It just didn’t make sense. The Minister for Finance announced on Thursday morning last that “the Government has decided, having consulted with the NAMA Board and the European Commission, that where the total exposure of a debtor is below a €20 million threshold in AIB [that’s Allied Irish Banks not to be confused by our foreign friends with Anglo Irish Bank] and Bank of Ireland, that debtor’s loans will not now be transferred to NAMA. The threshold had previously been set at €5 million. This change will ensure that NAMA can operate to the highest level of efficiency and effectiveness in the management of its loan portfolio and allow for the completion of all NAMA transfers by end-year”. The €5m lower limit will remain for Anglo and of course INBS and EBS have no lower limits (page 8 of the draft NAMA Business Plan in October 2009).
Why the announcement didn’t make sense:
(1) The priority is to get certainty on Anglo – not BoI or AIB. Anglo is now required to transfer its remaining €19bn of loans to NAMA by the end of October 2010. Anglo will then have a remaining €38bn of non-NAMA loans that are intended to go to the proposed Asset Recovery Bank. If Anglo is the priority then why not apply the €20m limit to Anglo as well as AIB and BoI? It is not clear how many loans or what value of loans that would re-route away from NAMA but in the context of the €38bn non-NAMA loans, it was likely to be relatively minor.
(2) The deadline for completing the NAMA transfers is February 2011. This is an EU-imposed deadline and if the deadline is not met, then the stars will not fall from the skies – the State will merely ask for an extension. EC Competition Commissioner Joaquin Almunia must now be an expert on the Irish banking crisis given the approvals sought in the last couple of years from his Commission. Surely he would not reject a request to extend the February 2011 deadline by a few months, particularly if the process was substantially completed by then.
(3) Why not apply the €20m limit to INBS and EBS? Wouldn’t that have resulted in a quicker transfer of their NAMA portfolios also?
(4) Given that NAMA’s principle was to cleanse banks of a particularly toxic class of assets, surely the retention of €6.6bn of these loans (the effect, the Minister told us of raising the limit at AIB and BoI was that €4.5bn of NAMA-eligible loans would remain at AIB and €2.1bn would remain at BoI) would undermine that principle?
It seemingly became clear in the middle of last week that AIB didn’t have a future in the short term without majority State control, though the feigned surprise at AIB at the decision by the Financial Regulator that the bank needed another €3bn of capital, was, to say the very least, amusing. So that meant that Anglo, EBS, INBS and AIB are effectively nationalized. The State already owns 36.5% of Bank of Ireland. Was the fear that if Bank of Ireland needed further capital, then that would signal the defeat of a government strategy that sought to avoid nationalization in September 2008? Let’s look.
(1) On 30th March 2010, our new-ish Financial Regulator, Matthew Elderfield announced the results of what he called a Prudential Capital Assessment Review. In respect of BoI he announced “ (1) An additional €2.66bn of equity capital to meet the base case target of 7% equity, and, (2) In meeting this requirement provided at least €0.25 bn of new Core Tier 1 is raised, then Bank of Ireland also meets (a) the base case target of 8% Core Tier 1, and, (b) the stress target of 4% Core Tier 1.” Now this all seems very complex but the Regulator did simplify things a bit when he gave the formula for the new capital requirements which started “Start with Current Capital of bank and forecast Operating Results Deduct impairments on NAMA loans Deduct impairments on non -NAMA loans until 2012”
So Bank of Ireland had to work out its capital requirements by reference to forecast losses on NAMA and non-NAMA loans. Like other financial institutions in Ireland, Bank of Ireland chooses to hide behind the temporary discretion allowed in IFRS 9 to avoid showing realistic estimates of losses on its loans. However the Financial Regulator was going to apply a more prudent measure of losses and reports in June 2010 suggested he was applying a 45% discount to AIB’s portfolio after AIB suffered a 42.3% loss in Tranche 1 – it remains unclear what discount he applied to BoI. The effect of raising the minimum NAMA loan from €5m to €20m reduced BoI’s NAMA-bound portfolio by €2.1bn and was reported by Bank of Ireland as “comprising land and development loans of circa €1.9 billion and associated loans of circa €0.2 billion. At 30 June 2010, the impaired element of this portfolio was €1.6 billion against which Bank of Ireland held IFRS provisions of €0.8 billion”. Was a 40% impairment charge enough (see below)?
Now subsequent to the Financial Regulator’s review, BoI went about raising €3.4bn of capital with a rights issue of €1.9bn, a €500m institutional placing of shares and the conversion of preference shares to ordinary shares. The €1.9bn rights issue eventually became €1.73bn after a €233m debt-swap. BoI has thus far however remained outside nominal majority State control.
(2) The Minister for Finance has put the NAMA haircut on remaining BoI NAMA tranches at 42% – “Bank of Ireland has already met the Financial Regulator’s 2010 capital requirement. To date the Bank has transferred €3.75bn of loan assets to NAMA at an aggregate discount of 36%. While the final tranche of NAMA loans may have a higher discount of up to 42%, the Central Bank has confirmed that the bank has sufficient capital to meet the PCAR standard to accommodate this increase.” Let’s look at the experience of the banks with Tranches 1 and 2 and the present forecasts from the Minister’s statement.
So of the relatively good performing Participating Institutions in Tranches 1 and 2, EBS’s haircut is to increase by 58% (in relative terms) from 38% to 60%, AIB’s haircut is to increase by 33% from 45% to 60% and BoI is to increase by only 16% from 36% to 42%. The basket cases Anglo and INBS see 16-22% increases but these are from very high levels already (55% and 65%).
Why should BoI’s remaining tranche be so much better than the other relatively good performers? A couple of days ago on here we looked at the Bank of Ireland loans to McDaid Developments (Ireland) Limited – GBP £42m of loans that are reported to be exposed to 85% losses. Although Bank of Ireland has been top of the class in Tranches 1 and 2 with the lowest haircuts (36.2% weighted average) and the statements this morning apparently confirmed that BoI was alright for capital even with a 42% discount, is 42% enough? Also, like the other banks, BoI seems to have been less than realistic in reporting its non-NAMA losses.
Of course by avoiding NAMA’s apparently stringent valuation and due diligence process, Bank of Ireland avoids crystallizing the true level of losses on €2.1bn of loans. And in so doing is perhaps avoiding a capital deficiency that might see the State having to take majority ownership of that bank also. And that is why it makes sense to increase the €5m limit to €20m despite the fact that on the face of it the decision makes no sense.