kathleen barrington

Carbon credits subsidise the polluters

2011-07-11T02:46:00.000-07:00

Sunday, July 10, 2011

By Kathleen Barrington

The emerging trade in carbon credits gets relatively little media attention, even though it is a rapidly growing global market worth up to $1 trillion.

Like motherhood and apple pie, carbon credits are generally seen as a good thing, because they are supposed to limit the amount of damaging greenhouse gases that a company can emit in a year.

The idea is that companies in areas like energy and cement get a free carbon credit allowance from the government.

If the company is a particularly dirty one, emitting more than its fair share, it must buy credits from other companies that pollute less.

If it uses up less than its allocation, it can sell the credits to others - its reward for being clean.

The system is known as ‘‘cap-and-trade’’.

The idea is that the polluters are forced to clean up or pay up. The ‘‘polluter pays’’ principle is dear to many environmentalists. But its appeal isn’t confined to the tofu-eaters; it’s also surprisingly popular with pinstriped bankers.

Investment bankers, in particular, like the idea that the amount of carbon that can be emitted will be continually lowered by governments.

This means that carbon credits should become scarcer over time, and that their value should therefore rise.

The cap-and-trade system has been up and running in Europe for years, but US president Barack Obama has hesitated to introduce it in the US amid fears that it could damage industry, though investment banks such as Goldman Sachs favour the legislation.

American journalist Matt Taibbi of Rolling Stone, who is a stern critic of Goldman Sachs, reckons the carbon credit market is attractive to investment banks because it is, in effect, a brand new commodities market where the main commodity to be traded is guaranteed to rise in price over time because of its scarcity value.

‘‘Well, you might say, who cares?” Taibbi wrote recently. ‘‘If cap-and-trade succeeds, won’t we all be saved from the catastrophe of global warming? Maybe. But cap-and-trade as envisioned by Goldman is really just a carbon tax structured so that private interests collect the revenues.”

The claim resonates here in Ireland, where certain private interests have been doing very nicely from our very own cap-and trade regime, though for the moment the beneficiaries appear to be mainly in industry rather than in the investment community.

It emerged last year that cement companies made an estimated €226 million windfall from surplus carbon credits as a result of the over-allocation by the government of carbon credits to the cement industry.

Among the chief beneficiaries were Irish Cement, a division of cement giant CRH, the Quinn Group, headed by businessman Sean Quinn, and Lagan Cement.

Peter Goode, a director of Goode Concrete and a vocal critic of CRH who is embroiled in a High Court dispute with the building materials firm, described the carbon credit trade in Ireland as a ‘‘scam’’, which the Irish government had bequeathed to the cement industry ‘‘as a gift from the heavily burdened taxpayers’’.

Worse still, said Goode, the measure, which was designed to encourage industry to close down inefficient plants, instead had the effect of keeping them open. ‘‘If they close the factory, the credits disappear,” he said.

Paddy Healy, a former director of concrete provider Healy Brothers, agrees. ‘‘The carbon credit system is operating the exact opposite of how it should,” he said.

This is not a uniquely Irish phenomenon. A report published last week found that the European steel and cement industry had already accumulated surplus carbon credits worth a combined €4.9 billion under the EU’s Emissions Trading Scheme.

Sandbag, a group lobbying for a public interest implementation of cap-and-trade, found that, ‘‘just as loosely-fitted seatbelts are useless in preventing injury, a cap sitting above the emissions of the majority of participants is also useless’’.

The scheme has outraged providers of more eco-friendly cement. They argue that polluting cement effectively receives a taxpayer subsidy.

The windfall gains to the cement industry have arisen partly because of the recession, with the result that demand dropped between 2007 and 2008, whereas the allocation of carbon credits during the period 2008-2012 had assumed a high-growth scenario.

But critics said the over-allocation was also a result of strong lobbying by the affected industries.

Now, the EU may once again be poised to over-allocate carbon credits to the cement sector in the next phase of the scheme.

The gains to Irish cement companies could be very large if this happens. One source estimated that the Irish cement industry stood to make a further €625 million in windfall profits over the next seven years, on top of the €226 million it has already made. The result is that the Irish taxpayer will have transferred about €850 million to the cement industry from 2008 to 2020, at a time when the government is financially stressed.

Much of this was entirely predictable, as correspondence obtained by The Sunday Business Post reveals.

As far back as 2005, Seamus Maye, head of the Quarry and Concrete Family Alliance, wrote to the Environmental Protection Agency warning that no account had been taken of the cyclical nature of the construction industry when it came to the allocation of credits.

He pointed out that the industry was then producing at unprecedented record levels.

‘‘When the inevitable fall-off in activity occurs, the cement industry and specifically CRH is set to be rewarded by cashing in on massive CO2 surpluses or ‘‘credits’’, potentially putting tens of millions of euro into the pockets of the polluters,” he wrote at the time.

Things have turned out more or less as Maye predicted. Earlier this year, the Economic and Social Research Institute noted the potentially large gains for plants covered by the scheme and called for a tax on such windfall profits in the electricity and cement markets.

Separately, the emergence of cap-and-trade schemes has given rise to a big global market in carbon credits, a market in which Ireland is seeking to play a role. Financial Services Ireland director Brendan Bruen said earlier this year that global carbon trading volumes were expected to reach $1 trillion by 2020.

The financial services industry has already successfully lobbied for changes in Irish tax legislation to allow carbon credits to be bundled up and traded as shares, in the process known as securitisation.

One effect of the amended legislation is that foreign investors will be able to take their profits from investments in carbon credits in a tax-efficient manner.

The foreign investors will, therefore, avoid paying certain taxes on profits made from investing in assets known as carbon credits - assets that were effectively a gift from European taxpayers.

You wonder if it wouldn’t have been better value for taxpayers simply to have carbon emissions taxed in a clear and transparent manner in the first place.

A stealthy, lucrative sleight of hand

2011-07-05T14:57:00.000-07:00

Sunday, July 03, 2011 By Kathleen Barrington

Do you remember Bob Diamond of Barclays Bank being examined before a British parliamentary committee earlier this year?

He was being asked to explain why Barclays had paid just stg£113million (€125million) corporation tax in a year when it made £6.2 billion in profits.

It was big news on TV and in the papers.

The House of Commons cross-party select committee wanted to know how the £6.75 million-a-year boss had managed to keep Barclays’ corporation tax bill so low, at a time when its profits were so high.

It turned out that part of the answer to that question was that Barclays had racked up massive losses lending to sub-prime borrowers in the US. It was then able to offset those losses against its British corporation tax bill.

It won’t be any surprise if our own bankers repeat Diamond’s trick.

And it will be equally unsurprising if some ambitious politician seeks to hog the headlines by hauling a few of them before a Dáil committee in a few years’ time, to make them explain why they are paying so little corporation tax now that they are profitable again.

The bankers are likely to answer that part of the reason they are paying so little tax is that they are legally entitled to offset losses racked up during the financial crisis against their newly-restored profits.

That is likely to prove controversial, as the tax losses available for offsetting against future profits are absolutely enormous - as this newspaper revealed last week.

The figures released by Minister for Finance Michael Noonan showed that the 100 largest banks operating in the state, which include IFSC operations, would be able to carry forward €34 billion in unused losses and capital allowances to reduce the amount of tax they pay in the future.

Take Bank of Ireland, for example. It is headed by Richie Boucher, who has been on the board of the bank since 2006, a period in which it engaged in a reckless lending spree.

Bank of Ireland has reported heavy losses in recent years, and has survived only with the support of billions of euro from the Irish taxpayer.

But every cloud has a silver lining, and some of those losses have morphed into assets on the Bank of Ireland’s balance sheet, assets that might be attractive to a potential purchaser.

Some of those tax losses are described as deferred tax assets, an accounting term used to describe an item on a company’s balance sheet that may be used to reduce its tax bill in the future.

‘‘In accordance with applicable accounting rules, the Group has recognised deferred tax assets on losses available to relieve future profits to the extent that it is probable that such losses will be utilised,” the note stated.

That’s an asset which could prove very attractive to a future owner of the bank - especially a bank that is currently very profitable and seeking to reduce its tax bill.

True, it’s perfectly normal business practice to allow businesses to write off profits against prior losses.

However, it is one thing to allow a business to write off losses against future profits when it is the shareholders, the board and management of those businesses who picked up the tab for the losses in the first place - and quite another to allow a business to write off big losses against future profits, when it’s the taxpayer who has picked up the tab for the losses after the shareholders were wiped out.

It is the support of taxpayers that has enabled the banks to avoid liquidation and their management and employees to remain in often well-remunerated employment in circumstances where, if the rules of free market capitalism had applied, they would be out of a job.

It is doubtful whether the public would be happy to see a new, private owner substantially reducing its tax bill as a result of availing of that deferred tax asset, particularly if some of the management team that caused the original bank problem in the first place survived intact under the new owners.

The public would almost certainly view such a move as yet another example of bankers getting the better of policymakers. Certainly, the Organisation for Economic Co-Operation and Development was so concerned about this issue that it published a report on the matter two years ago.

The report pointed out that, as a result of the financial crisis, a large number of banks had sustained substantial losses. ‘‘The scale of those losses, and the potential regulatory capital, profit and cashflow benefits for banks able to convert them into cash, mean that revenue bodies must be alert to potential tax compliance risks as a result of aggressive tax planning involving losses,” it warned.

The OECD pointed out that ‘‘these large commercial losses can be regarded as the flip side of large profits made in the years prior to the crisis, with increased bank leverage combined with asset valuations which underpriced risk, producing exceptionally large returns on . . . capital.”

In short, the banks made a fortune in the good times by taking excessive risks, secure in the knowledge they wouldn’t be allowed to fail; they passed the bill to the taxpayer when times got tough; and they are likely to offset the losses they have racked up against future profits - most likely when the banks are back in private ownership.

The previous government recognised this risk to a certain degree, when it imposed certain tax loss restrictions on banks transferring loans to the National Asset Management Agency.

The measure means that, when the institutions return to profitability, a minimum of 50 per cent of their trading income will remain chargeable to tax in an accounting period, notwithstanding claims for relief for losses carried forward into that period.

It remains to be seen whether this will be enough to satisfy a public that will have been reeling from years of cutbacks and tax hikes when the banks eventually return to profitability.

But if the example of Britain is anything to go by, the banks will get their way. British chancellor George Osborne, who initially floated the idea of stopping banks offsetting their losses against tax while he was in opposition, changed his mind as soon as he got into government.

Instead, he introduced a bank levy. Shares in the banks rose on the day the levy was announced, as it was less costly than the banks had feared.

Graduates face difficult career decisions

2011-06-27T10:44:00.000-07:00

By Kathleen Barrington

Now that they have finished their school and university exams, this year’s student graduates will have to consider where on earth they are going to find jobs at a time when unemployment is running at almost 15 per cent.

It is four years since this column pointed out that it would make financial sense for students sitting the Leaving Cert to consider a career in the public sector due to higher pay, better pensions and shorter working hours.

At that time, you could earn on average €47,000 a year in the public sector, compared with just €32,000 a year in industry.

You could also look forward to a pension pot that was typically worth about €1 million more than a private sector one.

It is still largely true that you stand to be better paid if you work in the public sector than in the private sector, judging by the CSO statistics published earlier this month.

They showed that average weekly earnings in the public sector amounted to €871.09, compared with €602.85 in the private sector.

But the backdrop against which students are making their career decisions has changed utterly since 2007.

There is an embargo on public sector recruitment, while public sector pay and pensions, which have already been cut, could be further slashed even if they currently remain more generous than private sector pay and pensions.

The harsh reality is that the public sector won’t be hiring en masse over the next few years, forcing a new generation of school and university-leavers to consider private sector solutions to their employment needs - whether that be at home or abroad.

A recent study by the international recruiting firm Manpower Group makes for interesting reading, as it shows where the job shortages are - both globally and domestically.

In a survey of 40,000 employers across 39 countries including Ireland, Manpower found one in three employers was experiencing difficulty filling positions ‘‘due to a lack of available talent’’.

It also said that employers were more likely to report difficulty this year than at any time since 2007.

The top jobs that global employers are having difficulty filling are technicians, sales representatives, skilled trades workers, engineers and labourers, according to the survey.

That’s followed by managers/executives, accounting and finance staff, information technology staff, production operators and secretaries.

Employers now find filling vacancies in Ireland easier than in all but one of the 39 countries surveyed.That won’t come as a surprise, given the sharp rise in unemployment over the last four years.

The relative ease with which employers can now fill vacancies means it is effectively an employers’ market, though the ready availability of labour should be helpful to the Industrial Development Authority in persuading foreign employers to locate here in the future.

