Tuesday 12 November 2019

The five factors the stress tests will tell us about the banks' parameters

1. How the State will tighten its grip on the banking system

The government is already controlling large parts of the banking system, including Anglo Irish, Irish Nationwide and -- for now -- EBS. It also has 90pc stake in AIB and a 36pc stake in Bank of Ireland.

Full-scale nationalisation may yet be on the cards, and as a minimum the government is likely to take majority control of the whole banking sector on the back of the stress test results today.

Bank of Ireland is the only bank that has been able to tap the private markets recently for fresh capital, raising €1.7bn in a rights issue last June.

In total it raised €3bn via bond buybacks, an institutional placing and when the government converted its preference shares.

It may be given the chance yet again to tap the capital markets, but, if not, state control of the banking sector will be copper-fastened.

When the banking crisis began in September 2008, the last government was steadfastly opposed to a state-owned banking sector, but increasingly it looks like Ireland will end up with one now as events have unfolded over time during the last three years.

2. The stance of the ECB on Ireland's banks

The ECB has been gradually trying to reduce its exposure to Europe's distressed banks, fearing a long-term commitment could infect its balance sheet.

Last year the Frankfurt-based bank ended one-year loans for our so-called "addicted'' banks. The bank is still extending liquidity on a weekly and three-monthly basis, with Irish and Greek banks among the bank's largest recipients.

But after cutting back the duration of credit it is prepared to advance, we may find out today whether the bank is going to do a u-turn. The bank in many cases has no choice -- the Irish banks are totally illiquid and without the ECB they would be on the brink of collapse.

A new long-term funding deal for the banks, say based on loans for three or five years in duration, would bolster the Irish banks significantly.

A proposal for a new funding package was put before ECB governing council members in recent days. We should find out whether it was agreed today and, if so, what conditions accompany it. Look out for a high interest rate on any long-term loans given.

3. How badly the banks' mortgage books are faring

The four banks being examined under the capital review have almost €100bn of mortgages and the results of the stress tests will reveal how bad the Central Bank (and its consultants) thinks these loans will perform in the three years ahead.

Already the damage is extensive -- 5.7pc of the mortgages are in arrears by 90 days or more, a hefty 44,508 mortgages in total. Worries are rising about the approximately 20pc of mortgages given to landlords, investors and those with second homes.

This so-called buy-to-let segment is likely to emerge as a key driver of the losses in this area. History suggests those with second homes or investment properties are not as motivated to keep making payments as borrowers with just one domestic residence.

UCD economist Morgan Kelly caused alarm last year when he claimed mortgages would finally sink the Irish banks. Today's results will at least shine a little more light on whether that claim is true or not.

4. How bank bondholders are to fare in any restructuring

Expect the word restructuring to be used repeatedly throughout today as the government -- at the instigation of the IMF and EU-- looks to re-shape the banking sector.

As this involves fresh capital, the issue of sharing the costs with other parties comes into play, particularly bondholders.

Today the stress test results will be pivotal in whether the government is able to force losses on bondholders, particularly in Irish Nationwide and Anglo Irish Bank.

The higher the capital requirement, the more likely the government will seek to place some of the burden on bondholders.

In an extreme case the government could even seek a deal with secured bondholders by doing a bond exchange, though this is considered unlikely.

If senior bank bondholders survive the various announcements today they should be safe for quite some time, unless of course Ireland defaults generally in the next two years, an event which can't be entirely ruled out.

5. What institutions have the biggest problems

All the negative news about loan losses to date has fallen on AIB and Anglo Irish, but today's tests will show just how fragile the assets belonging to EBS and Irish Life & Permanent (IL&P) are.

The presence of a huge portfolio of tracker mortgages in the loan book of IL&P is likely to result in that institution coming under state control.

This institution used to pride itself on not having taken any direct state assistance since September 2008, but the over-leverage in its balance sheet appears to have finally caught up with it.

The lender still has a well- capitalised insurance business, but the results will show that this is not going to be sufficient to keep it out of state hands.

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