How to wind down AIB in three easy steps, and save the nation €10bn into the bargain

No justification has been offered by the government for the preservation of AIB in our future banking landscape; it is to be a “pillar bank”, says new Minister for Finance Michael Noonan. But not once, as far as I am aware, has this vision been challenged in the mainstream media – not once has an interviewer or journalist asked the question “if AIB needs another €13.3bn of our money, then why don’t we just let it go?” If any journalist does manage to get around to the question, the response is likely to feature the concept of competition which is laughable in an Irish context – since the formation of the State in 1921 we have had Bank of Ireland and some form of Allied Irish Banks, yet it was only with the entry of foreign competitors that our market for deposits and loans was shaken up; operating a duopoly for more than half a century merely shows us how a small cartel can stifle competition. And there seems to be no reason why the future will be any different. So why keep AIB afloat? I don’t have the answer but I do know there will be some complex financial calculations that will underpin any feasibility study. On the other hand, I have this nasty feeling that no-one knows – in either the Central Bank or the Department of Finance.

So what would winding down AIB actually entail? Again, it would be complex but thankfully we have templates from the financial crisis in the past three years.

(1) Nationalise the bank : cast your mind back to the last nationalisation, of Anglo Irish Bank on 15th January 2009. Here’s the press release and the Frequently Asked Questions. We already de facto own 94% of AIB and the bank now needs another €13.3bn. Now that we have the Credit Institutions (Stabilisation) Act this should be easier now than it was with Anglo.

(2) Sell the ~€50bn deposit book : cast your mind back more recently to January 2011 when Anglo and Irish Nationwide Building Society obtained court orders to sell their deposit books. The NTMA just needs dust off its “data room” used to co-ordinate the February 2011 auctions and away we go. Along with €50bn of deposits, AIB would transfer NAMA bonds, cash, other assets including branches perhaps. Has any depositor at Anglo or INBS noticed any real difference with the transfer of their deposits?

(3) Do an “Anglo” with the husk of AIB, that is, wind it down over time or merge it with Anglo and INBS. Either way, it gets no more public money and if needs be, its bondholders get burned in the same way as the bondholders in Anglo and INBS.

One of the main reasons for winding down AIB is to enable some burden-sharing with bondholders. And to remind you here was the position with respect to bondholders in the State-guaranteed banks in February 2011.

Unless a “foreign” bank buys the deposits and commits to an even greater presence in Ireland, the likelihood is that AIB will disappear. Its branches will go the same way as Bank of Scotland (Ireland)’s and will be sold. There will be substantial loss of jobs but the nation may save €10bn-plus. Plainly there would need be more oversight of Bank of Ireland which we are likely to majority-own anyway but the Financial Regulator now has over 500 staff, surely some could oversee competition issues in Bank of Ireland.

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The mystery of the €7bn deposit into Irish banks by Minister Lenihan on the eve of the general election

Last Thursday 31st March, 2011 can’t have been a pleasant day for our new Minister for Finance, Michael Noonan. With the weight of the commitments contained in the Programme for Government, it cannot have been easy to tell the Dail late last Thursday afternoon that the State would need inject a further €24bn into the banks, that there would be no burning of senior bondholders and perhaps most disappointingly, he wasn’t even able to offer us the consolation that the ECB was at least committing to the medium-term funding of our beleaguered banks. Perhaps he might have taken some comfort from the fact that the mess that he is confronting is not of his making, but regardless it was a speech no Irish finance minister would have wanted to make. Fast-forward two hours to when the newly-created Economic Management Council gave a news conference, the first five minutes of which are available here. During the news conference, Minister Noonan stated that in February, 2011 former Minister Lenihan put €7bn into the banks and slightly smirked as he observed to the media that “ye didn’t pick that up”.

I would like to bring you the transcript of precisely what Minister Noonan said but the 45-minute press conference which was shown in full on RTE Online doesn’t appear to be available, certainly not from RTE’s website or the government information service merrionstreet.ie but the €7bn was alluded to again today during RTE’s This Week radio programme when Tanaiste and one of the four members of the Economic Management Council, Eamon Gilmore again mentioned it in passing.