But the Manpower survey also found there are still jobs which employers find relatively difficult to fill in Ireland. Top of the list are sales representatives, followed by engineers, secretaries, nurses, chefs and cooks.

The next most difficult positions to fill are drivers, skilled trade workers, managers, call centre operators and quality controllers.

In another pointer to job applicants, the three main reasons for having difficulty filling jobs are lack of experience, no applicants or lack of technical skills.

The lack of experience issue should be easily resolved by ambitious candidates if they gain work experience in their desired area during the holidays before presenting themselves for a formal interview.

Of course, many school and university-leavers will also want to take into account which jobs will likely pay them best.

However, the jobs for which there is most employer demand aren’t necessarily the best paid, judging by a salary survey published by Morgan McKinley this year.

The survey, which is available at www.morganmckinley.ie, shows that, despite the downturn in the financial services sector, jobs in accountancy and finance generally pay better than jobs in areas where employers are experiencing shortages, such as engineering.

For example, the top-paying job in information technology covered in the survey is a chief technology officer with more than five years’ experience. Someone in that position would expect to earn €125,000 a year. The next best-paying job in IT is a software development manager who, after five years, would expect to earn about €93,000.

By contrast, the top-paid finance director of a large company would expect to earn about €150,000 a year in Dublin, while a financial controller would expect to earn about €110,000 in Dublin.

The middle management jobs in financial services also appear to be better paid than middle ranking jobs in engineering, though comparisons between sectors are quite difficult as the job categories aren’t always strictly comparable.

At the bottom end of the scale, it seems that customer services staff with languages remain quite modestly paid even though employers say such jobs are hard to fill.

That suggests that candidates are either not particularly interested in the work or that they find the salaries unattractive.

One thing is clear though: this year’s crop of school-leavers and students need to study the jobs market carefully before making choices about their future careers.

They must consider where the vacancies are, what the pay and promotional opportunities are likely to be and how those match up against their own personal interests, knowledge, skills and ambitions.

Banks buying from their own borrowers

2011-06-20T08:32:00.000-07:00

Sunday, June 19, 2011

The subsidiaries of foreign-owned banks are poised to buy back prime properties on the cheap from their own distressed borrowers.

The banks are particularly keen on buying back fine investment properties in well located areas, according to market sources.

The sources said that in some cases it was the banks’ employee pension funds that would buy back the properties; in others it was special units of the banks which had been set up to hold distressed properties until there was a recovery in the market.

The expectation is that the subsidiaries of the foreign-owned banks in the South will soon be following the example set by their British and Northern Irish counterparts, who have been buying up prime assets from their own distressed loan book.

Last week, for instance, Ulster Bank took over a designer outlet retail park near Banbridge, Co. Down.

The stg£70 million Outlet, as it is entitled, was developed by GML Estates, a division of developer John Farmer’s Orana Group.

(The Orana Group is known to investors in the Republic, as some clients of Goodbody stockbrokers lost €31 million in the Northern Ireland Property Fund, which had a joint venture with Orana.)

The Outlet contains 82 stores employing 500 staff. The developer had originally hoped to attract many shoppers from the Republic. But southern consumers are no longer travelling there in such large numbers, as they now have less money in their pockets due to rising unemployment, lower wages and higher taxes. Higher petrol costs have also dulled enthusiasm for long distance shopping trips.

The vehicle used by Ulster Bank to acquire the Outlet last week was West Register (Northern Ireland) Property Ltd. The company is a subsidiary of West Register Property, a division of the Royal Bank of Scotland, the Scottish bank that is the ultimate parent of Ulster Bank. West Register Property acquires assets from RBS’s distressed property portfolio if it considers this the best way to recover the most money for the bank in the medium term.

Last year, Ernst & Young, which had been appointed as administrators to the Richmond Shopping Centre in Derry, sold the centre to West Register. The business had been placed in administration after RBS had called in its loans.

RBS is not the only British bank buying up assets from its own distressed borrowers: Lloyds Banking Group also currently operates a similar subsidiary in Britain.

The model that it has adopted was previously used by British banks following the British property crash in the early 1990s. The idea was to avoid having to account for the losses if the properties were sold on the open market and to benefit from any future recovery in the property market.

However, there have been suggestions in Britain that West Register has sometimes acquired distressed property at below market value, leaving the original borrowers with a sour taste in their mouths.

Last year, Property Week, the British property magazine, reported that RBS had sold one of its most high-profile distressed properties (Charters, the luxury residential development in Sunningdale, southwest London) to West Register.

The magazine said that RBS had, in July 2010, ‘‘sold’’ the scheme to West Register for stg£16.2 million, a year after appointing chartered accountancy firm PriceWaterhouseCoopers as administrators to the development.

John Morris, a director of the development, claimed at the time of the administration in May 2009 that RBS had turned down a £30 million plus offer for the scheme, an offer which was backed up by an independent valuation for Investec, the lending bank.

The July 2010 transaction for just £16.2 million raised eyebrows in Britain, given that luxury residential values in the south-east had risen markedly since May 2009. Property Week said at the time that it had been unable to obtain a comment from either RBS or PWC on the ‘‘cut price £16.2 million sale to West Register’’.

Of course, the banks will want to get the best return on their distressed property portfolios. And they may be of the view that the best way to get a good result is to hold out for a market recovery in the medium term.

But the distressed investors could be forgiven for thinking that they are being penalised for having acquired good assets, which will likely recover in value over the medium term.

They may also fret that the banks have a conflict of interest in that they may want to rush to buy assets at the current distressed prices, so that they can benefit from any future upswing.

The activities of West Register in the North and in Britain are likely to be of interest to property investors in the Republic who own prime assets funded with borrowings from Ulster Bank. That’s because Companies Office filings show that, in 2009, Ulster Bank set up a division called West Register Property (Republic of Ireland) Ltd, to acquire and develop property assets here.

A spokesman for Ulster Bank said that the southern West Register had done ‘‘nothing significant’’ so far. She indicated that West Register only bought back property in cases where Ulster Bank had provided the original loan for the property.

She also said that West Register normally only bought property when it had already been placed on the market for sale and that it would be sold at market value.

She said if there was only a single bid in the market, the deal was done at arms length.

The investors to whom Ulster Bank lent vast sums of money to buy assets at high prices in the past will certainly be hoping that Ulster Bank lives up to those assurances.

Investors left in limbo by apartment wrangle

2011-06-14T11:08:00.000-07:00

Sunday, June 12, 2011

By Kathleen Barrington

The fortunes of an estimated 120 investors in the Citywest Golf Suites developed by businessman Jim Mansfield have taken a turn for the worse in recent months.

The investors paid a combined €52 million for 140 apartments at Mansfield’s leisure and conference complex in west Dublin, which went into receivership last year.

They bought the apartments and leased them back to Mansfield. In exchange, they were to get a guaranteed annual rental for an initial period of seven years.

Things got off to a good start during the boom years.

But some of the investors say they suffered an initial loss when Mansfield’s HSS Developments ceased making timely rental payments to them two years ago, as his business began to struggle with the downturn.

That left the investors making repayments on hefty mortgages entirely out of their own pockets, as they were no longer getting any rental income.

Some of the investors have said they are very stressed as their banks are now demanding capital and interest repayments on their mortgages, which were initially interest-only.

The plight of the investors got worse after the decision of Bank of Scotland Ireland (BOSI), one of Mansfield’s financial backers, to appoint a receiver to HSS last year.

Due to complications arising from the receivership, the owner investors are being denied access to their properties, making it impossible to convert, rent or occupy them.

On top of that, investors are owed thousands in promised rental income from Mansfield’s company, which was using the apartments as hotel rooms.

BOSI, which was owed €180 million, appointed Martin Ferris as receiver over its interests in the ground floor and common areas in the Citywest Golf Suite block.

Investors are now uncertain whether the units they own in the ‘apart hotel’ are insured. Ferris told them that he had only insured his own interest in the building -the ground floor and the common areas.

Ferris told The Sunday Business Post that he was only responsible for insuring those areas. He also said that he had not received service charges from the investors.

He said they should be raising their concerns with their agent, a company called Capitacorp, which is headed by director Jack Kinnerk.

Kinnerk declined to comment. But it is understood that he is working on a solution to resolve a very complex situation that was not envisaged at the time that the investors bought their apartments.

The apartments effectively amount to units of three hotel bedrooms, sold at prices ranging from €200,000 to €400,000 per unit.

The investors enjoyed tax breaks associated with investing in hotels, which allowed them to write off certain costs against other income, mainly other rental income.

Peter Bradshaw’s mother, Angela, is one of the investors in the Citywest Golf Suites. He has a Land Registry document showing that she has legal title to one of the units in the hotel.

He said she was owed rent of €18,000, which was not paid by HSS. When she was paying interest only, her mortgage repayments were €800 a month. Now that capital and interest are included, she is paying €2,400 a month.

Peter Bradshaw said that he tried to gain access to his mother’s apartment the week before last, in order to begin work on converting the hotel bedrooms into an apartment.

He said he had given the management prior notice of his intention to gain access. But he was refused entrance by security staff, who told him they were working for Ferris. This leaves his mother in the position of owning a unit to which she has no access, on which she is servicing a mortgage and which may not be insured in the event of a fire or other damage.

He wanted to get access to her unit and convert it into an apartment so she can either rent it or move in.

‘‘Imagine owning an apartment and not being able to get into it, and paying €2,400 in capital and interest. We are not allowed to let the apartment and we are not allowed to get into the building,” said Angela.

Other sources said the question of returning the hotel bedrooms to apartment usage was fraught with difficulties, as it required a change of planning in circumstances where the building was licensed as a hotel.

The Bradshaws are not the only investors who are concerned. Other investors spoke on condition of anonymity.

One said he had spent about €1.2 million on three units, but hadn’t received any rental income from his units for the last two years. He said that when he pays capital and interest back to his bank, he will face repayments of €10,000 a month on units from which he is getting no income at all. He too would like to have the units converted back to apartments that could be rented out.

He was concerned that, if this problem was not sorted out soon, it could jeopardise his relationship with his bank, which is funding a separate new business venture that he says could bring 100 jobs to the town in the west where he lives. He said all he wanted was the ‘‘the apartment and the use of the apartment back’’.

An accountant who introduced clients to the development and invested in the development herself made the point that since the hotel tax breaks expired, there should be no difficulty in converting the units back to apartments.

She said many investors were very happy with the location of their investment, and were simply seeking a solution to their problem. The investors are believed to have mortgages with a range of banks, including BOSI itself. BOSI declined to comment, and referred all queries to Ferris.

Several sources have suggested that some of the investors have already defaulted on their mortgages, though the precise numbers could not be quantified. This raises the possibility that the banks may now have title to apartments that are uninsured.

One thing is clear: the situation is a mess and needs to be resolved.
Otherwise, the fear is that the matter could end up in court - where the only winners would be the lawyers.

Investors nurse losses after trusting sales rep

2011-06-07T04:49:00.000-07:00

05 June 2011

By Kathleen Barrington

It is three and half years since Leo and Marie Dunne invested €130,000 in what they say they understood was a capital guaranteed fund.

The couple, long-standing Bank of Ireland customers, invested in a policy called the Financials Fund, which was sold to them by a representative of Bank of Ireland Life.

They ended up losing €48,000 of the €130,000 when they cashed in their policy three years later, after discovering their capital wasn’t guaranteed after all.

The Dunnes were just two of many investors who invested a combined €25 million in the fund in late 2007.The fund’s top ten holdings included many international banks, as well as Bank of Ireland stock.

In October 2007, Leo left Eircom after 30 years’ service. Leo, then 47, and Marie, then 46, were planning to live in Italy, where they had a home. But it would be another 13 years until Leo turned 60 and his Eircom pension would kick in. In the meantime, they were planning to live on their €230,000 savings for the next 13 years, plus some rental income from their house in Ireland.

The €230,000 was at the time earning about 3.5 per cent with ICS, another Bank of Ireland subsidiary.

The couple wanted to invest some of the money in a secure, but higher-yielding, investment.

In the autumn of 2007, they met with a Bank of Ireland Life sales representative.

They say they told the rep their main requirement was that their capital be safe and that the term of the investment not exceed three years.

They say they repeated those requirements at a second meeting with the sales rep on December 13, 2007.

They say that at the second meeting they agreed to sign up for the Financials Fund in the belief that their capital was guaranteed.

They say they signed a form and the rep filled in all the other details. They returned to Italy on December 18, 2007.

In the spring of 2008, Leo and Marie became interested in buying a more expensive house in Italy. In order to proceed with a contract, they needed to know if they could borrow from Bank of Ireland if their existing house in Italy did not sell in time.

