Ireland!

Ireland!
David R. Kotok
September 30, 2010
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“Out of Ireland this morning is the news that the Irish government has no choice but to come to the aid of Allied Irish Bank which has had enormous trouble raising the capital it needs to meet demands upon it for increased capital by the international banking authorities. The government in Ireland had previously taken a type of “preferred shares” in the bank, and now in light of the fact that the Bank cannot raise capital itself is forced to ask the government to convert those preferred shares into common shares. Somehow we cannot see this as supportive of the EUR, but then again we’ve known that this sort of thing was going to happen sooner or later and few seemed to care previously, taking the EUR higher nonetheless. Eventually, however, harsh realities have to have harsh effects… don’t they?”

Dennis Gartman, today, September 30, 2010.

Talk about timing. GIC launched a worldwide series on the post-crisis financial and economic conditions. We did this in the context of our ongoing central banking series. Many months ago, we scheduled the Governor of Ireland’s central bank to be the lunch speaker on October 12 in Philadelphia. The venue is the Federal Reserve Bank. For further information, you may call GIC at 215-898-9453 or visit GIC’s website, www.interdependence.org.

I regret I cannot be in two places at the same time and have to miss this important session. Such is the price one has to pay for holding a day job. Nevertheless, readers are encouraged to attend. As of now, there are still some spaces available.

In case you missed the ongoing news, below is the Barclays Capital summary of the latest news from Ireland. Barclays is a GIC sponsor as is Cumberland Advisors and other firms who seek to support a neutral convener of dialogue.

“The Central Bank (CB) of Ireland has released two important statements today related to additional recapitalisation requirements for the banking system: one for Anglo Irish Bank and a second on the recapitalisation requirements for the rest of the banking system (see details below). The total additional recapitalisation costs under a baseline scenario are about EUR10bn for the whole banking system (EUR15bn under the stress scenario), of which EUR4.3bn is earmarked for Anglo Irish Bank (EUR9.3bn under the stress scenario). Despite the sizeable additional capital requirements under both the baseline and stress scenarios, we see the announcements as positive as they provide clarity to the markets with a mapping from the scenarios for the path of real estate prices to the additional haircuts on the real estate portfolios and the corresponding recapitalisation costs.

Anglo Irish Bank

Under the new baseline estimates for Anglo Irish Bank, total recapitalisation needs stand at EUR29.3bn (up from EUR25.0bn in previous estimates, of which EUR22.9bn has already been injected by the government). EUR29.0bn is for the Asset Recovery Bank and c.EUR0.3bn for the Funding Bank.

Under an alternative stress scenario the additional capital requirements would be of EUR5.0bn. The additional losses are based on a hypothetical stress scenario of a fall in real estate prices of 65% from their peak values. So far there has been a 35% fall from peak values based on official statistics that do not rely on actual transactions information – it is deemed that prices have fallen by an average of 40-45%, based on evidence from actual transactions. As a result of the significant drop in house prices under this stress scenario, losses on the risky segments of the non-NAMA portfolio would range between 43% to 70%, which would require an additional capital injection of EUR5.0bn mentioned above (the post NAMA portfolio of about EUR37bn consists of mixed exposures to Ireland, the UK and the US). The estimates under these alternative scenarios are in line with our report dated 16 September entitled Ireland – the sovereign implications of the banking crisis.

With regard to the treatment of Anglo Irish Bank bondholders, the MoF in a separate note has clearly stated again that senior debt obligations rank equally with deposits under Irish law, and there are no plans to change this. However, the MoF agrees with the principle of burden sharing for subordinated debt holders (the same principle will also apply to the subordinated debt holders of INBS, the troubled building society).

According to the MoF, the additional capital will be provided by increasing the Promissory Note issued by the State and by appropriate burden-sharing exclusively by holders of Anglo subordinated debt instruments. Indeed, the MoF has stated that no additional borrowing arises this year as a result of the capital support to the banks. The promissory notes will be amortised over a 10 yr period.

The rest of the banking system

The CB also announced today that it has advised the Irish banks that participated in the Prudential Capital Assessment Review PCAR, conducted earlier this year, that the year-end deadline for meeting the PCAR standards (8% core tier 1 and 7% equity by end of 2010) remain in place. The recapitalisation requirements were conducted taking into account both NAMA losses and projected expected losses on non-NAMA portfolios through 2012.

Based on the haircuts on NAMA transfers and on the expected haircuts on the remaining loans to be transferred to NAMA, the CB has requested new capital injections for the banks, most notably, an additional EUR3bn for Allied Irish Bank by December 2010 (after taking account of disposals of AIB’s Polish and US assets). Bank of Ireland (the largest bank) is deemed to have already sufficient capital to meet the PCAR standard.

With regard to Irish National Building Society (with the highest recorded haircuts on the loans transferred to NAMA), the MoF indicates that it will need an additional injection of EUR2.7bn to cover expected losses in the residual loan book and bringing the total capital support to EUR5.4bn. The MoF plans to inject this extra capital via promissory notes as well. There seems to be ongoing discussion on its restructuring plan (in our view, this could include merger and/or acquisition by another institution).

The Central Bank will conduct its next PCAR exercise in 2011.”

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David R. Kotok, Chairman and Chief Investment Officer