ANALYSIS:Some 83 days after the State guaranteed €440 billion in deposits and debts at the Irish banks, the Government has injected €5.5 billion into AIB, Bank of Ireland and Anglo Irish Bank with the possibility of investing up to another €1 billion each in AIB and Bank of Ireland in the issuing of new shares.
All told, the State's investment in the three big banks could reach €7.5 billion. In return, the Government says it will earn about €470 million a year, take control of Anglo and have a say in "key issues" at AIB and Bank of Ireland.
There will be major boardroom and management clear-out at Anglo, which lost chairman Sean FitzPatrick and chief executive David Drumm last week arising from the controversy over the concealment of €87 million in loans to Mr FitzPatrick over an eight-year period.
Minister for Finance Brian Lenihan says the State's investment in Anglo is the "last step short of nationalisation" and believes the cash injections for the State's two big banks, AIB and Bank of Ireland, will be sufficient to meet "the challenges facing them" over the coming years.
"Were we to go the nationalisation route (at Anglo) I think we would be affirming that we have no confidence in the capacity of the bank to survive," said Mr Lenihan.
The Minister said the recapitalisation plan as laid out was "in the public interest."
"We have used our investment in preference shares to protect the public interest but we have also created an incentive for the banks themselves to raise capital themselves," he said.
The deal bears shareholders' interests in mind at AIB and Bank of Ireland. The State is taking preference shares in both banks, which means it will be paid ahead of ordinary shareholders, but existing investors will not initially be affected by any dilution in the value of their interests.
The cost to the banks is 8 per cent in the case of AIB and Bank of Ireland, and 10 per cent for Anglo, which reflects the higher risk associated with Anglo and the interest the State is taking in that bank. This is lower than the 12 per cent the UK has charged banks in its recapitalization programme.
This amounts to €160 million a year for AIB and Bank of Ireland, and €150 million for Anglo. If the banks can't pay this, the Government has the power to take ordinary shares in the banks instead.
Mr Lenihan said he "didn't want to charge too high a price to restrict lending." The Government has bided its time on recapitalisation. The Minister said he didn't want to be rushed.
"I never agreed that we should proceed in haste in this matter. Other countries have proceeded in haste and have made mistakes. I believe we have got it right here," he said.
The aim of the deal is to encourage the banks to buy out the State's interest within five years. "It can buy back at face value for the first five years or 125 per cent if it went beyond that," said Mr Lenihan. So the State could earn €2.3 billion over the five years in return for the initial investment of €5.5 billion.
Given that the €18.7 billion National Pension Reserve Fund has lost substantial money this year due to falling stock markets, the annual returns of 10 per cent and 8 per cent aren't too bad.
AIB has deviated from the line it has consistently (and emphatically) stood by in recent months by informing the stock exchange today that it has "indicated our interest in seeking up to a further €1 billion from our shareholders."
The bank says its capital ratios are good but that it is "mindful though of the growing market expectation for banks everywhere to have higher capital levels." In other words, the bank thinks it has enough capital, but the market wants more and it is reluctantly agreeing.
Bank of Ireland has signalled that it will hold a rights issue offering new shares that will be underwritten by the State. The rights issues will give existing shareholders an opportunity to buy into the shares again and give them the potential to benefit from any potential upside in the stocks.
"The institutions should be given an opportunity to raise the private capital. The onus is on them to raise it and the reality is if they do raise it, they protect their existing shareholders," said Mr Lenihan.
Analyst Scott Rankin at Davy stockbrokers said the recapitalisation deal "looks like a very bank-friendly deal", while Sebastian Orsi, analyst at Merrion Capital, described it as "relatively shareholder friendly."
Irish Life & Permanent, and Irish Nationwide and EBS building societies, will be dealt with in the second round of recapitalisation, which is likely to take place in January. Mr Lenihan said he wanted to deal with the three main banks first as they had the biggest exposures to property and construction.