Leo contacted the sales rep who had advised him on his Financials Fund investment.

The sales rep referred him to a loan officer.

When Leo asked the loan officer if he could use the Financials Fund as collateral for the loan, he said the loan officer told him that the capital in the Financials Fund was not guaranteed, but that he was sure it would be fine, as he himself had invested in the fund. ‘‘This obviously caused us some concern," Leo said.

Leo then e-mailed the sales rep who had originally sold him the fund.

The rep contacted him by phone. During the May 2008 phone call, Leo asked the rep if the loan officer was correct in his assertion that the capital in the Financials Fund was not secure.

Leo said the sales rep told him the loan officer was either mistaken or had misunderstood the question.

Leo and Marie returned to Ireland for a family wedding later in May and picked up the information about the Financials Fund that had been posted to their Irish address, even though they had been living in Italy since October 2007.

They became concerned that it did not appear to offer the guarantee they had asked for. They complained to Bank of Ireland Life. The company’s position was that it was clearly stated in the policy documentation that the investment was not guaranteed. It said the policy was sold in good faith, the risks were explained and that the couple had been offered a cooling-off period.

Bank of Ireland Life said in a letter that it did not hold a recording of the May telephone conversation during which Leo was allegedly reassured that the fund was guaranteed.

‘‘As such, we are unable to comment on any information or policy details provided to you during this call in relation to the security of your capital sum."

The sales rep has since left the bank and could not be reached for comment.

The Dunnes subsequently complained to the Financial Services Ombudsman that they had been mis-sold the investment. In May 2009, the Ombudsman found against them.

The Ombudsman ruled that the essence of the complaint was whether they were aware that the policy did not have a capital guarantee. The Ombudsman noted that the Dunnes had signed the personal review form which contained a declaration that they had received and read a copy of the company’s terms of business document, that they had read and understood the information provided and that it was an accurate reflection of their circumstances.

The Ombudsman also noted that the Financials Fund booklet said the illustrated benefits were not guaranteed. The Ombudsman also noted that the documents were sent to the address given on the application form in December 2007.

But the Dunnes say they didn’t know what was on the form because it was filled in by the sales rep after they had ‘‘naively’’ signed it blank. They also say that they didn’t read the documents sent to them at their Irish address because they were in Italy.

In an interview stretching over several hours at their home in Navan, Co Meath, Leo and Marie pointed to many inaccuracies in the form that they believe could prove they did not get an opportunity to review it. Chief among these is a monumental overstatement of their monthly income.

‘‘The form states we have monthly incomes of €30,000, each which is incorrect," Leo said.

The couple say the only income they had at the time was the €650 in rent from their home in Ireland. Marie said that even when she was working, she barely earned €30,000a year, never mind a month.

Unfortunately, there was no oral hearing held at which the Dunnes’ version of events could be tested against the sales rep’s account.

The Dunnes are also unhappy that they had only 21 days to make an appeal to the High Court (they did not appeal). They are also unhappy that they had no right to have the case reviewed internally.

Eddie Doyle, managing director of financial claims company Refund.ie, has also met the couple.

He remarked on ‘‘the large number of apparent errors’’ in the documentation originating from the bank, and the inconsistencies in the comments and observations of the bank’s representative.

‘‘One would have imagined that these anomalies would have triggered some form of verbal examination of both parties by the adjudicator before arriving at a final decision," he said.

The Dunnes feel it would be unwise to take legal action on their own as it would be too expensive to redress a loss of €48,000. They are going public in the hope that anyone who has had a similar experience will contact them.

It is believed there may be others who suffered even bigger losses than the Dunnes, as Bank of Ireland launched a second Financials Fund in February 2008.

There was also a geared version of both funds where investors borrowed to invest in bank shares, leaving them nursing even larger losses, possibly in excess of 70 per cent.

© Thomas Crosbie Media 2011.

Another Anglo mess to be unravelled?

2011-05-30T07:30:00.000-07:00

Sunday, May 29, 2011

By Kathleen Barrington

A senior businessman took time out from his hectic schedule last week to explain to me what he considers to be the ‘‘multiple conflicts of interest’’ that Anglo Irish Bank has in its dealings with private investors, through its wealth management division.

The executive, who spoke on condition of anonymity, was one of a number of investors who, in 2006, invested between €500,000 and €1 million in Anglo’s European Geared Property Fund.

The fund ultimately raised about €1.3 billion in equity and borrowings to acquire property in Britain, Ireland, Belgium, Germany, France and Romania, some of it developed by Anglo’s own Irish developer clients.

The businessman has now been told that his investment is worth about 28 per cent of the amount he invested.

So anyone who invested €1 million in the fund has seen €720,000 wiped off the value of the investment. If the €1 million was borrowed from Anglo, the loan remains to be repaid even though the assets in the fund have plunged in value.

Investors lost even larger sums in other investments touted by Anglo’s private banking and life assurance subsidiaries.

Last year, The Sunday Business Post reported that people who bought into Anglo’s Select Geared Property Fund, opened in 2007, had seen 97.5 per cent of their investment wiped out.

The businessman says many of the properties backing the two funds were sourced from property developers who were some of Anglo’s biggest borrowers.

‘‘As a result of the continuous stream of publicity from the courts, it is now apparent that most of the properties were bought from, or with, clients of the bank. Since then, it has become obvious that those clients were in serious trouble at the time. Some have been declared insolvent,” he said.

The businessman says he understood that when he invested in the European Geared Property fund in October/November 2006, he was investing in properties that had already been secured by the bank up to 18 months previously, and that they had increased in value since.

He shows a handwritten note from Anglo Irish Private Banking, in which the executive promoting the fund writes:’ ‘Give me a shout when you have had a chance to review. A considerable number of the properties are substantially in the money having been secured 6-18 months ago.”

He believes this claim was misleading, as subsequent documentation showed that the vast bulk of the properties were acquired after 2006.

The businessman also says that about a year after he invested in Anglo’s European Geared Property Fund, he was offered a loan facility to invest in the Select Geared Property Fund.

He says that he told Anglo that he did not want to participate in the second fund, as he thought the valuations of the properties were too high.

‘‘I was astounded some time later to discover that the European Geared Property Fund had, in fact, bought at least one of those properties which were part of the Select Geared Property Fund that I had refused to invest in,” he said.

The businessman raises a number of serious questions, such as whether the interests of the investors in the fund were being adequately protected by the wealth management division, in circumstances where the equity the investors were putting up may have had the effect of bailing out the bank and/or its clients.

Anglo strongly rejects the idea that a conflict existed.

‘‘The vast majority of the properties in the European Geared Property Fund [EGPF] were bought on the open market from third parties, in conjunction with - not from - the relevant joint venture partner,” the bank said in a statement.

‘‘In a small number of cases, Anglo bought from the developer on pre-agreed contractual terms when the site was being developed.

"Importantly, in those instances, investors were not exposed to development risk as Anglo contracted to buy the finished building only, thereby removing development risk from the EGPF. The intention of the bank was not to have development risk in the fund.”

Anglo also insisted that the European Geared Property Fund was marketed in a fully transparent way.

‘‘All clients were made well aware, during the equity raising period, through the fully disclosed information contained in the fund brochure that Anglo provided senior debt and temporary equity bridging finance for the projects in question.

The full extent of Anglo’s relationship with all parties, including developers and JV Partners, was made very clear to all potential investors,” it said.

Anglo also said the brochure included a clear statement of all fees, expenses and costs associated with the acquisition and management of the fund and underlying properties.

It said that ‘‘all investors have had, and continue to have, the right to come into the bank and review all documentation related to the fund and each of the underlying properties’’.

The brochure, seen by this newspaper, did make absolutely clear that the charges would have wiped out 29 per cent of the investor’s initial investment at the end of the first year.

The figure assumed no rental income and no change in the capital value of the properties in which the fund invested, though in practice investors would have been expecting rental increases and rising property values.

The charges were large because there were so many advisers feeding at the investors’ trough.

The typical costs included fees for agents, surveyors, valuers, lawyers and tax experts, and a slice for the taxman in the form of stamp duty, capital duty and Vat.

The documents reveal that investors paid between 1 per cent and 1.5 per cent to the fund’s joint venture partners for originating and structuring the transactions. This fee was calculated on the gross property value. Anglo’s offer documents also show that the bank charged loan arrangement and other fees, equivalent to about 1 per cent of the amount borrowed.

It is true that Anglo informed investors that the investments were high-risk. In particular, the Anglo documents clearly warned about the dangers of borrowing to invest. It noted that a fall in the capital value of the investment of 20 per cent would reduce the value of investor equity to zero.

Some of the investors have hired solicitors LKG to examine whether there is the basis for taking a case that Anglo’s wealth division was either incompetent or failed in its fiduciary responsibility to its customers.

At the time of writing, the solicitors had been contacted by 15 disgruntled investors after the firm placed an ad in a national newspaper.

It remains to be seen if there is any basis for taking legal action, and whether the investors will show willing to throw good money after bad.
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The great pension double standard

2011-05-24T01:32:00.000-07:00

22 May 2011 By Kathleen Barrington

I vividly recall my first lunch at Irish Life, more than 20 years ago. The management team invited business journalists to join them in their private dining room following the publication of the company’s results.

The lunch was served by waitresses dressed in black and white maids’ outfits, while a butler served wine from crystal decanters.

I wondered briefly, at the time, about the impact the cost of Irish Life’s swanky head office would have on overall pension performance.

It is a question I’m now wondering about again, as I consider the impact that high pension fund charges are having on the performance of Irish pension funds.

It was good to see the pensions industry finally coming clean on the dramatic impact that the charges can have over the lifetime of a fund, even if the industry’s motive was to embarrass the government over its new pensions levy.

We now know that a 0.6 per cent annual levy on pension schemes could result in a 21 per cent fall in the value of private pension funds if it were to be continued over the lifetime of the fund.

Even if you are hostile to the pension levy, you can’t help noticing how loudly the industry is willing to shout about the impact of a 0.6 per cent tax on the value of pension schemes, while it is generally silent on the question of the impact that its own (often higher) charges have on pension outcomes.

For the reality is that Irish pension fund charges are high by international standards, and that the high cost of charges here impacts on the performance of pension funds.

In the case of Personal Retirement Savings Accounts (PRSAs), for example, some pension managers charge 5 per cent of every contribution plus a 1 per cent management fee.

So when you contribute €100 to your PRSA, the fund manager swipes €5.95, leaving you with just €94.05 of your original €100 investment.

The fund manager would have to deliver a return of almost 7 per cent when he invested that €94.05 just to give you back your original €100, never mind to increase it.

Industry sources argue that the PRSAs are expensive due to regulatory costs, and that charges for the management of other kinds of pension funds can be as low as 0.25per cent for certain schemes.

But research carried out by Aidan Mahon, a postgraduate student at the Waterford Institute of Technology (WIT), found that industry charges swallowed up a staggering 26 per cent of the total pot of retirement income over the lifetime of a pension in private sector schemes.

Mahon didn’t have a raft of PR advisers to promote his findings on radio, television and in the print media, which meant that his work didn’t get the media and political scrutiny it deserved, although it was mentioned in this newspaper and in the Irish Independent.

It is worth repeating some of Mahon’s key findings, including the fact that charges borne by the smallest schemes represent 3.64 per cent of assets while the charges borne by the larger schemes represent only 0.32 per cent of assets.

The difference that these charges make to the final pension pot available for retirees is absolutely enormous.

Mahon found that, for a small Irish pension scheme with just 36 members, charges would lead to a reduction in the retirement pot of almost 76 per cent.

He reckoned that each member of the 36-person pension scheme forked out about €2,000 in charges each year.

By contrast, the members of the larger schemes faced only a relatively modest reduction in their retirement pot of just 6.67 per cent due to charges. Mahon calculated that the members of the larger schemes typically shelled out about €175 in charges each year.

The greater charges carried by members of smaller schemes make a huge difference to the pension pot available because funds that would otherwise have been invested on behalf of the member are instead swallowed up in charges.

Mahon recommended that smaller occupational pension schemes should be merged, to allow them to gain the efficiencies associated with economies of scale. The case for consolidation of pension schemes was particularly strong for some semi-state bodies because they had similar pension scheme arrangements.

He also recommended that service providers should be required to report costs in a standardised broken-down manner which illustrated the effect of charges on the overall pension fund; and that a study should be carried out to compare pension costs across countries.

The charging structures of Irish pension funds are notoriously opaque, giving rise to problems comparing charges across pension providers. But Mahon cited research that suggested that Irish pension fund charges were substantially higher than elsewhere.

