Based on a worst-case situation of a 45% fall in property prices and 13.5% unemployment, BoI says it can maintain its capital ratios, writes SIMON CARSWELL

LESS THAN 12 hours after Minister for Finance Brian Lenihan unveiled a Government injection of €3.5 billion into Bank of Ireland, the bank said it may have to write off up to €6 billion in bad loans in the period to March 2011. The bank’s trading statement raises questions about whether the Government’s investment will be enough to prop up its levels of capital – essentially cash reserves – to absorb spiralling losses on loans.

The bank believes that it has enough capital to absorb these much higher loan losses and survive through the financial crisis.

In almost four months, the bank has revised upwards its bad debt projections for the next three years from €3.8 billion to €4.5 billion, with the prospect of this rising to €6 billion in “a stressed scenario” if the dire economic situation continues to deteriorate.

The head of Bank of Ireland’s capital markets division, Denis Donovan, and the finance director John O’Donovan – who both led the recapitalisation talks with the Government – blamed rising unemployment and greater house price falls for the higher bad debt estimates.

Mr O’Donovan said the bank’s estimate last November was based on the expectation that unemployment would reach 8-9 per cent and house prices would fall 30 per cent from peak levels.

The skies have darkened considerably since then.

He said the €6 billion estimate was based on “a stressed scenario” where unemployment could reach 13.5 per cent and house prices in Ireland and the UK drop 45 per cent, peak to trough.

He said these projections were “significantly outside the consensus”, while Mr Donovan said the bank wanted “to create a bottom” and to show that it still had the adequate capital buffers to suffer large surges in loan losses.

The bank said it had not tweaked its bad debt estimates for its €13 billion property and development loans up to the €4.5 billion estimate. Last November, the bank said it would write off 14 per cent of this book over three years.

However, half the increase in the bad debt forecast from €3.8 billion to the worst-case scenario of €6 billion was due to bad property loans.

Some 30 per cent was due to impaired consumer loans and 20 per cent on business loans.

The bank was at pains to explain that its estimates were broadly in line with an independent analysis by London financial risk specialists Oliver Wyman.

Some 19 staff from the firm spent a month from December 19th examining 600 files representing a sample of the loan book.

The bank says it will make an underlying loss for the second half of its financial year to the end of March but will post an underlying profit for the full fiscal year.

The estimated bad debts – plus the €420 million the bank must pay the Government for the €3.5 billion in recapitalisation money and for the State guarantee – will likely send the bank into a loss for the years to March 2010 and 2011, especially given the sharp slowdown in the bank’s markets.

This will mean that capital will be eaten away. However, the bank says that with the Government’s €3.5 billion, it has €10.8 billion in reserve to absorb these losses.

Mr Donovan said the bank could, for example, take the worst-case €6 billion hit now and still have enough in reserve to keep its capital ratios over the 4 per cent floor allowed by regulators.

Mr O’Donovan said the taxpayers’ investment will not be frittered away, but that it will give the bank additional comfort.

“Is this money going through the cracks in the floor? Absolutely not,” he said.

The bank will be praying that its worse-case scenario will be the very worst that the economy gets.