The past week saw the Irish Prime Minister present a bill to Parliament designed to purge the Irish banking sector of its enormous stock of bad assets and enhance banks’ access to capital markets. The plan consists of two parts: the establishment of a National Asset Management Agency (NAMA) and the introduction of a new debt and deposit guarantee scheme to replace the previous one, which expires on 29 September 2010.

NAMA’s principal aim is to relieve lenders of their toxic assets by buying them at a discount. It will spend around €54bn on toxic assets with an estimated book value of €77bn, meaning that the system-wide haircut on the assets is around 30% (although the haircut will vary by asset). The two largest Irish lenders, Allied Irish Banks (AIB) and Bank of Ireland, have already commented that their loans are unlikely to be subjected to the full 30% discount. Nevertheless, those banks putting the largest amount of assets into the scheme (see table below) are likely to find themselves undercapitalised. The intention is that banks will address undercapitalisation by raising private capital – indeed, AIB has already announced that it is looking to raise €2bn of capital over the next twelve to eighteen months. But if banks are unable to raise the required amount of capital privately, the Irish government will provide it, leading to increased state ownership of the Irish banking sector.

Irish banks’ contribution to NAMA (€bn)*

Source: Irish Ministry of Finance.  *Book value

Meanwhile, the proposed guarantee is structured along similar lines to those already in operation in various countries across the world. From the inception date of the new Eligible Liabilities Guarantee (ELG – expected to be established in October 2009) until 29 September 2010 (when the previous guarantee scheme, or CIFS, closes), banks will be able to issue debt out to five years and have it guaranteed by the government. The guarantee will be unconditional and irrevocable and will provide for a timely payout. Eligibile liabilities include all deposits (not already covered by any other deposit insurance scheme), senior unsecured certificates of deposit, senior unsecured commercial paper and other senior unsecured bonds and notes. The fees charged will be calculated according to the ECB’s recommended formula, which currently applies an institution’s median CDS spread from 1 January 2007 to 31 August 2008 plus 50bps. There has been no mention of currencies in which guaranteed issuance will be permitted. In terms of interaction with the CIFS, under which all bank liabilities are guaranteed until 29 September 2010:

i) Lower Tier 2 bonds and ABS issued before the ELG commences will continue to be guaranteed under the old scheme, while such bonds issued after this date will not be covered by either scheme as they are not eligible liabilities;

ii) From the time that an institution first uses the ELG, only liabilities already outstanding or contracted will continue to be covered by the CIFS. All new issuance will be guaranteed only by the ELG or not at all.

The Irish plan seems to tick all the important boxes. If the bill is passed, it will relieve the banks of their bad assets, achieve their recapitalisation and ensure that their liquidity needs are met. The Irish government has also made an attempt to protect taxpayers, with any eventual loss by NAMA intended to be offset by a one-off levy on the banks. But uncertainty persists over whether the bill will be passed, given that it means that an already unpopular government is proposing to spend 28% of 2008 GDP on assets valued for their long-term returns: the €54bn it proposes to pay is well above the assets' current market value of €47bn, a point the opposition will doubtless ram home to the electorate. And the opposition claims to have developed a solution of its own to the banking crisis, which it intends to reveal during next week's debate. It all points to a difficult and uncertain week for Ireland's government and its banks. That said, the bill looks set eventually to be passed. All politicians are painfully aware that there can be no true recovery in the Irish economy until its banks' balance sheets have been cleaned up.

Nick Smallwood, Credit Research

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