Colm McCarthy: State's gigantic portfolio of property and bank loans will be a tough sale
The Government must persuade international investors to buy up its unwanted holdings, writes Colm McCarthy
Asked to name the Government's larg-est commercial enterprise, most people would nominate the Electricity Supply Board. They would be wrong, and by a large margin.
The State's biggest commercial exposure, by far, is to the property company Nama. The State has also acquired Allied Irish Banks, Permanent TSB, Irish Life, the Educational Building Society -- merged into AIB -- and an entity called the IBRC, the wind-down vehicle for the former Anglo Irish Bank and the Irish Nationwide Building Society.
This acquisition spree was motivated, not by a desire to extend the State's portfolio of valuable commercial companies but to prevent the financial collapse of the Irish economy. These companies were acquired at enormous cost and only because they were in terminal trouble. The stress on the Exchequer balance sheet has been so great that the credit-worthiness of the State itself has been a casualty.
Whether the measures chosen to stem the collapse of the Irish banking system were sensible and prudent is a debate for another day. Most commentators have by now concluded that costly mistakes were made, starting with the blanket guarantee of October 2008.
But these measures cannot be undone and in the here and now the Government owns a gigantic portfolio of property and bank loans, mainly in Ireland, with liabilities to match. Over the next seven or eight years, the intention is that some units will survive -- AIB/EBS and Permanent tsb will slim their balance sheets and be sold as functioning banks -- while others are to be run down, their assets disposed of and, hopefully, their liabilities retired.
In both cases, the State will be a big seller of property assets and portfolios of bank loans. There is limited capacity to locate buyers in Ireland since the Irish private sector is also weighed down with excessive debt. Most of the State's unwanted holdings of property and bank loans will perforce be sold into international markets.
Indeed there can be no deleveraging of the national balance unless this is done. If the Government is to exit these unwelcome entanglements without further cost, or hopefully with a financial surplus, the priority is to persuade international investors that Ireland is a safe place to invest their money.
The scale of the required sales is enormous. Nama alone needs to dispose of assets carried on its books at almost €30bn. The IBRC has half as much again to dispose of and AIB must somehow shrink its loan book of €99bn substantially, as must Permanent tsb.
Much of this de-leveraging involves property or property-related loans. In total Irish State entities could need to shrink balance sheets, through borrower repayments and asset disposals, to the tune of €100bn in the years ahead. Even at the top of the credit bubble, the Irish commercial property market had an absorption capacity of about €2bn a year.
Nama has a target of winding itself up inside eight years, IBRC is on a similar timescale while the surviving banks are under pressure to slim their balance sheets even faster. The State will be competing with other sellers: the banks still privately owned, including Bank of Ireland, Ulster, National Irish and the wind-down vehicle for Bank of Scotland (Ireland), all have property and loan assets they would be pleased to get rid of. The necessary sales cannot be financed through credit from the banks doing the selling, since this defeats the object of the exercise, which is de-leveraging and balance sheet shrinkage.
The same applies to Nama. Excessive external debt in the overall economy needs to be reduced and this boils down to persuading foreigners to buy the surplus assets whose retention can no longer be financed. You cannot deleverage by lending money to people to buy your surplus assets. Retiring excess debt through asset disposals needs cash buyers, not buyers financed through domestic credit extension.
The task of persuading foreign investors to commit to Ireland on this scale should not be under-estimated. Property and banking assets are for sale at reduced prices in many countries whose international reputations are in better shape. Not merely has Ireland endured a mighty property bubble and near-collapse of the banking system, the State itself has been forced from the markets and into the care of official lenders in the form of the EU and IMF.
The bubble and banking crash has left a residue of unresolved legal disputes and criminal investigations. Separately from the banking disaster and its aftermath, there has been a spectacular insurance industry bust amidst evident corporate governance failures as well as tribunal reports into corrupt practices harshly critical of prominent politicians and business figures. The persons named include two former prime ministers, a clutch of former government ministers and some prominent businessmen.
In the last few weeks, the Central Bank has closed a spread-getting firm; inquiries into the Custom House Capital collapse continue and foreign bidders have been crying foul over the disposal of the Siteserv company.
Had there been no banking collapse, the Quinn Insurance debacle would have been seen as a major financial scandal in its own right and substantial costs have been imposed on the general public. The company lost a large multiple of its capital under the nose of the regulator, assets appear to have been pledged to support borrowing of unrelated companies owned by the shareholders and there had been a history of regulatory infractions.
The IBRC has been fighting court actions in several jurisdictions in its attempts to recover the collateral which backs loans to the Quinn family and its lawyers have alleged that improper attempts have been made to divert assets.
Viewed from behind the desk of an international investor with plenty of options around the world, this is not a pretty picture. The reputation of the country has been damaged and the perception created that Ireland is suffering from an acute outbreak of crony capitalism.
This may be unfair but perception is what matters and the perception needs to be altered decisively if foreign investors are to be re-assured. The sheer scale of the capital inflows required means that portfolio investors new to this country need to be involved on a massive scale. These people are perfectly entitled to be cautious about committing funds to a small country which must appear to them to tolerate a dodgy business and political culture.
In the circumstances the Government must focus on rebuilding reputation and has consciously made this a priority. There are other positives -- the Irish commercial courts are seen as thoroughly independent and quite prepared to find against local interests, including the State, should the law and the facts point in that direction.
But progress has been slow under several headings. Four years after the emergence of the banking crisis, and given clear evidence of malpractice in some banks, there has been no definitive inquiry into their governance and behaviour, in particular no review of bank-by-bank lending policies in the years when the damage was done. Despite evidence in the public domain of insider lending, balance sheet window-dressing and share-support operations in some banks, no prosecutorial actions have been taken.
The referendum on restoring investigative powers to the Oireachtas was lost through a weak government campaign, but a parliamentary inquiry is nonetheless desirable. It should cover the Quinn Insurance affair as well as the banking collapse and should delve further into the failures of regulators and the mistakes made in the policy response. A well-resourced inquiry should be seen as helping to restore the country's reputation.
Selling large property and loan portfolios is a complex business and given the sloppiness of banking practice during the bubble, legal disputes are inevitable. It would help if assets unaffected by such disputes could be disposed of in the most transparent manner available, which is by public auction. The professional bodies could help too, by insisting on over-compliance with ethical standards and conflict-of-interest rules.
When a government must undertake asset disposal on such a large scale, the competence and integrity of the state, its public services and its business culture come under the microscope. Competence requires that best possible prices be secured. Integrity requires that the disposal process is seen to be transparent, fair and above board.
There is no conflict between these objectives: a process perceived as lacking transparency will scare off buyers, particularly first-time investors unfamiliar with the country.