Question lingers as to adequacy of Government's €7.5bn injection

REACTION:THE GOVERNMENT has finally revealed how much the State is offering to invest in Allied Irish Banks (AIB), Bank of Ireland (BoI) and Anglo Irish Bank - the country's three biggest lenders. The two main banks, AIB and BoI, have changed their tunes and are taking most of cash on offer.

Yesterday evening's announcement the State would invest up to €7.5 billion in the three main banks (though Anglo's take is likely to rise further) comes 83 days after Minister for Finance Brian Lenihan provided the €440 billion guarantee to the banks. The guarantee was part one of the save-the-banks plan. Part two - State investment in recapitalisation - was detailed last night.

Weeks of negotiations have led to this multibillion euro hand-out that stands at €5.5 billion. The total amount involved will rise to €7.5 billion if AIB and BoI decide to sell new shares in a State-backed rights issue and investors don't participate, as the Government has said it will underwrite these rights issues.

The Government believes it will earn €470 million a year in dividends from the three banks.

The State has chosen to exclude private investors in the first instance, though it keeps the door ajar for their involvement later.

The State is taking control of Anglo Irish Bank with an investment of €1.5 billion in return for preference shares. This amounts to almost six times the current market value of the bank.

In return, the State is taking 75 per cent of the voting rights in the bank, and will clear out its board, with the exception of former PricewaterhouseCoopers accountant Donal O'Connor, and install new senior executives.

Anglo was the problem child in the banking market and needed an urgent solution, as the Government brought forward its recapitalisation plan from January following the dramatic resignations of the bank's chairman Seán FitzPatrick and chief executive David Drumm last week. The bank is estimated to need more than €3 billion, though the initial €1.5 billion and the State's 75 per cent ownership should tide it over in the short term as it comes to terms with last week's upheaval. The cost to the bank is 10 per cent a year in a dividend payment.

The bank's survival would have been threatened further had the Government not stepped in.

Injecting €2 billion of State money each into AIB and BoI (in return for preference shares, 25 per cent voting rights, two more board members and an 8 per cent annual return) will help. Taking preference shares means the holders of ordinary shares will not be diluted. The deal is "very shareholder-friendly", said one analyst.

However, the Government has promised to buy any new ordinary shares that existing shareholders do not purchase in a future rights issue that could raise up to €1 billion for each lender.

This means shareholders' interests won't be completely diluted and they can benefit from any potential upside if they buy new shares and they rise again when things improve.

AIB has previously signalled it won't hold a rights issue, saying it can raise capital by selling assets instead, though the Government said last night the bank had "indicated an interest" in such an underwriting. The sale of its 25 per cent stake in US bank MT could yield more than €1 billion.

BoI has indicated it will take up the Government's offer on a rights issue. Institutional investors, existing shareholders in the banks, are unlikely to be happy as some believe the money the State is putting up will not be enough.

Some believe a total injection closer to €15 billion is needed - €5 billion for each of the three main banks to cover rising losses on loans as the economy worsens.

Concerns about the adequacy of the State's recapitalisation plan will deter existing shareholders from participating in any rights issue planned at BoI, as they will not participate if the banks need to raise money again.

As the Government has agreed to underwrite any new sale of shares in the bank, the State could end up owning most of the bank, given the amount needed and the level of the bank's share price. The British government ended up owning 58 per cent of Royal Bank of Scotland after investors shunned a sale of new shares in a state-backed rights issue.

The plan has the potential to bring core tier-one capital ratios - the barometer of a bank's ability to cover unforeseen losses on loans - up to 8 per cent, the higher capital bar set by the UK at its banks.

However, if the economic situation deteriorates further and the banks lose more money than expected on loans, the market could demand more.

"To bring the banks up to 8 per cent on their core tier capital ratios, you would be looking at about €6 billion, but it is all dependent on bad debts next year and the year after," said Oliver Gilvarry, head of research at Dolmen, last week. "We have been seeing bad debt projections that three months ago we would never have thought would be as bad."

In the property market, the decline in values is only halfway to the projected bottom, 22 months into the downward cycle - so the "correction" has some way to go.

Taking much higher loan losses into account, NCB stockbrokers has suggested AIB, BoI and Anglo combined would need €13.4 billion for a core tier-one ratio of 6 per cent by the end of 2011 or €16.9 billion for 7 per cent, if their losses on property loans matched the writeoffs posted by British bank Barclays in the early 1990s.

However, the coming years could be far more challenging and the capital needs of the banks could be rise significantly - even beyond existing expectations.

Bank details: what is each getting?

AIB

The Government will invest €2 billion in AIB and has committed to underwriting a rights issue to raise a further €1 billion in funds.

The shares pay an annual dividend of 8 per cent a year at the discretion of the bank.

If the bank is not able to pay in cash then it will paid through issuing further shares.

The dividend to the State must be paid before any dividends are paid to the ordinary shareholders.

The preference shares can be redeemed by the bank at any stage.

AIB can repurchase them at par at any stage over the next five years and at 125 per cent of par after that.

If they are repurchased, the bank has to maintain its core tier-1 capital at the pre-repurchase level. The repurchase also has to be approved by the Financial Regulator.

The Government has the right to appoint 25 per cent of the bank's directors, including any appointed under the Government Guarantee Scheme.

They have voting rights in respect of changes in the banks capital structure and also in any transaction amounting to change of control.

Bank of Ireland

The Government will subscribe for €2 billion of 8 per cent core tier-1 preference shares in Bank of Ireland.

These shares will have voting rights in respect of change of control and any changes in the capital structure.

They will also confer 25 per cent of the voting rights in respect of appointments of directors and 25 per cent of the directors on the board, currently including any directors to be appointed in connection with the Government's Guarantee Scheme. Bank of Ireland may redeem the preference shares within five years at the issue price or after five years at 125 per cent of the issue price. The preference shares are non-convertible and will be treated as core tier-1 capital by the Financial Regulator and are replaceable only with other core/equity tier-1 capital.

"Against the continuing uncertain and volatile conditions in global financial markets, the group recognised that market expectations for capital ratios had increased and committed to further strengthening its capital through a range of options.

"It is against this background that Bank of Ireland welcomes the initiative by the Government."

Anglo Irish Bank

The Government's investment will be in the form of perpetual preference shares which will rank pari passu to ordinary share capital. A fixed annual coupon of 10 per cent will be payable on these shares and will be paid in priority to dividends on ordinary shares.

The preference shares will carry 75 per cent of the voting rights of Anglo Irish Bank. These shares may only be redeemed with the approval of the Financial Regulator.

Redemption can take place at par within five years from the date of issue or at 125 per cent of nominal value thereafter.

An egm will be convened in January 2009, at which shareholder approval will be sought for resolutions, the passing of which will allow the additional preference share capital to be raised.

A circular outlining in detail the terms of the new preference shares and the proposed resolutions will be posted to shareholders by Wednesday.

The group's regulatory core tier-1 capital ratio increases from 5.9 per cent at September 30th, 2008, to 7.7 per cent .