U-turn as AIB looks at disposal of some assets

ANALYSIS:THE ADMISSION by the Government and Allied Irish Bank (AIB) that the State's €3.5 billion investment into the bank will not be enough to absorb possible extreme losses is hardly a surprise. The bank has continuously raised its bad debt forecasts since last summer, and claimed not to have foreseen such a collapse in the economy and property market.

The Government has over recent weeks been carrying out due diligence at AIB ahead of concluding its €3.5 billion investment by the middle of next month. “This due diligence has shown that in certain extreme stress-test scenarios AIB’s core Tier One capital [a measure of its reserves to protect against losses] could need to be further strengthened,” the Government said yesterday. The Department of Finance concluded that a total of €5 billion would be “appropriate” to provide sufficient strength to AIB’s capital.

Minister for Finance Brian Lenihan said that he had “no reason to anticipate any further problems will emerge” over the remainder of the due diligence.

He said the decision by AIB to seek a further €1.5 billion was taken after lengthy discussions with him over the weekend.

AIB has €7 billion more in developers’ loans than Bank of Ireland. The Government clearly feels AIB’s own extreme stress-test, the results of which were outlined last month, was not severe enough.

The bank said last month that it would write off bad debts of up to €8.5 billion in a “severe” stress scenario over the three years to 2010, and that with the Government’s €3.5 billion capital it was “adequately capitalised” to cope. However, the bank hasn’t exactly inspired confidence in its bad debt forecasting. Last month the bank said the bad debt charge for 2008 was €1.8 billion, almost double the forecast provided five months earlier.

AIB chief executive Eugene Sheehy said last October that AIB would “rather die than raise equity”. The bank said it would raise the required €1.5 billion itself and that this could involve asset sales.

AIB said this “commitment” was “a reappraisal of our previous view in relation to asset disposal”. In other words, this is a U-turn.

This would suggest the bank is considering the sale of its Polish subsidiary, Bank Zachodni WBK, a previously undesirable move. No asset is now sacrosanct in the bank’s bid to raise extra capital.

The bank could sell its 24 per cent stake in US bank MT, which would add about €500 million to €660 million to its capital.

Selling the Polish bank is unlikely to generate much cash, given the collapse in its market value, but a sale would remove the risk-weighted assets or loans against which AIB must set aside higher levels of capital to cover.

Analysts said the bank could also boost capital by buying back debt from investors at a discount.

Investors responded positively at first yesterday as AIB’s shares climbed 16 per cent, although they fell back later and closed just 2.3 per cent higher.

Analysts believe the capital raising by AIB is a move to stop the slide towards nationalisation.

However, investors clearly fear their shareholdings will be diluted and that the Government will eventually acquire ordinary shares rather than preference shares, the route chosen so far where the State’s capital is used as a buffer only in the event of a winding up.

This may be inevitable as AIB agreed yesterday to sell bad assets, including €21 billion in development loans, to the State’s bad bank, the National Asset Management Agency.

Depending on the discount sought by Government buying the loans, this may lead to higher, up-front losses for AIB, a need for yet more capital and the State taking a majority stake.