Restructuring and bank mergers will be on the agenda as part of the price for Nama

THE GOVERNMENT decided not to get into specifics on how it might shape the Irish banking industry in the future when Minister for Finance Brian Lenihan outlined the €54 billion price to be paid for the Nama-bound loans.

There had been growing expectation that he would make more detailed reference to possible mergers, given that any State capital injections would be conditional on approval from the European Commission with a nod to some kind of sectoral restructuring.

However, it was a case of first things first and providing a broad estimate of how much the Government would pay for the bad loans.

Mr Lenihan said that the banking system had “let us down” and that “the existing structures cannot remain the same”. A number of banks are developing restructuring plans to “tight deadlines”, he said, to meet EU requirements to win approval for their recapitalisation by the State. He is referring to the business plans being put together by Bank of Ireland and Allied Irish Banks (AIB), which have each received €3.5 billion from the Government, and by Anglo Irish Bank, the State-owned lender into which the Government has invested €3.8 billion.

The Government’s recent and prolonged focus on these three banks has encouraged investors.

The share prices of Bank of Ireland and AIB rallied yesterday as the Nama announcement on the face value of the loans to be acquired – €24 billion for AIB and €16 billion for Bank of Ireland, and the potential “haircuts” on the loans (less than 30 per cent for both banks) – brought some much-needed certainty to the market and to the future of the banks.

This, in turn, stirred appetite for risk among investors, which had already been improving on banks internationally, to punt on the two largest banks after the Minister’s statement on Nama.

Sebastian Orsi, analyst at Merrion Stockbrokers, said the rising share prices also helped to generate some positivity in the stocks, creating a “virtuous circle rather than a vicious circle”.

This was because rallying stocks would mean less dilution of existing shareholders in any possible rights issue by the State.

Investors were buoyed by Mr Lenihan’s statement but were encouraged more by AIB’s assertion that it would try to raise €2 billion privately over a period of 12 to 18 months and that it left open the possibility that the loans heading to Nama may be moved on a phased basis giving the bank breathing space to absorb the resulting losses over 12 months.

The range of self-help measures suggested by AIB to raise capital to keep Government investment to a minimum – the sale of assets, a possible investment by Canadian bank CIBC and a potential rights issue – also encouraged investors.

The Nama announcement sparked some glimmers of hope for the two largest banks which are so vital to the plan for unclogging the banks of their bad loans and kick-starting fresh lending. Boosted by a liquidity injection of about €30 billion through Nama, Bank of Ireland and AIB will take a competitive advantage over Ulster Bank, the third-largest lender to corporate, and small and medium-sized enterprises (SMEs).

The three banks control 90 per cent of lending to this sector, so Ulster Bank, which is owned by Royal Bank of Scotland, the part-nationalised UK lender, is likely to be keeping a close eye in the coming year over any disadvantage facing the bank by being excluded from the Nama club.

Mr Lenihan noted on Wednesday that any lender participating in Nama would be forced to restructure and this would lead to a reformed banking system.

The Minister said it was “too early to outline a definitive shape for the new system” but observed that there “has to be scope for subsidiaries of external banks to play their full part” and that this would be “the focus of his work over the coming weeks”.

The reference to foreign-owned banks participating in any restructuring of the banking system ticks several boxes with the European Commission, which will be keen that Nama doesn’t put any of the Irish subsidiaries of overseas institutions at a competitive disadvantage due to the level of State aid generated under the State’s toxic loans plan. Mr Lenihan’s comments on Wednesday will hearten Bank of Scotland (Ireland) (BoSI), which is owned by another part-nationalised UK bank, Lloyds Banking Group, as it seeks to push its case for inclusion in the so-called “third force” merger in banking that the Government is eyeing as a foil to the dominance of Bank of Ireland and AIB.

As it stands, Ulster Bank is arguably the “third force” in Irish banking but, as a non-Irish-owned lender, it falls outside the bailiwick of the Government’s planning.

Plans to merge Irish Life Permanent’s banking division Permanent TSB with EBS building society and the rump of Irish Nationwide remaining after Nama into a domestic third force will now move up the Government agenda as the focus of the efforts to repair the banking sector shifts away from the big two players.

Such an enlarged bank will be a savings and home loans operation and is likely to form along the lines of a mutual or “super-mutual” given the tradition from which the three lenders have grown.

A missing string to the group’s bow is SME lending, which has piqued BoSI’s interest in the venture given its ownership of the former State-owned business lender ICC.

At a time when the Government is seeking to ease the concerns of credit-hungry small businesses, making a business lending division the fourth leg of the “third force” stool might be a viable option, but banking sources point to the challenges of merging three separate institutions, never mind four.

Involving a foreign-owned bank in a domestic marriage could be complicated but some capital dowry from Lloyds in return for a possible stake of 20 per cent might help secure the blessing, though the Government and Permanent TSB are likely to hold the largest stakes if such a merger took place.

This week’s disclosure of the loans to be moved to Nama from the State’s two building societies, Irish Nationwide and EBS, lays the groundwork for a merger of the State’s three smallest domestic lenders at the very least.

Analyst Kevin McConnell, of stockbroker Bloxham, said that the loans-to-deposits (LTD) ratio – a gauge of a bank’s reliance on outside funding – for the three institutions would stand at 195 per cent following Nama.

This means that for every €1.95 out on loan to customers, the enlarged banking group would have €1 on deposit.

This is still well above the 125 per cent targeted by lenders in the current financial environment, but Government-guaranteed funding would help bridge the gap.

Of the six domestic lenders, Permanent TSB currently has the heaviest reliance on outside funding with a ratio of more than 300 per cent.

However, from a funding perspective, the bank would benefit from joining forces with Irish Nationwide as the building society’s loan book will fall sharply from €10.5 billion to €2.5 billion after Nama takes over its property development and related loans.