When Minister for Finance Michael Noonan made the Big Bang announcement in the aftermath of the stress testing of Irish banks in March 2011, and outlined the strategy of supporting two pillar banks, there was criticism on here – after all, why do we need two pillar banks in relatively small economy, wouldn’t just one be sufficient alongside credit unions, post offices and foreign banks.
But the “two pillar” concept was embraced and since March 2011, we have seen the merger of EBS into AIB, and we have seen both AIB/EBS and Bank of Ireland recapitalised with our money. In many towns throughout the land, we still have an AIB and Bank of Ireland competing with each other. We own 99.8% of AIB. On paper we own just 15% of Bank of Ireland having flogged 35% to a bunch of five Yanks, but in actual fact our €1.5bn of preference shares in that bank practically give us the means to take majority control if we so wish. For all intents and purposes, we control both pillar banks.
But what wasn’t announced with any fanfare was the decision to support a third “pillar bank” in the guise of Permanent TSB, and somehow events have unfolded over the past 12 months so that we now own 99% of a third bank which competes with the other two pillars and indeed, is busying itself in strengthening the foundations of its own pillar. It was questionable whether or not we needed two pillar banks, supporting a third is an extravagance we can’t afford, and now is the time for robust intervention to put a stop to yet another money pit which is competing for resources and customers, which is not just duplicating but triplicating costs and which is stealing funding that would otherwise go to more deserving parts of our society and economy.
On Wednesday last, Permanent TSB published its report and accounts for the first half of 2012. It is striking how similar this bank is to Anglo in early 2010, when the incoming top team of Mike Aynsley and Alan Dukes were fighting tooth-and-nail to keep Anglo afloat as a going concern. Ultimately the European Commission decided that Anglo couldn’t be supported, and it may well be the case that the pending Commission decision on Permanent TSB – whose restructuring plan was delivered to the EC at the end of June 2012 – will receive a similar thumbs-down from the EC. But we should not be relying on the Commission to show us the right course of action, we should at this stage be capable of accepting the inevitable and dealing with PTSB ourselves.
Permanent TSB is a basket case
On Wednesday last, the state-owned PTSB announced that it had lost nearly €600m in the first six months of 2012, that’s nearly four times the 2012 household charge if there was 100% compliance and more than a year’s worth of cuts in the health service. We have become desensitised to these losses at the banks, convinced that they are inevitable to prop up the wider economy, but (a) they’re not inevitable and (b) at this stage in the crisis when we have dealt with AIB and Bank of Ireland, the fallout from closing PTSB would not capsize our economy. PTSB itself says it doesn’t expect a profit before 2015. This is what the overview of its lending looks like today.
This is its Republic of Ireland mortgage lending book
Most of PTSB’s lending is with so-called tracker products which means that PTSB charges a margin on the central bank’s main lending rate. In the case of both the UK and EuroZone, the main lending rate is 0.5% and 0.75% respectively which means PTSB is receiving very little on its loans, whilst at the same time, its cost of funding is 3-4%.
If PTSB’s tracker mortgage book with €23bn of loans, comprising two thirds of PTSB’s total loan book is doing so badly when the ECB main interest rate is 0.75% what will happen in a couple of years if the main rate has risen to 2-3% and Ireland still has an unemployment rate of 12%-plus? The outlook for Irish residential property is not good in the short term with a consensus of estimates from economists and commentators which gravitate around a 60% decline from peak, compared with a 50% decline today. Mortgage arrears continue to grow and 22% of Irish owner occupier mortgage accounts are either in arrears or have been restructured. The buy to let mortgage books are understood to be in a worst condition. Both are deteriorating.
Why we don’t need a third pillar bank.
Contained in a recent Central Bank of Ireland report was an analysis of competition in Ireland’s mortgage lending sector. The report’s authors produced so-called Herfindahl-Hirshman indices (HHI) which aim to measure competition in an industry – Wiki has a helpful entry on what the index measures, how it is calculated and what its results mean. The authors of the recent CBI report calculated that at present our banking sector has a HHI of 0.19 – the Americans consider a Herfindahl index between 0.15 and 0.25 to be moderately concentrated, and given the distress in the Irish economy, it doesn’t seem harmful to have a Herfindahl index in the mid-20s which is where it would likely be if PTSB shut up shop. In terms of competition, we have two pillar banks practically controlled by the Irish state, we have credit unions which offer savings and loans, we have post offices which provide savings. We have at least four large foreign banks with branches. We have two thirds of Irish households having access to broadband and by extension internet banking. We have a reasonable network of ATMs which would not be significantly diminished by PTSB’s exit.