You will recall that in February, 2011 we were supposed to have injected €10bn into the banks as part of the EU/IMF bailout but that Minister Lenihan decided on 9th February, 2011 that he didn’t have a mandate, the general election having been called on 1st February2011. He invited the finance spokespeople for Fine Gael and Labour to write to him if they disagreed with his position, which neither did. So you might have thought therefore that no money was put into the banks in February, 2011? Not so, it seems according to Minister Noonan and Tanaiste Gilmore – €7bn was put in.

And where did the Department of Finance magic this €7bn from? In what must make the financial accountability of our government a travesty, we don’t know. If you consult the Exchequer Statement for the month of February, 2011 there is no mention of it there. There was obviously no press release at the time. So how did the banks get €7bn? My guess is that it comes from NTMA reserves or from National Pension Reserve Fund liquidations of position but neither has made any statement on the matter. But it might also come from the Central Bank of Ireland who doggedly refuse to disclose information on the €70bn Emergency Liquidity Assistance programme.

What significance does this €7bn have? Arguably none because we now seem resigned to injecting a €24bn into the banks, of which this €7bn is part. The significance I draw from it is that there is no presumption of accountability on behalf of government. A Minister can claim on one hand that he doesn’t have the mandate to inject €7bn+ into the banks but on the other can engineer €7bn of deposits. And when Minister Noonan said, “ye didn’t pick up on that”, how was the media supposed to have picked up on that when neither the national accounts, the Exchequer Statement nor other state agencies including the NTMA and Department of Finance didn’t make any statement on the matter.

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Present estimates of bailing out the banks

Certainly Sean Fitzgerald, David Drumm and Michael Fingleton have attracted widespread outrage at their perceived greed, incompetence and perhaps more. But as the latest estimates of the cost of bailing out the banks, totalling €70bn, show, the cost for AIB is going to be just as excruciating as the cost of bailing out Anglo and INBS.

The bailout information comes from

(a) the Department of Finance in September 2010 which showed €46bn committed to the banks.

and (b) the release from the Central Bank of Ireland/Department of Finance on Thursday last which showed an additional €24bn committed.

And here are the totals by institution

And finally, here’s a little chart to show that relatively-speaking, AIB’s position is really no better than Anglo’s or INBS’s. And frankly Bank of Ireland and Irish Life aren’t great either.

I suppose in fairness, part of the injections into AIB and BoI is “buffer capital”, and given the banks subjected to stress tests are projected to make a combined total of €3.9bn in operating profits in the three years to end 2013, then who knows, we might get some part back. Also there is talk about burden-sharing with subordinated bondholders and some part of the capital needs might be met privately. But still, for all that, it is surprising that there hasn’t been a greater outpouring of outrage towards AIB in particular, but Bank of Ireland and Irish Life also. The Independent today reports that as the time for the stress test announcements grew near last Thursday afternoon, former AIB CEO, Eugene Sheehy was to be found on a bench in the grounds of Trinity College where he is now reportedly a history student with an annual income from his pension put at €458,000. “It’s a sad day” was his reaction to the day’s announcements before donning his Stealth-technology membrane and disappearing into the university buildings. The fact is that the losses at his former bank are every bit as painful as those in the other institutions.

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Delivering the Programme for Government pledge on retrospective commercial rents

“What is unnatural will not endure”
German Chancellor Konrad Adenauer in 1963 at the sight of the Berlin Wall

This new government is getting off to a disappointingly slow start. Even though it is a coalition of centre-right and centre-left politics, the election manifestoes were surprisingly similar and the Programme for Government can’t have been too difficult to hammer out. But amidst the U-turns, hidden qualifications, and general procrastination, we heard from RTE on Friday last, that new Minister for Justice, Equality and Defence, Alan Shatter is to refer the issue of implementing upward-downward reviews in upward-only leases to the Attorney General, Maire Whelan to consider the compatibility of any change to legislation, with our constitution. This hasn’t happened yet mind, it is something that the Minister is to do in the future.

