Shareholders and taxpayers alike will be anxiously scrutinising the fine print when Anglo Irish Bank issues its results for the full year to 30 September on Wednesday.
There has been a marked deterioration in forward-looking statements from its peers – AIB, Bank of Ireland and Irish Life & Permanent – since the government saved the whole sector from collapse by introducing the bank guarantee scheme two months ago. Now everyone will get a better idea of how Anglo was faring in the run-up to the rescue – and of what we can expect in the year to come.
Anglo is typically full of bravado. While others are in the frame for consolidation and recapitalisation, Anglo has been asserting its independence. Morgan Stanley has reportedly found five or six sources for a €1bn capital injection that will keep the bank off the government welfare rolls, according to one report.
AIB and Bank of Ireland have issued particularly bearish updates recently, with grim predictions for bad debts in their commercial property loan books. Anglo is the commercial property specialist in the market, so the omens are not good.
However, the bank has surprised before. This time last year, chief executive David Drumm delivered a sterling set of results when the market was expecting something a little more tarnished. In fact, Anglo shares rallied to record highs of €11.58, putting the bank at a market capitalisation of €8.8bn.
Obviously, a lot has changed since late 2007, when investors still thought they could blow the dying embers of a cooling market into another raging inferno of cheap credit and rising prices. Anglo shares are on the floor, having shed more than 90% of their value in just 12 months. This unprecedented collapse has left the price wheezing at €0.85.
The market is telling us something. It's not telling us what Anglo told us in a trading update in August: that earnings would be strong enough and impairments low enough to create significant organic capital generation. The assertion may have been accurate as far as the end of September, but the future of Irish banking is much more bleak than the recent past indicated.
So far, the other three listed banks have consistently underestimated just how steeply bad debts would rise. AIB and Bank of Ireland especially were forced to make embarrassing revisions of optimistic predictions made as recently as late July. Now, with impairments mounting, the need for fresh capital and/or consolidation has become urgent. Why should Anglo be immune to this?
Management has a few arguments. The key one, made in its August interim management statement, was that retained earnings would create organic capital growth such that the bank could achieve a core tier-one equity ratio of 7% by the middle of 2009. That hope was predicated on two things: high earnings growth (circa 15%) and low impairments (the bank was looking at a charge of just 0.18% for the year at the time).
The shocking weakness in the property markets will hit Anglo hard, as 80% of its loans are tied to property. Earnings will moderate as loan growth slows. While the bank will be adding fewer risk-weighted assets to its balance sheet, there will simply be less cash to retain.
But the real impact of the downturn will be felt in bad debts, as more of Anglo's business and developer borrowers go into administration or are forced to restructure their debt. As Anglo executives are fond of pointing out, falling property prices in themselves do not affect their loan book. However, when tenants begin to default on their leases, the cash flows on which Anglo depends will start to dry up as the developers can no longer finance the loans that built their office buildings and shopping centres.
This is why ratings agencies Moody's and Fitch issued negative outlook reports on Irish banks last week. Analysts singled out Anglo for special concern because of the specialised nature of its business – commercial property lending.
"The use of personal recourse and cross collateralisation to the borrowers' other assets provides support in addition to the property on which the loan is secured," said Moody's senior analyst Ross Abercromby. "However... the ability of the borrowers to make up any shortfall may have also declined as stock markets and property investments have slumped in 2008."
The slowdown is already causing dramatic increases in insolvencies, which will lead to commercial vacancies, which will lead to loan defaults among property investors and developers. It's simple: no lettings, no cash flow. Worse, repossessed properties in many cases would be worth less than loan value, as already prices have dropped at least 30% across the board.
Consequently, Moody's says Anglo will have higher provisioning needs going into 2009 as asset quality declines, eating into profits and capital. This isn't exactly surprising and is presumably what's behind the reported €1bn private placing.
Last year at this time, when the duration and depth of the credit crisis was still uncertain, Anglo executives talked about exploiting opportunities in the US as the investment banks faltered. That prediction was clearly fanciful. What's left of the banking sector appears to be heading back to traditional balance sheet lending in the domestic economy – the complete opposite of Anglo's boomtime business model.