Irish Nationwide is looking vulnerable as it faces significant capital requirements this year, writes SIMON CARSWELL

AS THE Government focuses on the capital needs of the three smaller guaranteed lenders, the mixed messages emanating from Irish Nationwide this week run counter to the prevailing belief that the building society will require support to cover large losses on its loans to the declining commercial property market.

Minister for Finance Brian Lenihan has announced the recapitalisation of Allied Irish Banks (AIB) and Bank of Ireland with €7 billion and has nationalised Anglo Irish Bank, though it’s not clear how much capital Anglo will need.

Irish Life Permanent (ILP), the Educational Building Society (EBS) and Irish Nationwide are next on Mr Lenihan’s agenda.

He said on Wednesday that ILP was well capitalised. The company is seeking €500 million to “fireproof” its capital reserves.

EBS will seek €300 million to bring its capital ratios up to the expected international standard.

The signals from Irish Nationwide are confused. The building society outlined in discussions with the Department of Finance last November that it could remain independent and shore up its capital by shrinking its loan book.

In response to a downgrade in its debt ratings last Monday, the building society’s company secretary told staff in a circular that it would “probably” be the only financial institution not to seek fresh capital from the Government.

Stan Purcell told staff on Monday that the building society had a buffer of €1.5 billion to absorb any negative impact.

Then on Tuesday in his resignation letter to the lender’s board, the building society’s chairman, Dr Michael Walsh, said: “It is clear to me that Irish Nationwide Building Society cannot survive without reorganisation and significant Government support.”

Dr Walsh, a former professor of banking and finance at UCD, said that he believed “the board and ultimately the Minister should have the opportunity to provide new oversight and leadership”.

The most pressing issue for the taxpayer is the building society’s capital requirements. The difference of opinion between Walsh and Purcell muddies the water at a time when the Government is seeking clarity on Irish Nationwide’s needs to tide it over. The size of the Government injection required depends on the scale of the bad debts on the building society’s €12.4 billion loan book.

Irish Nationwide chief executive Michael Fingleton has consistently avoided providing detail – “granularity” as analysts of the public banks like to call it – on how many loans the society is likely to have to write off over the coming years.

Judging from the bad debt projections at AIB and Bank of Ireland, Irish Nationwide is facing equally large loan write-offs.

Yesterday, AIB raised its bad debt forecast for 2008 to €1.8 billion from €950 million four months ago. Some €500 million of this 90 per cent increase arises mostly on the €10.7 billion Irish residential development book.

The bank, which has the largest Irish development loan book of any lender, had said in November that it would be writing off 3 per cent of this book in 2008 and a further 4.8 per cent next year.

Adding a further €500 million in write-offs on this book means the bank will writing off as much as 8 per cent of its Irish development loans in just one year.

The pressure was on AIB to revisit its bad debt estimates since last week when Bank of Ireland raised its three-year forecast to €6 billion from €3.8 billion.

All this raises difficult questions for Irish Nationwide as the society is estimated to have the largest development loan book of any guaranteed Irish lender as a percentage of the overall loan book.

Debt ratings agency Fitch has said 80 per cent of the building society’s loans relate to commercial property. Some 45 per cent of its loan book is on UK property, mostly in or around London.

The building society has never broken down how much of this relates to commercial investment - office blocks, hotels and shopping centres – and to development, incomplete buildings and landbanks earmarked for buildings.

Assuming that even 60 per cent of the building society’s €12.4 billion loans are borrowings secured on development – and applying AIB’s write-off percentage in 2008 – Irish Nationwide would have to write off €595 million in 2008.

This would significantly erode Irish Nationwide’s capital buffer of €1.5 billion in just a single year.

The building society has the added complications of having a high concentration in its loan book, with a large amount of its loans to a small number of borrowers; a high loan-to-value ratio on many loans and a large number of equity stakes in some of the developments it has provided loans to.

The society recorded pretax profits of €239 million in 2006 and €390 million in 2007, two years marking the height of the boom. Profitability of this scale will be hard to achieve in future.

Irish Nationwide has indicated that it can remain independent and shore up its capital reserves for the years ahead by shrinking its loan book. It is planning to achieve this by severely curtailing new lending and redeeming loans of €2 billion to €3 billion.

It is applying significant pressure to its developer customers to rearrange their loan agreements so the society has more security.

However, shrinking the book will not solve the problem loans.

Dr Walsh’s view dovetailed with many points by made another debt ratings agency, Moody’s, last Monday when it downgraded the society’s financial strength to “D-“, which marks a level of “modest” strength, “potentially requiring some outside support at times”.

The debt ratings were downgraded by two notches to one level above speculative or “junk” grade – a status at which would stop many large companies investing in the building society’s bonds.

This leaves the society’s vulnerable as it has €2.3 billion in debt maturing this year, though it has previously said it can cover €800 million of this with deposits. However, it still must raise €1.5 billion.