November 16, 2008
Every evening, there is a little ritual in our house. Our young children, having been settled by their mother, demand dad tells them a story ‘‘from your head’’ before bed. This lark involves all classes of adventures, heroes and implausible tales starring themselves as central characters.
There are usually myriad frequently unpleasant baddies who are vanquished by our brave and incorruptible champions.
This nightly Jackanory session ends with the younger child mumbling while fighting back the tiredness: ‘‘But that’s all not true in real life, is it dad?” The older one, just eight, interrupts: ‘‘Of course it’s not true, dad makes it all up.” Sadly, by next year, they’ll both be too old for these stories. Children grow up and they stop swallowing their dad’s made-up yarns. Someone should tell the Irish banks the same applies to the rest of us. There are only so many made-up yarns we can take.
This week, two of our main banks – Bank of Ireland (BoI) and Irish Life & Permanent (ILP) – tried to spin stories to the world, yarns a dad wouldn’t tell to a six-year-old.
Not surprisingly, as a direct result, their share prices fell again. Shares fell after the chief executives of both banks indulged in more financial Jackanory, telling us there was no real problem in their accounts and that a modest bit of provisioning would do the trick.
Investors have had enough of this nonsense. Last week, AIB was at it, now BoI and ILP are at the same game. Bad enough that these people presided over a 90 per cent fall in the share prices of their banks but, to add insult to monetary injury, they are behaving as if nothing systemic has occurred. Let’s cut through this and state one basic truth: without the government guarantee a number of our banks would be in serious trouble – and some would be insolvent.
Not only are our bankers in denial but, more worryingly, their statements give the impression they don’t know what they are doing.
Last week began with the new boss of Merrill Lynch stating that the environment was as bad as it was in the 1930s.
This was followed by news that British mortgage lending in October was at its weakest in 30y ears; sterling plummeted; in the US, General Motors, Chrysler and Ford went cap in hand to Washington pleading bankruptcy. Germany was formally declared to be in recession last Thursday. Meanwhile, Banco Santander – the bank which told investors two weeks ago it did not need capital – announced it would seek to raise â‚¬7 billion immediately. All the while, it is getting more and more expensive to raise money.
Goldman Sachs paid Warren Buffett 10 per cent for money five weeks ago. Barclays Capital paid Arab investors 14 per cent for money two weeks ago. What price now for the recapitalisation of Irish banks?
Yet, despite all this, our banks’ bosses are saying everything is fine and they don’t need any new money. At this point, let’s just look at the numbers again. Last week, this column focused on AIB; this week, we’ll shine a light on BoI and ILP. All the following details of their balance sheets are freely available.
Interestingly, although both banks are in trouble, they have very different problems. ILP faces a funding problem, whereas BoI’s issue is bad debt. ILP has a loan to deposit ratio of a staggering 245 per cent. This means that, for every â‚¬10depo sit it has, it loaned â‚¬24.50.But how, you might ask, did it fund this? Its funding structure reveals that 34 per cent was through deposits, 36 per cent was short-term debt, of which one-third (or 12 per cent of total financing) came from loans from the European Central Bank (ECB).This dependence on the ECB is astounding, as it accounted for only 1 per cent of total funding in 2006.
The rest of its funding (â‚¬6.9 billion) comes from longer-term loans which have to be refinanced at the end of 2010.
This type of funding structure is simply not sustainable when the wholesale markets are shut. As a business model, the ILP approach will never re-emerge as a way to finance banks.
Looking at these figures, you have to ask yourself how they got themselves into this situation in the first place. The answer is very simple: ILP lost the plot at the tail-end of the property boom. Instead of curtailing lending when house prices reached ludicrous levels the bank went mad, giving out 100 per cent mortgages in Ireland’s own version of the sub-prime crisis.
Its loan book expanded from â‚¬21 billion to â‚¬41 billion in the three years to 2008.These loans were given to the young, working, commuting families – the ‘Juggler generation’ – who are now suffering from negative equity. Their ability to pay back these mortgages will be severely affected by rising unemployment.
Yet the boss of ILP who, incidentally, was the boss of the bank – not the life assurance – part of the company during the madness of the past four years, believes that, of ILP’s loans, less than 1 per cent will be bad over the course of the recession.
This means 99 per cent of the Juggler generation will be able, or willing, to payback their huge mortgages. Not likely. While there is little doubt that many older mortgages on the ILP books are absolutely watertight, the risk of default on new mortgages – given out when it doubled its loan book at the top of the market – must be very high. However, the major problem for ILP is that its funding model is a shambles.
Over at BoI, the difficulties are directly related to construction – where it was late to the party and took huge bets on developers in an effort to catch up. On top of this, it has funding problems, too. Its loan-to-deposit ratio is 160 per cent. This is way out of whack with the European average.
However, what makes BoI particularly degenerate is that it also went mad at the end of the boom.
Its loan book rocketed from â‚¬80 billion at the start of 2005 to a whopping â‚¬145 billion by the middle of this year. An enormous 26 per cent of the total loan book (or â‚¬38 billion) has been lent to the property sector.
This is a huge black hole which is bound to yield crippling bad debts as the property market capitulates next year. None of the mollifying nonsense we are getting from our senior bankers is credible – and the markets are responding.
In fact, these types of trading statements are about as believable as a bedtime children’s story. The only problem is that, this time, the financial bogeyman is real.