It sounds like the kind of decision a family around the death bed of a loved one faces. Though perhaps the comparison isn’t in the best taste, the reality is that the venerable 185-year old bank is facing insolvency and it is only the dogmatic government strategy of maintaining a duopoly of “Irish” banks not to mention over €10bn of public funds and significant ECB funds that is keeping the bank afloat. This entry examines the status of AIB and the cost of keeping it alive.
Firstly for our international friends, AIB is Allied Irish Banks PLC – note the plural “Banks”. It has nothing to do with the biggest failure in Irish corporate history, Anglo Irish Bank which is referred to domestically simply as “Anglo”. AIB was conceived in 1825 with the opening of a bank called Provincial Bank and over the next century and a half merged with other domestic banks to give us the Allied Irish Banks that we know today. Alongside Bank of Ireland it is seen as the rock of Irish banking.
During the property boom in the 2000s the bank was a late participant in the mania but there is evidence that once it arrived at the party it wasted no time in trying to catch up with the existing party-goers. The Minister for Finance estimates that the bank’s remaining NAMA loans are worth 40c in the euro (including long term economic value).
Its most recent set of accounts for the first six months of 2010 show that the bank had assets of €169bn, liabilities of €160bn and capital of €9bn. So it is a huge business in an Irish context but clearly solvent by reference to these results. Unfortunately the results don’t reflect the true condition of the loan assets. The cumulative provision for losses on NAMA loans in the interim results was 26% – that is, the loans were worth 74c in the euro. The most recent ministerial estimate is 40c in the euro. This should result in a further loss to AIB of €5.5bn. But NAMA loans form a small part of AIB’s total loanbook and the company will have some €81bn of non-NAMA loans (plus €4.5bn of €5-20m formerly NAMA loans) once NAMA has absorbed the poison. The cumulative provision on these loans in June 2010 was just €3bn (note 22 on page 83). Given that these loans include commercial property and business lending in a state which has suffered the greatest contraction in GDP amongst developed countries in modern times, I would suggest that provision is utter fantasy.
Like some shady cash-in-hand sole trader, AIB maintain a second set of books under the auspices of the Financial Regulator who in March this year set out the capital requirements for AIB and other banks (the Prudential Capital Assessment Review). In September using this second set of books, the Regulator announced that AIB needed raise €10.4bn by the end of this year. AIB’s strategy was to dispose of some assets and then to raise additional equity underwritten by the State. There is a detailed entry on these capital raising efforts here but in summary the bank disposed of its Polish operation (still subject to approvals) which yielded €2.5bn capital from the €3.1bn sale price and yesterday AIB held an EGM in which shareholders approved the sale of the bank’s stake in US bank M&T which should add €0.9bn to the capital coffers. The bank announced yesterday that it was placing the sale of the UK operation on hold (though there appears to be some back-pedalling on these comments this morning). Unless there is some dynamic between the UK sale and capital that means that the bank still needs €7bn in new capital in the next 60 days. And there is only sucker with that level of available funding that is willing to invest in what is likely to be an insolvent bank, and that’s the government who seem intent on placing just under one half of our National Pension Reserve Fund (that’s the €3.5bn invested in preference shares last year and the €7bn now needed as a proportion of the €24bn funds in the NPRF) in one basket (case) – AIB. UPDATE/CORRECTION 4th November, 2010. It has been pointed out that in the Minister’s statement on 30th September 2010, he stated that €1.7bn of any shortfall in take-up of the forthcoming AIB share issue would be via a conversion of the existing €3.5bn investment in AIB preference shares made by the NPRF at the Minister’s direction. And that should the sales of assets (now just of Bank Zachodni and M&T) not materialise by 31st March 2011, then the remaining €1.8bn of preference shares would be converted to ordinary shares. This means that for now (and on the basis that the sales of Bank Zachodni and M&T will complete by 31st March 2011 and it seems that Bank Zachodni’s sale is progressing slowly) the additional investment in AIB is €3.5bn and not €7bn as shown above. And that consequently just less than one third (as opposed to just less than one half) of the NPRF’s total funds will be invested in this one company. The remaining analysis stands.