The cost of maintaining PTSB as a third pillar bank
On Wednesday, the PTSB CEO Jeremy Masding claimed it would be 2014 or “the start of 2015” when PTSB returned to profitability. Given the uncertain nature of our economy, he might as well said “the start of 2020”. The immediate outlook for PTSB is a vista of impairments, losses and retrenchment. The cost of maintaining PTSB includes maintaining a branch network which triplicates the state-owned pillar banking offering, there is triplication of management, IT, finance and other functions which would benefit from economies of scale if PTSB’s operations were to be merged into another bank.
The benefit of shutting PTSB down and merging remnants into the other two pillar banks
Although, PTSB still has several billion of bonds to repay, the main ones are guaranteed by the Government, so shutting down PTSB will not avoid these payments, unless the Government wants to deeply upset the ECB and our creditors. The main benefit of closing down PTSB should be the removal of a triplication of costs, and dysfunctional competition for resources and customers. PTSB has run up operating costs of €136m for the first six months of 2012, almost the same as the €135m run up in the first half of 2011. We would expect annual operating costs at PTSB to be €250-300m. How much would be saved by merging branches with another bank like AIB or Bank of Ireland, transferring accounts and loans, and then eliminating large swathes of centralised operations? Difficult to say, but a figure north of €100m per annum would not be surprising.
Closing PTSB
PTSB has three main components (1) a UK buy to let mortgage operation called Capital Home Loans or “CHL” (2) an impaired Irish mortgage book and a colossal loss-making tracker mortgage portfolio and (3) some good loans and a branch network. The UK operation, CHL can be separated out from PTSB and sold at an opportune time, last year it came on the market but the offers were deemed too low, ultimately we don’t need a UK mortgage operation so it is just a matter of getting an acceptable price. The impaired Irish lending can be flogged off to IBRC or NAMA and the good business can be sold to the highest bidder.
Great piece, spot on analysis.
If they do get the green light to keep pouring money into dead banks, the least they could do to try and fix PTSB (and by extension BoI and AIB) is dump all the trackers that no longer meet their LTV and switch them to variable.
Trackers need to be dealt with anyway – but if the zombie that is PTSB staggers on, then they needs to be dealt with urgently.
“…is dump all the trackers that no longer meet their LTV and switch them to variable.”
How many of them would have the sort of LTV covenant that would allow the banks to do that? They can’t do it just because it suits them.
All of them will – it should be pro-forma.
When it comes to Irish banking, “should be” rarely equates to “is”. A shocking number of commercial loan agreements that I have encountered don’t have LTV covenants (different issues, mostly relating to interest-only periods, but the same underlying principle applies). As for resi./BTL letters of offer, I can say with certainty that at least certain institutions don’t have such LTV triggers. I’ve heard that a couple of lenders tried it with sample cases, and had their necks stood on pretty quickly by the Financial Ombudsman, but I’m subject to correction on that.
If that approach was doable, I expect it would have happened already. What it would achieve at this point, I’m not entirely sure; you’d be swapping loss-making loans that are largely being serviced for a whole lot of new non-performing ones. It strikes me as a frying-pan-to-fire scenario.
True!
As for the FO stepping in – I would imagine that’s more of a political decision than a financial one.
As for what it would achieve, as it stands taxpayers own the banks (more specifically their losses!) and thus loss-making loans being serviced are merely cosmetically/politically more acceptable than facing the true state of the loans.
Keeping the (guaranteed) loss-making trackers performing is an insane business plan!
No arguments on the insanity of it from me! But until the banks are prepared to give realistic write-downs to genuine “can’t pays”, or there is a sensible personal insolvency regime in place that hasn’t been designed to help the mongos in the banks to stop wetting the bed at night, there will be divil a’ bit of sanity to be found on the issue.
You’re right, it’s all about cosmetics. The general approach of the last 4 years has been to treat gangrene with applications of foundation and blusher.