The issue in a nutshell is that Ireland & the UK are the only countries in the EU where commercial leases have traditionally provided for upward-only changes to rent levels. We have had a major economic shock but many leases still demand tenants to pay rents in excess of current market rates. Some commercial tenants are struggling. Should the government allow the rent in these leases to be reviewed and to put in place a current market rent, then landlords, investors, pension funds, banks, NAMA and others will see the value of their assets drop significantly. On the other hand, some businesses that would otherwise fail will survive. Also a factor of production, property, will be priced at current levels. The government intervening in private contracts is seen as a major intrusion that may also be unconstitutional and may deter investors in property generally.

Thus far, this blog has taken a neutral stance on the issue. The change would bring about winners and losers. There will be more winners in terms of headcount – a landlord may only employ a couple of people but a retailer might employ 500 – and the cynic might say this was the reason that politicians offered this change during the election. But how will the economic gains and losses tally if the change is made? Difficult to say – on the one hand you will have a more competitively-priced factor of production without an historical distortion disproportionately benefiting one group. On the other hand, you will see owners of the factor of production, and related supports, facing actual losses in wealth and the general discouragement of investment (domestic and foreign) in a jurisdiction which intervenes in private contracts. The neutral stance on here has changed however, and now leans more towards the implementation of the election pledge contained in the Programme for Government.

The main reason for the change of heart is the appreciation that property as a factor of production is vital to our economy and should be priced at a competitive level determined by the market.  Current market rents are more than 50% off peak and have been dropping at 20%+ per annum annualized in each of the last four quarters’ indices from Jones Lang LaSalle. To distort the market through historical agreements is anti-competitive . All other jurisdictions in the EU, except the UK, allow upward-downward reviews of commercial rent which follow local economic conditions. In terms of the EU, upward-downward reviews are the standard – Ireland and the UK stand alone as idiosyncrasies. I feel that I should produce more detail in support of this position, but allowing markets to operate freely is an ideology and to a large extent, you accept that ideology or you don’t.

Of course, our freely- operating market had given rise to upward-only review leases in the first place and these leases were entered into voluntarily by both tenant and landlord. Arguments that the government should never have allowed such agreements are moot and in the coulda-shoulda-woulda category because the fact is that we have lawful contracts today which maintain rents above current market rates. So what can the government do to deliver its Programme for Government commitment?

(1) Legislative changes. This seems to be the preferred route and is presumably why the Minister is to refer the matter to the AG. There may be constitutional issues with the government intruding upon private contracts but I think this has been overblown. Other countries, including the UK, have successfully made changes to property related contracts, eg residential leases which have faced immense resistance but have been upheld at a European level. Also we have had legal changes here in recent years which have diluted rights of landlords, for example the precedent established in 2009 that companies in examinership can repudiate leases.

(2) Taxation changes. If the legislative route is seen to be too difficult then the government can deliver its commitment through changes to the tax system. Take the scenario illustrated above. The rent specified in the upward-only lease is €100 per sq foot per annum. The current market rent is €45 psf. A change to the tax system might see the difference between the current market rent and the lease-determined rent, €55, taxed at 100% and a tax allowance of the same given to the tenant. This is Proposal A. There is a second proposal, Proposal B which would further penalize the landlord by taxing him at 100% of the difference PLUS 10% and would not pass all the benefit to the tenant by only giving him 90% relief on the €55 difference. This would be to pay for the cost of administering this tax system and also to encourage landlord and tenant to agree a market rent.

