Saturday 25 November 2017

Dan White: Thinking the unthinkable about Allied Irish Banks

AFTER last week's dreadful half-year results just how bad can things get at AIB? With the tide of loan losses showing no signs of ebbing is it time to start thinking the unthinkable about AIB?

Last week brought a slew of half-year results from most of the major UK banks including RBS (which owns Ulster Bank), Lloyds (owner of Bank of Scotland (Ireland)) and Barclays. After the carnage of the past two years there are clear signs that the UK banking sector is on the mend with all of the banks reporting results last week recording sharply improved first-half performances.

RBS recorded first-half profits of £1.1bn as against a £300m loss last year. Lloyds turned a first-half 2009 loss of £1.6bn into a £4bn profit this time around. Meanwhile, Barclays went from first-half profits of £2.75bn in 2009 to £3.95bn for the first six months of 2010.

The gradual recovery of the UK banking sector is good news for British taxpayers. Former Chancellor Alistair Darling was forced to pump £66bn of fresh capital into RBS and Lloyds in 2008 and 2009 leaving HMG with an 84 per cent stake in RBS and 41 per cent of Lloyds. The value of these two stakes is now £6.6bn higher than the original price.

While things may be on the mend across the water, it's a different story on this side of the Irish Sea. As last week's AIB interims demonstrated things are still getting worse.

While the €2.3bn bad debt charge, although hardly unexpected, was bad enough, it was the sight of AIB managing director Colm Doherty effectively pleading with the Government not to let the unconditional deposit guarantee expire at the end of next month that was most disturbing.

Although Doherty didn't say it in as many words, one didn't need to be a financial genius to interpret his comments: unless the Government extends the guarantee for at least another 12 months it faces a potential funding crisis as nervous overseas banks withdraw deposits no longer guaranteed by the Government from AIB.

So where does AIB go from here? The latest write-downs bring its total loan losses since mid-2008 to more than €9.3bn. And there's plenty more where that came from. Even if the average discount applied by Nama to the €23bn of bad loans it proposes to purchase from AIB remains at the 43 per cent it got on the first tranche of loans transferred last April, AIB is looking at total losses of almost €10bn on these loans alone.

And then there's the little matter of its other loans, which had a book value of approximately €110bn at the end of June. What sort of losses can AIB expect to suffer on these loans?

At the end of June, fully one-third of AIB's loan book of just under €130bn fell into the "criticised" category. This meant that, while not all of these loans were in default, AIB reckoned that they were at risk of going bad. That's €42bn of potentially bad loans sitting on the AIB balance sheet.

While over €14bn of these bad loans are headed for Nama, that still leaves almost €28bn of potentially bad loans on its books. Even applying the 43pc discount suffered by AIB on the first tranche of loans transferred to Nama, that translates into a further €12bn of loan losses.

In other words, on top of the €9.3bn of loan losses already recorded, AIB is looking at a minimum of a further €13bn of loan losses, possibly even more.

Loan losses of this order of magnitude threaten to make a mockery of AIB's capital raising plans. The Financial Regulator has insisted that AIB raise a minimum of €7.4bn of fresh capital by the end of the year. AIB hopes to raise most of this money from selling its 22.5 per cent in US regional bank M&T and its 70.4 per cent of Polish bank BZWBK.

Unfortunately for Doherty, even if it can raise this capital, €7.4bn will almost certainly be not enough to plug the hole in AIB's balance sheet caused by mounting loan losses. This means that AIB will have to go cap in hand to the Government for more capital.

De facto nationalisation of AIB is now almost certainly a matter of when rather than if.

All of which will leave Brian Lenihan facing some awkward questions round the turn of the year. Having struggled mightily to avoid taking AIB into state ownership he will then be confronted by the very same issues Doherty and his colleagues failed to resolve.

With AIB's Irish loan book now shrinking rapidly, excluding loans going to Nama, its Irish loan book shrank by more than 10 per cent to €69bn over the past 12 months, AIB is effectively in run-off mode. This will force Lenihan and his colleagues to ask some very hard questions about AIB.

How can AIB's previous lending capacity be revived? Does it even have a future in its current form? Is it time to think the unthinkable about AIB? Over to you Brian.

Sunday Independent

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