For instance, the mean percentage of assets absorbed by fees in Ireland amounted to 1.25 per cent compared with 1.08 per cent in Australia and between 0.2 and 0.9 per cent in the United States.

The Green Paper on Pensions published in 2007 also noted the impact that charges had on the performance of Irish pension funds and the opacity of the pension fund charging structures.

The returns recorded by the pensions industry in recent years have been very poor due to a combination of high charges, falling interest rates, improved longevity and poor pension fund performance.

Irish pension funds were the worst-performing in the world in 2008, the year of the financial crash, as they were over-exposed to shares and property, according to an OECD report.

In short, we appear to be paying our pension managers more money for inferior performance.

The Pensions Board had been leaning on employers to contribute more to their pension schemes in recent years, in an effort to plug the very big deficits in many of the country’s pension schemes.

Many employers contributed very generously in an effort to meet the promises they made to their employees. Now, those employers can only look on in horror as the government swipes some of the money that was intended to fill pension fund holes.

Against that background, it is unlikely that employers will be willing to contribute more to their pension funds, making it highly probable that the promised benefits to pensioners will have to be cut. It would be far preferable if the pensions industry started by cutting its own costs before eating into its customers’ pension funds.

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Gamble that put a spanner in Saxony’s works

2011-05-16T03:50:00.000-07:00

15 May 2011

By Kathleen Barrington

Dr Gerhard Schick is a German economist and Green MP who represents the state of Baden-Wurttemberg in the national parliament.

He was in Dublin recently to bone up on the causes of the Irish financial crisis. One of the places he told me he wanted to see was the office of Ormond Quay Funding, a special purpose vehicle (SPV) located in the International Financial Services Centre.

You probably don’t remember a whole lot about Ormond Quay Funding, an early casualty of the international credit crunch. But the SPV is of big interest to German taxpayers, who were forced to inject €17 billion in emergency liquidity after Ormond Quay lost access to short-term borrowing to fund long-term investments.

‘‘Lehman toxic debt advice led Leipzig bank to ruin via Dublin’’, was the headline on one story describing the impact that Ormond Quay had on the finances of the state of Saxony.

The story, published in 2008, recounted how teachers at the Clara Zetkin Middle School in Freiberg were counting on a budget surplus to ease staff shortages across the state.

But those hopes had faded because of bets made by state owned Sachsen Landesbank on structured investments backed by mortgages in the US.

The gambles were made using Ormond Quay and another Dublin-based SPV.

‘‘They gambled away money needed for Saxony’s teachers,” complained Wolfgang Renner, 55, a maths teacher.

The story began in 1999, when Sachsen decided to set up a Dublin operation, Sachsen LB Europe Plc, to take advantage of Ireland’s 12.5 per cent corporate tax rate, which compared very favourably with Germany’s 30 percent rate.

At first, the Dublin unit focused on low-risk, low-margin investments, such as European corporate and government bonds.

Then Sachsen LB Europe overreached. First, it created Ormond Quay Funding in early 2004. It later set up another Dublin vehicle - Sachsen Funding I - that invested in dodgy US subprime mortgages.

The risks taken in Dublin were technically off the balance sheets.

However, the Saxony state government was forced to pick up the tab when the market would no longer fund the Dublin vehicles, threatening the bank’s solvency.

‘‘The poison was the off-balance sheet vehicles that far outweighed the amount of risk the bank could shoulder,” one former Sachsen Landesbank board member told business news agency Bloomberg.

‘‘The bank might have survived, had it invested within the scope of its own capital.”

It is worth bearing all this in mind at a time when almost 1,700 foreign SPVs have established residency here with apparently relatively little oversight by the Irish authorities.

The numbers of SPVs locating here continues to be significant even since the credit crunch hit.

Section 110 of the relevant Irish tax legislation provides for specific tax treatment for qualifying SPVs.

Where these criteria are met, the cost of funding and other related expenditure is tax-deductible with the result that most securitisation and structured finance vehicles can cut their tax bills if they are resident in Ireland. This is big business for the IFSC - and for Ireland.

Irish accountants and lawyers make fortunes advising banks on how to avail of such tax breaks.

Financial institutions don’t quibble too much about the very high cost of professional services here if they can succeed in obtaining substantial reductions in their tax bills and can write off much of their accounting and legal expenses against tax.

Minister for Finance Michael Noonan told the Dáil earlier this month that the Revenue Commissioners had received 1,694 Section 110 notifications since 2003.

While the figures have fallen from 444 in 2007, they remain substantial.

There were 140 Section 110 notifications last year, and 50 in the first quarter of this year alone.

Noonan was unable to supply a figure for the value of the underlying assets held by qualifying companies. ‘‘This information is not available,” he said in response to a parliamentary question asked by Labour TD Eric Byrne.

This is worrying, given that tax sources have told The Insider that some of the 1,700vehicles may contain assets of up €1 billion each, though many contain far smaller amounts.

The sources are concerned that all this money is sloshing about ‘‘without any proper supervision.’’

Besides reducing tax liabilities, SPVs can be used to keep losses off the balance sheets of parent companies or to hide the ownership of assets. This means that SPVs can deliver nasty surprises if losses arise.

The Revenue Commissioners also freely admit, in their guidance notes on Section 110, that securitisations help financial institutions to get around the liquidity requirements set down by the regulatory authorities.

‘‘Without securitisation, the financial institution might be constrained in generating new business by the liquidity requirements laid down by the Central Bank,” the notes state.

Yet, despite the importance of bank liquidity and the importance of re-establishing Ireland’s reputation, the authorities don’t seem to know a whole lot about what is going on inside the SPVs.

Noonan could not provide a figure for the number of audits carried out on Section 110companies. ‘‘No specific statistical code exists for companies that avail of section 110. . . Consequently, it is not possible to separate audits of section 110 companies from other audits carried out by Revenue auditors,” he said.

Noonan was also unable to provide figures for the tax take from Section 110 companies. ‘‘It is not possible to provide this information. No specific statistical code exists for companies that avail of Section 110,” he said.

The minister also said that there had been no meetings between the Revenue Commissioners and the Financial Regulator specifically on the issue of policing compliance levels with Irish law by Section 110 companies.

The apparent lack of supervision suggests that the type of vehicles which played a role in causing the credit crunch continue to remain below the radar of the Irish authorities.

It is hardly a reassuring message to be sending the Germans and the other EU partners who are funding our bailout, even as we plead with them for better bailout terms and insist on retaining our 12.5 per cent corporation tax.

Cartel claims rock the cement industry

2011-05-10T10:18:00.000-07:00

08 May 2011

By Kathleen Barrington

It is almost a quarter of a century since Olivia O’Leary presented a Today Tonight documentary on RTE about the cement market. The programme highlighted how cement giant CRH had reacted to competition.

A long line of businessmen recounted how CRH had allegedly secretly photographed their operations to identify their customers; how it had sought to cut off their supplies of cement from abroad; and how it had even sought to engage in discussions about operating a cement cartel.

CRH admitted to some of the practices, but strenuously denied that it operated a cartel. One of the businessmen who featured in the documentary was Sean Quinn, who complained that CRH had leaned on his bankers in an alleged effort to thwart his attempts to enter the cement market.

Quinn subsequently became a billionaire through his successes in the cement, construction and insurance markets, before losing control of his businesses over the last year due to having billions of euro worth of unpaid debts.

The documentary was broadcast in 1987, a time when the building industry was also under considerable pressure. The businessmen complained the effect of CRH’s alleged practices was to keep the cost of cement in the Republic higher than in Northern Ireland, though CRH defended itself against the allegations arguing that companies were dumping cement at below cost north of the border.

The Construction Industry Federation complained about certain practices prevalent at the time, including a condition that local authorities could only use Irish-certified cement, which the federation described as a ploy enabling CRH to preserve its monopolistic position.

The businessmen said prices in the Republic were about 25 per cent higher than in the North, which resulted in higher construction and housing costs in the Republic, even though the economy was on its knees.

Some of the restrictive practices about which the businessmen complained have since been discontinued, partly under pressure from the European Commission.

But, watching a copy of the 1987 documentary last week, I was struck by the fact that the allegations that CRH continues to abuse a dominant position in the Irish market haven’t gone away.

Earlier this year, Goode Concrete managing director Peter Goode failed in his attempt to secure a High Court injunction restraining CRH and Kilsaran Group from selling concrete at what he claimed was below cost.

Goode alleged that CRH and Kilsaran had lowered their prices to a point where they had recently been submitting bids of €52 per cubic metre - and, in some cases, €50 - for concrete.

Goode said his own costs during 2010 amounted to approximately €65 per cubic metre, and that it was difficult to see how his competitors’ costs could be materially lower. He also alleged that Kilsaran was secretly controlled by CRH.

CRH and Kilsaran strenuously denied the allegations. Mr Justice John Cooke noted that Goode’s case placed reliance on the transcript of one conversation which director Barry Goode said he had on April 27, 2010 with a director of Kilsaran which, ‘‘while rich in expletives, is said to corroborate the proposition that Kilsaran intended to eliminate the plaintiff from the market by reducing prices to uneconomic levels.’’

The judge noted that the defendants categorically denied the allegations. He refused to grant the injunction for a number of reasons, including lack of adequate proof that any commercial loss suffered by Goode could not be adequately compensated by an award of damages at the trial.

Goode said that his company, which once employed 200 people, had ceased trading since February this year.

He plans to continue his case in the High Court, but claims that his efforts are being hampered because CRH and Kilsaran are seeking security of costs in the amount of €1.5 million, which he doesn’t have.

Now Goode has written to Taoiseach Enda Kenny, highlighting what he claims are anti-competitive practices in the cement and concrete market.

He said that his father had started in business in 1969 and had been in the concrete business since 1977, and that since that time had been subjected to anticompetitive behaviour by the dominant firm in the market, CRH.

In the letter, Goode asked Kenny to ensure that the state complies with EU competition law.

He also noted that the EU and the IMF, which have bailed out the country, attached significant weight to the importance of competition in driving down the costs of doing business.

The Goode allegations of anticompetitive practices have yet to be tested in a court of law. But the fact that the allegations are being made at a time when the EU and IMF are effectively running the country could mean there is a greater-than-usual chance that the Irish authorities might separately investigate the issue of alleged cartels in the cement sector, given the importance that the EU and IMF attach to competition policy.

The operations of Irish cement producers have been investigated by some foreign competition authorities. Two years ago, CRH was fined €25 million by Poland’s competition watchdog. CRH has appealed the decision.

Separately, the Quinn Group and CRH were among five companies found to have been operating a price-fixing agreement in the Northern Ireland market between 1985 and 1992. The European Commission also fined CRH in the mid-1990s for being part of a European price-fixing cartel.

If the Irish Competition Authority were to mount a successful case against CRH, it could result in a fine of up to 10 per cent of the company’s €17 billion turnover.

That’s €1.7 billion which could come in very handy for a government that is strapped for cash, not to mention the possibility that busting a cartel - if one existed - would reduce the cost both to the taxpayer and the private sector of construction projects in the future. Is this a risk that shareholders in CRH need to consider?

Accounting procedures flatter UniCredit Ireland’s performance

2011-04-23T12:45:00.000-07:00

17 April 2011

By Kathleen Barrington

If I asked how much your house was worth, you probably couldn’t tell me for sure.

You might guess it is worth half what it was worth at the peak of the boom.

Or you might fear it is worth even less, as there is a house on the road quoting half the peak price and it still hasn’t found a buyer.

There is no reliable indicator of what the market price of houses currently is.

The Permanent/ TSB ESRI index is based on too small a sample, while data protection laws prevent estate agents from disclosing transaction prices even if they were minded to do so, although Friday’s distressed sale auction by Allsops has partially helped fill the information gap.

Things aren’t much different in the world of high finance. Many bankers don’t really have a clue what once-valuable assets are now worth, as the assets rarely trade (and when they do, the prices they fetch aren’t necessarily disclosed on a stock exchange).

Bankers may also fear trading those assets as the price they would achieve might be so low as to do damage to their balance sheets and force them to raise new capital.

This is the case with asset backed securities, particularly those securities backed by mortgages of doubtful quality. It is also true of sovereign bonds issued by countries with big deficits as well as corporate bonds issued by institutions that are under stress.

Many European financial institutions still carry these troubled assets on their books.

That is why, three and a half years into the credit crunch, many banks are still struggling with the legacy of the collapse in market confidence which began in August 2007.

Take, for example, the accounts of UniCredit Bank Ireland plc, a subsidiary of Italy’s largest bank, UniCredit.

UniCredit’s Irish operations are pretty substantial with total assets of €23.7 billion at the end of 2010.

Many of those assets include the complex financial instruments that have proven difficult to value ever since the credit crunch hit.

