We came through fairly unscathed — let’s hope this the end of it all

THE first real signs that the Irish banking system was in deep trouble appeared on March 17, 2008.

In what became known as the ‘St Patrick’s Day Massacre’, the share prices of Irish banks went into freefall following the collapse of the US investment banks Bear Stearns. The global financial edifice was about to crumble as the true extent of the US subprime crisis became evident.

The banking ‘house of cards’ eventually cost the Irish taxpayers roughly €64bn.

The Government will certainly be hoping that October 26, 2014 will book-end the worst financial crisis in the history of the State. The results of the ECB’s Comprehensive Assessment of the banking system shows that the Irish banks came through this intrusive probe relatively unscathed.

To put it in context, there were 25 banks across the eurozone that failed the stress tests, which showed up a total capital shortfall of €25bn. That is less than it cost the Irish taxpayer to bail out Anglo Irish Bank.

As had been well flagged, Permanent TSB was the only one of the five Irish banks to fail one of the stress tests. The shortfall is just under €855m. It is important to emphasise that PTSB is not in any danger of closing on the back of these tests.

Moreover, it is highly unlikely that the 99.2% State-owned bank will have to go back to the taxpayer to plug the capital shortfall. Even though the results of the ECB’s comprehensive assessment showed up a capital shortfall of €854.8m, that was calculated using the bank’s balance sheet as of December 31 2013. Since then, PTSB has returned to profitability; it has sold a number of loanbooks and it has €400m in contingent convertible (CoCo) liability notes, which means the shortfall is roughly €125m.

The Government put €4bn into PTSB. It has got €1.3bn back through the sale of Irish Life. But to attract outside investment into PTSB, the Government’s stake is likely to be heavily diluted. Consequently, it is unlikely that the Government will recoup its original investment in PTSB.

The quid pro quo is that there will be a fully functioning bank in the market which is crucial for the wider economy.

PTSB’s main weakness is the high number of tracker mortgages on its balance sheet. Roughly 60% of its mortgage book is made up of loss-making trackers because the cost of funding on these products is greater than the return, which is pegged to the main ECB rate. The Department of Finance had been looking at ways of shifting these mortgages off balance sheet into an EU-funded vehicle, but all attempts have so far failed.

AIB is the other State-owned bank. The fact that is has come through these stress tests is good news for the Government and its electoral strategy.

The taxpayer has pumped a total of €21bn in the 99.8% state-owned lender. The bank’s chairman, David Hodgkinson, has said that over time, the Government will be able to recoup its full investment in the bank.

Ireland is one of the fastest-growing economies in the EU. It has gone from been massively overbanked during the boom years to a current situation of being underbanked. AIB was formerly the biggest bank in the country. It has the infrastructure to take advantage of a recovering economy. It should be an attractive play for investors looking to Ireland. The fact that it has come through the stress tests will greatly strengthen its appeal as the Government looks to cash in over the near term. It is now highly likely that it will be partially offloaded as early in 2015 as possible.

The valuation of the Government’s 14% stake in Bank of Ireland will also be enhanced following the release of these results.

It is by far the healthiest of the domestic banks and returned to profitability earlier this year. Bank of Ireland was kept out of majority State-ownership by a consortium headed by the US investor Wilbur Ross.

Mr Ross exited Bank of Ireland in June, having made a substantial profit on his original investment. Some market observers had concerns that the performance of Bank of Ireland was made to look better than the underlying reality in order to facilitate a profitable exit for Mr Ross. In other words, the bank had not been recognising, in full, potential losses sitting on its balance sheet.

The results of the Asset Quality Review would suggest that this is not the case, as a sizeable chunk of the loanbook was closely examined for the collateral held against loans and the level of bad debt provisioning.

The results of the ECB’s tests is aimed at restoring confidence in the region’s financial system. Ultimately, that hinges on the credibility of the stress tests. So far the reaction from the market appears to be broadly positive.

In the run-up to the stress tests, the obvious concern for each bank was whether it held enough capital.

Responsibility for supervision of the Irish banks passes to the ECB next month. Far-reaching reforms introduced in the past few years should mean that the Irish taxpayer is never burdened with bailing out the banking system again.


Bank fails component of ECB stress tests

by John Walsh Business Editor

Permanent TSB failed one of the adverse scenario components of the ECB stress tests, which exposed a capital shortfall of €854.8m.

There were two parts to the ECB’s comprehensive assessment of the banking system. The Asset Quality Review looked at each bank’s loanbook and the quality of collateral held against these loans, as well as the level of bad debt provisions. PTSB passed the AQR.

The stress tests look at a bank’s capital levels and determine whether it is holding enough capital to withstand future shocks to the economy. PTSB passed the baseline stress tests, which look at the economy trading under normal conditions.

The adverse scenario looks at how the bank would cope if economic conditions deteriorated. This includes a drop in property prices, a rise in unemploymentm and GDP growth coming to a shuddering halt. PTSB passed the adverse scenarios for 2014 and 2015 but was deemed to have insufficient core tier one capital to make it through 2016.

