Stress Tests - Initial Reaction

By Eoin Fahy, Thursday, 31st March 2011 | 0 comments
Overall Comment:
The total amount needed in extra capital for the banks (€24bn) is very much in line with expectations.  But the surprises are that there is no annoucement re an ECB medium-term liquidity provision (i.e. no conversion of emergency lending into longer-term funding) and there does not appear to be any suggestion that senior bank bondholders will be “burned”.  These are both things that the government and Irish authorities badly wanted, so it appears that they have either lost the debate with the ECB, or that the issues are still being debated at EU level.
Stress Test Assumptions:
  • Banks must have a 6% core tier 1 capital ratio in the stressed scenario (this compares with 4% in the last stress tests). 
  • Repossessions and losses on mortgages are assumed to be as bad as in the US (in practice the authorities do not think that losses will be anywhere near as bad as that).
  • Total capital required: €23.6bn.
  • Of the total, €18.3bn is the amount required under the stress test per se, but the regulator has added another €5.3bn as a capital buffer to take account of further losses after three years (the stress tests cover only the next three years).
  • The €23.6bn figure is before any asset sales by the banks and before any write-offs of subordinated bank bonds, so the actual costs to the taxpayer will be lower. 
  • Losses are assumed to be 6.7% of mortgages, 4.9% of corporate loans, 12.3% of small business loans, 22% of property loans, and 21% of consumer loans. In total across all categories and all banks, the stress test assumes losses of 10%, or €27bn, over the loan lifetimes, of which 69% is assumed to arise in the next three years.
  • AIB needs €13.3bn, Bank of Ireland needs €5.2bn, ILP needs €4.0bn, and EBS needs €1.5bn.
  • The minimum core Tier 1 capital ratio requirement will be 10.5%, on an ongoing basis.
  • Senior bank bonds will not face any losses under this plan.
Government decisions:
  • The number of banks to be reduced so that there will be two “pillar” banks, and a restructured Irish Life and Permanent.
  • The first bank will be Bank of Ireland, and AIB and EBS will combine to be the second one.  Bank of Ireland will be given some time to see if it can raise private capital and avoid full state control.  AIB and EBS will be combined, keeping Northern Ireland operations and some “deposit funded operations” in the UK.
  • ILP: management have agreed to produce a detailed capital plan very shortly, and the basics of that plan are already clear.  It will immediately begin the sale of Irish Life.  Banking assets will be divided into core and non-core assets. €10bn of non-core assets will be available for sale, in total.  [The company separately announced this afternoon that it will raise €1.1bn from the sale of non-banking assets and from liability management exercises (i.e. forcing its subordinated bond holders to accept losses), leaving 2.9bn to be raised from other sources (presumably the government, ultimately).] 
  • Each  bank will separate assets into core and non-core.  Non-core assets are to be run-off over time, avoiding fire sales.  This, together with asset sales and the extra capital, will reduce the size of the bank balance sheets over time and allow ECB funding to be repaid.
  • Bank of Ireland will sell €30bn of assets by 2013, and will become much more domestically focussed.  It will be allowed time to see if can raise private capital, and the government will provide the money if it cannot.
  • AIB and EBS will combine, and deleverage €23bn by 2013.
  • €3bn of the total €23.6bn required will be ‘contingency’ funding, and may not be required/must be returned if not needed.
  • There will have to be further significant contributions from subordinated bondholders (no mention of senior bond holders, so presumably they are escaping).
  • The government will look at the situation for Anglo Irish and Irish Nationwide in May (they were not included in this exercise).
  • The government will use €17.5bn of its own resources to supply the required capital (presumably from both the National Pension Reserve Fund and from the government’s existing cash reserves).
  • There will be changes to the boards of directors in the banks.
  • The government continues to be committed to the fiscal parameters of the IMF/EU programme, although it does want to see some changes.

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