How might the government address the downsides to any changes

(1) Compensation for landlords. Landlords and their associated supports, eg banks and property agents, are being disadvantaged because contracts agreed on an open market basis are being intruded upon and changed in a way which will reduce the value of the landlord’s asset. All to assist the economy and ensure we are a competitive country. So might there be some way in which this mandated sacrifice might be compensated? I think there is, but it won’t unfortunately be an upfront lump-sum because the State can’t afford that. But on an ongoing basis, the State can act to reduce certain taxes or levies which would provide landlords with a share of the increased national wealth generated by having a more competitive factor of production. It was interesting to hear yesterday that NAMA apparently lobbied the Department of Finance in May 2010 on this issue. I wonder how such an approach today would be viewed through the prism of the NAMA Code of Practice on the conduct of NAMA officers which forbids lobbying of the sort set out under section 221 of the NAMA Act – on a strict reading of the Act, NAMA would probably be okay but would this sort of lobbying be contrary to the spirit of the Act?

(2) Deterring investors. Imagine that you are investing in a foreign country, a country that you assess as stable and which upholds the rule of law and allows you to generate a return on your investment. All of a sudden that country decides to appropriate your asset and not pay you for it. How likely are you to invest in that country again? Well the experience of countries where this has happened tells us that investors will come back but they will be more cautious than before. But what Ireland is proposing to do is to bring its commercial leases in line with the rest of Europe and ensure that a major factor of production is priced at a competitive level. Even if this government yellows it on this commitment, then investors will still have somewhere in their minds that the next government, which might be more left-wing by the way, will introduce the change.

To bring us back to Konrad Adenauer’s philosophy on the Berlin Wall, upward-only review leases are unnatural and will eventually fall because the natural dynamics of competition will prevail. It is to be hoped that the government addresses the issue sooner rather than later – procrastination helps no-one.

UPDATE: 5th April, 2011. On the RTE Frontline programme last night the new Minister for Justice Equality and Defence Alan Shatter appeared on a panel to discuss this subject. The upshot is that legislation to allow downward reviews in Upward Only Rent Reviews (UORRs) will be presented to the Dail before the summer recess, or shortly afterwards and will be enacted “before the end of this year”. It is unclear if the legislation will be backdated, that is there may be a refund due to the tenant for historical rents and it is also unclear how market rents will be determined – the eligibility for using the new legislation and the arbitration process for examples – but it seemed clear from last night’s programme that tenants felt the present arbitration process was biased towards landlords.

UPDATE: 6th April, 2011. If a reminder was needed, today in the Irish Times the negative impact of the proposed legislative changes is detailed with respect to the pensions industry where the Irish Property Unit Trust (IPUT) describes the effect of the proposed change on its prospects. IPUT is the largest property unit trust in Ireland, founded in 1967 and having some €427m in assets under management. It is reportedly the second largest property fund in Ireland after Irish Life. It acts on behalf of investors, pensioners, charities. It repeats the credible claim that property values will drop by some 20% on average (that’s for an average basket of UORR and non-UORR properties, apparently and based on research undertaken by IPD on behalf of the SCS). IPUT says that it may challenge the constitutionality of any legislation in the Supreme Court. IPUT also claim that a large proportion of retail tenants that have sought relief from UORRs has been accommodated by landlords. On a separate matter, IPUT’s outlook for rents is not so good with a prediction that it will be 2012 before there is any upturn and then possibly only in Dublin 2.

UPDATE: 7th April, 2011. And on the other hand …. Retail Excellence Ireland is certainly ramping up its campaign to have legislative changes made to UORRs enacted, with claims that employment will be protected and expanded if the expected changes are implemented, though there seems to be an additional hook that reductions in business rates might also be needed.  There’s a press release here and re-publication of a letter to the Irish Times here.

UPDATE: 8th August, 2011. The Sunday Business Post reports on a meeting between justice minister Alan Shatter and commercial tenants from Grafton Street in Dublin. The report suggests that the legislation will be introduced in the autumn but that there are difficult Constitution-related obstacles to be overcome.  Again the term “exceptional circumstances” has cropped up in the context of tenants seeking rent reductions, suggesting that tenants will face obstacles in seeking reductions.

