Banks to lose billions in bad debt wipeouts
Experts fear investor panic and call for urgent measures to shore up lenders facing cash crisis
Ireland's banks are facing a behind-the-scenes crisis as the true extent of the country’s economic freefall becomes more apparent.
With Ireland in recession for the first time in 25 years, the banks are now facing the prospect of having to write off billions in bad debt.
The country’s four leading banks will be forced to account for what some commentators say has been their “reckless” behaviour throughout the boom when they appear before an Oireachtas committee on Wednesday.
It is thought they will reject the charge of recklessness and ignore political pressure on them to help the economy through recession.
They will also downplay, publicly at least, their level of exposure. But privately the banks are known to be extremely anxious.
It is now widely accepted that the sharp downturn in the economy, and the credit crunch, has placed most banks here in a very grave situation.
If catastrophe is to be averted, several experts believe the Government must introduce measures to kickstart the construction sector, and possibly introduce emergency shortterm measures to protect the banks from a liquidity crisis.
Ireland’s banks have extended loans of at least €106bn to builders and developers, accounting for over half of all loans to businesses. At present, associated bad debts are thought to be in the order of €500m.
But the full ramifications of the residential property market crash, now 21 months old, have yet to be seen.
Within the banking sector, however, the issue of real concern is the downturn in the commercial property market, which started only late last year. It will be another year before these effects are felt.
Some experts believe there is even a risk that, should the difficulties in a heavily exposed bank be confirmed, it might set off a domino effect causing depositor panic and triggering forced asset-sales across the entire system.
Taoiseach Brian Cowen last week moved to dampen such speculation when he said it was “important to point out” that the Central Bank had said the Irish banking system was “well capitalised and is in a healthy state in terms of its own financial situation”.
To date, the banks have adopted a “roll with it” approach, rather than take aggressive action. There is, however, growing pressure within the banking system to limit the potential exposure.
In the past few months, there has been an unsustainable situation where overstretched banks have had to borrow money at higher interest rates than they can lend it. The effect has been to send bank shares plummeting.
It is now clear that banks here took enormous risks with shareholders’ capital in recent years. It is also clear that the banks will have to raise substantial amounts of cash in the next few months.
During the housing boom of 2000-2006, banks lent freely to builders, and loans rose in step with housing starts.
Now, although housing starts have fallen sharply, loans to builders have continued to rise to €25bn. This suggests that many builders with unsold houses cannot repay their loans.
Because builders do not usually have to pay interest until the project has been completed and sold, one economist, Morgan Kelly of UCD, says “there must be a suspicion that banks are suffering considerable impairments on these loans, and concealing them.”
He says there is credible anecdotal evidence that several large building firms are now being run by their banks, while many small builders have been simply called in by their bank managers and told to stop writing cheques until they lodge some money into their accounts.
Mr Cowen last week suggested that Ireland may not begin to emerge from the economic crisis until 2011 — some 12 months later than previous predictions.
The banks’ softly-softly approach with the larger property developers is, therefore, expected to be severely tested within six months to a year.
Commercial property values are expected to fall 20 per cent from their peak as the credit crunch bites and growth in the Irish economy slows to recession.
This will lead to a rise in vacancy rates as demand for space softens. High rents will drive many firms out of business. This will leave some developers, who now have adequate rental income, unable to service their borrowings.
Davy Stockbrokers last month said the banks want to “roll with it”, but an extended period of economic weakness and/or a foreign bank withdrawing support could break this consensus.
In their analysis, Davy said: “As we saw with the US banks, it can take up to two years after the peak in a housing boom for non-performing loans to appear in the banking system, due to the length of interest roll-up facilities.
“As such, we expect a significant deterioration in nonperforming loans from this source over the next year.
“We met recently with banks, valuers and a number of the largest developers. We think the banks will tread softly in this market, and do what it takes to help clients work their way out of trouble.
“However, we see two risks to this consensus. First, as a meaningful recovery in the Irish economy looks postponed until late 2009/2010, we think the willingness of the banks to ‘roll with it’ may be tested.
“The second risk we see is a foreign bank withdrawing support from a large developer.
This could create a domino effect across the market.” The four major Irish banks quoted on the Irish Stock Exchange have agreed to appear before the Oireachtas Finance Committee on Wednesday to explain the ongoing credit squeeze of mortgage customers and businesses.
At that meeting, AIB, Bank of Ireland, Permanent TSB and Anglo Irish Bank are expected to downplay the level of risk to which they are now exposed.
In the Dail last week, Labour leader Eamon Gilmore said that when the economy was booming, the banks were in the driving seat. But now the banks were “behaving in a way that may add to our economic difficulties”.
He said he did not expect the banks to act in a way that was not “commercial”, or “responsible” to their shareholders. But he said they could apply their credit policies in a more “measured and sensitive way in the new circumstances in which we find ourselves”.
Mr Cowen agreed it was important that banks continue to provide “prudent risk to business” and, he said, the performance of Irish business during the good times “should stand as a strong criterion for continued support for those businesses which continue to invest and to require access to finance.”