UniCredit Bank Ireland has, by its own admission, endured a difficult period for liquidity, and was among the banks that availed of emergency amendments to accounting rules introduced in October 2008 at the height of the financial crisis.

The Irish subsidiary, which is based at the International Financial Services Centre (IFSC) in Dublin, reclassified about €3 billion of assets in 2008. This meant that those assets did not have to be valued at market prices which were then in turmoil.

UniCredit Ireland continued to avail of this accounting treatment in subsequent reporting periods.

The bank did it again in 2009 and then also in the 2010 accounts, which were filed in the Companies Office in recent weeks.

Writing in the annual report, chairman Ronan Molony said the significant turmoil experienced in 2008 and 2009 continued in 2010, culminating in Ireland accepting the bailout in November.

This had a negative affect on UniCredit Bank Ireland’s funding costs.

However, Molony reckoned the bank had produced a ‘‘satisfactory’’ result for the year, taking into account the ‘‘considerable market headwinds, recording a net profit after tax of €89 million compared with a net profit after tax of €131 million the previous year.”

But the notes to the accounts reveal that the continued use of the emergency accounting treatment flattered the company’s reported profit figure by €63 million in 2010.

The reclassification is permissible under the emergency accounting rules which were introduced at the height of the crisis. In the case of UniCredit Bank Ireland, the reclassified assets are now described as ‘‘loans and receivables’’, whereas previously they were described as ‘‘held for trading’’.

If they were still described as ‘‘held for trading’’ they would have to be written down to their current market value, which would dent the reported profitability of the Irish subsidiary.

Elsewhere, the accounts show that there was a €344 million reduction in the value of certain assets which were available for sale during 2010.However, this reduction has been written off against shareholders’ equity rather than to the profit and loss account, a move which accountants say is entirely legitimate, but which also flatters headline performance.

It is true that UniCredit’s performance at group level continues to appear stellar when compared with the performance of our own Irish banks.

In March, UniCredit reported fourth quarter net income of €321 million, down from €371 million a year earlier after provisions more than doubled to €472 million.

The bank generated full year profit of €1.3 billion, down 22 per cent from a year earlier.

But there are concerns that the bank’s expansion into eastern Europe, and elsewhere, may lead to greater loan losses in future, which would require the bank to raise new capital. This has been reflected in a fall in UniCredit’s share price over the last few years.

The shares closed at €1.71 last week, compared with €5.06 in August 2007 when the credit crunch began.

UniCredit has been under particular pressure ever since the banking foundation Cari Verona, one of its largest shareholders, declined to take part in a rights issue at the height of the credit crunch in 2008.

UniCredit then controversially accepted funding from the Libyan dictator Muammar Gaddafi’s Libyan Investment Authority.

The decision to accept those funds contributed to the loss of shareholder confidence in UniCredit chief executive Alessandro Profumo, who was ousted last year. It has proven even more embarrassing now that Gaddafi’s own people are in open revolt against his rule.

There have been repeated suggestions that UniCredit may be forced to raise new capital either through asset disposals or fundraising.

Among the assets that might be disposed of is Pioneer Investments, its IFSC-based fund management division.

It just goes to show that in this global financial crisis, a road that leads to Rome may well also lead back home.

Secret banking in offshore world

2011-04-12T05:45:00.000-07:00

10 April 2011

By Kathleen Barrington

Valartis, the Swiss bank that acquired a €600 million Austrian deposit book from Anglo Irish Bank in September 2008, is one of the sponsors of a conference that promises to teach those attending about hidden opportunities in the offshore world.

Valartis is co-sponsor of the Total Wealth Symposium, which takes place in the five-star Hotel Riu Panama Plaza in Panama later this month.

The conference is organised by the Sovereign Society, a US group that promises to show attendees how to lower their incomes taxes, discover little known global investment opportunities and avoid invasions of their financial privacy.

The Sovereign Society says in its promotional literature that it is often contacted by people wanting to know how they could have all the benefits of the offshore world without having to move to another country to do it.

One of the speakers at last year’s conference was Patrick Doherty, a former Anglo Irish Bank employee who is now a senior vice president of international private banking with Valartis Bank’s Austrian subsidiary.

The Irish banker gave a presentation to last year’s conference in Montreal.

When contacted by the Sunday Business Post at his office in Vienna, Doherty declined to comment when asked if he would be speaking at the Panama conference this year.

The decision by Anglo Irish Bank to get rid of its €600 million Austrian deposit book in 2008 came as a surprise, given that the bank was in dire need of deposits at the time.

Anglo has always said the disposal was in line with its strategy of disposing of noncore assets.

Anglo has pointed out that it had previously disposed of other non-core businesses in the Isle of Man and Switzerland.

The Sovereign Society appears to target its conferences primarily at US citizens.

But the society has Irish links, including a business address in Waterford.

Another company called International Living Publishing Ltd, which publishes magazines distributed by the Sovereign Society, has a registered office in Dublin.

The magazines promote living and investing in some of the world’s offshore tax havens.

The magazines have in the past featured articles about the advantage of opening an offshore account with Anglo Irish Bank in Vienna.

One 2006 article said the Sovereign Society’s convenient offshore account partners included Anglo Irish Bank, which required a minimum balance of$100,000 or equivalent.

Has insurance industry finally learned from its mistakes?

2011-04-11T02:49:00.000-07:00

10 April 2011

By Kathleen Barrington

About 20 per cent of Irish based insurance companies cannot meet new EU capital requirements from their existing financial resources, according to a report from the Financial Regulator.

The regulator examined the impact the proposed rules, known as Solvency II, would have on insurance and reinsurance companies. It found that while the majority would meet the solvency capital requirement from existing resources, about one in five firms fell short.

About five per cent would fail to meet even the lower minimum capital requirement. Forty-three companies did not have sufficient own funds to meet the higher requirement.

Of these, 12 would have to raise more capital to meet the lower requirement.
The report found general insurers needed more capital compared with life insurers when the new test was applied.

Overall, 220 companies - representing 81 per cent of the companies impacted by the proposed new rules - participated in the survey.

The Financial Regulator acted after the European Commission asked the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) to run a study on the impact of the so-called Solvency II rules.

The test was conducted between July and November 2010 and based on data at December 31, 2009. It was designed to show how the new rules would have affected companies if they had been in force at that date.

At European level, the test found the financial position of the European insurance sector remains comfortable.

The insurance industry’s funds exceeded the regulatory requirement by around €360 billion, a decrease of €120 billion compared with the current regime.

At European level also, 15 per cent of the participants did not fully meet the solvency capital requirement which would trigger regulatory action.

Just under 5 per cent of the participants did not fully cover the lower minimum capital requirement which would trigger the most serious intervention from the supervisor - the withdrawal of the license.

The European insurance lobby was out in force last week warning of dire outcomes if the proposed new rules are introduced.

Writing in the Financial Times, the Comité Européen des Assurances, Pan European Insurance Forum, Chief Risk Officer Forum and Chief Financial Officer Forum were not behind the door in reminding readers that the European insurance industry employs one million people and invests more than €6,800 billion in the European economy. The industry argues that the new rules could make the industry more vulnerable to economic downturns and force companies to charge higher prices.

The rules are being designed to protect consumers by requiring insurers to hold reserves in proportion to the risks they underwrite. But the industry is arguing that the new rules are too conservative and will have the opposite effect.

The firms argue, for instance, that the rules result in excessively high capital requirements for non-life and catastrophe risks.

Peter Vipond, director of financial regulation and taxation at the Association of British Insurers was quoted in the Daily Telegraph saying that ‘‘the current draft of the rules are poorly thought through in places, leading to them holding unnecessarily high levels of capital, ultimately penalising consumers.’’

The industry may be right that higher levels of capital will penalise consumers in the form of higher insurance prices. But it is also true that lower levels of capital can ultimately penalise taxpayers if struggling insurance companies end up being propped up at enormous public expense when things go wrong - as has happened with the banking industry.

The cost of bailing out insurance companies can be truly enormous, as the example of American Insurance Group (AIG) has shown.

AIG had to be bailed out at a cost of $182 billion at its peak, after it emerged that it had written so much credit default and mortgage protection insurance that it would break the company - and possibly the entire US financial system - if it were not rescued. Too-big-to-fail AIG had several Irish subsidiaries based in the International Financial Services Centre in Dublin.

Among them was AIG United Guaranty. Its main business in Ireland is providing reinsurance coverage for mortgage indemnity guarantees written throughout the EU, including Spain. Many of those guarantees are being called on as Spain and other countries have suffered a major property crash.

AIG United Guaranty began to report significant losses in 2008 when the credit crunch hit.

So it decided to stop writing new business and to lay off some of its risk with a related party in the US known as MG Reinsurance.

The notes to the Irish company’s 2009 accounts reveal that the move had the ‘‘intention of protecting the company’s surplus in relation to all business written and in force at December 31, 2008.’’

When a reinsurer lays off some of its risk with another reinsurance company, it is known as retrocession.

The notes to the Irish company accounts reveal this retrocession manoeuvre improved the Irish company’s 2009 year end performance considerably.

‘‘The 2009 retained profit of the company of €9.587 million in comparison with a retained loss of €114.784 million for 2008, reflects the impact of the retrocession coverage purchased during the year,” the notes to the accounts reveal.

Closer to home, there are fears that Quinn Insurance, which has been in administration for more than a year, may yet have to rely on the taxpayer to prop it up if no buyers are found willing to assume all the risks that the company has insured.

Insurance is a complex business which is difficult for the lay person to understand. But it is hard to escape the conclusion that many insurance companies have learned little from the financial turmoil of the last few years.

It seems they dislike the proposed new solvency rules because they will require companies to allocate more capital for the risks they are writing, a move that would dent the profitability of the insurance industry.

Instead, they would prefer to report big profits on small capital bases when times are good, and hand taxpayers the bill when times are bad.

The tycoon and the bank job

2011-04-04T05:51:00.000-07:00

03 April 2011

By Kathleen Barrington

Let’s say you are a teller in the bank.
Your books don’t balance at the end of the day, giving rise to a suspicion that you haven’t followed correct procedures. What protocol would normally be followed?
According to the Irish Bank Officials Association, the teller would be sent home until the matter was resolved, or suspended on full pay while the matter was investigated.
It is not unusual for bank employees to step aside to protect the bank, even though the presumption of the individual’s innocence continues to apply while the matter is being investigated and adjudicated upon.
It is disappointing, to say the least, that the board of Bank of Ireland did not follow that protocol when considering the appointment of Denis O’Brien to the court -as Bank of Ireland’s board is known - back in 2000.
If it had, it would have been spared the embarrassment of the Moriarty Tribunal’s findings, that its former director had given IR»900,000 in clandestine payments and loan support to onetime Fine Gael minister Michael Lowry, and that Lowry had delivered the state’s second mobile phone licence for O’Brien.
Bank of Ireland appointed O’Brien to the court following the successful sale of his Esat Telecom business to British Telecom for €2.4 billion, even though there were already serious questions being asked about the manner in which the mobile phone licence had been awarded to the Esat consortium.
There had been complaints from rival bidder Persona as far back as 1996 about the selection process for the competition to obtain the mobile phone licence, which Lowry had awarded to O’Brien’s Esat consortium in 1995.
The Moriarty Tribunal had been set up in September 1997 to inquire into payments to politicians, one of whom was Lowry.
Admittedly, it wasn’t until 2001 that the tribunal began following a specific line of inquiry in relation to a £420,000 Investec/ Woodchester loan involving both O’Brien and Lowry.
But, by 2002, it was abundantly clear from newspaper headlines that O’Brien was a key witness at the Moriarty Tribunal - so much so that some shareholders raised their concerns at the Bank of Ireland agm in 2002.
The then Bank of Ireland governor, Laurence Crowley, asserted that the bank was far ahead of modern standards on corporate governance and that, if any directors were found to have been involved in wrongdoing, they would be removed from the court.
We know, of course, from subsequent media leaks that, behind the scenes, there was some disquiet in relation to O’Brien’s continuing membership of the court.
Specifically, it emerged that TK Whitaker, the eminent public servant and former governor of the Central Bank, had raised concerns with Crowley, but no action was taken.
Instead, on September 15, 2005, O’Brien was promoted to the position of deputy to the new governor Richard Burrows - one of the most responsible and prestigious positions in Irish business.
Two weeks later, Justice Michael Moriarty issued a preliminary ruling which left no doubt that O’Brien was under intense scrutiny in relation to certain payments to Lowry.
But it would be another year before O’Brien finally resigned from the Bank of Ireland in September 2006, citing time constraints due to his other business commitments.
The precise circumstances in which he came to get the post of deputy governor have been the subject of much speculation in business circles.
But in the absence of any on the record comments from the parties involved, the process by which he came to be elevated has remained a closely guarded secret.
Another thing that remains unclear is what role O’Brien played on the court of Bank of Ireland - specifically, whether he took any part in driving lending policy at the bank during the boom years.
Earlier this year, O’Brien gave an interview to Michael Lewis, the US financial journalist and author of the bestselling The Big Short. Lewis used the resulting quotes in a lengthy article about the Irish banking crisis for Vanity Fair magazine.
In the interview, O’Brien gave the impression that he had sought to rein in the former Bank of Ireland chief executive officer Brian Goggin.
‘‘I remember the chief executive coming in and saying: ‘We’re going to grow at 30 per cent a year’,’ ’O’Brien told Lewis.
‘‘I said: ‘How the fuck are you going to do that? Banking is a 5to-7-per-cent-a-year growth business at best.’ “
Unfortunately, it would appear that, despite his extremely forceful personality, O’Brien was, at the very least, unable to rein in the bank’s aggressive lending.
Indeed, Bank of Ireland lent so recklessly to the Irish property sector during the boom years that it would now be bust were it not for the generous support of Irish taxpayers - with the notable exception of O’Brien himself, who is, of course, a tax exile.
In the same week that Moriarty published his report, the Financial Regulator published new fit and proper rules for bank directors.
The rules state, among other things, that a director must be able to demonstrate that his or her ability to perform the relevant function is not adversely affected to a material degree where the person has been under investigation by a tribunal.
Some observers believe that this measure would have been sufficient to prevent the appointment of O’Brien as a director had the rules been in force at the time.
Others believe the wording is open to interpretation.
So I asked the Financial Regulator the following question: if O’Brien’s name had been put forward for a directorship of Bank of Ireland while he was under investigation by the Moriarty Tribunal (but before the tribunal had reported), would his candidacy have been successful if the proposed new fit and proper rules had been in force?
The Financial Regulator responded that it could not comment on individual cases.
When I rephrased the question in general terms without naming O’Brien, the Financial Regulator said that, ‘‘while we do not comment on hypothetical cases, in implementing our fitness and probity regime, normal principles of fairness and natural justice will apply’’.
That leaves a lot of wriggle room for a powerful individual under a cloud of suspicion to fight his case for membership of a prestigious bank board.
The Financial Regulator needs to tighten up this wording or run the risk that our learned friends will have another field day arguing over how exactly being under investigation by a tribunal would affect performance to ‘‘a material degree’’.

