D-day looms for Irish banks

September 15, 2009

A branch of Allied Irish Bank is seen in London August 14, 2009. By Carmel Crimmins

DUBLIN, Sept 15 (Reuters) – Ireland will outline this week how much a make-or-break plan to revive its banking system will cost, setting the stage for possible further capital injections in the top two banks and a near doubling of the national debt.

Finance Minister Brian Lenihan wants to revive the flow of credit in the economy and restore confidence in the financial system by taking risky property loans with a book value of up to 90 billion euros ($132 billion) off stricken banks’ balance sheets and into a “bad bank” or National Asset Management Agency (NAMA).

The crux of the plan, dubbed the biggest financial gamble in modern Irish history, is what sort of haircut Lenihan will apply to the loans to reflect the impact of a spectacular property crash and appease a sceptical public, which fears he will overpay for the assets and lumber them with years of debt.

The bigger the discount demanded the greater the likelihood Dublin will have to inject more money into Bank of Ireland and Allied Irish Banks (AIB), possibly leaving the state with a majority stake in the latter.

“From a banking perspective it is one of the biggest days in the history of the country,” said Ciaran Callaghan, analyst at NCB Stockbrokers.

Economists’ median forecast in a recent Reuters poll was for a haircut of 27.5 percent across the sector and the chief executive of building society EBS, one of the institutions that will participate in NAMA, said on Monday that a discount of around 30 percent may emerge.

Such a haircut, above equity analyst forecasts of around 20-25 percent, could mean Dublin having to top up an existing 25 percent stake in the two main lenders but whether that happens will depend on the capital cushion required, existing provisioning, tax credits and their own ability to raise funds.

The larger stock of loans that Allied Irish Banks will likely transfer — estimated at around 25 billion euros compared with Bank of Ireland’s 16 billion — makes it the most likely candidate for state funds and possibly a majority stake.

Lenihan will indicate how much debt Dublin will issue to fund NAMA when he opens a parliament debate on the “bad bank” on Wednesday, allowing investors to work out the impact on lenders.

The exact discount applied to each institution, however, will emerge when tranches of loans are transferred over, starting with major blocks of assets later this year and finishing up with smaller loans by mid 2010.
Bank stocks and Irish sovereign debt may drop in the immediate aftermath of Lenihan’s speech but over the short-to-medium term there could be upside for both.

By clearing up uncertainty around their capital position, NAMA could encourage investors to buy into AIB and Bank of Ireland, enabling them to cut the state’s 25 percent stake to 15 percent before a Dec 31 deadline.

AIB said in August it had received an approach from a third party — thought to be a Canadian bank — for a minority stake but said talks were not expected to progress until there was more clarity around NAMA.

Economists in the Reuters poll forecast, on a median basis, Ireland would issue around 60 billion euros in bonds, nearly doubling the national debt, to pay for NAMA.

But the banks will be able to cash the bonds they receive with the European Central Bank, injecting liquidity into the market for fresh lending and also likely creating demand for high-yielding Irish paper.

Strategists at Royal Bank of Scotland see such demand offering the potential for Irish spreads, which blew out to 284 basis points over German bunds in March, to converge to Italian levels of around 77 from around 165 currently.

Ireland’s large cash balances of nearly 30 billion euros also mean that the government is unlikely to have to raise fresh debt to fund any capital injections it may need to make.

Lenihan is expected to get parliamentary approval for NAMA after agreeing concessions with his coalition partners but public disquiet at having to pick up the tab for a decade-long property binge means that he has shelved the NAMA vote until after an Oct 2 plebiscite on the EU’s Lisbon Treaty.

But getting the law passed is only part of a process to encourage investors back into the Irish market.

“The only big unanswered questions is where this whole banking crisis ends in Ireland and, at the moment, it looks like it will end with NAMA. But it has got to be executed,” said Padhraic Garvey, head of Investment Grade Debt Strategy at ING.

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