Bank shares have fallen further just as plans for a €7bn recapitalisation are shaping up, ARTHUR BEESLEY.

A DELUGE of bad loan provisions throughout the bank sector underscores the vulnerability of Irish lenders to acute pressure on the wider economy. In advance of the €7 billion Government recapitalisation of Allied Irish Banks (AIB) and Bank of Ireland, the outlook is worsening appreciably.

With a draconian mini-budget on the way as Taoiseach Brian Cowen warns that unemployment could yet climb to 450,000 from around 350,000, preparations for the recapitalisation of the big two banks take place against the backdrop of further sharp falls in their stock prices.

Amid considerable international volatility, shares in AIB and Bank of Ireland fell to new lows again yesterday.

Renewed market scepticism about the big two comes in spite of clear indications from Minister for Finance Brian Lenihan that the Government may set up an bespoke asset management company to take the most toxic assets in the banking system off the balance sheets of the financial institutions.

This would be an important second pillar of the recapitalisation scheme, which also involves some form of an extension to the State guarantee on bank liabilities. In the absence of firm data about the scope of the toxic asset plan, bank shares continue to slide.

Meanwhile, the newsflow from the sector is resolutely negative.

If rampant fear of a dangerous spike in bad loans fuelled the collapse in Irish banking shares, losses anticipated by the market long ago are now beginning to materialise with a vengeance.

That these losses are sharply at odds with relatively positive projections from the banks only recently raises questions about the quality of their internal forecasting and their willingness to confront in public the escalation in their difficulties.

Although not all financial institutions have delivered figures for their performance in 2008, the totality of bad debt already reported by AIB, Permanent TSB, Ulster Bank, National Irish Bank, Bank of Scotland (Ireland) and ACC Bank is not far off €3.5 billion.

This picture reflects worsening economic conditions last year – but before the onset of an ongoing spate of significant job losses since the start of January. It says nothing of loan losses at Bank of Ireland, Irish Nationwide Building Society and the Educational Building Society, which seem certain to add to the burden when these institutions report.

Two days ago, Permanent TSB’s parent Irish Life Permanent took a €139 million impairment provision on its €39.81 billion loan book. Looking ahead, it said bad debts will reach at least €480 million in the next three years, but may rise to €650 million in a “stress” case. Given worsening unemployment, this “stress” scenario already looks somewhat optimistic.

At the start of the week, AIB revealed that its loan losses climbed in 2008 to €1.8 billion from €106 million a year earlier. The bank has said it may have to write off up to €4 billion this year and €2.6 billion in 2010, but it believes the “charge-offs” are more likely to come in around €2.9 billion this year and €1.6 billion next year.

Although such projections indicate that the banks are facing up to the difficulties in the books, their outlook still remains more favourable than market analysts.

“The stress scenarios that all three banks are guiding towards are getting closer to market estimates, but they’d still be well short of the most extreme worst-case scenario estimates out there,” said Emer Lang, bank analyst at Davy.

“Our models are assuming impairment losses that would be a bit, but not dramatically, higher than the guided stress estimates. The pace of change is what is most extraordinary in the last six months.”

The market is already questioning the merits of public recapitalisation with preference shares, as planned by Mr Lenihan. Although preference shares qualify as tier-1 capital, the market seems to prefer an increase in pure equity in the banks as the first absorber of loan losses.

This presents a big problem for Mr Lenihan, the Government and the State at large, as State recapitalisation with pure equity instead of preference shares would lead to nationalisation.

Just three weeks ahead of Bank of Ireland’s egm on the recapitalisation plan (no date has been set for AIB’s), this is something the Minister is very keen to avoid.

While he may be preoccupied with the collapse in the public finances, doubt about the parameters of his toxic asset plan only fuels uncertainty about the prospects of the recapitalisation scheme. The market awaits.