The government strategy seems chauvinistic (“we need a duopoly of Irish banks”), knee-jerked, immoral (not a word you’ll often see on here but taking money from the pension fund to prop up an insolvent bank is flagitious when there are other options to protect a functioning banking system), recklessly risky (one half of the pension fund is “invested” in one company in one sector). AIB should be taken into 100% state ownership immediately, the State should assess the value of any shareholdings in AIB (I expect they are worth nothing), negotiate with the €4bn+ of junior bondholders the company had at June 2010 and assess if senior bondholders might make a contribution to the insolvent bank. Only then should the State assess the systemic importance of AIB and should probably seek a buyer for the rump of that company. Even if the state is left with only one Irish bank so what? We have a Financial Regulator with 520 staff that should be able to regulate a restricted market to combat uncompetitive practices and when the Irish economy recovers other banks may see prospects here.
If on the other hand, we maintain the pretence that AIB is a viable bank then €7bn will need be found in the next 60 days. At the very best we are set to lose €1.8bn if we continue with the madness of the NPRF underwriting a share issue at €0.50 per share when the shares are presently trading at €0.35. With the healthiest Irish bank, Bank of Ireland, having to borrow 3-year funds at 5.875% last week (excluding costs) in a market where mortgages and commercial lending is still available at 3%, the prospects for profitability at AIB are slim in the context of the NPRF’s investment strategy which allows it invest in any market across the globe.
It is time to say our goodbyes and pull the plug.
[…] This post was mentioned on Twitter by Declan Ganley, Stephen Kinsella, Eagle, Mark Dennehy, Blackhall Publishing and others. Blackhall Publishing said: RT @stephenkinsella: Brilliant analysis & correct use of the word 'flagitious', Considering letting AIB go, it's got to be Namawinelake: http://bit.ly/bsD3dk. […]
Very clear. Where is the bank resolution scheme which could have a central role in restructuring our banks????????
Memo to BL and DofF: Ask the UK Treasury for a copy of that drafted for Northern Rock.
@Brian Flanagan
Actually, the relevant UK legislation is the Banking Act 2009, passed after Northern Rock. Note (p. 10) that this Act permits haircuts to be administered to senior debt without a wind-up of the insolvent bank – a debt restructuring. (This has not in fact happened yet in the UK.) Note also that while the UK doesn’t have to contend with Article 43 of our constitution, it does have to comply with the very similar requirements of the European Convention on Human
Rights.
[…] links: Ireland may have one month to stave off bailout – Bloomberg Is it time to let AIB go? – Nama Wine Lake Let them eat Irish bonds – FT […]
Kudos once again NWL…
[…] Read the best exposition of why we should think about winding up AIB here. […]
Hi NWL,
I refer to your comments as follows:
‘the government who seem intent on placing just under one half of our National Pension Reserve Fund (that’s the €3.5bn invested in preference shares last year and the €7bn now needed as a proportion of the €24bn funds in the NPRF) in one basket (case) – AIB.’
Before you get too carried away with the “brilliant analysis’, can you recheck your figures please and re-read the Minister’s statement of 30 Sept. You seem to think that the capital of E7bn needed in the next 60 days is additional to the existing pref shares of E3.5bn already invested.
In fact, the E7bn will be achieved by a Government cash injection of E3.7bn plus a conversion to equity of the existing prefs of E3.5bn. In other words, taking account of the asset disposals which have yielded E3.4bn to date, the new Regulator’s target capital of E10.4bn by December 2010 is already covered.
I heard one of your fans above(who should know better) on radio yesterday calling for the winding up of AIB, presumably influenced by your analysis above. Could I suggest that he too might read the Minister’s Statement of 30 September. The last thing we need at the moment is public hysteria and I suggest that people in positions of responsibility need to be a lot more restrained and responsible in making public pronouncements on the banking situation.
