Can Anglo-Irish be saved?

Dóchas 19/06/2009

Dóchas:
Question: Should Anglo’s debts have been guaranteed, i.e. should it have been allowed to fail in September and guarantees extended only to other viable / systemically important banks?

* Would it have been practical / feasible to treat depositors and (senior and subordinated) debt providers in the different banks differently? Yes on debt but probably political issues with depositors.
* Logically would have to treat INBS similarly to Anglo.
* Would have required a decision as to which banks were systemically important and which were not.
* Would have amounted to a clear admission of failure of regulation in those banks which the state was not prepared to support, which of course was in fact the case.
* How would international providers of debt and deposits have reacted? Would they have been spooked and withdrawn funds from other Irish banks even if they had a guarantee?
* Government etc saw crisis as a funding / liquidity crisis and not a capital adequacy problem. The solution was to provide a guarantee to restore confidence and resolve the liquidity issue. The bolder the guarantee the greater the sign of government confidence and the more powerful the market impact. Arguably a selective or diluted guarantee could have been seen as a weakness and could have given rise to confusion and not resolved the liquidity issue which threatened the whole system.
* If Anglo and INBS were excluded from the guarantee they would have gone bust immediately and the depositors, debt providers and creditors would have taken a bath.
* Anglo and INBS going bust would in turn have accelerated the fall in property values – the liquidation could not have been controlled or managed (as NAMA hopes to do) to minimise collateral damage to other banks – and would have added further to the concerns as to the extent of possible property loan impairments in the remaining banks and the impact on their capital adequacy.

Conclusion:
The government had little time to act in September 2009 and were faced with a huge crisis in the banking sector. It is important to remember this was an international crisis peaking just two weeks after the US government decision to let Lehmans Bros go bust. A decision, which in hindsight, was a mistake. The Irish government (like almost all other governments) had not a planned end game for the sector which might have informed a different and more sophisticated approach to the type of guarantee scheme adopted. The overwhelming imperative was to deal with bank liquidity which the blanket guarantee did effectively. There were huge uncertainties as to how providers of funding would react and the clear, bold (if ultimately expensive) stroke had the intended effect on markets. If international investors believed at that time that the sovereign could not support all the banking system (as a limited guarantee could most likely have been interpreted by them given the total fragility of confidence and panic in debt markets) then the liquidity crisis would have continued and AIB and BOI and the rest of the Irish banking system would have collapsed, just like Iceland, as debt providers withdrew funding. This was a risk that the Irish government could not take.

It is also the case that in September 2009 neither the government nor the banks (or most others for that matter) had any idea how far wrong they were on the likely level of loan impairments and the implications that would have for bank capital. Both government and banks completely underestimated the pace and severity of economic decline that was in train and probably genuinely believed that the guarantee would not be called on in reality.

[It is worthwhile noting that the ESRI Qtly Economic Commentary, Autumn 2008, which was released on October 7th, was at that point forecasting GDP growth of minus 0.7% for 2009 and clearly they were behind the curve along with everyone else.]

Question: Following the disclosure of governance failures in Anglo, and the resulting collapse of confidence, the government abandoned its plans to inject preference capital into Anglo (as it has done for AIB and BoI) and instead nationalised the bank in January 2009. The decision now is what should be done with Anglo? Should it be wound-up immediately or wound-down over time in an orderly manner? What would be the consequences of a wind-up? Alternatively can it be re-invented as a viable bank?

