According to the Irish Independent, the recent fall in Irish bank shares is due to a loss of faith in their bad debt provisions. On Tuesday, Bank of Ireland fell 14%, the largest amount in 20 years.
After last week’s dive in their share prices, the Irish banks are under pressure as never before. It is now abundantly clear that investors no longer believe the bad debt numbers being published by the Irish banks. Until they do, bank share prices will keep on falling.
Tuesday was a defining moment for the Irish banks. With their share prices already down by between 63 per cent and 76 per cent since their peaks in the first half of 2007, banks shares tumbled by a further 5 per cent on Tuesday morning.
Events in the UK, especially the implosion of Bradford & Bingley, have been weighing on Irish shares as similar previously hidden losses are expected there soon as well. Moreover, Irish banks are also heavily exposed to the UK, where there has been a steep drop in house pries.
Overseas investors are looking at the Irish and UK property markets, to which all of the Irish banks are heavily exposed, and not liking what they see. Irish house prices are down by almost 12 per cent since March 2007, while commercial property values are down by an estimated 20 per cent. Across the water, house prices are falling at their fastest rate since 1992.
The numbers are startling. At the end of 1997, total Irish private sector credit stood at just €56bn. By the end of 2007, just 10 years later, it had risen almost seven-fold to €375bn. However, it was not just the scale of the Irish credit explosion with average annual credit growth running at over 21 per cent a year for a decade, which spooked overseas investors, but the changing composition of Irish bank lending.
A decade ago mortgage and other property-related lending, such as loans to builders and real estate developers, made up 38 per cent of all bank lending or about €21bn. By the end of 1997, the volume of such property-related lending had increased more than eleven-fold to €236bn and made up over 61 per cent of all bank lending.
In other words, property-related lending increased from just over a third of all Irish bank lending to almost two-thirds in a decade. Over the same period, average Irish house prices rose by 208 per cent.
Overseas investors take one look at those numbers and head for the hills. It is their perfectly legitimate fears — that such a huge increase in property-related lending and property prices will be followed by a price collapse, resulting in massive bad debts, and not the activities of the largely mythical short-sellers, which have caused the collapse in Irish bank share prices.
So just how massively exposed are all four quoted Irish banks to the property market?
Least exposed is AIB which has 59 per cent of its loan book tied up in bricks and mortar. Next up is Bank of Ireland where property-related lending makes up 71 per cent of all the loans on its books. IL&P’s banking subsidiary Permanent TSB is even more exposed with over 90 per cent of its loans being property-related.
Unfortunately the other Irish quoted bank, Anglo Irish, doesn’t produce a meaningful sectoral breakdown of its lending.
However, we have it from the horse’s mouth. Actually from finance director Willie McAteer, in Anglo’s recent interim results conference, that: “All lending [is] secured, cross collateralised with personal recourse”. Translated from bankerspeak that certainly means that most — if not all — Anglo’s €69bn loan book is directly or indirectly property-related.
Add it all up, and the four major Irish banks have a total exposure of about €280bn to property-related lending. Most of it to the falling Irish and British property markets. With that sort of an exposure, the only question is not if bad debts will increase but by how much. One possible answer is provided by the fall in the combined value of the Irish banks.
At their peak AIB, Bank of Ireland, IL&P and Anglo were worth a combined €58bn. By the end of this week this had fallen to just €17bn. That’s a total reduction in value of almost €41bn.
A combined bad debt charge of €41bn would be catastrophic for the four main banks. In practice, things probably aren’t quite that bad. Just as the Irish banks were overvalued in the first half of 2007 they are now probably oversold. However, bad debts of even half that amount would still condemn the Irish banks, and with them the Irish economy, to years of grinding retrenchment.
After last week’s events, there is no longer anywhere left for the Irish banks to hide. The most recent bad debt figures published by the banks, which show annual bad debt charges of between 0.09 per cent and 0.26 per cent of their loan books belong to another era and are no longer credible.
The Irish banks are going to have come clean on the real level of their bad debts. We are now entering a much more difficult period during which bank lending will at best stall and probably contract while property prices will continue to fall. This will mean much higher levels of bad debts. Unless and until the Irish banks respond to this new reality, their share prices will continue to fall.
All of that said, recent events in the US, like the bankruptcy of IndyMac can only serve to make investors in Irish financial service companies that much more nervous.