Hi Kevin, thank you for your comment and I have added an update/correction to the entry above to reflect the Minister’s statement on 30th September, 2010 where he said “In order to afford every opportunity to AIB to raise as much as possible of the required capital from the markets and to minimise further Government support, it has been decided that this capital requirement will be met through a placing and open offer to shareholders of AIB shares to the value of €5.4bn. This transaction will be fully underwritten by the National Pension Reserve Fund Commission (NPRFC) at a fixed price of €0.50 per share and is expected to be completed in 2010 subject to shareholder and regulatory approval. If necessary, the NPRFC’s underwriting commitment will be satisfied by the conversion of up to €1.7bn. of its existing preference shares in the bank into ordinary shares along with a new cash investment for the balance of €3.7bn in ordinary shares. This transaction structure assumes the sale of AIB’s stake in M&T Bank and disposal of other assets in due course” and “In the event that the bank’s residual capital requirement is not met through asset sales by 31 March 2011, any shortfall will be met by the conversion of a proportion of the remaining €1.8bn. of preference shares.”
In other words, the new investment in AIB will be c€3.5bn and not €7bn as stated in the entry above. That is on the basis that the two asset sales, the disposal of AIB’s share in Bank Zachodni and M&T, can be concluded by 31 March 2011. Bank Zachodni’s sale seems to be progressing at a very slow pace no doubt as a result of waiting for approvals and any remaining due diligence, so it is to be hoped that the €3.5bn does not become €6bn.
One of the great advantages of this medium is that an entry can be honed and updated to perfection, not something available to traditional print or broadcast media and for some reason MSM online media do not tend to do updates/corrections despite containing glaring errors.
Despite the update and correction, I would suggest that the analysis is not changed at all in any significant way. Although the NPRF’s investment will now be just less than a third of its funds (rather than just under one half), it is still a colossal investment in one company. The rest of the analysis remains though for interest, by reference to yesterday’s closing price for AIB shares, the State is proposing to make a loss of €1.944bn rather than €1.8bn by underwriting the new share issue with funds from the NPRF.
With respect to the second part of your comment, I am interpreting this to mean you take a contrary view to that expressed in the entry above. If that is right and I have not got the wrong end of the stick, then that is positively welcomed. It would be even more welcome if you added reasons for taking a contrary view. I feel you have expressed some things in a loaded way. I think you are referring to Stephen Kinsella’s characterization of the above entry as “excellent analysis” – inverted commas can betoken a direct quotation though in the this age of airquotes it can betoken sarcasm and the word “hysteria” certainly carries negative connotations of panic and ignorance. I must admit that the intention with the entry last week, last Sunday and in this entry has been to provoke debate. To date the underwriting of AIB’s share issue has taken about 10 seconds of parliamentary time (a brief reference to it by the Minister for Finance in the Dail on 30th September and a written matter-of-fact question and answer exchange with Joan Burton on 14th October, 2010). The mainstream media has either ignored the issue or buried it in other AIB-related reporting. I am flabbergasted that there has not been uproar at the prospect of deliberately losing the nation’s pension reserve fund €1.8-1.9bn in a single transaction and placing such a large part of the fund in one company. It is a very significant sum of money to lose when shareholders and €4bn+ junior bondholders keep value in their investment (admittedly the shareholders’ investment is presently only worth less than €300m).
And you will continue to find contrary analysis on here. Take the NAMA accounts this week. Whilst other media is focusing on a €6m profit or a €x thousand payment to some company or other, on here the lead was with the fact that NAMA has bought loans at a time when property values were still falling in its primary market and NAMA has paid a premium over the value of the property and if correctly valued at the end of June 2010, that would result in a loss which would render insignificant a few million here and there in other areas of the NAMA operation. I hope such analysis provokes debate and on occasion, uproar (a neutral word) which might lead to better transparency and ultimately a wider buy-in to the momentous decisions that are being taken in these days which will impact us for generations to come.
http://www.finance.gov.ie/viewdoc.asp?DocID=6515&CatID=1&StartDate=1+January+2010&m=n
Hi NWL,
Thanks for your comments above. Could I respectfully suggest you amend your comments to the effect that “the new investment in AIB will be E3.7bn in cash and E3.5bn by way of conversion of prefs to equity, rather than the sum of E3.5bn and E7bn as stated above.”
I don’t have any problem with your interesting analyses on this forum, although I may not always agree with everything you say.
What I do have a difficulty with is people such as Stephen Kinsella calling publicly for a winding up of AIB on the 6pm radio news. While such comments may help Stephen’s celebrity priofile, they also tend to cause fear and panic among the public, particularly among the tens of thousands of AIB clients around the country, and tend to undo a lot of the work being done at official level to try to rehabilitate the bank on the world stage. Is it any wonder the the Minister has to make a statement on the matter today to reassure the public.
