Elderfield surprised few when he said regulatory weakness contributed to the domestic crisis, and that he was planning to bring in an "assertive" regime "underpinned by credible threat of enforcement".

But it's what he has told the country's top bankers in private since then that has sent an icy chill up their spines.

The new sheriff in town wants them to raise enough cash over the coming months to leave them with an equity tier one capital ratio of 7pc at the bottom of the cycle. This ratio is one of the most keenly followed gauges of a bank's financial stability, set as a percentage of its risk-weighted assets.

"We expect AIB and BoI to require additional capital of €4.85bn and €2.5bn respectively in order to remain above the 7pc equity threshold," said Ciaran Callaghan, an analyst with NCB Stockbrokers. Allied Irish Banks, for example, has been arguing to investors that it should be able to get away with a ratio of 5pc, before building it up to 8pc over the next few years through retained earnings.

Many observers believe the market would laugh at any Irish bank targeting such a low figure, especially when there is so much uncertainty about the future of the domestic economy.

Most analysts believe the banks need to recapitalise over the coming months to have 6pc equity ratios at the bottom of the cycle, rising to 8pc by 2012.

But an upfront figure of 7pc could be the difference between the Government having to take a majority stake in the two main banks or not.

It also increases the amount the State will have to pump into nationalised Anglo Irish Bank as well as the two building societies. AIB's managing director Colm Doherty chipped €445m off his recapitalisation bill this week through a bond restructuring.

"Attention now turns to asset disposals, as the group focuses on limiting the cash-call required from shareholders," said Mr Callaghan. "In this regard, a sale of M&T at current levels would boost AIB's equity by a further €1bn."

WELL-PLACED sources have BoI following a different strategy. The bank, under Richie Boucher, who has been chief executive for just over a year, hopes to launch a three-pronged €2.5bn-plus recapitalisation plan as early as next month.

As reported in February by this newspaper, three investment banks -- Credit Suisse, Deutsche Bank and UBS -- are currently in the frame to partly underwrite or guarantee a €1bn-plus rights issue.

Those familiar with the plan see the Government converting a tranche of its €3.5bn of preference shares into stock, and also helping underwrite the rights issue. (The State was forced to take a 15.7pc stake in the bank in February in lieu of a cash dividend for the preference shares, as the EU blocked such a payment as it continued to mull the bank's restructuring plan.)

The final element of a massive fundraising, would see BoI raise about €500m through a conversion of its so-called tier 1 and upper tier 2 subordinated bonds into equity. But the more onerous the capital targets -- and tighter the deadline -- the greater the likelihood of major state involvement in both recapitalisations.

Any sign of distressed sellers in the market would automatically affect what they could achieve through asset or share sales.

It would also appear that Elderfield is not for turning -- despite signs of tension between the watchdog and Department of Finance officials on the issue. Bankers in the audience of his recent luncheon speech felt twinges of indigestion when he said "we will be prepared to substitute our prudential judgement for (banks') commercial one and say: Just do it."

Few believe Elderfield is here for the salary (his new €340,000-a-year package is down over a third from what he was getting in Bermuda), or to be closer to his beloved Leeds United, wallowing in the third tier of English football since 2007.

"It's pretty obvious that he has his eye firmly on his next salary," said one senior banking executive.

Regulatory regime

"It will be a pretty impressive thing to have on your CV that you turned around the regulatory regime of Irish banking. There is only an upside for him in forcing the banks to hold high levels of capital -- but at what cost to the banks or, indeed, the Government?"

It is often argued that banks left holding too much capital are less competitive and deliver much lower returns on equity -- which is not exactly what you want to hear if you're an investor.

However, Max Watson, the former deputy director of the International Monetary Fund, who has been drafted in to co-author a report on the Irish banking crisis, recently told an Oireachtas committee that his previous work had found otherwise.

"They were able to fund themselves very cheaply and are even more profitable," he said.

Irish Independent

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