Are private pensions up for grabs?

2011-03-28T02:59:00.000-07:00

27 March 2011

By Kathleen Barrington

The focus on the enormous holes in the balance sheets of our banks has distracted attention from some of the alternative solutions being adopted by other EU countries to help resolve their financial crises.
These solutions are of interest to investors in private pension funds, as the crisis measures have included seizing private pension assets to plug the gaping holes in both bank and government balance sheets.
Take Hungary, for example. In February, it cancelled $7.5 billion worth of government bonds after grabbing privately-managed pension funds to cut the country’s indebtedness.
The appropriation of the assets came despite protests from leading pension fund managers, as well as legal threats.
The raid was carried out by Hungary’s Debt Management Agency, which is roughly equivalent to our own National Treasury Management Agency.
László Buzás, the deputy chief executive officer of the agency, told news agency Bloomberg that by cancelling the government bonds, the government would reduce Hungary’s debt by 5.5 percentage points from about 80 per cent of gross domestic product.
Hungary followed the example of Argentina, which in 2001 confiscated about $3.2 billion of pension savings before the country stopped servicing its debt.
The Argentinian government also nationalised the $24 billion industry two years ago to compensate for falling tax revenue after a 2005 debt-restructuring. The February raid on private sector pension funds was a measure of how desperate the financial situation in Hungary had become.
The idea of raiding state pension funds has long been popular with European governments seeking to plug the holes in their exchequers’ finances.
Our own government has plundered the €24 billion state owned National Pension Reserve Fund to help cover the costs of recapitalising our bust banks. It has also imposed a pension levy on public sector workers, and increased the age at which the state pension will be paid out.
The effect of increasing the retirement age from 65 to 68 is that people will be missing out on state pension payments of about €1 billion a year.
The affected cohort of 65-year-olds will forgo a state pension of €12,000 a year for three years once the retirement age is increased to 68, an effective loss of €36,000 per person.
With our state pension reserves heavily depleted and our senior citizens soon being expected to work till the age of 68, the cash-strapped government is increasingly turning its attention to other sources of funding.
While no one is suggesting that the government has any plans to nationalise our private pension funds, both the former and the current administrations have been dreaming up wheezes to use private sector pension funds to help prop up the public finances.
The now-departed Fianna Fáil/Greens government introduced the concept of a sovereign annuity bond, which is to be issued by the state to Irish pension funds.
Once the technicalities have been ironed out, this will pave the way for private pension money to be invested in high yielding Irish government bonds.
The pensions industry lobbied for the move because it saw the higher returns available as a way of plugging the holes in private sector pension schemes.
But the risk is that, if the Irish sovereign were to default (as some influential commentators expect), private pensioners would lose out.
The new government is also eyeing private-sector pensions as a source of revenue. Fine Gael’s election manifesto called for the introduction of a 0.5 per cent tax on all private pension funds.
The party said during the election campaign that it would publish a jobs budget with a cost of €381 million within 100 days of entering government, which would be funded by the early payment of the first tranche of the 0.5 per cent levy on pension funds.
The pensions industry opposes this proposal.
Jerry Moriarty, chief executive of the Irish Association of Pension Funds (IAPF), has argued that applying a levy to the pension fund industry would only make matters worse at a time when many pension schemes have been struggling to plug the massive holes in their schemes.
The shortfall in the private sector defined benefit schemes was estimated at €13 billion at the end of 2008.
Since then, trustees, employers and members have been focusing on reducing those deficits. ‘‘To now levy those funds only makes a bad situation worse,” he said.
It has been suggested that those schemes could cut the benefits of an estimated 65,000 pension members to take account of the levy - a move which would, in Moriarty’s words,’ ‘penalise the prudent’’.
But the scale of the EU’s banking and fiscal crisis is now so enormous that it is entirely possible that governments will find themselves penalising the prudent in an effort to shore up the public finances.
This column has previously highlighted how the Danish government decided that some depositors in Amagerbanken, a small, insolvent Danish bank should contribute to the cost of bailing it out.
The depositors learned last month that they would lose 41 per cent of any amount they held on deposit over the statutory guarantee limit of €100,000.The depositors were effectively forced to take a 41 per cent haircut alongside the bondholders.
The Hungarian and Danish governments’ moves serve as yet another reminder that the financial crisis in Europe is now so deep that EU governments are giving consideration to measures which were unthinkable only a few short years ago.

The subprime saga of Ron Weisz

2011-03-21T03:44:00.000-07:00

20 March 2011

By Kathleen Barrington

It is almost 12 years since The Sunday Business Post conducted a major investigation into the activities of US businessman and mortgage lender Ron Weisz. Many Irish clients of Weisz had been unaware of his previous business difficulties in the US, including a conviction for attempting to get a bank loan by fraudulent means.
In this newspaper, journalist Catherine O’Mahony revealed that, in 1979, Weisz had been charged on five counts related to his bank dealings.
Weisz absconded from the US in 1984 before facing trial - travelling first to Israel,then Britain. He ended up in Ireland, where he has been based since 1994. He said at the time that he left because he feared being sent to jail, although he returned after prolonged negotiations with the US courts.
In 1995, he entered a ‘‘guilty’’ plea to the Eastern District Court of New York on a charge of supplying ‘‘false statement to influence the award of a loan from a federally insured institution, a class E felony’’. Because of a plea bargain, four other charges were dropped, and he was fined $500 for the offence.
‘‘It’s not something that I’m proud of,” Weisz said in 1998. ‘‘But it’s a fact. It’s true. And I did also settle it, for $500.”
O’Mahony also reported that US court records listed a series of unsatisfied judgments totalling $400,000 against Weisz arising from civil appeals to a move by him to file for bankruptcy in the early 1980s.
But Weisz categorically denied that he was ever bankrupted. ‘‘I did not go bankrupt, I will swear to that. I was poorly advised [to file for bankruptcy] and the bid was withdrawn,” he said.
Weisz had also been to the District Court in Ireland in 1995, after the Central Bank of Ireland spotted an advertisement by his company Wise Finance seeking to take in deposits - something the company was not licensed to do. Having pleaded guilty, Weisz was fined IR£150. He described the Central Bank case as a misunderstanding.
The following year, Weisz’s fraud conviction was raised in the Dáil with specific reference to The Sunday Business Post article.
The response was that there was little the authorities could do as Weisz fell through various legal and regulatory loopholes, leaving him free to sell what we now call subprime loans - in other words, high-cost loans to borrowers who were unable to borrow elsewhere.
In 1999, the then Tánaiste Mary Harney called for amendments to two separate pieces of legislation, following an investigation by the Department of Enterprise, Trade and Employment into Weisz’s activities.
Journalists continued to report on his business dealings over the years, while the Irish Farmers Association warned farmers in 2008 to stay a million miles away from lenders of last resort such as Weisz, following a furore after many farmers who had taken out mortgages with him faced repossession proceedings.
But despite the questions that have been raised about whether a man with a fraud conviction ought to be allowed to sell financial services to Irish consumers and despite the warnings from the likes of the IFA, Weisz has continued to operate through various companies down the years. His many firms include the Wise Mortgage Company, the Wise Finance Company and Secured Property Loans.
Secured Property Loans was in the headlines again last week, after it emerged that it was charging a Co Clare businesswoman a mortgage interest rate of almost 20 per cent, a rate which her barrister Brian Sugrue described as ‘‘unconscionable’’ in court. The woman is challenging the level of interest being charged by the lender at a time when the European Central Bank rate is at a historic low of 1 per cent.
The court heard that, in 2008, the woman borrowed €125,000 by mortgaging her Co Clare pub, which was also her home, to pay off debts and to pay her former husband as part of a separation agreement.
She had hoped to refinance the loan.
Counsel for the lender, Alastair Rutherdale, said there was no evidence, historically, of the courts intervening to set aside loans where interest rates as high as 60 per cent were charged. He said the woman had not objected at the time the loan was taken out.
The woman had received legal advice at the time of taking out the loan. Ms Justice Mary Laffoy reserved her judgment until next week.
The high interest rates being charged by Secured Property Loans spell misery for many of Weisz’s clients. But they appear to be paying off for him personally.
The abridged financial statements for Secured Property Loans examined by the Insider reveal that it had retained profits of €1.78 million and total assets of €6.9 million at November 30, 2009 - a very good performance in the middle of a deep recession.
The reality is that all the bad publicity over the years hasn’t stopped Weisz, because the legislators have failed to plug the legal loopholes which allow people with fraud convictions to lend to riskier borrowers.
Then there is the question of the interest rates which lenders may charge borrowers. It is generally assumed in Ireland that lenders should be free to charge an interest rate that reflects the risk they are taking in lending to risky borrowers such as the Co Clare publican.
But the long queue of subprime lenders seeking to repossess homes before the courts suggests that it may be time to challenge that assumption. For what is the point of making finance available to borrowers if its main effect is to drive them so much further into debt?

Sutherland declared Libyan conflict of interest at LSE meeting

2011-03-14T10:31:00.000-07:00

13 March 2011

By Kathleen Barrington

Peter Sutherland, the banker and chairman of the London School of Economics, declared a conflict of interest at the LSE council meeting which decided to accept £1.5 million from a charity headed by Libyan leader Muammar Gaddafi.
LSE records show Sutherland took no further role in that part of the June 2009 meeting, where it was agreed to accept the donation from the Gaddafi International and Development Foundation, Sutherland’s spokesman said.
Sutherland’s conflict was that British Petroleum had signed an oil deal with Libya two years previously, at a time when Sutherland was chairman of the British oil giant.
He found himself caught up in the Libyan upheaval after it emerged that the LSE had accepted the first £300,000 of a promised £1.5 million donation from the foundation, spread over five years.
Sutherland last week accepted the resignation of Howard Davies as director of the LSE.
Davies, who is a former chairman of the Financial Services Authority, Britain’s single financial regulator since 1998, resigned after admitting that accepting the donation was a mistake which had damaged the reputation of the LSE.
Sutherland has set up an independent inquiry to establish the full facts of the LSE’s links with Libya, to ascertain whether errors have been made, and to establish guidelines for international donations to, and links with, the LSE.
When asked last week whether he thought Gaddafi should stay or go as Libyan leader, Sutherland declined to comment.