We all know that the Government is committed to saving AIB (since the alternative would be financial and economic Armageddon), and is probably endeavouring to secure some public funding for the recap, and so avoid bringing it into full public ownership. It is premature to talk about subordinated bondholders taking a hit, while the ordinary shares still have some value and while pref shares exist. There is an order in which the various providers of capital suffer losses and they don’t all rank equally. Such talk may be appropriate down the road but not yet.
I agree that the plan to underwrite shares at E0.5 each when their market value is less is a bit generous to existing shareholders but what’s at issue here is the quantum of shares the Minister is getting for his E5.4bn, not the actual E5.4bn itself, which has to be invested to keep the bank adequately capitalised.
No, I’m not an AIB shareholder but I am a small depositor and am grateful to the other taxpayers of Ireland for guaranteeing bank deposits and for rescuing the Banking System in general from financial meltdown. I am also retired after 36 continuous years of hard work and payment of taxes to provide, inter alia, free education to several generations of younger people. I continue to pay tax on my pension and have no difficulty in paying more tax if necessary to keep the Ireland Inc show on the road. All I ask is that educated people, such as celebrity economists, exercise restraint and responsibility in their public utterances on the banking situation so as to avoid making matters any worse.
Hi Michael,
By reference to the closing price last night (€0.30 per share), on the proposed €5.4bn issue underwritten at €0.50, the immediate loss to the National Pension Reserve Fund would be €2.16bn. That loss will change by €100m for every €0.01 change to the share price, positive or negative.
You say that the plan to “underwrite shares at E0.5 each when their market value is less is a bit generous to existing shareholders but what’s at issue here is the quantum of shares the Minister is getting for his E5.4bn, not the actual E5.4bn itself, which has to be invested to keep the bank adequately capitalised.” I would disagree with your characterization of the underwriting as “a bit generous” as it represents an immediate loss to the pension fund of €2.16bn at current prices. If the €5.4bn were to be invested at current share prices (rather than at €0.50 a share) and there were no third party takers, then the State would end up with 95.4% of the shares. Even if it were 90% though and in light of AIB’s provision of €3bn against non-NAMA loans of €81bn, I would suggest that AIB is insolvent and should be 100% nationalized.
After 100% nationalization which would involve appointing an assessor to determine what if anything was to be paid to shareholders, the State should negotiate with junior bondholders and open “amicable discussions” with senior bondholders. The unrecognized loss (that is, the difference between the €3bn existing provision on €81bn of lending and a realistic provision) should be assigned to shareholders and junior bondholders first (and that would absorb perhaps €4-5bn) and only then should the State consider recapitalizing the bank further or selling it. That is the proposal on here. I did not hear the interview with Stephen Kinsella but if this is along the lines he suggests then I would certainly seek to add my support. I think economists have a duty in these momentous times, when we still have the latitude to make decisions, to highlight issues and call for debate. It won’t be next year when we will be living with consequences of the decisions taken during these momentous days.
Now you say that “the alternative [to saving AIB] would be financial and economic Armageddon”. I am certainly not suggesting cutting that bank loose and leaving it to its own devices – after all it has a balance sheet total of €169bn and is systemic to the economy and the banking sector generally. What I am suggesting is that its wind-down be carefully managed with the possibility that any rump of the bank be either capitalized by the State with a view to an eventual privatisation or it be sold to a third party. Surely we have by now learned lessons from Anglo as to the best and most cost efficient way of running down a bank.
If you believe the future banking landscape in the State should include a majority State-owned AIB at a €2bn cost to the pension reserve whilst protecting junior bondholders I would be interested in hearing from you why you would hold that position (not least because it seems to align with the Minister’s position – though it is contrary to the markets that thin there is a 64.5% chance of AIB defaulting on its bonds in the next 5 years and the market think that AIB is worth €324m). Would you object to AIB being controlled by a “foreign” bank eg Santander or Deutsche Bank? Do you think it vital that there be two Irish banks?
