Here is the text of an article I wrote in the aftermath of last week’s stress test announcements that was carried by Monday’s Evening Echo.
The much anticipated bank stress tests revealed that four of the six banks covered by the guarantee will require an additional €24 billion to cover the losses built up during the property boom. These banks (AIB, BOI, EBS and IL&P) have already received €11 billion in recapitalisation funds from the State.
The bulk of the money spent by the State in what is now ‘the costliest bank bailout in history’ went to Anglo Irish Bank and Irish Nationwide. These zombie institutions have already consumed €35 billion of State resources. None of this money will be returned.
As these banks are being wound down they were excluded in the current stress test process. The report gives the belief that no additional capital will be required by Anglo and INBS. It would be nice to think that this is true. The previous recapitalisation process for Anglo has made provision for an additional €5 billion of funds to be provided by the State. We will know more about these two banks when further details of their wind-down process are revealed in May.
Thus far, the State has poured €46 billion into our delinquent banking system. Of this, €35 billion has been with borrowed money with the remaining €11 billion coming from the destruction of the National Pension Reserve Fund – a €25 billion savings fund the state had built up during the good times.
There has been a lot of talk recently about debt sustainability and the inevitability of default. Things are not as bad as many would have us believe. The key to debt sustainability is the amount of debt accumulated and the interest cost of services that debt. So far the banking crisis has burdened us with €35 billion of debt.
It is likely that there will not be a significant increase in debt as a result of the stress test results. The banks need an additional €24 billion of capital but it is not necessary that this all come from the State.
For example, Irish Life and Permanent is actually two companies – the profitable pensions and insurance business, Irish Life and the loss-carrying banking business, Permanent TSB. As part of the process to recapitalise Permanent TSB, Irish Life will be sold and other resources of the company will be used. This will provide €2 billion of the €4 billion required by Permanent TSB.
The Minister for Finance has indicated that subordinated bondholders will continue to carry the cost of this disaster. So far, subordinated or junior bondholders have had losses of €10 billion applied to their investments. Nearly €7 billion of subordinated bonds remain in the four banks. The Minister for Finance has indicated that a ‘haircut’ of around 75% will be applied to these bonds. These bondholders are only going to get about €2 billion of their money back. The other €5 billion will not be paid back and this reduction in the banks’ liability will see their capital bases improve by that amount.
These two elements alone reduce the State’s contribution by €7 billion. There is still €17 billion to be found to prop up our ailing banks but it may be possible to do this without incurring any additional borrowings.
The Memorandum of Understanding agreed between Ireland and the EU/IMF as part of the rescue deal allowed for a “worse case” scenario of an additional €35 billion to be put into the banks. Of this money, €10 billion was to come from the remaining funds in the NPRF, €7.5 billion was to come from the remaining cash balances of the State with €17.5 billion borrowed from the EU/IMF as part of the €67.5 deal agreed. We no longer need all of this money.
The €10 billion contribution from the NPRF was already agreed and was actually postponed by the previous government in the run-up to the election. This money is waiting and will be used as part of this final-stage recapitalisation. That leaves €7 billion and we had already committed to providing about that amount from the €15 billion of cash balances the National Treasury Management Agency had built up in the early part of the crisis through bond issues.
It is very possible that the €24 billion could be found for the banks without any recourse to additional borrowings by the State. Of course, it appears that the State will still have to provide around €17 billion to this process and this is a huge waste of State resources. We could borrow the final €7 billion required as keeping a large cash buffer would be useful as the country tries to work its way out this economic crisis.
The final cost of this banking disaster could approach €120 billion. Shareholders in the banks have seen €60 billion of value eroded to close zero. Shareholders have been almost completely wiped out. Subordinated debt holders will have been forced to take losses of around €15 billion with 70% haircuts applied to their investments. We now know that the State is contributing about €63 billion to clean up this mess. The remainder of the cost will have come from the sale of assets and other sources within in the banks.
This €63 billion is a colossal waste of money for the State. However, because we came into the crisis with a €25 billion sovereign wealth fund and €15 billion of available cash balances we will not need to borrow all of it. Debt sustainability and the probability of default depends on the amount of debt accumulated. If a family buys a home, sustainability is determined by the repayments on the mortgage rather than the initial purchase price. If a large deposit had been used it reduces the size of the debt and makes sustainability more likely.
We have already borrowed €35 billion for the banks. The most that could be added to this as a result of the recent stress tests is around €7 billion. This gives a banking-related debt burden of €42 billion. The rest comes from the destruction of savings we had built up during the boom, but just like a household will not have to pay interest on the amount they paid in a deposit, the State will not have to pay interest on the full amount of the bank bailout.
A banking-related debt of €42 billion is sustainable and will not tip a country with a GDP of €154 billion into default. We can service the interest payments on this debt. The entire process is a huge waste of money but it will not ruin the country. Sustainability does not require that we pay off this money, but that we can meet the interest repayments. The €42 billion debt at an interest rate of 6% would require €2.5 billion of interest payments to be made each year.
It is also important to remember what we are getting for this money. The consultants who undertook the stress tests estimate that over the next three years the four banks that we now own will generate €4 billion of operating profit. There are huge losses on the banks’ balance sheets but they also generate substantial profits. Anybody who has a current account, chequing account, credit card or business account knows of the charges and interests that are levied by the banks.
These day-to-day charges have not gone away in the current crisis, but have been completely swamped by the huge losses built up as the traditional banks got dizzy chasing the shadows of Anglo Irish Bank around the Irish property market. In time, the banks’ balance sheets will be cleaned up and it is hoped that three viable business will emerge, the two “pillar” banks of AIB and Bank of Ireland and a smaller, leaner Permanent TSB.
With substantial annual profits these banks can be sold on. This money will not come anywhere near allowing the State to recoup all of the money this crisis has wasted, but when evaluating the long-term consequences the benefits as well as the costs must be considered. Many commentators have focussed almost exclusively on the costs of this crisis.
This process is an extraordinary waste of resources, but it is one that we can survive. It has seen the destruction of assets and savings built up over the last decade, and the imposition of a significant debt burden on the State. However, default is still an option rather than a necessity and we can work our way out of this crisis.