Rapid Business Growth’s Blog

With the collapse in the Irish property market there has been a question over the major Irish banks.  Collectively the banks have 90 Billion Euro in outstanding property development loans.   These loans are apparently secured to various extents against development sites and the personal undertakings of property developers.  In the past 18 months the property market has gone into a steep dive from which it has yet to recover, so development sites have lost a lot of value and property developers a lot of their net worth. 

All commentators believe that some percentage of the 90 Billion will not be repaid, the only question is how much.  If most of the loans will perform the banks can absorb the losses and recover.  If the non performing loans are greater than the banks capacity to absorb losses IE the banks’ capital, the banks go bankrupt and get taken over.

The first step to recover this situation was to guarantee the banks’ deposits.    BY placing the resources of the Irish state behind the banks at the end of September 2008, the Government was able to stop panicking depositors withdrawing all their cash. 

The second step was to beef up the Banks ability to absorb loses, by pumping in a massive 7 billion in capital.  The so called recapitalisation scheme announced in February 2009. In return for this cash the state secured an income stream and preference shares. 

The latest step is for the state to force the banks to transfer the 90 Billion in development loans to a new state run agency, NAMA.  Apparently NAMA will value all the banks development loans and take them over from the banks.  The developers still have the same obligations to repay the 90 billion plus whatever interest payments were agreed.  The banks will exchange their debts for government bonds and walk away from all property related debts.  The state will have a property portfolio of worth tens of Billions of Euro, which can be managed over several years to maximise value for the tax payer. 

Apparently AIB have 200 staff preparing documents to hand over to NAMA, and NAMA will have between 30 and 40 staff.  So Nama must be planning to let the banks continue to manage the day to day operation of all these loans and simply provide oversight, and hold the risk.  It will be interesting to see how Nama manages to align the interests of the taxpayer who will own the loans with the interest of the bank manager who has to negotiate with a developer about repayments. 

One thing we do know is that NAMA will only pay less than 90 Billion for the loans, according to the Minister for Finance Nama will pay “at an appropriately written down value”.  What is not clear right now is how much the state will pay for these loans? 

If the write down is 50% reflecting the collapse in the price of development land, the banks will face a massive write down in loans, that will wipe out the banks’ capital.  The only conceivable solution will be for the state to pump in replacement capital and take a major stake in the remaining banks.   Or as the Minister says:  “If the crystallisation of losses at any institution requires additional capital the State will insist on participation by way of ordinary shares in the relevant institution.”  IE the state take control of the banks and today’s shareholders lose what little they have left. 

If the write down is a more genteel figure, say 10%, then the banks can absorb the loss.  Yes they will take a bit of hit on their capital ratios (See page 49) but they will be free of these dreadful development loads and profitable.  Don’t forget that most divisions of the Irish banks were and are very profitable.  Strip out the toxic development loans and the Banks look like very attractive cash generating businesses.  In this scenario the poor taxpayer would be left with a huge portfolio of property loans that will never be repaid. 

But the Minister has his “Sword of Damocles plan” to stop the banks getting away scot free: “The stream of income from the assets and the proceeds from the eventual sale of the underlying asset will accrue to NAMA. The State will incur a loss only if the assets transferred to the State cannot over the long term repay the investment made by the State in their purchase from the banks. However, if NAMA make a loss over the long term, the Government intends that a levy should be applied to recoup the shortfall.”  So even if the banks negotiate a sweet heart deal with Nama there is a still the threat to the future shareholders of the banks. 

In either scenario the bank shareholders will have to pay for the excesses of the Celtic Boom.   

Yet BOI shares have rebounded from a low of 12 c to 193c  valuing the company today at about 1.8 Billion euro.   Similarly AIB has risen to 195c from a low of 27c in March, with a market capitalization of  1.6 Billion euro.  Yet when we look at AIB for example they have a Tier 1 capital of 7.7 billion (about 9%) and they stand to write off 8.5 billion up to 2010.   Remembering that the Tier 1 capital ratio cannot drop below 6-8% AIB can only afford to lose a few billion.  If AIB have to write off more than a few billion which looks increasingly probably, they will be insolvent. 

Logic seems to suggest that the share price should be on the floor.    Yet the Stock Market is backing the company heavily to survive and thrive – is this blind optimism or am I missing something?  

I keep hearing that we have a banking crisis in Ireland. I’m just not too clear if I know what that means.

Right now there is no run on the banks as the state has provided a guarantee. AIB’s last bond issue was oversubscribed as they raised 1.5 Billion. What we see on the business pages and discuss over pints is a much smaller problem: The share price has collapsed as shareholders have lost confidence in the banks’ ability to generate acceptable returns in the next few years. Hence the shares have been dumped in vast quantities and the price is on the floor. Bad news for private investors and people approaching retirement age. Possibly good news for people who are seeking long term investments. A source of great war stories over pints. But this is not a systemic threat to the Irish economy.

So what is the “threat vector” that has the nation so disturbed? The threat is the lack of cash in circulation in the economy due to a lack of confidence. Banks are terrified of non performing loads, so they hoarding capital and being very slow to authorise loans to anything with an element of risk. It is not just the banks that are hording cash: As spending has stalled in Ireland the effective saving rate has soared. Consumers and businesses are holding onto cash at an unprecedented level. Calling this a banking crisis is to miss the point.

This situation has its own scary logic. People now boast about cancelling Christmas parties and no longer spends vast amounts on a Friday night in bars and restaurants. This causes the bars & restaurants to close and triggers another wave of belt tightening. There are now 2 restaurant leases available around the Triangle in Ranelagh alone! The landlord will not fill those premises quickly and will have to accept a reduced rent when they are taken.

This lack of spending is the problem which need to be solved right now. Ownership of the banks is a secondary issue. The only way to restore spending is to first restore confidence. People will not spend if they fear for their future. Restoring confidence will be a slow process as the effect of this shock work through the system. Right now we have a confidence crisis and we all will be much more cautious for a few years.

Obama’s infrastructure package in the States will help and we should bring forward large scale capital schemes like Metro North (and wave power?) to help kick some life into the economy. We should never again have an economy so relient on the property market. Most importantly now is the time to start thinking about the kind of economy we want in future. If not property then what?

Do we have the leadership skills to start that discussion?