Friday 15 December 2017

The thirty five billion euro question

EU authored programme will use 'capital assessment' and 'liquidity assessment' to determine level of funding for bank bailout

WITH all the dire predictions of the scale of the next banking bailout, it would come as little surprise if our bank bosses were beating a path to the psychiatrist's couch, or the recruiter's office at the very least.

Ten days ago, fledgling Finance Minister Michael Noonan warned that next Thursday's 'stress tests' results are "likely" to trigger a bailout bill higher than the €10bn originally mooted.

Since then, speculation has been rife that the banks will actually need more than €35bn -- a sum so great it would threaten the very viability of Ireland, since our international bailout only leaves us €35bn to deal with the banks.

The apocalyptic scenario has sent shockwaves across the globe, with the interest premium commanded by Irish government bonds soaring to record highs on Tuesday, but the banks at the centre of the storm see things differently.

The theory doing the rounds among senior executives is that the latest stress test won't trigger a bill of more than €35bn, because the stress tests can't trigger a bill of more than €35bn.

Or as one senior executive succinctly puts it. "The €35bn is the budget, it [the banking bailout] can't go over that."

Their conviction stems from the role of the "external authorities". The IMF, ECB and European Commission authored a bailout programme that allowed €35bn for bank rescues -- and bankers increasingly believe the troika will ensure no more than that is spent.

The theory goes like this.

The banks are being put through two separate tests -- a "capital assessment" that examines how much cash they need to withstand future losses and a "liquidity assessment" that looks at how Irish banks should restructure so they can fund themselves.

The capital element, dubbed PCAR, is reasonably predictable.

Banks have been given detailed spreadsheets to fill out showing the losses they'd suffer in the event of certain 'stresses' like a rise in unemployment and falls in property prices.

The 'stresses' involved have already been laid down by the Central Bank, in collaboration with the external authorities, and the numbers are being scrutinised by a team from BlackRock Solutions to give the tests added credibility.

By in large the die has already been cast, PCAR will cost whatever PCAR will cost, and word in the street is that it will cost more than expected because of heavy losses on mortgages in particular.

The other element, PLAR, is where the flexibility exists and where things get interesting.

Banks are going through PLAR because they've built up a €150bn dependency on last resort lending from the Central Bank, and the ECB is keen to rein in these "emergency" measures and stop giving banks across Europe unlimited access to cash.

The core Irish problem is that banks loaned out far more money than they took in deposits throughout the boom, and with international money markets closed to Ireland the Central Bank is making up that gap.

The PLAR challenge is to find a way to eliminate about €80bn of loans and other assets from AIB, Bank of Ireland, Permanent TSB and EBS so they will no longer have such big operations to fund.

The fastest way to do this is simply to sell the assets and turn the loans into cash that can be repaid to the ECB, but experts warn that this is also the most expensive way, with Davy suggesting losses of €20bn could "realistically" be triggered from that kind of fire sale.


The other approach is to take the excess assets away from the main bank companies and "warehouse" them somewhere until they can be sold for a better price.

This requires co-operation from the ECB or another source because even though those loans would no longer be funded through the banks, there's still going to be a funding cap and someone's going to have to fill it.

"Europe holds the key to the cost of PLAR," says one senior banking executive. "Our read of it is that if the PCAR turns out more expensive, then they'll have to accept a cheap version of the PLAR [ie not selling the assets immediately].

"It's not in Europe's interest to go above the €35bn in the [IMF/EU] bailout because if they do that the whole bailout deal is broken -- nobody wants that."

Some go further, suggesting that the bailout will have to come below the €35bn because Anglo Irish Bank and Irish Nationwide aren't covered by the stress tests and may need more cash when a separate review of their books concludes in April.

The bankers' theory is backed up by their interpretation of recent statements made by Finance Minister Noonan.

Arriving in Brussels for his first meeting with ECB supremo Jean Claude Trichet, Mr Noonan told the press gallery that the cost of the banking bailout would be more than the €10bn that had been expected.

He added that the "sustainability" of Ireland's overall debt situation could be an issue if the a massive bank bailout bill was heaped on the already-stretched sovereign.

