Commentary on the current Irish Soveriegn and Banking crisis by Oliver Gillvary (Head of Research at Dolmen Securities)

Please find below an interesting commentary by Oliver Gillvary (Head of Research at Dolmen Securities) on the current Irish Soveriegn and Banking crisis. (edited slightly by me where jargon crept in).

Basically my interpretation of what he is saying is that the EU Bank Bailout will be a good thing for the economy as it will free the banks to lend more, and will free the government (state) from covering deposits through the

deposit guarantee. This will lower our bond yields and allow us to borrow again next Spring to cover the budget deficit. The only people to suffer in the short term will probably be Bank Shareholders and Bond Holders.

Continued speculation continues over the scale and size of the deal to be done for Ireland. The best is to look at what is relatively well know or at least accepted by the market at the moment along with the potential scenarios facing the Irish banks.

• The bailout seems to be focused towards the domestic banking system with figures of €50-88bn being spoken about in the media, but no detail is being provided on what shape this fund will have or its intended uses. This involves the EU loaning these amounts to the main Irish Banks to shore up their capital problems.
• Comments from Irish Government Ministers indicate that any deal will not involve the Irish Government Bonds, but no denial of any deal for the banks is given.
• Therefore if we accept the bailout is focused on the banking system what is the impact on the banks and in particular their shares and bonds
• Under the first scenario the ECB along with the Government nationalise the entire banking system with Irish Life, BOI and AIB taken into state control. Equity and some bonds in such a situation would be wiped or in the case some of the bonds, heavily discounted. The bailout funds from Europe would then be used to provide funding for the banks in the case of deposit outflows along with recapitalising them and allowing a re-listing after a set period.
• Such a scenario in our view will be difficult for Europe to undertake as it would highlight significant problems with European Stress tests as both AIB and BOI passed these. Also BOI raised capital from the private market backed by discussions with Europe and following an Irish stress test supported by Europe. A similar situation exists for Irish Life & Permanent which passed the Irish PCAR test a number of months ago.
•  A wipe out of equity in BOI after a rights issue will raise questions over other European banks that passed stress tests and bring into questions Europe’s treatment of the banking issue.
• We see it as unlikely Europe will force a nationalisation of the whole system due to contagion impact it will have on other Europe financials.
• Under the second scenario, the bailout funds are provided solely as liquidity for the banking system, allowing the State to remove itself from providing guarantees to the domestic banks. This will remove this responsibility from the State Balance sheet allowing it to distance itself from the banking issue, resulting in bond yields to fall and reduce pressure on other peripheral Euro-Zone economies.
• This would be positive for bank equity and junior debt for the domestic banks as the funding will allow them to fund themselves more cots effectively and take more control of their destiny.
• In the case of BOI and IPM it will allow funding to drop to more normalised levels as the banks in more difficult circumstances remain reliant on the bailout fund.
• The fund in this scenario may also be used in part to recapitalise AIB, EBS , Anglo and Irish Nationwide.
• A difficulty with this scenario is that no pain is being passed onto the private market. Equity holders remain whole along with bond holders. It is difficult to see how European Government could sell such a deal.
• The final scenario is for a mixture of the previous two. The fund is part liquidity and partly for recapitalisation of the banks.
• Under this case, recapitalisation is undertaken for AIB, EBS and potentially Anglo and Irish Nationwide from the fund.
• Reducing the exposure of the Government to the banking system. Part of the fund is used to provide liquidity to the weaker members of the Irish system in the hope that BOI and IPM will be able to raise from private sources in a timely manner.
• Capital could be used for both IPM and BOI to increase capital ratios also with dilution for existing shareholders.
• Some bonds in the banks would be under threat in particular AIB in this scenario. I believe BOI will muddle through with no forced restructure, but there is a risk of further capital being injected as part of the whole scheme.

Conclusion

The outcome of the discussions at EcoFin in coming days will determine the structure of the plan for the bailout for Ireland and/or Irish banks.

• From the different scenarios we have outlined above, we believe the last is the most likely at the moment.
• The greatest risk is to AIB bond and equity holders.
• I still believe BOI will get through and their bonds will continue to be serviced due to its capital raise. In the case of AIB I would sell the exposure ahead of any bailout announcement.
• Similar for equity, the risk is to at least further dilution in the case of BOI and IPM, and I would recommend reducing exposure in part or in full ahead of the announcement.