Questions raised over AIB €1.1bn problem loans sale to Cerberus

The sale by Allied Irish Banks of € 1.1 billion of problem loans to a consortium led by Cerberus Capital has raised questions over whether the bank took advantage of a transitional accounting arrangement to artificially boost profits.

At the state-controlled bank's results in July , its then chief executive Bernard Byrne revealed that AIB had made a gain of € 140 million — equivalent to nearly 20 per cent of its half-year pre-tax profits — when it sold the loans to a consortium led by the distressed debt fund.

The gain came after Ireland’s largest lender used transitional arrangements designed to help banks shift to a new international accounting standard, IFRS 9.

These allow banks to write down problem loans without hurting their reported profits in the year of the changeover, merely taking the impairment straight to balance sheet reserves. The hit to regulatory capital is also deferred, with any shortfall from the impairment being phased in over the following five years.

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In AIB’s case, the bank booked the profit on the sale of part of its loan portfolio, but in the small print revealed that it took advantage of the IFRS 9 concession to exclude losses of €271 million from the income statement, raising concerns that the loan sale to Cerberus might have in fact been a loss that was then portrayed as a profit.

In a statement to the Financial Times, the bank said it breaks down its loans into different buckets known as stages 1, 2 and 3, depending on how risky they are. AIB claimed the € 271 million loss allowance was applied to stage-2 loans whereas the loans sold to Cerberus were from the riskiest stage-3 bucket.

However, analysis of the bank’s figures shows that after the transitional adjustments, the provisions against stage-2 loans actually fell by € 591 million as a result of the switchover, as opposed to rising by € 271 million.

"What appears to have happened is that AIB allocated the €271m to stage 2, but then shunted a whole load of loans and provisions to stage 3. Through this it constructed the opportunity to create artificial profits," said Cormac Butler, a financial consultant who has testified before both the Irish and British parliaments on international accounting standards.

AIB refused to confirm or deny that any of the loans sold had benefited from the additional loss allowance, saying that it would be wrong to provide any additional financial information to that it had already disclosed.

Mr Butler, a longstanding critic of European banks’ accounting practices, claims AIB’s ability to extract profits from the sale of problem loans appears to be an abuse of transitional arrangements.

“Using transitional arrangements to create profits would be an outrageous fiddle,” he said.

Mr Butler said it stretched credibility to believe the Irish bank could have made such profits on selling loans to value-conscious investors such as Cerberus.

“The bank disclosed that these loans had been heavily underwater for some time, with nearly three-quarters five years in arrears,” he said. “It is hard to see how these could have appreciated in value by nearly 25 per cent between December 31st last year, and May 17th when the portfolio was sold.”

Sue Lloyd, vice-chair of the International Accounting Standards Board, said the arrangements were intended solely to help banks adjust to the new reserving standards imposed by IFRS 9 without "artificially distorting a company's profit in the period of the change".

IFRS 9 requires banks to make provisions on their balance sheets for expected losses in the future, rather than losses they have already had. The old standard, IAS 39, required them only to recognise losses when loans actually turned bad.

However, there are worries that some banks may have “front-loaded” expected losses to take advantage of the favourable optics of the scheme and the generous regulatory capital treatment.

The rules mean banks only deduct 15 per cent of the impairment from their “core equity tier one” capital in the year of transition. In AIB’s case, that would mean the bank taking off only € 14 million of the € 271 million provision, while still getting to record the full benefit of the € 140 million “gain”, thus producing a temporary strengthening to regulatory capital of € 126 million. The full impairment is then unwound over the following five years.

“In theory, any artificial gains could be used to support bonuses for managers and even additional dividends,” said an accounting expert who did not wish to be named. “These are emphatically not why the transitional arrangements were invented.”

AIB, which is 71 per cent owned by the Irish government, has been lobbying hard for an end to curbs on pay and bonuses. Chairman Richard Pym warned last month that these restrictions were turning the group into a "training ground" for bankers, who then went on to work for higher paying, often foreign firms.

Mr Byrne recently announced his resignation as chief executive to join Dublin stockbrokers Davy as deputy chief executive. In September, finance director, Mark Bourke, said he would stand down "early next year" to join Novo Banco, a Portuguese bank.

Loan sales to hedge funds are a particularly sensitive political issue in Ireland. The country has about 100,000 mortgages in long-term arrears, a legacy of the financial crisis. A number of US funds, including Cerberus and Lone Star, have bought up portfolios of mortgages, where they are seen as far more likely to evict householders than conventional lenders. – Copyright The Financial Times Limited 2018.