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State may take stakes in banks
Sunday, October 12, 2008 By David Clerkin, Markets Correspondent
US and EU discussions on investing in banks may lead to similar move here.

The dice-rolling goes on. While the Irish government dithered last week over whether it should sign up for another €50 billion of liabilities by extending its €450 billion guarantee to include foreign-owned banks operating here, Britain’s top politicians were busy formulating a separate emergency rescue for their own banking system.

Prime minister Gordon Brown and chancellor of the exchequer Alistair Darling did not disappoint.

Spurred on by crisis talks last Tuesday night after the share prices of Britain’s heavyweight banks had crumbled by up to 42 per cent just hours earlier, the chancellor and his predecessor dug out the big calculators reserved for special occasions and punched out a total of stg£500 billion (€650 billion). But the difference between this and the Irish scheme is that much of the money will be hard cash instead of notional guarantees that may or may not be called into play.

For the British banks in need of their intervention, it was the end of an era. Top executives finally accepted that their institutions were no longer viable as independent entities.

Instead, they would need up to stg£50 billion from taxpayers, giving the government in return preference shareholdings that would outrank existing investors, and unprecedented influence over their operations.

The British government also followed elements of Ireland’s untested guarantee scheme by announcing it would stand over new debt issues needed by the banks, effectively telling the markets that money could be lent to the banks covered by the scheme without the risk of default.

Crucially, however, it expected that the level of debts guaranteed would be in ‘‘the order of’’ stg£250 billion. This was an important step in managing market expectations by signalling that it was prepared to travel that far to help the banking system, but that no one should count on it going any further. Ireland’s guarantee, meanwhile, remains uncapped and exposes the government to unlimited liabilities.

A grim hat-trick was completed when the Bank of England agreed to lend stg£200 billion to the banks, to make sure they would have sufficient liquidity to avoid further collapses.

For Irish banks and building societies, the decision to extend the special treatment applied the previous week to the six Irish-run institutions - AIB, Bank of Ireland, Anglo Irish Bank, Irish Life & Permanent, EBS and Irish Nationwide - to include other major banks operating here betrayed signs of a policy that, as time went on, was looking less like a silver bullet than it had first appeared.

Not only was finance minister Brian Lenihan’s guarantee being blamed for creating major distortions in the money markets, as money flowed into the original six institutions at the expense of banks - in Ireland and overseas - outside the scheme, but it was being touted as a solution that solely addressed liquidity problems.

Just a week later, the British government’s intervention to shore up its banks’ capital positions has threatened to throw an unwelcome spotlight on the capital problems that are as relevant to Irish banks as to those in Britain.

Further pressure could come on the Irish government to put capital into the Irish banks after the US said it plans to invest directly in American banks for the first time since the 1930s.Reports in Paris this weekend suggest EU leaders will examine European initiatives to do the same thing.

Banking analysts began to wonder how - if British banks were being forced to call in the government to boost their balance sheets - could Irish banks sail through the ongoing storms without similar support.

The answer, it appears, will lie in Irish banks issuing more shares in return for precious cash. But whether this course of action will succeed is likely to depend on the Irish government helping them along the way, by underwriting share issues or perhaps even stumping up its own money to take a slice of the action.

‘‘To increase perceived creditworthiness in future, we expect banks will carry higher levels of capital,” said Merrion Capital analyst Sebastian Orsi.

‘‘The scale of dislocation in international credit markets means this is more likely through rights issues, rather than profit retentions over the next few years. Preferred share options exist, but we believe the government would have to underwrite this, as Britain has done.”

Orsi said AIB, Bank of Ireland and Anglo would need capital injections of almost €7 billion between them to increase their core capital ratios from their current levels of between 5.8 per cent and 6.3 per cent, to a more desirable 8 per cent. ‘‘Government support may be required to underwrite capital increases,” he said.

One senior banker told The Sunday Business Post, however, that even this level of capital injection might not be enough, saying the bill could go as high as €14 billion. For existing shareholders, the prospect of issuing new shares to bump up capital ratios would be a shattering blow.

If their bank puts more shares in circulation, existing shareholders will own a smaller slice of a pie that has been shrinking relentlessly for 18 months, further depressing its share price.

Even the possibility of a fresh share issue is usually enough to prompt some investors to dump stock, in anticipation of a dent in the share price in the future. Panicked shareholders thus fuel a vicious cycle - selling in anticipation of further selling, which in turn prompts other investors to sell as the share price continues to fall.

Just as investors were once happy to climb on board an individual stock if its price kept climbing, a falling share price usually only attracts bottom feeders.