@Michael: “I agree that the plan to underwrite shares at E0.5 each when their market value is less is a bit generous to existing shareholders….”
I may be missing something here, but I do not understand how underwriting a new issue at 60% above the market is generous to existing shareholders?
To be honest, I believe that shoveling the Irish taxpayers’ money into such a putrid corpse of a bank like AIB is far worse financially than any liquidation or sale of the bank. The fact is that currently it doesn’t really earn the title of bank – it isn’t lending, treats its clients in an execrable manner and is a liability to the country, not an asset.
Here in the USA banks that are broke close every week, what makes AIB so special that it must be kept alive at such an appalling cost to the Irish people?
Hi NWL,
Good to hear that you do not want to cut the bank loose and leave it to its own devices.
I agree with you that paying 50 cents per share needs to be challenged at a time when the share price has fallen to par or below. However, to characterise it as an immediate loss of E2.16bn to the NPRF is a bit misleading since some 95% of any share premium paid for the new shares would still “belong to” the NPRF as the majority shareholder. That would still leave a sizeable value shift (about E100ml per my calculations) in favour of the existing shareholders which we should shout about.
I’m guessing that some private capital may be invested as a result of the share placing; Maybe I’m naive but lets wait and see on that score. I also believe that there is value in retaining the company’s public quotation and don’t think it wise to rush into nationalising the company.
If your suggestion of underprovisions is eventually proved right then AIB will need capital of not just E5.4bn but also some additional billions at which point, we will own 100% of the company, the prefs will have disappeared, and the subordinated debt should come into play.
@who_shot_the_tiger:
AIB in Ireland provides I guess about 35% to 40 % of our retail banking facilities; If we don’t support it, warts and all, a corresponding percentage of our businesses may end up without facilities to pay salaries or wages or creditors generally or to receive payments from debtors; ATM cards and credit cards could become useless and pensioners like me could lose our savings on deposit. These are just some examples of the “nuclear winter” that our Government is seeking to avoid.
Hi Michael,
I’m afraid I disagree with you regarding the NPRF keeping 95% of the share premium. What share premium? AIB had capital of €9.5bn at the end of June 2010. That was before taking NAMA losses at 60% (the provision up to June was 26%). So you could deduct €5.5bn from P&L reserve in the €9.5bn which leaves €4bn before any further losses on non-NAMA loans (and to repeat the cumulative provision on non-NAMA loans was just €3bn on a total of €81bn). But the €4bn also contains our €3.5bn preference shares. So the capital before any additional non-NAMA loan losses is €0.5bn.
If we inject €7bn (€5.4bn assumed the UK sale would complete), then I believe non-NAMA losses will very quickly eat into the €7bn. That’s the whole point, AIB is insolvent and it becomes a question of who should absorb the losses and in what order. The position I have outlined is that the shareholders take the losses first, the junior bondholders second and there should be “amicable discussions” with the seniors. Only then should we put further State funding at risk. What is being proposed here is that we put even more money into AIB which will pay off junior bondholders and preserve some existing shareholder value. That’s completely wrong. That’s my position.
We already have the nuclear winter. The deposits are guaranteed. It does not deserve the support it has received from the Irish people. It is a cancer on us and needs surgical removal.
NWL
I do understand your point.
However the possibility of an immediate loss of E2.16bn for NPRF on the issue of new shares does not arise (as you suggest) because the new shares are to be issued at a premium on the current market price for the existing shares. Such a loss would arise only and solely on the assumption of underprovisions in the accounts as you suggest and you need to make that clear in your statements.
Stepping around all the hyper technical arguements for a minute:
If,…if there were a lot of other banks whose shares dropped to 20 odd cents, during a major recssion, while sitting on a lot of dodgy loans, in an economy undergoing historically savage cuts, who subsequently recovered, well then by all means throw some taxpayer money at it.
That would be reasonable.
Although it is about much, much more than share price, ultimately, right now isn’t the share price fatal?
– twenty-odd cent shares in an Irish bank – who would buy them (voluntarily?)
It’s reasonable to be a little less than optimisitic about the chances of survival, and probably wise to start looking up phone numbers of relatives who live far away.
To borrow a phrase from medicine of the new millenium – ‘it’s time to move that gurney out of the corridor and into a private room’.