See full story below

Sutherland caught in crossfire over Gaddafi money

2011-03-14T08:28:00.000-07:00

13 March 2011

By Kathleen Barrington

Irish businessman Peter Sutherland was among those inside the tent when former British prime minister Tony Blair visited Libya’s Colonel Muammar Gaddafi in May 2007.
The tent was decorated with imprints of camels and shuddered with every gust of Saharan wind, according to a report in the Daily Telegraph at the time.
But it is an ill wind that doesn’t blow some good.
And Sutherland, who was then chairman of British Petroleum (BP), must have been pleased with the opportunity to sign a valuable oil exploration agreement with the Libyan government which BP would later disclose was worth about $900 million.
As a former attorney general to a Fine Gael government, Sutherland would have had a particular appreciation of the significance of the meeting between the British prime minister and the man who had once supplied arms to the IRA.
Blair was understandably keen to demonstrate that British diplomacy was paying off as far as Gaddafi was concerned, just as it had in Northern Ireland. The fact that Gaddafi renounced nuclear weapons was seen as a major coup on Blair’s part.
Many western governments, businesses and institutions such as BP took the rapprochement between Blair and Gaddafi as their cue to renew relations with Libya, though some had second thoughts when flag-waving crowds greeted Abdelbaset al-Megrahi, the Lockerbie bomber, on his return to Libya in 2009.
Now Gaddafi has found himself an outcast again, with most of the international community reacting in horror to his decision to turn the army on those of his own people who have been demanding greater political freedom.
Many countries have frozen Gaddafi’s assets, and there have been calls for a no-fly zone over Libya to prevent Gaddafi from using his air power. British prime minister David Cameron has seized the opportunity to criticise Labour’s ‘‘dodgy deals with dictators in the desert’’.
Sutherland found himself caught in the crossfire after it emerged last week that the London School of Economics (LSE), which he chairs, had accepted the first £300,000 of a promised £1.5million donation from the Gaddafi International Charity and Development Foundation.
A spokesman for Sutherland said LSE records showed that he declared a conflict of interest at the LSE Council meeting in June 2009 which decided to accept money over five years from the Gaddafi Foundation, a UN registered charity.
The spokesman said the records show he took no further part in that part of the meeting. His conflict was that, two years previously, BP had signed the deal with Libya.
Sutherland declined to comment last week in a telephone interview when asked whether he thought Gaddafi should stay or go.
Sutherland had earlier reluctantly accepted the resignation of Howard Davies as director of the LSE. Davies, a former chairman of the Financial Services Authority, Britain’s single financial regulator since 1998, fell on his sword after admitting that accepting the donation was a mistake which had damaged the reputation of the LSE.
The LSE has now commissioned an inquiry into its relations with Libya.
It will examine the donations, the acceptance by the LSE of $50,000 in return for Davies’s advice to Libya’s sovereign wealth fund, a contract to train Libyan civil servants and the academic authenticity of an award by the LSE of a doctorate to Gaddafi’s son, Saif.
It was the LSE-educated Saif who threatened the Libyan people with ‘‘rivers of blood’’ for daring to demand the very democratic freedoms that he might have been expected to champion given that his LSE thesis was on the role of civil society in the democratisation of global governance institutions.
It has all been very embarrassing for the LSE - and for Sutherland, who has enjoyed a stellar career in the private and public sectors, first as a barrister, then as attorney general, later as EU commissioner.
He also served as director-general of GATT and general counsel of the World Trade Organisation. Besides his chairmanship of BP and the LSE, he has served as chairman of AIB and nonexecutive director of the Royal Bank of Scotland (RBS) and is currently chairman of investment bank Goldman Sachs International.
But if Sutherland prefers not to comment on Gaddafi, he has certainly been vocal on Irish matters. Last week, he wrote a ‘‘hard-hitting’’ op-ed article in the Financial Times, in which ‘‘I let my patriotism run loose’’ as he put it to The Sunday Business Post. In the article, Sutherland emphatically stated that the interest rate being charged to Ireland on the EU/IMF loan facility was ‘‘exorbitant’’.
The interest rate payable on the loan is 5.8 per cent compared with a funding cost of 2.9 per cent.
‘‘It is also probably unsustainable having regard to likely growth rates," he wrote. ‘‘Far from helping the problem, it is therefore likely to exacerbate it."
Sutherland told The Sunday Business Post that addressing our deficit was the key to Ireland restoring its credibility.
His intervention came just days after former Fine Gael taoiseach John Bruton, who is now employed by the banking sector here, delivered a speech at the LSE.
Bruton accused the European Central Bank of a major failure of supervision in not restraining British, German, Belgian and French banks from lending to Irish banks, though he also warned of the reputational cost to Ireland of breaking our word by inflicting losses on bank bondholders.
Sutherland has repeatedly argued that Ireland should not burn the bondholders.
He said he was ‘‘offended’’ when informed that his call for the bondholders to be repaid had raised eyebrows in some circles, given that Goldman Sachs had been named in a document published on Britain’s Guido Fawkes website as a bondholder in Anglo Irish Bank.
His spokesman separately makes the point that Sutherland would not have been aware of every position that Goldman held in bonds.
Sutherland will have done Ireland some service if his intervention helps persuade the European authorities to cut the interest rate bill now facing the Irish taxpayer.

A stung investor wants answers

2011-03-14T07:40:00.000-07:00

13 March 2011

By Kathleen Barrington

An investor who lost his entire pension pot in two property funds sold by a leading stockbroker has expressed his disappointment with a decision by the Financial Services Ombudsman.
Dave Gorman was unhappy that Bill Prasifka did not uphold his complaint against Goodbody Stockbrokers, despite finding that the firm had engaged in ‘‘a negligent misstatement’’.
Prasifka found that Gorman could not show that he had relied on the erroneous statement by Goodbody, as he had already invested in the funds and had been fully apprised of the risks involved by the time the statement was made.
The decision will be of particular interest to those clients of Goodbody who lost a combined €56 million on their investments in two property ventures sold at the height of the property bubble.
Goodbody clients invested €31 million in the Northern Ireland Property Fund, which is now written down to zero.
Goodbody clients also invested €25 million in a loan note issued by Brackville Holdings, which once offered a return of 16.5 per cent per year, but is now also worthless.
The purpose of the loan was to provide finance to the Lalco Group, headed by Galway developer John Lally, for a proposed development at Sandyford in Dublin.
In November 2005, Gorman’s bank manager at the Sutton branch of AIB introduced him to Goodbody Stockbrokers, then a subsidiary of AIB.
Hibernian was managing Gorman’s pension fund at that time, but Gorman cashed it out and transferred the proceeds to Goodbody.
On November 11, Gorman signed an advisory portfolio agreement with Goodbody, which noted that Gorman’s attitude to risk was ‘‘moderate’’, while his investment knowledge was ‘‘good’’.
Gorman invested in the Northern Ireland Property Fund and Brackville Holdings in 2006.
He claims that Goodbody advised him to just sign the authorisation forms on the front and back, but that he filled in none of the other information on the papers.
By May 2010, the value of Gorman’s investments had fallen to just €1,310, with no prospect of recovery.
Gorman complained to Prasifka that Goodbody was negligent in introducing property deals to him to the exclusion of all other products and that it was negligent in introducing him to high-risk products when he was seeking investments in medium-risk products.
Goodbody responded that Gorman had referred to himself as a ‘‘property guy’’ in his meeting with David Lambe, director of portfolio business with Goodbody Stockbrokers, in 2009 and that this was borne out in a number of recorded telephone conversations that Gorman had with Barry Kennedy, a Goodbody portfolio manager, during 2006 and 2007.
According to a copy of the ombudsman’s decision obtained by The Sunday Business Post, Prasifka accepted Goodbody’s submission that Gorman only sought investments in property. He said this was evident from the tapes of telephone conversations and from the documentation supplied to his office by both parties.
‘‘I am therefore satisfied on the balance of probabilities that even if the stockbroker had broached the idea of investing in other asset classes, the complainant would not have been interested in such a suggestion,” Prasifka found.
Prasifka accepted that Gorman had advised Goodbody that his risk profile was ‘‘medium-risk’’, and that the products introduced to him were ‘‘high risk.’’
Goodbody had not explained why high-risk investments were introduced to Gorman.
The ombudsman noted that if a building were let to a government agency for a term of 25 years, an investment in that property would be less risky than investing in a development project.
‘‘Just because an investor wishes to invest in a particular class of asset, it doesn’t necessarily follow that all categories will be attractive to him,” Prasifka said.
‘‘That being said, I do not believe that financial service providers should be necessarily precluded from introducing products which are a different risk profile from the level initially advised by the client. I believe that if a provider wishes to introduce a product with a higher risk to a client, the fact this is of a higher risk category should be specifically brought to the client’s attention and an explanation should be provided as to why the provider believes it may be suitable to the client.”
Prasifka said Gorman had received documentation outlining the risks involved in each of the investments. He noted that on page 12 of the prospectus for Brackville Holdings, it was stated that ‘‘the company intends to apply for planning permission within six months and plans to complete construction within a five-year period.’’
Prasifka pointed out that this was a project that didn’t even have planning permission and that the 16.5 per cent rate of return ‘‘would itself indicate that the project was of a high-risk category’’.
Prasifka said he had a concern that Goodbody had, in March 2006, sought to suppress the risk profile attaching to the Northern Ireland Property Fund. During a brief discussion with Goodbody on the Northern Ireland brochure, Gorman said: ‘‘When I was reading through the risks, it scared the shit out of me. I presume we’re through the most of that.”
Goodbody’s Kennedy replied that the solicitors had to point out everything and that the document had been drafted by solicitors.
‘‘I believe this is a clear attempt by the stockbroker to dilute the potency of the risks provided in the documentation,” Prasifka said.
‘‘In circumstances where Mr Kennedy was providing advice to the complainant, I believe that this constituted a negligent misstatement. I believe Mr Kennedy should have clearly stated to the complainant that the property was a high risk investment.”
But Prasifka found that Gorman would have to prove that he incurred losses due to his reliance on that erroneous statement. Noting that Gorman had not claimed he relied on the statement, he added that by that stage Gorman had already invested in the product and was fully apprised of the nature of the investment and the risk involved.
Prasifka remarked in his findings: ‘‘Unfortunately, many people thought of property as an asset that would always increase in value, or at least never fall in value, and I believe the complainant fell into that category.”
Gorman remained unhappy. He said Goodbody had a duty of care to advise him in relation to his pension and, in particular, to advise against putting all his eggs in one basket. He said he was never offered other asset classes, until after the money had been invested in the property ventures.
Gorman wrote to Prasifka last November, expressing his disappointment.
‘‘While I never expected to get all my pension monies back, I did expect the findings to be proportioned in a more balanced way, taking into consideration what they should have done but failed to do,” Gorman wrote.
‘‘They knew this was my only pension, and they also knew that I did not want high-risk. They persuaded me that it was safe.”