On top of this, the extent of the price falls affecting Irish banks has been so great that the pool of bargain hunters, which first entered the market when prices had fallen by around 20 per cent from their peak, had long been exhausted by the time prices were down 85 or even 90 per cent, as they were last week.

Despite the rally that lasted for several days after news of the government guarantee emerged, the share prices of Irish banks were once again back on the floor last week. Bank of Ireland’s share price, for example, fell to levels not seen since 1995.

The panic selling that triggered the British government’s intervention was quick to spread to the Irish market, as investors discounted the benefits originally attached to the guarantee and sent Irish banks even below the levels prior to Lenihan’s bailout.

At one point last week, the combined value of Ireland’s four quoted banks -AIB, Bank of Ireland, Anglo and Irish Life & Permanent - fell to just €9 billion. This was less than half what AIB had once been worth on its own. Anglo’s share price bottomed out 90 per cent off the peak it had recorded early last year.

The immediate threat of Irish banks collapsing on liquidity grounds was eased by the government signalling it was prepared, if necessary, to repay the money they had borrowed, but it did not take long for investors to start worrying afresh. They had moved on to questions about the impact of bad debts on future profits, an expectation that dividends would be off the table for the foreseeable future, and worries that capital constraints would prevent them from carrying out lending activities.

The two-year lifetime of the guarantee may also weigh on their minds. If the guarantee expires before the interbank lending markets return to anything resembling the normal service that existed pre-credit crunch, some Irish banks – those more reliant on wholesale borrowing - would find themselves back to square one and in an even more vulnerable position.

If the government failed in such an event to signal that it would extend the guarantee, depositors could be prompted to flee, and other banks could begin to cut funding lines beyond the guarantee’s anticipated cut-off date.

As the British banks prepared for a time when their own executives and shareholders would no longer be calling the shots, their Irish equivalents showed signs of being conscious of politicians’ influence.

Within 24 hours of the emergency interest rate cuts by the ECB and other major central banks last Wednesday that knocked 0.5 per cent off the eurozone’s base interest rate, every mainstream Irish lender had agreed to pass on the benefit of the cut in full to mortgage customers.

This was despite the stubbornness of the key Euribor interbank borrowing rates, which remained at astonishingly elevated levels. Three-month Euribor, the benchmark rate used by Irish banks in the past to price their mortgage books, perversely went up following the ECB cut, soaring to 1.6 per cent over the ECB rate. This rate stayed within 0.2 per cent of the ECB rate in the almost forgotten days before the credit crunch and, until recently, had tracked the ECB rate to within 0.9 per cent.

Bankers were quick to point out the customer-friendly nature of last week’s price changes. But they will have some explaining to do to shareholders who want them to take in more from their existing loans to help generate cash and repair their profits and capital bases. In reality, the price cuts were decided by the government, not the banks.

It is unlikely to be the last time the government flexes its muscle in return for the bailout. ‘‘There’s a new bank in these islands, and it’s the governments,” said one senior banker.

But as the Irish government takes its time over agreeing the final details of its guarantee - postponing its publication until this week, more than a fortnight after the plan was first floated - many bankers were bracing themselves for further revolutionary steps.

‘‘The government has resolved the liquidity issue, but what it hasn’t dealt with is the capitalisation issue,” said Bank of Scotland (Ireland) chief executive Mark Duffy.

Another Dublin financier said it was unlikely that the Irish government would ignore developments in Britain when finalising the terms of its guarantee. Further initiatives were likely to ensure that its intervention in the market resembled more closely the British approach, he said.

For Lenihan, offering guarantees may have seemed difficult at the time. But it may have turned out to be the easy part, as the prospect of writing cheques and handing out hard cash looms large. His dice won’t be disappearing from the table just yet.

British government helps out the heavyweights
Eight of the biggest banks and building societies operating in the British market have been offered the unprecedented support of the British government.

They are: Abbey, owned by Spanish bank Santander and a former takeover target of Bank of Ireland; Barclays; HBoS, which is active in Ireland under the Halifax and Bank of Scotland (Ireland) brands; HSBC; Lloyds TSB, which has agreed to buy HBoS; Nationwide Building Society, which has no connection with Ireland’s Irish Nationwide and is, so far, the only building society in the scheme; Royal Bank of Scotland, the owner of Ulster Bank and First Active; and Standard Chartered.

Chancellor Alistair Darling has pledged that each bank that takes part in the support scheme will agree to restrictions on its operations, including pay curbs for top executives and stringent oversight by Treasury officials. He has also insisted that each bank take immediate steps to strengthen its capital position.

Other banks in Britain have been invited to apply to join the scheme. The government has said it will consider these applications on a case-by-case basis.

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