UPDATE: 5th September, 2011.  I am beginning to see why Brendan Burgess has banned discussion of house prices on the askaboutmoney.com website, after a discussion attracted 8,000 posts which were said to have generated more “heat than light”. The UORR debate is in danger of going the same way on here, though thankfully it looks as if there will at least be some clarity on the contents of the new bill in the next couple of weeks. This text is being shown as an update to deliberately avoid an avalanche of mostly perseverated comments, though there will be a full entry once the heads of the new bill are published. Today the Irish Times carries an editorial-type 1,500-word article by its economics correspondent, Pat McArdle which must be one of the most shameful contributions ever to Ireland’s “paper of record”. Far from an independent review of the issues, it contains error and bias on a scale which you might expect to see from a representative of one of the vested interest groups whose interests will be affected by the imminent changes. Even the title of the piece “Changing rent reviews will have serious consequences” heralds bias – “serious consequences” could theoretically be positive or negative but you rarely hear that winning the lottery would carry “serious consequences”. The article opens with a call for a debate on the subject. What does Pat think has been taking place for the past couple of years? Is he not familiar with our legislative process whereby a bill is presented to the Oireachtas and debated in both chambers and at committee? And no doubt the contents of the bill will be thoroughly aired in our media. No, what Pat seemingly wants is for the legislative process to stop proceeding along its assumed path and scale down the changes. Pat claims that there would be “a further 20 per cent decline in prospect if UORRs are banned.” We have heard this 20% from different sources, most notably IPD and I think IPD’s projections are respected but IPD made its projections before the start of 2011 and already this year commercial property prices have dropped by 7% and industry sources confirm that some element of the drop is attributable to imminent changes in legislation on UORRs. So if IPD were asked to re-calculate their estimates today, it is likely they would be estimating 10-20%. Now 10% is still a major decline but let’s keep in mind the decline will be less than 20%. Pat claims “the stress tests have allowed for extra falls in commercial property prices, any generalised scheme could quickly erode existing capital buffers in the banks to the ultimate detriment of taxpayers” – indeed the banks have been stress tested for the abolition of UORRs and that is why the adverse case decline in 2011 was 22.5% whereas the baseline was a 2.5% decline. Of course any loss to state-owned banks is to be regretted but the banks have been capitalized with the abolition of UORRs in mind. Pat cites a study in Wicklow town carried out by CBRE and funded by property companies in which it was found that very few retail tenants had sought rent reviews and been turned down; Pat claims that only 2% of the total units were refused yet this claim is at odds with Pat’s position on serious consequences of the imminent changes – after all, if only 2% of units will be affected then will the consequences really be that serious? Pat throws up a few graphs but puzzlingly he shows a graph of transactions rather than values and concludes on the basis of transactions that UORRs have blighted the market. If he were to examine prices he would see the market in 2011 is pretty flat with 2010, no change one way or the other. There are several references in the article to the Colm McCarthy report which Retail Excellence Ireland (mostly represents retail tenants) commissioned. REI has declined to formally provide me with a copy though I have read the report. Colm tends to be respected by most sides of most debates and when he suggests rents account for around 15% of a retailers turnover that claim generally commands respect though Pat in this article says that “industry sources put it at 3 to 7 per cent”

UPDATE: 6th September, 2011. The Irish Independent today carries an article by Roisin Burke, a journalist at the Sunday Independent Business Desk which cites sources and insiders. Notwithstanding the credibility of said sources, the article does carry detailed claims, that the bill will be introduced in “October/late November” and whilst in line with Aine Coffey’s article in the Sunday Times in July 2011 there is an important new claim – “A lease would be judged on a standalone basis. “For example, if you have 12 shops across Ireland and 10 of them are doing quite well, but say two of them are crucifying you because of off-the-wall rent, you should be able to get a review on the basis of those two individual stores and not on the basis of your overall balance sheet,” the insider said.”. If true, conceivably this could mean a retailer with vast disposable means might be able to secure a revision to his lease, as long as the enterprise subject to the lease was confronting with at present unquantified financial distress.

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