Irish banks must scale a high debt mountain as eurozone crisis deepens
A staggering €77bn of Irish bank debt falls due this year. It is called the 'wall of worry' by outside commentators. Can the Irish banks manage to climb it?
IT HAS the potential to become the ultimate financial pile-up. Irish banks, already desperately chasing deposits and managing crippling loan losses, have €77bn of liabilities maturing in 2010, with a large portion of this debt falling due in September and October. The debts must be either repaid or rolled over at a time of immense stresses in the European bond market.
The problem is that, as with deposits, Irish banks could, if the process is not properly managed, end up competing with each other for funds at a vital period.
This so-called 'wall of worry' represents the chief systemic threat to the banking sector in the latter half of this year, according to executives in the industry. The Financial Regulator is monitoring the situation closely, while the Department of Finance is said to be considering various contingency plans if some of the debt cannot be rolled over.
Bonds worth €51bn is just one component of the so-called 'wall of worry', but there is also believed to be €24bn of other liabilities coming up for renewal before the end of October, leaving the banks facing the biggest funding challenge in the history of the sector.
While the banks are publicly relaxed about the challenge -- pointing to the liquidity available via NAMA bonds lodged with the ECB -- the financial environment in Europe could not be worse, on a number of levels. First, the European sovereign bond market is severely distressed despite the €750bn rescue package announced for the euro in May.
A large amount of US money is no longer prepared to invest in peripheral European bonds, either those of governments or of banks, and removing such a vital buyer from the market is likely to push up funding costs sharply, particularly for banks with the weakest balance sheets.
But while demand from those who lend to banks always waxes and wanes, what makes things different this time, according to the ECB, is that banks could end up competing with countries to find buyers for their bonds.
In some cases, banks could end up competing with their own sovereign; in other cases, it will be with other European sovereigns. The big concern is that some of those issuing debt, with or without government guarantee, will get crowded out. The ECB in its last financial stability report pointed out that 70pc of all global bank bonds would mature by the end of 2012.
"The risk of crowding out in the debt markets, owing to competition from sovereign issuers and other financials, may impact profitability and capital adequacy through higher funding costs,'' the Frankfurt-based organisation said.
This reference to "other financials'' is certainly relevant to Ireland. If Irish banks go to issue debt together they are likely to find a thin pool of demand and the risk premium demanded by investors is likely to surge upward, smashing the net interest margins at the banks.
Of course, this is a concern for after the summer months, because effectively the bond market enters a dormant period in July and August.
Ultimately, if the euro crisis cools somewhat and issuance picks up again, money will become available. As Morgan Stanley said recently, it is not that funding won't be available it is just that it will be very expensive.
"Overall pressure is building, but, unlike 2008, given the support mechanisms in place it is more a question of the cost of funding for the banks, not the availability of funding."
US fund managers supply credit to European banks in a number of ways, from short-term commercial paper to subscribing for long-term bond issues. With so many of them leaving the market, the key question in the European bond market for banks is -- will there be enough buyers out there?
European bond markets have experienced a significant reduction in issuance since the first three months of this year. For the first three months, an average of €38bn a month was issued by eurozone banks. But dramatically this dropped to €1.9bn in May. This has led to concerns over the ability of European banks to finance maturing debt from the markets.
However, since the start of June some signs of recovery have been seen, with a number of banks able to issue unsecured bank debt. "For Irish banks, this is a positive, but they remain heavily reliant on wholesale funding, which has impacted banking margins negatively,'' explains Oliver Gilvarry, a banking and economic analyst at Dolmen Stockbrokers, who tracks all the Irish banks closely.
The big difficulty is that bank debt is now viewed as effectively sovereign debt and while so-called "national champions'' like AIB and Bank of Ireland are likely to find it easier to roll over debt without taking a major hit on cost, it may not be so easy for more fragile and second-tier lenders like Anglo Irish Bank and Irish Nationwide.
The gloomy background for Irish bond yields doesn't help -- this week 10-year Irish government paper was trading at just below 5.5pc, an extremely elevated level.
If yields hit and remain somewhere near 6pc, this would be very dangerous for Ireland and for the banks. On the positive side, the Irish banks have already funded a large amount of their debt this year. But the environment is still difficult.
The European banks do have ECB as an effective backstop and Irish banks could go even further afield for their funding, says Gilvarry.
"Another alternative for Irish banks is to use collateral to obtain funding from the ECB and in some cases the Bank of England."
The other negative, as the crucial period approaches, is the EU Commission. It is still taking its time over what to do with Anglo Irish Bank and in time it will start scrutinising Irish Nationwide.
While the EU must do this under state aid rules, it makes some potential bond purchasers nervous.
Could the EU impose things on Anglo or Irish Nationwide that would be damaging to the interests of bond holders?
Presumably not, but even the mere suggestion of future haircuts on Irish bank bonds (known as 'burden sharing') would make life almost impossible for Irish issuers.
So far, that has not happened, but the lingering presence of the EU Commission in the area of banks and how they fund themselves does not help.
Next week the Financial Regulator is due to publish a large report on the future of banking. Some reflections on the issue of refinancing risks are expected to be in there. As of now, everyone is expecting the European banks, including Ireland's, to get through the period ahead. But the cost of "getting through'' could be very high indeed.