All eyes on Permanent TSB as bank stress test results loom

On August 19th, the Minister for Finance Michael Noonan issued a statement welcoming the improved half-year results published that day by Permanent TSB, the bank that is 99.2 per cent owned by the State.

“PTSB have demonstrated in their half-year results that the bank is continuing to improve and has made significant progress in delivering key elements of its restructuring plan,” he said. “It is likely to be an investable proposition well ahead of our original timetable given the significant improvements made by management and the continued improvement in the Irish economy.”

His remarks were largely unreported but, viewed at this remove, with the crucial pan-European bank stress tests results now just 10 days away, they seem more significant.

For a number of months now, the European Central Bank and the European Banking Authority have been engaged in a series of tests as part of a comprehensive assessment of the capital strength of 130 banks in the region.

There are two important elements of the comprehensive assessments – the asset quality review, a backward-looking exercise, and the forward-looking stress tests. The tests are point-in-time exercises using data from December 31st, 2013. As such, it won’t reflect the improved metrics for the Irish banks from the rebound in the economy. This was a point noted by former stockbroker Kevin McConnell at a session on the stress tests hosted recently by the Institute of Bankers.

McConnell said the Irish macro scenarios were “wholly outdated” and “implausible”. He added that the lost cashflow from non-performing loans under adverse case were “unsuitable and illogical” against a backdrop of a recovering economy.

McConnell said the methodology of the stress tests was “not suited to recognise any significant economic recovery”. He said the actual capital position of Irish banks would be “vastly superior” to the stress test output due to the “economic rebound, collateral pricing, [and] the drop out of extraordinary measures”.

Five banks in Ireland are part of this exercise – AIB, Bank of Ireland, Permanent TSB, Ulster Bank and Merrill Lynch International. Earlier this week ratings agency Fitch predicted that the majority of banks would pass the tests without naming the ones it believes might fail.

There will certainly be failures, with institutions in Austria, Germany and Italy thought to be in the firing line.

The process is shrouded in secrecy, which is not easy when so many of the banks are publicly listed companies with strict legal responsibilities to inform the markets of any material events. To get around this, bank executives have been required to sign a non-disclosure declaration.

Last week, the Irish banks were summoned to Frankfurt for separate three-hour briefings on certain findings from the asset quality reviews and stress tests. It is understood that none of them was given enough information to form a full picture of the results which will be published on October 26th but they would have left Germany with some sense of what’s coming down the track.

For Irish taxpayers, who have already provided a €64 billion bailout to the banks, the key question is whether AIB, Bank of Ireland or PTSB will be required to raise additional capital and if they will be tapped for this money.

The consensus is that AIB and Bank of Ireland, which both returned to the black earlier this year, will come through this exercise without the need to raise more capital.

Ciaran Callaghan, an analyst with Irish stockbroker Merrion Capital, carried out his own comprehensive assessment of the stress banks recently. He believes the Irish banks will all negotiate the asset quality review (AQR) exercise, which is similar in scope to the balance sheet assessments carried out by the Central Bank of Ireland last year as a condition of the State's exit from the EU-IMF financial assistance programme. Those assessments resulted in the banks taking extra provisions but none of them required additional capital.

The stress tests might be more problematic, particularly for PTSB, which has yet to record a profit and still awaits clearance from the European Commission for its restructuring plan.

According to Callaghan’s calculations, AIB has a €4 billion capital buffer while Bank of Ireland has leeway of €2 billion. He estimates that PTSB’s is €850 million. PTSB remains tightlipped about the stress tests but there appears to be an acceptance that the result could go either way. It depends on the sums applied by the ECB in the stress test scenarios.

If it fails the stress test element of the process, the bank will have two weeks to submit a proposal to the ECB for raising capital. It will then have nine months to raise the funds. The bank has already engaged Deutsche Bank to raise capital and it is understood the financier has already begun exploratory engagements with potential interested parties.

At a press briefing following the announcement of Budget 2015 this week, Noonan said PTSB was well placed to raise capital in the event that it fails the ECB test. “If they require extra capital, they’re strong enough to get the small amounts of capital they require in the markets, so we don’t see any risk to taxpayers,” he said.

According to a report by Bloomberg, Noonan said he had "a fair idea" of how the assessments were going and that the other two lenders, Bank of Ireland and AIB "are very secure in capital terms".

The Government could convert the Contingent Capital or CoCo notes its holds in PTSB into equity if the bank needs more capital. PTSB has €400 million worth of CoCos having also received a €2.7 billion cash bailout from the State.

It is not clear how much PTSB would be required to raise but one source suggested it would be a “digestible” sum.

And with the Irish economy having bounced back, and the likelihood of provision writebacks on problem loans in the years ahead, securing external investment doesn’t seem as far fetched as a year ago.

The results will be announced around lunchtime on October 26th.