Banks still too optimistic?

The_Conductor

http://www.sbpost.ie/post/pages/p/story.aspx-qqqt=NEWS+FEATURES-qqqm=nav-qqqid=37572-qqqx=1.asp

The reality of a crashed out property market has begun to bite hard into the profits of the main Irish banks.

In response to this they are writing off more loans and ratcheting up their estimates for how bad things will get over the next two years. Just as their conversion to the new reality was slow, the speed with which they are changing their minds is now very rapid. However, analysts believe bank chief executives may still be too optimistic about the future.

In the last two weeks we have seen revised estimates for bad debts from Bank of Ireland, Irish Life & Permanent and AIB. Anglo Irish Bank is due to come out with its figures early next month.

Bad debts are less of an issue for Irish Life & Permanent because it has mainly lent to residential mortgage customers. Its big challenges lie in rebuilding its mortgage business and changing its funding model.

For months now the international investment community has been estimating that bad debts at Irish banks would hit between 3 per cent and 5 per cent of their total loan books. That would equate to bad debts of between €10 billion and €18 billion.

The banks themselves were suggesting the figure would be less than 1 per cent or €3.6 billion, but are now indicating a cumulative total of just over 2 per cent for Bank of Ireland and AIB between 2008 and 2010.That puts the figure up around €5.2 billion for both combined.

Irish analysts now estimate that Anglo Irish’s bad debt figure will hit a cumulative 3.1 per cent for those years, equal to around €2.2 billion. That gives a total bad debt charge for the three of them of around €7.4 billion. This is well short of what international investors believe and raises the question of how they are coming up with this number. Bank of Ireland was the first to signal that it would rack up significant impairment losses on bad debts. In September it indicated a rise in bad debts, and then last week said that situation had got worse.

A few months ago, Bank of Ireland, AIB and Anglo Irish Bank were maintaining that their bad loan losses would peak at somewhere between 0.8 per cent to 1 per cent of their total loan books. The figures varied from one bank to another.

This would equate to around €2.9 billion to €3.6 billion in the worst year for the three of them. Now they are suggesting the worst year of bad debts, likely to be in 2010,would see the total hit between €3.2 billion and €5.4 billion. Impaired loans are those which are not delivering according to plan and the bank has to pursue its money from the customer. In many cases they get some money back from the security they have over the loan, but either way they have to take a financial hit on the amount they don’t recover. Not all impaired loans lead to the same amount in actual losses, because the bank may get some money back.

The deterioration in the performance of the economy can be seen in the problems emerging in the profiles of the banks’ loans. For example, in September 2007 Bank of Ireland had impaired loans of €1 billion.

By the end of September 2008 that figure had reached €1.9 billion. On top of that, the bank’s loans which were ‘‘past due but not impaired’’ amounted to e€4.4 billion at the end of September 2008, up from €3 billion a year earlier.

Bank of Ireland has a total loan book of around €145 billion. It has €38 billion in loans out for construction and property. Of that around €13.1 billion are property development loans and €5.4 billion was lent out for ‘‘land bank’’ or development sites.

Residential development loans are proving to be the most toxic in this downturn. Banks are now expecting to take hits of between 3 and 5 per cent of all the loans they have in this category. Analysts still believe these estimates may be on the optimistic side, especially when the wider economic situation is taken into account.

For example, a bank may lend €50 million to a developer for a site. The developer can’t raise the cash to build houses in the current market and nobody would buy them right now anyway. He may be servicing the loan from other income streams he has, such as rent on commercial buildings. However, the wider downturn is putting pressure on rents and they are expected to fall further over the next two years. The recession means that retail businesses or office tenants could fall behind in paying their rents.

In this scenario, the developer’s ability to service or pay back the loan on the site is greatly diminished. If he defaults and the bank moves, the site itself is worth less than he paid during the boom. If he has pledged other security, such as his commercial property building, or shares or other investments, they too are now likely to be worth less.

This may be one of the reasons why Davy Stockbrokers put out a cautionary note in response to AIB’s trading statement earlier this month. The broker said that Irish residential development is the core problem, but ‘‘we are concerned that AIB is downplaying potential damage elsewhere’’.

AIB indicated that around 5 per cent of its residential development loan book would go bad; a surprisingly low estimate in this market. It seems to be based on the fact that the figure was around 3 per cent in the last big downturn in the early 1990s. But there is every reason to believe things will be a lot worse this time round.

Bad debt updates from AIB prompted brokers to reassess the bad debt potential at Anglo Irish Bank. Davy cut its profit forecasts for 2008, 2009 and 2010 by 17 per cent, 35 per cent and 52 per cent.

The broker sees Anglo Irish Bank’s bad debts hitting 1.5 per cent of its loan book or €1.1 billion in 2010. Brokers see Anglo’s biggest hit coming in residential development loans in 2009 where they have pencilled in bad debts of 5 per cent of outstanding loans in this category.

It is hard as things stand right now to see the figure remaining that low. Financial Regulator chief executive Patrick Neary told an Oireachtas committee last month that the six main Irish banks had lent property developers a total of €39 billion.

Of that, €15 billion of the construction loans were secured directly on the properties themselves. The other €24 billion was secured on other assets such as additional collateral or realisable securities. This means that at least €15 billion of development loans are vulnerable.

It also means that the collateral given for the remaining €24 billion such as shares, other properties or cashflows from other businesses, could also be vulnerable given the extent of the downfall. The banks are now waking up to, or publicly acknowledging that there is bad news coming in relation to bad debts. However, they may have several more upward revisions of those estimates in the months ahead.

gurramok

his is well short of what international investors believe and raises the question of how they are coming up with this number

There is the problem. They know the banks here are not disclosing the full extent of the issue hence the 80% drop in bank share prices over the last year.

Expect more re-adjustments of these bad debts in the coming year as the banks slowly admit the huge scale of the problem.