Banks crisis worsens, so don’t rely on them to get credit flowing again

THE Government has told us repeatedly over the past 18 months that a fully functioning banking system is essential to our economic wellbeing. This has been its justification for keeping what are in reality failed banks in existence.

The promise has been that once NAMA comes into being and the banks offload most their biggest loans to the property developers – by selling them to NAMA at a most generous and excessive price – the banks will become more active in providing fresh finance to customers, both personal and business. It is a nice theory but doubtful if it is going to work in practice – our crisis with the banks is still getting worse.

The sums involved at NAMA are going to be different to those first envisaged. The realisation has dawned on those working in NAMA, and more importantly at the Department of Finance, that it is implausible to say the €77 billion of loans being transferred off the books of the six main banks are worth €47bn: the valuation of the underlying assets, especially land on which no development has taken place, means they are worth far, far less.

This means the price to be paid for these loans – €54bn or the so-called “long-term economic value” – is even less justifiable than it was in the first place.

NAMA will pay far less. That may seem like good news for the state, but it is a mixed blessing. It means the existing remaining capital of the banks is going to be wiped out when they formally recognise the extent of the losses that will result from the transfer of the ownership of loans to NAMA.

The State, already facing a likely bill of €10bn or so for putting extra equity in AIB and Bank of Ireland, could be required to pay even more. That money will have to be borrowed, on top of the money the State is borrowing for day-to-day expenses.

Tánaiste Mary Coughlan may have told the Dáil this week that the banks hope to get the money from private sector sources, but that is most unlikely, especially when the likes of Standard & Poors (S&P), the rating agency, has downgraded Irish banks again, this time severely.

It now rates the Irish banking sector in the group four category, having been group one before this crisis, alongside countries like Greece, Slovokia, South Korea and the Czech Republic. S&P thinks the Irish banks – and the Irish economy – are in such bad shape they could lose a combined €50bn over the next two years.

These losses may become a self-fulfilling prophecy because the actions of the banks are making things worse in this economy. While banks have held off on action against many of the highly indebted big property and developer borrowers – because they want to offload their troubles to NAMA – they have been far more ruthless in dealing with profitable business customers, let alone ones who are struggling.

Companies that want to borrow to make investment are being offered far less than they need and owners are being forced to offer personal guarantees on their houses to get money – if they can get it.

Companies, big and small, are having problems getting sufficient overdraft facilities, essential to those who are waiting to be paid for goods and services.

The banks are not forwarding the cash because they are not convinced their customers will be paid and therefore can repay. But some of those who have to pay have not been able to get credit from their banks. It is a Catch-22.

Good customers who have never missed a payment on their loans – even in the property sector – are facing demands for cash either by way of lump sums or increased interest charges. Banks work on a “loan to value” basis for making bigger loans, insisting the borrower always invests say 30% of his own money into a deal.

The boss of one established property company – which has never missed a repayment – told me the collapse in property values means the debt to equity ratio at his business has increased from 40% to 80%. He is still comfortable making his existing repayments but as his loan covenants say his ratio cannot be more than 70% he has been asked to pay higher interest charges each month or stump up extra cash to bring his debt to equity ratio back below 70%.

So while the European Central Bank has kept headline interest rates low, some banks have been charging business customers much higher rates, in just the same way as they earn massive additional margins on credit card debts and other loans.

The banks have a funding problem as well as a capital one, although again this is self-inflicted. They are finding it much harder and more expensive to get money.

Unfortunately, and this is the nub of much of the crisis, the banks are massively over-borrowed and have to find new money to replace old money they must repay. NAMA is meant to provide the capacity to borrow new money from the European Central Bank, using the bonds the Government has provided in return for the transferred loans as collateral for the borrowing of fresh funds. But as former AIB chief executive Eugene Sheehy told an Oireachtas committee last November, the banks are going to leave these bonds sit on their balance sheets. The banks have been taking a slowly, slowly approach to personal debts for political reasons. They have been patient too in relation to property developer debt because they have been waiting for NAMA to take the problem off their hands. Recently the Irish Banking Federation issued details of a voluntary code of practice for dealing with domestic mortgage arrears to which 10 member institutions have subscribed.

IT urged people to admit potential repayment problems quickly and suggested loan restructuring – such as going interest only for a time before resuming principal repayments or extending the life of the mortgage to make monthly repayments lighter – would be offered. It promised at least a six-month window before any legal action was initiated that could result in repossession. Of equal interest to the wider economy is whether such an approach would be taken with businesses which, after all, are employers and essential to the income of people.

Good businesses are likely to have put the squeeze on them. The owners of indebted businesses who provided personal guarantees on their borrowings, putting their homes on the line on occasion because there was no other way to persuade banks to provide essential finance, are facing ruin.

The banks have the power effectively to force the receivership or closure of businesses to which they are not committed. The more you owe the more likely a bank will do a deal over partial repayment. Owe a relatively small amount and you may find you are pursued ruthlessly.

Quietly, settlements will be reached with some major borrowers, with part of the debts written off as unrecoverable, giving these entrepreneurs another chance to get back on the merry-go-round. This is what happened with Larry Goodman in the early 1990s, for example.

The only chance for many businesses is to have part of their loans written off, but will banks do so? Such examples may be few and far between, however. The behaviour of the banks this year is going to be one of the big stories in Irish life.

The Last Word with Matt Cooper is broadcast on 100-102 Today FM, Monday to Friday, 4.30pm to 7pm.