This may be the straw that breaks Anglo’s straining camel

QUITE apart from the shock resignations of chairman Sean FitzPatrick and chief executive David Drumm, Anglo Irish Bank had been under severe pressure since the start of the year.

Since then, it has seen more than €10 billion wiped from the value of its shares, which were seven cents lower at 25c in Dublin by mid-afternoon yesterday, having earlier fallen as low as 19c.

Anglo’s share decline has been a major feature of the group since the start of the year, simply because fund managers believe its exposure to the property sector will see it face massive bad debts in the years ahead, calling into question the ability of the bank to survive as a separate entity.

When it reported its annual results three weeks ago, the markets reacted poorly to the figures.

Reassurances from the bank’s now former chief executive that the bank would make profits over the next two years despite a sharp rise in its bad debt exposure did not wash with the market and its shares subsequently fell to 50c, valuing the bank at less than €400m.

Today, the value is down to just over €200m.

Having provided for more than €700m for current and future bad debts in its end-of-year results, Drumm boldly declared on the day of its results that Anglo would make profits over the next two years, despite its total exposure to the crumbling property sector.

Anglo is unique as an Irish bank in that sense. Its lending is totally secured on property, a high percentage of which is now in severe difficulty. It has no loans to the domestic mortgage sector, which is a lot more secure than other parts of the market.

The bank’s problems are compounded by the fact that not only are property prices falling, but the market for commercial and residential property has dried up since the credit crisis began in August 2007, starving core Irish and British markets of cash.

Unfortunately for Anglo, it committed the grave error of staying too narrowly focused on commercial and residential property developers. Anglo should have seen what was coming down the track but did not.

And it now looks as if Anglo made the fatal mistake of cultivating its relationship with property developers during the boom period and are about to pay a heavy price for it.

Drumm, who succeeded Sean FitzPatrick as chief executive in January 2005, continued to lend into the boom. By March 2007, total bank lending had gone from €49bn to €67bn under Drumm’s regime, which was at a significantly faster pace than under his predecessor.

As a result, some speculate that the amount of bad debts facing the bank will require a level of funding that could be three or four times that required by Bank of Ireland or AIB.

But because the banks have been more than coy about how bad their exposure is, it is hard to tell what the recapitalisation requirement of the bank will ultimately be.

That, to an extent, depends on just how bad the recession in Ireland becomes and whether or not the US goes into a deflationary spiral over the next 12 months.

One of the most puzzling aspects of the bank’s lending policy over the past year is that in the six months to March 2008, the bank, as one analyst observed, went counter-intuitive and lent a massive €6.5bn to its property development customers in both the commercial and housing segments of the market, pushing lending to that sector to €17bn.

That fact has raised serious doubts about the bank’s future and serious questions over Drumm’s commercial judgment, as, despite the threat posed by the subprime crisis, he continued to increase lending to developers in the most exposed housing and commercial property sectors.

Of the €17bn lent to residential and commercial developments, about €6bn is on Irish residential development, where values have dropped by about 30% in the past 12 months.

Despite the fact that Anglo made reasonable profits of €784m in the year to last September, the emerging reality is that its love affair with property developers of various hues could mean the end of the road for the group.