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“Stark Reality” of Bank Losses

September 12, 2010 1 comment

“Stark Reality” of Bank Losses

Madam,

I refer to Dan Loughrey’s, Head of Group Communications, Bank of Ireland (BoI), letter published 10th Sept 2010 Irish Times.

On 16th September 2009, Minister for Finance, Brian Lenihan, advised by PricewaterhouseCoopers, reporting consultants to NTMA and the Department of Finance(PWC are also auditors to BoI – potential conflict of interest?), presented to Dail Eireann the summary details of the Loans Listings from 5 Irish owned banks which would be participating in the NAMA Project.

The facts were as follows:- The Minister told the Dail that NAMA would purchase loans totalling €77bn from the Banks for €54bn.  Included in the €77bn were €16bn loans to be purchased from BoI.

Mr Lenihan stated that the loan write-downs applicable to the €77bn would total €23bn, representing an average write-down of just under 30%.  We were told that BoI had the least “bad” loans and therefore its loan write-downs would be below the average of 30%.  A 30% write-down on €16bn indicated that write-downs on BoI’s €16bn NAMA destined loans would amount to €4.8bn.  This level of write-down would put pressure on BoI to re-capitalise in order to be able to buffer further losses on its Mortgage loan book, its corporate loans, its personal lending book etc.  Re-capitalisation at a €4.8bn level would result in severe dilution to the existing Shareholders.

Dan Loughrey states that BoI’s NAMA listed loans at audited (by PWC) Balance Sheet date 31st December 2009, only 3 months after 16th September 2008, amounted to €12bn.  Curiously, a large €4bn amount of re-classification of NAMA “eligible” loans had materialised in the 3 months since September.  No plausable, transparent explanation has been offered.  The effects of that re-classification were as follows:- At a 30% write-down level, reducing the NAMA destined loans from €16bn to €12bn, achieves a smaller total write-down of €3.6bn instead of €4.8bn and, correspondingly, a reduction in losses of €1.2bn.  In turn, this reduces by €1.2bn the pressure on the Bank to re-capitalise thereby reducing / avoiding existing shareholder dilution.  This type of “massage” accounting actually undermines  proper measurement and true assessment of the capital requirements of the bank, and, arguably, undermines the safety of customer deposits.

As Christmas 2009 approached, all emerging evidence across the banks and markets indicated that the scale of the asset bubble and bust was far greater than the Government and the banks and their beholden professional advsers had feared. Unfortunately, from the very outset of the NAMA Proposal in April 2009, despite the warnings of a substantial body of independent analysts, the Government and its cheerleader advisers had insisted that their approach was unassailably correct. However, shortly after Christmas it had become obvious that far higher levels of loan write-downs were required.  Levels of at least 40% were clearly indicated even on the relatively better and less impaired well documented loan cases.

40% write-down on BoI’s €16bn loans amounts to €6.4bn. This should be rounded to €6.5bn as a minimum capital replacement requirement to adequately address the non-recoverable element in its original NAMA listed loans all of which still have to be managed and worked out irrespective of any and all re-classification carried out prior to 31st Dec 2009.

In relation to reviews and re-classifications on the original NAMA loans lists since September 2009: not surprisingly Anglo’s NAMA listed loans rose from €28bn to €36bn; AIB’s NAMA loans essentially remained at €24bn; Nationwide’s (INBS) rose from €8bn to €9bn; EBS remained at €1bn; Lastly and completely “against the tide”, and surprisingly, BoI’s fell from €16bn to €12bn!  There’s no apparent objective logic for such a major reduction re-classification by BoI.

Some observations are relevant.  A re-classification by BoI would have been helpful to any share placing or rights issue under contemplation for early 2010.  Lower loans listed for NAMA in the audited 31st December 2009 accounts would present a stronger capital position to would-be investors.  To use Dan Loughrey’s term, a stronger audited Balance Sheet at Dec 2009 would become a “major plank” for such would-be investors.  And as pointed out above, even a €1.2bn improvement in the capital position, as a result of €4bn lower NAMA loans at a 30% write-down level, is quite significant.

More recently, the bank’s half year results to 30th June 2010 revealed evidence of some further “massage” accounting.  In this instance NAMA listed loans on the audited balance sheet were transferred to NAMA shortly after 30th June, crystallizing losses of €300m after 30th June that had not been provided for at 30thJune.  This meant that losses for the 6 months to 30th June 2010 were understated by €300m.

In relation to PCAR capital ratios, there’s an inbuilt assumption that the assets and liabilities of the institution will realise their stated amounts.  That’s where the problem is for Irish institutions.  The recoverability of the loan assets of the Irish Banks is still only in course of truthful measurement.  To date loan losses have been hopelessly undermeasured.

Two years have passed since the Blanket Guarantee date 30th September 2008. Discovery of the true extent of appalling lending by the banks and the frightening scale of loan losses have terrified the government, the institutions, the banks and their professional advisers into drawn out denial.  This has been unhelpful and the real economy has been hurting badly for 2 years.  Businesses are bankrupt, hundreds of thousands of jobs have been lost, unemployment stands at 14%, intelligent educated young people emigrate etc.  People are depressed from lack of truth and honesty amongst our politicians and professionals.  These are the real stress tests that the people of Ireland have experienced.

In regard to Moody’s upgrade, I invite BoI to furnish Moody’s with a copy of my article in the Irish Times, together with a copy of Dan Loughrey’s letter on behalf of BoI and also this reply.  I should be delighted to take any questions from Moody’s

I would remind Dan Loughrey and the Board and Management of BoI that all the citizens of this State, jointly and severally, guarantee all the liabilities of BoI and all the other Irish owned banks. That’s why we should have a say in what levels of capital each and every bank should maintain. The regulators are merely our assistants.  We shouldn’t be in awe of our public servant assistants.

Finally, I should be pleased to cordially invite the Board and Management of BoI or any of their representatives to a public debate on radio or on TV on the issues discussed in my article, in BoI’s letter to the Irish Times and in my reply.

Yours truly

Peter Mathews

B.Comm, MBA, AITI, FCA.