And he then told journalists he was going to pursue the possibility of a "medium term funding" commitment with Msr Trichet.

Bankers suggest that this was a tactic -- convince Msr Trichet that PCAR is going to be really expensive, and you're in a better position to appeal for a "medium term funding solution" that would lead to a cheaper PLAR.

If it was a ruse, it worked too well. Noonan did such a good job of convincing people the stress tests could be worse than expected that rumours of a €35bn plus price-tag and an "unsustainable" debt situation began to gain currency.

Cue, another intervention to calm things.

"I don't believe it [the bailout cost] will be anything like the extravagant figures that have been circulating," he told reporters in Brussels this Monday.

Even if the bankers are confident the latest bailout won't be so expensive, it will lead to the implosion of the EU/IMF deal, the situation is still very grave and the fate of some of Ireland's biggest institutions still hangs in the balance.

Of the four banks in the mix, AIB has already been all but nationalised and EBS is already fully state-owned. Bank of Ireland, which has ceded 36pc to the state, and Irish Life & Permanent, which has never been bailed out, have the most to lose.


The fate of both institutions hinges chiefly on the "pace of deleveraging" or the speed at which they will be forced to sell assets [see panel]. The casting vote lies with the ECB, unless the EU's EFSF rescue fund is preparing to make a maiden voyage into the realm of bank liquidity.

Trichet's public comments on the topic have been less than encouraging. At the monthly ECB press conference, he has repeatedly told reporters that Ireland must "stick to the plan" already agreed with the EU/IMF.

This week, his statements in Brussels invoked similar sentiments. But behind the scenes technical work is taking place in Frankfurt and teams have been on the ground in Dublin again this week to see how the Irish banks could be helped.

One option is to allow the Central Bank of Ireland to continue channelling "emergency" ECB money to the banks once the ECB itself stops offering unlimited cash, but this has its own complications for eurozone-wide money supply.

Another is for the ECB or the Central Bank of Ireland to agree to fund a vehicle that would be used to hold the banks' surplus assets until they can profitably be sold.

The important thing is Frankfurt is coming round to the idea that a fire sale will help nobody.

And the ECB has form in helping us before, albeit quietly.

A discrete part of the last bailout allowed Irish institutions to issue bonds to themselves and use those as collateral to get ECB money -- an unprecedented concession that's given banks access to about €19bn.

As Michael Noonan hinted in Brussels this week, "frequently they [the ECB] are criticised in Ireland but I think people do not have the full picture, they have been very helpful to the Irish banking system".

What's keeping bankers awake at night is the uncertainty. They've submitted plans to the regulator outlining what assets they would have to get rid of in order to reduce their demand on central bank cash.

Some have included estimates of how much this would cost but sources say it's a "very very subjective exercise", being conducted blind since no-one yet knows how long they'll have for asset sales.

The capital number for PCAR remains elusive, even though they've already plugged in their numbers into the various scenarios given by the Central Bank.

"BlackRock is the wild card in all this," says one executive. "They're going over all the PCAR data, and you don't know what they're going to make of different things."

Banking analysts are struggling to estimate how it will all play out. The Central Bank has published some of the parameters for the stress tests, but key assumptions like the rate of mortgage defaults and the interest rate developments are still unknown.

Analysts also point out that loan losses are not the be all and end all for stress test results, particularly since loan losses accounted for just 63.5pc of the capital demand that stemmed from US stress tests.

Other factors could include losses to the portfolio of bonds and other debt instruments held by the banks, and hits on "counterparty" defaults that would be triggered if a bank's trading partner doesn't pay up.

Loan losses

Yesterday, Davy took a stab at the PCAR number, suggesting loan losses in the range of €16bn to €19bn, with potentially another €5.3bn for other losses, but the report was covered in caveats.

Even Alan Dukes, who famously predicted the banks could cost Ireland another €50bn, says he "doesn't know" if the new stress tests will show that the banks need more or less than that.

The good news is the fog is beginning to lift.

This time tomorrow, the banks are likely to have the "draft findings" of the stress tests. This time next week they'll have certainty of the stress test's demands for each of their institutions.

Depending on the results, bankers might reconsider that psychiatrist or recruiter.

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