Friday 15 November 2019

Emmet Oliver: Time for ECB to face reality on Irish banks' predicament

Emmet Oliver

According to ECB president Jean Claude Trichet, Ireland's bank and sovereign debt is sustainable, affordable and serviceable. "My working assumption is that Ireland can do it, Ireland will do it,'' Trichet told the European Parliament last week.

Trichet's critics here had an appropriate riposte on blogs and message boards. If the French central banker is so confident Ireland "can'' and "will'' do it, would he object if his monthly salary was paid in the form of two-year Irish government bonds?

Not likely.

Trichet may be saying one thing, but the markets are saying and thinking other things. In a little noticed interview this week, the world's largest bond fund, Pimco, said it was now time to "bail in'' senior creditors of the Irish banks.

In other words, the system cannot be properly restructured here unless at least some classes of senior creditors, in at least some banks, have to sustain losses. Whether this happens or not will be revealed today in a government statement on the banking system.

But whatever the contents of this statement, the ECB has to face up to certain realities about the Irish banking problem, which so far its governing council members appear to want to ignore.

For example, on Tuesday, a board member of the ECB, Juergen Stark, was still saying the entire problem was purely one for the Central Bank here.

The ECB is the largest creditor of the Irish banking system. This is not going to change for several years, even if dramatic deleveraging takes place and deposits return to Irish banks from corporate sources.

If the Frankfurt bank is tied into the Irish banks for several years, it has no choice but to formalise this arrangement in a new funding agreement, subject to a set of rules that finally defines how the ECB wants to handle distressed banks across Europe.

The ECB is also going to have to accept that if will retain a role in bank funding in other European markets for several years.

The new rescue plan for Europe, the European Stability Mechanism (ESM), will provide assistance to countries overall and help with negotiations with private sector creditors, but other types of temporary liquidity assistance will still be needed from Frankfurt, one suspects. The ECB will still be a lender of last resort.

Of course, the ECB is right to draw the line at providing direct equity to banks, but this is not the same as saying no to any role in stabilising the financial system. This role will continue even after Trichet departs and the Irish banking system is reformed.

The ECB will also have to learn a bigger lesson from the Irish banking crisis. The best time to make interventions and close down non-viable institutions (and move their deposits elsewhere) is at the beginning of the crisis, not later on after truckloads of capital have gone in.

One of the reasons the ECB itself is now on the hook with the Irish banks is that it failed to get involved earlier in the crisis and separate out the institutions that have a future from those with none.

Permo shareholders should have it seen it coming

Now shareholders in IL&P know how other Irish bank stockholders feel.

Ever since January 2009 when Anglo Irish was nationalised overnight, shareholders in other Irish lenders have been effectively all but wiped out because the company they invested in apparently had inadequate capital.

Irish banks can be full of confidence and brimming with capital one day, only for shareholders to be told the next day they can barely be considered a going concern and their capital is entirely inadequate.

The more savvy investor has avoided the whole Irish banking sector since September 2008, but others have bought into a recovery story which is now coming apart at IL&P as shareholders face having their holdings dramatically diluted.

But was there any warning this time around? IL&P had 10.6pc capital at the end of last year and this was even before taking advantage of another €243m available from its life assurance business.

This was an adequate position the market thought. Yes, stress tests by Messrs Honohan and Elderfield found the company needed another €243m, but this could all come from "internal resources'' shareholders were assured.

But now apparently the company, led by chief executive Kevin Murphy , needs up to €1bn in fresh capital.

Clearly the company's warning about the latest stress tests, carried out at the behest of the IMF and the EU, might have been more forthright, but Murphy and his colleagues said about all they could say, without knowing the outcome of the exercise being carried out by BlackRock, the giant US money manager. With an eye-watering loan-to-deposit ratio at the end of last year of 249pc and a mortgage book weighed down with loss-making trackers, it was always going to take a huge leap for IL&P to come through very severe capital and liquidity tests intact.

Unfortunately many shareholders in the company were too complacent about the outcome, but they weren't the first group of Irish bank shareholders to exhibit such characteristics and probably won't be the last.

Kelly won't be the only 'non-viable' borrower

While messy and not entirely satisfactory, NAMA is finally separating out viable borrowers from non-viable borrowers.

Crudely, the agency has put borrowers into three categories: those who have reached a memorandum of understanding with the agency (Treasury Holdings is one of them); those who have not (Bernard McNamara, Paddy Kelly); and those who are still in limbo, trying to get the agency to back their business plan.

Battling a perception that the agency is a bailout scheme for developers and trying to deal with a hostile incoming government, NAMA is finally taking firm action against groups who have no real way of ever digging themselves out of the debts they've accumulated.

The seizure of Paddy Kelly-linked properties late last week was a prime example. It is reported several of the properties are either breaking even or turning a profit, but the stock of debt behind them is not sustainable, NAMA appears to have concluded.

While it is relatively easy (though not cheap) to put the assets of so-called non-viable borrowers into receivership and or liquidation, the more difficult challenge will be rehabilitating those who are still viable, but damaged.

NAMA will shortly restructure the debts of this group, lengthening maturities on their loans, reducing repayment rates and effectively waving a magic wand transforming non-performing loans into performing loans.

But there is no certainty some of this group can reach their new repayment targets either and many of them may yet join Mr Kelly as simple bystanders in a receivership process.

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