The three domestic banks finished 2013 in a much healthier position compared with 12 months ago, although it is far too early to say the sector has returned to normality.
Bank of Ireland, AIB, and Permanent TSB were not required to raise new capital following balance sheet assessments completed by the Central Bank at the end of November. However, all three will have to increase their loan loss provisions.
Bank of Ireland had to increase such provisions by €1.3bn. The part-State-owned bank disputed the methodology used by the Central Bank to arrive at this figure. Unfortunately for the bank’s shareholders and potential investors, there is little clarity on this issue.
The Central Bank conducted the balance sheet assessments as part of EU-wide assessments of the banks ahead of the ECB taking over direct supervision of the sector at the start of 2015. The results of the assessment will feed into the asset quality review of the Irish banks. These, together with the results of the stress tests, will not be made public until the end of 2014.
This creates a huge deal of uncertainty for the banks. It wasn’t just the lack of clarity over the results of the balance sheet assessment that was a problem for Bank of Ireland, it was also the timing. Bank of Ireland was just about to go to the markets to tap investors for over €1.8bn in order to redeem the Government’s preference shares in the bank.
In the event, Bank of Ireland had no problems refinancing the preference shares. It raised €580m in equity through a share placing, while the remaining €1.3bn in preference shares were sold on to private investors.
The Government’s stake in Bank of Ireland has been reduced to 14% of its ordinary share capital, and the State is on course to make up to a €2bn profit on its initial €4.8bn rescue of the bank.
It is much less certain how much it will recoup from its roughly €25bn investment in AIB and Permanent TSB. Both are 99.8% state-owned.
Like Bank of Ireland, both banks will have to increase their loan loss provisions following the balance sheet assessment, although by how much will not be known until their end-of-year statements.
The EU-wide stress tests of the banks are obviously among the biggest challenges facing the sector. Another enormous challenge is the level of mortgage and consumer loan losses in the system that still have to be worked through.
The introduction of the personal insolvency and bankruptcy regimes will hasten the recognition of losses sitting on their balance sheets. The good news is that house prices have stabilised and are starting to increase in some urban areas, particularly south Dublin. Moreover, the unemployment rate is dropping faster than expected.
Another problem for the banks is the €48bn of Irish tracker mortgages and a further £21bn of tracker mortgages held by their UK subsidiaries. These mortgages were wildly popular during the boom.
Given that the ECB has cut interest rates to an historically low 0.25% and is likely to keep them at a very low rate for the foreseeable future, tracker mortgages are set to remain a significant barrier to returning to profitability.
The problem is particularly acute for PTSB. It has €15bn of tracker mortgages on its books, but is awaiting approval from the European Commission for restructuring plans, which would see it split into three divisions: A good bank; an asset management unit that would wind down its loss-making assets; and a separate UK division.
Key to the plan is finding a funding model for its troubled assets, such as tracker mortgages. As revealed by the Irish Examiner at the time of the last troika review at the beginning of November, the Government had proposed a tracker mortgage solution that included an ESM guarantee. The banks would guarantee the first 10% of losses of their tracker mortgages, with the Government guaranteeing 90%. The Government guarantee would be underpinned by a guarantee from the ESM. The tracker mortgage books could then be used as collateral to set up funding from the ECB through its LTRO operations.
However, the ESM and ECB are said to be implacably opposed to the plan.
The outlook for Permanent TSB would appear bleak unless its restructuring plan is accepted by the commission. The Irish Examiner revealed in March that the Central Bank had been looking at different scenarios in the event an Irish bank fails the stress tests.
One of these included turning one of the three institutions into a winddown bank. Toxic assets from the other domestic banks could be transferred to this bank. It is believed the plan has found little support, particularly from the Department of Finance. However, if PTSB’s restructuring plan is rejected by the commission, could this be looked at again?
Over the first few months of this year, the Government will look to sell its €1bn of contingent convertible notes in AIB, while that bank will look to redeem the Government’s preference shares in it.
Over the medium term, the focus will be on the outcome of the comprehensive assessment of the banks. Over the longer term, the banks will have to raise their capital levels to meet new international rules known as Basel III.
In this environment, the flow of capital to the SME sector is likely to remain constrained. Calls are likely to grow for the creation of a state investment bank.
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