The bank’s chief executive, Jeremy Masding, said it was 80% towards plugging the €854.8m shortfall. It has two weeks to submit a full capital raising plan to the ECB and a further nine months to raise the capital.

It has €400m of contingent convertible (CoCo) liability notes that it can use to cover some of the shortfall. Whether these CoCos are converted into equity, and at what valuation, will be agreed in discussions with the Irish Central Bank over the next two weeks. The criteria for PTSB’s stress tests was done according to a ‘static balance sheet’ methodology fixed at December 31, 2013. Since then, it has sold a number of loan books and returned to profitability, which means that the shortfall is roughly €125m.


Passing assessment a ‘validation of recovery’

by John Walsh Business Editor

AIB comfortably passed the ECB’s Comprehensive Assessment, which is good news for the Government and the Irish taxpayer, which has a 99.8% interest in the bank.

AIB’s balance sheet was stress tested under two scenarios: Static and dynamic. This was because the bank’s restructuring plan was accepted by the European Commission after December 31, 2013. Under the dynamic balance sheet scenario all measures taken to improve its capital position over the past year were included in the comprehensive assessment.

The minimum core tier one equity requirement for the banks under the AQR was 8%. AIB had a ratio of 14.6% under both the static and dynamic balance sheet scenarios.

Under the baseline stress tests, which looks at the economy under normal trading conditions, AIB had a core tier one capital ratio of 12.43% under the static balance sheet scenario and 14.29% under the dynamic scenario. The minimum capital requirement was 8%.

Under the adverse scenario, AIB had a core tier one ratio of 6.92% under the static balance sheet scenario and 10.26% under the dynamic balance sheet. The minimum requirement was 5.5%.

AIB chief executive David Duffy, said: “The results mean that AIB does not require any further capital from the State or from other sources.

“This is another important external validation of the bank’s ongoing recovery and the success of the strategy that we are implementing.

“Crucially, it also means that, as a bank, we can continue to focus on supporting our customers and economic recovery, while working towards returning capital to the Irish state over time.”


‘Substantial’ capital above requirements

by John Walsh Business Editor

Bank of Ireland has substantial capital buffers above what was required to pass the ECB’s comprehensive assessment of the banks.

The biggest and most profitable of the three domestic banks had a tier one core equity ratio of 12.43%, which was 4.43% above the 8% threshold. Under the adverse scenario, the bank had a core tier one ratio of 9.31%, which is 3.81% above the 5.5% threshold.

From the perspective of the asset quality review, Bank of Ireland was deemed to have €6.9bn of core equity tier one assets at December 31, 2013 and €55.3bn of risk- weighted assets at the same date. That meant a core equity tier one capital ratio of 12.4%.

There was a minor adjustment during the AQR which saw an increase in provisions of €300m. The post-AQR core equity tier one capital ratio is 11.8%.

Bank of Ireland was the first of the three domestic banks to return to profitability earlier this year.

The Government has so far made a €1.2bn profit on its original €4.8bn investment in Bank of Ireland.

The Government still has a 14% stake in the bank.

A department spokesman said that there has been no decision on when the Government’s interest in the bank will be off-loaded.

The group continues to expect to maintain a buffer over a Common Equity Tier 1 ratio of 10% on a Basel III transitional basis, it said in a statement. Bank of Ireland will issue its interim management statement on Friday, October 31.

Chief executive Richie Boucher returned to work last month following a leave of absence over the summer for a medical procedure.


Ulster Bank draws a line under losses

by John Walsh Business Editor

Ulster Bank passed both the Asset Quality Review and the stress tests, which draws a line under the heavily loss-making bank.

The subsidiary of Royal Bank of Scotland has needed a combined injection of nearly €16bn since 2009 to absorb massive property-related losses.

Ulster Bank’s core tier one capital under the ECB’s adverse scenario was 6.2%. This was 0.7% above the post-stress minimum ratio requirement of 5.5%. Under the baseline scenario, the bank had a 0.8% buffer above the 8% common equity tier one capital required.

Following the AQR, it was deemed to have a core tier one equity capital of 11.5%. Core tier one equity capital is the level of liquid assets a bank is holding that provides a cushion against future losses.

“The positive outcome of the comprehensive assessment demonstrates the progress we have made over the last number of years,” said Ulster Bank chief executive Jim Brown. “This progress has continued through 2014 with our return to profitability and an acceleration of our disposal of legacy assets resulting in an expected common equity tier one ratio of circa 17% at September 30, 2014.”

The capital position of Ulster Bank has strengthened considerably during 2014, reflecting actions taken to reduce legacy asset exposures coupled with a significant improvement in trading performance, the bank said in a statement.

There has been a considerable amount of speculation about the future of Ulster Bank and whether RBS will sell it to a private equity firms or retain it as part of the banking group. Market observers say the results of the stress tests will prompt a result sooner rather than later.

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