At AIB and Bank of Ireland the Government will have voting rights in respect of change of control at the bank in the event of any potential takeovers and changes to capital structure. It will also get to appoint 25 per cent of the directors. In the case of the banks, this will mean two board members in addition to the two directors that the State has already appointed under the bank guarantee scheme.
No senior executives will be leaving AIB and Bank of Ireland under the deal, though they may be facing with a difficult situation if private investors shun the planned rights issues at the banks and the Government is left with ordinary shares. Calls for resignations could take place then.
The story is very different at Anglo. The Government will be taking 75 per cent of the voting rights and there will be a clear-out of the bank's board and management, though former PricewaterhouseCoopers accountant Donal O'Connor, who replaced Mr FitzPatrick last week, will stay on as the new chairman.
Mr O'Connor has some experience of working with troubled financial institutions, having managed Icarom, the State company that took control of the Insurance Corporation of Ireland, the insurance subsidiary of Allied Irish Banks that almost collapsed the bank in the mid-1980s following poor underwriting.
Mr Lenihan said the Government decided not to hold a rights issue at Anglo because the bank had "a very low value on the markets and therefore the prospects for a rights issue would be poor."
"We believe that with appropriate public direction this bank can survive and be turned around," said the Minister. Anglo shareholders must approve the deal at an emergency general meeting next month.
The Government's plan has been broadly welcomed in terms of the big two banks, AIB and Bank of Ireland. Investors responded favourably, with Bank of Ireland climbing 27 per cent at 10am. AIB gained 20 per cent and Irish Life & Permanent was up 12 per cent.
However, Anglo Irish Bank shares declined 14 per cent to 30 cent having risen in the first hour of trading. Clearly ordinary shareholders don't believe €1.5 billion will be nearly enough and investors have reacted to the Government's decision not to offer them the opportunity to buy new shares in a rights issue.
While the market will want to see some significant equity issuance in the New Year, this is a good start," said Scott Rankin of Davy.
The Government has also agreed to inject additional capital through underwriting or otherwise support to the three banks. "This should help put a floor under the banks get us into the New Year," said Rankin.
In addition to recapitalisation, the banks have agreed to increase their lending to small businesses by at least 10 per cent and mortgages to first-time buyers by at least 30 per cent in 2009.
"The most important issue for the Government is the capacity of the banking system to provide credit to the economy," said the Minister.
Dermot O'Leary, economist at Goodbody Stockbrokers, said the €5.5 billion initial investment is the equivalent of 14 per cent of the State's estimated tax revenue in 2008 and up to 30 per cent of the National Pension Reserve Fund, which was set up to fund public pensions from 2025.
"Given the close correlation of credit and economic growth, if the injection succeeds in protecting the financial system in Ireland and providing an increase in credit to businesses and households it will be paid back in the future through higher tax receipts, not to mention the terms of actual recapitalisation," said O'Leary.
Mr Lenihan said the rights issues give the banks "every incentive… to preserve its independence from the State."
The Government said that the core tier one capital ratios - the key measure of a bank's ability to absorb unforeseen losses on loans - would rise "over time" to between 8 and 8.5 per cent for AIB, close to 9 per cent for Bank of Ireland and 7.7 per cent for Anglo Irish Bank.
Minister for Finance Brian Lenihan said that core tier one ratios are the "gold standard" and "the ultimate cash deposit that the markets look at."
Prior to recapitalisation, the banks' ratios stood at around 6 per cent, below the 8 per cent level set by state capital injections in the UK, so the State recapitalisation plan will bring the capital ratios up to the higher benchmark levels set in Britain. This should appease nervous stock market investors.
Kevin McConnell, head of research at Bloxham Stockbrokers in Dublin, said the plan was on substantially better terms than similar moves in the UK, saying the Government has learned from the mistakes there.
"Whether it's enough or not just depends on your viewpoint of the bad debt cycle," he said.
In other words, if the bad debts are considerably higher than expected – the three main banks say they will amount to about €9 billion over the next three years – then more capital will be needed.
The fresh capital from the State will undoubtedly offer more shelter for the stormy years ahead.