It was once said that governments should operate as if working behind a pane of glass. Judging by its management of issues in the Irish banking system, the government here is operating behind heavily tinted widows with all the lights off inside.
While it has stress-tested the capital requirements of AIB and Bank of Ireland, the government has not published the results of the stress tests or even circulated the
criteria used to carry out the tests.
This is in stark contrast to the approach in the US, where the US Treasury is happy to release a document outlining the approach it takes to stress-testing its banks. It will also publish the results on 4 May and possibly hold a press conference to discuss the outcomes.
The act of publication and disclosure, while not popular with many, including the Financial Times, is an attempt to provide the market and the taxpayer with some sense of the future capital requirements facing the US financial system.
Here, shareholders, taxpayers and even debt investors have been told that Bank of Ireland and AIB need additional capital, but none of these parties has been told officially on what criteria this judgement is being made, apart from some vague mutterings about their capital ratios being depleted in the period ahead.
However, while transparency is not being embraced by policy makers here, the market is still getting a real sense from the few
fragments of information the banks and the government are choosing to disseminate – that, in terms of asset quality, AIB has a crippling problem which dwarfs even the challenges facing Bank of Ireland.
Two weeks ago, the government and AIB admitted the following: "Arising from... stress tests, the Minister for Finance and AIB have formed a view that to strengthen our capital position a total amount of €5bn new core tier 1 capital is appropriate.'' The bank added that disposals were the most obvious sources of capital, although M&T and its Polish subsidiary BZWBK were not mentioned by name.
Bank of Ireland passed the same type of stress tests back in March and €3.5bn was drawn down on 31 March. The obvious explanation for AIB's difficulty is passing the stress tests is its higher property-related exposures.
The figures there are stark. AIB's total Irish loan portfolio in 2008, under IFRS rules, was €92.6bn, with €33.2bn coming via construction and property, a percentage of 35.8%. The bank's chief executive Eugene Sheehy has talked about the bank's risk appetite being "too strong" over recent years and that is no understatement. Between 2005 and 2008, again under IFRS, the country's biggest bank grew construction and property lending by an extraordinary 124%.
Last year, the bank's lending to property developers and construction firms was 10 times the size of its advances to the manufacturing sector. Even more startling, last year loans to Irish property development companies and construction firms represented 25.2% of all loans, across its entire global operations. In contrast Irish services companies only managed to convince the bank's loan officers to extend them 4.1% of all their loans.
In terms of its exposures Bank of Ireland had gross Irish loans in fiscal 2008 of €78.1bn, with advances to construction and property companies totalling €20.3bn, a ratio of 26%, almost 10% less than AIB. This difference could prove crucial as property-related bad debts plough through the balance sheets of each bank.
The overall quantum of property loans only tells a partial story. The precise composition of the loan books are also crucial to the level of 'haircuts' which will be implemented by Nama. For example the more UK commercial property a bank has the smaller the haircut, the more Irish development land the bigger the haircut.
Accepting this basic framework, the lingering impression of AIB as the laggard comes through very forcefully. About 19% of AIB's construction and property loans are Irish land banks, whereas Bank of Ireland only has 8% of its loans falling into this dangerous category. Once again this is after accepting the basic figures showing AIB's has much larger property exposures to start out with.
Last week Davy Stockbrokers highlighted the toxicity of land bank assets, where AIB is the clear market leader. These assets could end up taking a 44% haircut, whereas UK commercial investments may end up taking just a 5% haircut.
Of course it's always worth remembering that the government here believes the loans will be transferred at "economic value", which is allowed under EU rules, whereas the banks would literally collapse if forced to mark the loans to market prices, which is what US accounting rules demand.
Davy expects AIB to be transferring about €30bn of loans to Nama, with Bank of Ireland shifting over €20bn of loans. The write-downs once again show the level of exposure at AIB is far worse. The write-downs for these loans is €6bn for AIB and €3bn for Bank of Ireland (or 20% and 15% respectively).
If these figures are true, and many analysts expect larger haircuts, AIB's equity – effectively the net worth of the bank – falls to a startling €1.7bn or a equity tier 1 of just 1.6%, a level regarded as catastrophic for any European bank. Bank of Ireland would be marginally better off with an equity of €3.3bn, and a core equity ratio of 3.6%.
Of course, AIB has assets to sell and can buy back its own debt, but even after doing this it still only has an equity ratio of 3.2%, to the slightly healthier ratio of Bank of Ireland of 4.5%.
The markets, Davy claimed last week, now demand that Irish banks produce a core equity ratio of 6%. To stretch to this level AIB will need to find €2.7bn from somewhere, most likely government, while Bank of Ireland is in a less tight corner, with a requirement for only €1.5bn.
The clear message in these figures is that government control of AIB is going to be much higher than Bank of Ireland, even when AIB unlocks the value from M&T and the Polish businesses. What is clear is that AIB and Bank of Ireland had risk appetites in recent years way out of line with underlying value of the assets they were accumulating. It was a spectacular own goal by both, but AIB managed to score into a much bigger net.