* Anglo is not a systemically important bank for Ireland in that if it wasn’t there we wouldn’t need to create it. It is a specialist property lending bank that was a creation of the property bubble and a period of unprecedented cheap credit. To the extend that there is a demand and a requirement for commercial property lending in the economy this can be met by the large universal banks as part of their diversified lending activities.
* However given that Anglo is a reality and given the wider crisis in the Irish banking sector the resolution of the Anglo problem – in whatever fashion – has consequences for the rest of the banking system as well as direct costs to the Exchequer. This reality makes it systemically important.
* The policy objective in resolving the issue should be to minimise the cost to the taxpayer whether in the form of direct support to Anglo or as a result of knock-on effects on other Irish banks where the state ends up picking-up the tab.
* What would be the consequences of a decision to wind-up immediately?
o The externally provided funding of Anglo would dry-up. It’s impossible to say how much and how quickly. Any funding that could go would do so by Sept 2010 when the government funding guarantee expired and the government would have to borrow the monies instead.
o There would be outflows from commercial deposits (€16.1bn), commercial paper / CDs (€2.8bn), MTN bonds maturing before Sept 2010, non-CB inter-bank funding (€7bn) and a loss of retail deposits (€18bn) would also be likely. The Central Bank, i.e. the government, would have to make good this shortfall as all these funding sources would be covered by the government guarantee.
o If Anglo were to be wound-up it would by definition no longer be a going concern. It would be funded by the government and ECB. That would make its liabilities part of the overall government debt giving rise to funding issues for government in debt markets and to issues with the EU on fiscal policy.
o The only providers of debt who would not be automatically repaid would be senior debt providers and subordinated debt holders, where the debt matures post Sept 2010, and other providers of loan capital. Anglo’s subordinated debt and other loan capital amounts to €5bn and this would probably be written-off in full in a wind-up, bearing some of the cost of the bank’s loan losses. It is not clear how much of the senior debt, €11bn, would not be covered by the guarantee and therefore likely to be written off or down.
o Debt holders would clearly not be happy but there is a strong case for them sharing the cost of the bank’s failure. To the extent that other Irish banks are holders of this debt then they would record these losses in their books which may be painful and add to their existing capital problems which the government would probably have to make good. Don’t know how big this exposure might be.
o There is an argument that liquidating Anglo and reneging on large amounts of debt would be bad for Ireland’s reputation with international investors in the long term, and therefore should be avoided. However this debt is already trading at distressed levels in the market and investors are realistic. They expect to make losses, the issue is how much.
o A further problem with an accelerated wind-up would be that it could force the sale of assets – the bank’s liquidity portfolio – at distressed prices and crystallise losses. An orderly wind-up over a longer time frame should result in better value being realised as bonds are held to maturity.

Conclusion: In terms of minimising the cost to the taxpayer it doesn’t make sense to liquidate and wind-up Anglo. It would quickly create a massive funding problem for the government. On the other hand it is next to impossible to envisage any viable future for the bank. An orderly and managed exit seems to be the best option. It maintains the funding lines to the bank without adding directly to the public debt burden. The transfer of assets from Anglo into NAMA will further significantly ease the bank’s liquidity position.

Equity holders have already been wiped out. The taxpayer will bear an indeterminate amount of costs. It makes sense that providers of debt capital also share the pain. This can be done by buying them out at very significant discounts which the bank has announced it will do. Whether other lenders to Anglo, whose loans are not covered by the guarantee (e.g. MTN bond holders), should also take a share of the losses is an open point. Would this create more collateral damage in terms of reduced access to funding and damage to our international reputation?

It may be possible to dispose of parts of Anglo’s business over time, e.g. the US and / or UK loan books. This would make sense. All of the foregoing implies major cost reductions are necessary to reflect shrinking revenues and the reduced scale of operations in the bank. It may be that the resized and reconfigured operation could merge into something bigger but it is not clear who or what that might be.

Anglo is a mess and a major cost. But we are where we are and have to extricate ourselves out of this mess carefully and astutely to minimise the cost to the taxpayer. Precipitate action could be very costly. It is clear that the government and the board of Anglo are looking to manage the problems in an orderly fashion over time. Talk of creating a new banking business is more about creating the semblance of an ongoing business which provides a better context in which to manage the wind-down rather than any great conviction that Anglo has a future as a real bank.