‘Bankspeak’ is hiding the truth

2011-03-07T04:48:00.000-08:00

06 March 2011

By Kathleen Barrington

In October 2008, in the Oireachtas, Fine Gael TD Kieran O’Donnell asked Patrick Neary the billion-dollar question: how did the Regulator define whether a loan was ‘‘being serviced’’?
‘‘I define loans being serviced as loans operating in accordance with the contractual terms of the loan agreement,” Neary replied.
‘‘Has the Regulator gone in and looked at them?” O’Donnell asked. ‘‘These could be loans that are not being repaid, they are just rolled up. Does the Regulator regard that as a repayment?”
‘‘There can be situations where loans are given on that basis where there is a roll-up of interest,” Neary replied. ‘‘That is absolutely right.”
The term ‘‘interest roll-up’’ is used by bankers to describe an agreement under which the borrower need not make any interest or capital repayments on the loan for a certain period.
During the boom, bankers often offered interest roll-up to developers who were not required to make repayments until they had constructed and sold a development.
This meant Neary could describe the loan as being serviced at a time when the borrower was not making either capital or interest repayments, though it was by then clear that many developers couldn’t repay their loan. It was Alice in Wonderland language.
Neary’s words meant what bankers and regulators wanted them to mean, leaving everyone else to try to figure it out.
O’Donnell was among those struggling to understand the regulator’s language.
‘‘Therefore, what about bad debts?” he asked. ‘‘This is the key question.”
‘‘Exactly,” Neary said. ‘‘This is the point.”
‘‘The Regulator is not answering the question,” O’Donnell said. ‘‘The question is very simple. Does he believe that the banks have a black hole in terms of bad debts? Is there a requirement for the state to immediately inject capital?”
‘‘No,” Neary said. ‘‘I have identified €24 billion in relation to the speculative lending construction and property development sector. Most market commentators believe that is the area which is the riskiest part of the business.”
The banks have lost a lot more than €24 billion on their development lending.
But that hasn’t stopped the regulatory authorities and the bankers engaging in the same kind of Alice in Wonderland thinking when it comes to the banks’ residential mortgage books.
For the last two and a half years, they have adopted various forbearance measures such as allowing struggling borrowers to extend the terms of their mortgages, or to pay back far less than what they actually owe - for example, allowing them to pay only interest on their mortgages, or only part of the interest on their mortgages.
The forbearance measures adopted by the banks are designed to stave off a wave of repossessions of homes which mortgage holders can no longer afford.
But the measures have the unwelcome side-effect of masking the true scale of the likely future bad mortgage debts on the banks’ balance sheets, as a loan may be described as performing even when the borrower hasn’t a hope of repaying it in full.
The Central Bank revealed last week that 44,508 mortgage accounts - equivalent to 5.7per cent of the total residential mortgage book - were in arrears. In value terms, €8.6 billion was owed in relation to all accounts that were more than 90 days in arrears.
The figures published by the Central Bank also revealed, for the first time, that 59,229 mortgages were restructured. In total, about 79,713 accounts were either in arrears for more than 90 days or had been re structured due to financial distress.
Of the restructured loans, 35,205 are classified as performing and not in arrears. But you have to wonder about how collectable those so-called performing mortgages really are if many borrowers can only afford the interest or a portion of the interest on them.
The Central Bank figures published last week are shocking, all the more so when you consider that they were calculated at a time when the universal social charge had not yet been deducted from wage packets; before the impact of new higher variable rate mortgages announced earlier this year is factored in; and before expected hikes in the European Central Bank interest rate are announced later this year.
Ciaran Phelan, chief executive of the Irish Brokers Association, said: ‘‘Once homeowners go into arrears, very few successfully emerge. With no economic recovery, forbearance has turned out to be a sticking-plaster that simply extends the borrower’s debts.”
The current $6 billion question relates to the size of the black hole in the banks’ residential mortgage book as these bad debts look set to rise.
Mortgage broker Michael Dowling said it was unclear what provisions the banks were making in relation to their mortgage books.
The Central Bank told the Insider that each bank had its own impairment and provisioning policy which complied with accounting rules, but may not be similar across the banks. As a result, there is no definitive answer to the question of how banks account for rescheduled mortgages on their balance sheets.
When asked if the Financial Regulator attached a higher probability of default to interest only mortgages, the Regulator said it didn’t apply probability of defaults to bank portfolios, as the banks use their own models.
The Regulator also said that interest only loans were not, per se, an indicator of non-performance.
Yet, as this newspaper disclosed last year, credit rating agency Fitch estimated that Irish interest-only mortgages maturing in less than ten years’ time had a 40 per cent greater chance of foreclosure than traditional repayment mortgages.
The lack of clarity on whether banks are accurately providing for possible future bad debts on their mortgage books is likely to discourage any prospective buyers bidding for our troubled banks and is therefore likely to delay any recovery in our banking system, effectively prolonging our economic agony, as property values will continue to fall in the absence of credit being available.
In short, the new government will be caught between a rock and a hard place.
It must either force the banks to admit to the scale of the bad debts on their mortgage books and find the money to plug the new black holes that will then emerge in the banks’ balance sheets - or live with the consequences of zombie banks for several more years.

Irish bond grenades explode in Berlin

2011-02-21T02:18:00.000-08:00

20 February 2011

By Kathleen Barrington

The more you look at the links between troubled German banks and troubled Irish ones, the more you notice that many of the German banks have exploded with the help of bond grenades made in Dublin.
Many of the German banks that blew up during the credit crunch had subsidiaries at Dublin’s International Financial Services Centre.
Chief among these was the giant Depfa, which is being bailed out at a cost to the German taxpayer of €100 billion.
Depfa used the short-term funding markets to raise funds to lend to long-term infrastructural projects.
It was unable to raise funds when the credit crunch hit and the flow of funds in markets dried up.
Depfa’s Dublin operation, which was famously described by the German regulator as a ‘‘pigsty’’, is just one of the many troubled German banks that ran funding subsidiaries from Dublin.
Others include West LB, Sachsen LB, IKB and Hypo Real Estate - which merged with Depfa shortly before the credit crunch struck.
But the trend for German banks to set up funding subsidiaries in Dublin, where regulation was light-touch and corporation tax was low, is not a phenomenon exclusively associated with the credit crisis that began in 2007.
Many have forgotten that Bankgesellschaft Berlin (BGB), which collapsed more than a decade ago, also ran a funding subsidiary from Dublin.
The subsidiary raised funds for BGB Berlin which, like Anglo Irish Bank, engaged in aggressive real estate lending at the height of a property boom.
In 2001, BGB went running to the Senate of Berlin, seeking an emergency injection of €2 billion in new capital.
The shocked senators knew the regulator would close BGB unless taxpayers supported the bank.
The senate voted to inject new capital into BGB, which was majority owned by the city of Berlin and was one of Germany’s top ten banks.
BGB had made a series of massive loans to property developers during the boom years of the mid-1990s. When Berlin’s property bubble burst in 1999, it led to massive losses on the bank’s property-linked portfolios.
BGB reported a loss of €1.65 billion for the 2000 financial year, in what was seen at the time as the most serious financial crisis in Germany since the immediate post-war years.
The state government offered a series of guarantees to BGB, which ultimately resulted in the transfer of about €21 billion in potential liabilities to the taxpayer.
In the ensuing fallout, it emerged that wealthy clients - including select members of Berlin’s political and banking elite - had invested in the property boom through funds which had offered them guarantees against much of the risk of their investments.
Erisk.com, which designs learning materials for risk managers, has produced an account of the collapse on which we have relied here.
It says there are many lessons to be learned from the collapse of BGB, including that investment guarantees can be an expensive way to build business volumes, that strict loan approvals are critical to sound bank risk management, that boards must be informed about the economic risk factors underlying key business activities, and that politicians and bank risk management don’t mix well.
But Anglo Irish Bank chairman Sean FitzPatrick clearly wasn’t the kind of guy who was reading the risk management manuals.
Or, if he was, he wasn’t paying much attention. At any rate, he appears to have learned entirely different lessons from the collapse of BGB - including that politicians are useful allies, and that the folks at BGB in Ireland were very good at raising funds.
The Insider has learned that Anglo drew on expertise previously employed by BGB in Dublin to raise new funds - funds that FitzPatrick and his chief executive David Drumm then lent to property developers.
Indeed, as revealed exclusively by The Sunday Business Post last weekend, Anglo asked the then Minister for Finance, Brian Cowen, for legislation to be introduced that would expand the volume of funds it could raise by allowing it to issue covered bonds backed by commercial mortgages even though the regulator was worried about the measure arguing that commercial property lending had ‘‘greater inherent volatility by comparison with other asset classes in terms of valuation and default experience’’.
Anglo eventually got its way following an intensive lobbying campaign by Anglo, Depfa, West LB and others for certain legislative measures, which Cowen rushed through just before the 2007 general election.
Anglo went on to issue billions of euro of covered bonds, backed by commercial mortgages, under the new legislation.
Covered bonds enjoy a good reputation, and have weathered the credit crunch relatively well. This is because they are effectively guaranteed by the banks that issue them.
In the case of Ireland, however, the covered bonds are now underwritten by the taxpayer, as our banks are insolvent due to their reckless lending.
The scale of the taxpayer guarantee is so enormous that it has called into question the creditworthiness of the state.
So it was little surprise that, last week, credit rating agency Moody’s downgraded the covered bonds issued by Anglo and the other Irish banks, as it now has serious doubts about Ireland’s ability to honour the guarantee.
It seems our made-in-Ireland bond grenades have been exploding at home and abroad for the best part of a decade - leaving German and Irish taxpayers to pick up the tab for the collateral damage.

Freefall scoops IFTA

2011-02-17T03:42:00.000-08:00

Anglo pressed Cowen for bank law change

2011-02-14T03:58:00.000-08:00

13 February 2011

By Kathleen Barrington

The Financial Regulator repeatedly expressed doubts about the contents of proposed 2007 banking legislation of which Anglo was a key beneficiary.
One of Brian Cowen’s last acts as finance minister prior to the 2007 general election was to enact the legislation.
The legislation was published in February 2007 after former Anglo Irish Bank chief executive David Drumm and other bankers mounted an intense lobbying effort. Drumm and other leading bankers had written to Cowen the previous October urging him to speed up the timetable for getting the changes enacted.
The timetable had been delayed partly because the Financial Regulator was concerned about extending the so-called Asset Covered Securities (ACS) legislation to provide for the issuance of bonds backed by commercial mortgages - the provision which most interested Anglo.
Andrew Mawdsley, the regulator’s deputy head of banking supervision, had written to William Beausang, assistant secretary of the Department of Finance, in March 2006, warning that there was ‘‘a challenge’’ in extending the legislation to provide for commercial mortgage ACSs.
This was because commercial property lending had ‘‘greater inherent volatility by comparison with other asset classes in terms of valuation and default experience’’.
Drumm wrote to Cowen on October 10, 2006 to tell him that Anglo Irish Bank was ‘‘a key sponsor’’ of the proposed changes to the act, ‘‘in particular those provisions relating to the inclusion of commercial mortgage loans as eligible cover assets collateral’’.
But he was worried that the timetable for the proposed changes was slipping. Drumm argued that the power for Anglo to issue the kind of bonds envisaged in the proposed legislation was ‘‘a key part of its funding strategy going forward’’.
But the Financial Regulator persisted in raising questions about the commercial mortgages aspect, and other aspects of the legislation, in a number of exchanges with the Department of Finance and the Irish Banking Federation.
As late as January 2007, Mary Burke, head of banking supervision at the Financial Regulator, complained in a letter to Beausang of the late submission of a proposal to allow building societies to benefit from the act, a provision which would have benefited EBS.
‘‘The late submission of this proposal, given that the Department of Finance seeks to provide final instructions to the draftsman tomorrow, does not allow sufficient time for comprehensive analysis of the full prudential and legal implications of the proposal including its compatibility with current Building Society legislation," Burke wrote.
Frank Brosnan, deputy head of banking supervision, said in February 2007 that the documents received from the EBS and the Irish Banking Federation did not address the regulator’s ‘‘substantive concerns’’.
Many of the provisions bout which the Financial Regulator expressed initial doubts were included in the act. A spokesman for the Financial Regulator said this weekend: ‘‘We are satisfied that all our concerns were accommodated to our satisfaction as reflected in the final act and our secondary legislation."
The regulator’s concerns are contained in documents obtained by The Sunday Business Post following a Freedom of Information Act request. Documents published by the Irish Times yesterday on the passage of the legislation referred to intense lobbying by the banks, but made no mention of the reservations expressed by the Regulator about the proposed legislation.

Note to readers: the next item on this blog is designed to be read in conjunction wtih the above article.

Bowing to the bankers

2011-02-14T03:26:00.000-08:00

Bowing to the bankers

13 February 2011

By Kathleen Barrington

It was Friday October 13, 2006. Colm Breslin, a senior civil servant in the Department of Finance, was under pressure.
He was being hounded by bankers demanding a new law that would make it easier for them to raise money to fuel their lending spree.
The bankers had been seeking the changes since 2005, and they were growing impatient.
The delays were largely because the Financial Regulator was questioning certain provisions in the proposed legislation, including one which would benefit Anglo Irish Bank.
Just before 10 o’clock in the morning, Breslin sent an email to Enda Twomey, deputy chief executive of the Irish Banking Federation (IBF).
‘‘The IBF is certainly an effective lobby coordinator; we are under seige (sic) from reps from banks about slippages in the ACS time path," he noted.
ACS stands for the Asset Covered Securities Act. That was the legislation which the bankers were seeking to have amended (see panel below).
But, as Breslin explained to Twomey in his e-mail, the Financial Regulator had ‘‘concerns."
So Pat Farrell, the powerful chief executive of the IBF and a former general secretary of Fianna Fáil, had been stepping up the pressure on finance minister Brian Cowen to get things moving.
Just a few days earlier he had written a ‘‘Dear Brian’’ letter to Cowen expressing his ‘‘disappointment’’ that the timetable for the legislation had fallen behind schedule.
Cowen had received similar letters from David Kelly, managing director of AIB Mortgage Bank; Michael Doherty, managing director of Germany’s WestLB and Austin Jennings, chief executive of Bank of Ireland Global Markets.
Cowen was also coming under pressure from the masters of the banking universe, namely Gerhard E Bruckermann, the chief executive of Germany’s powerful Depfa Bank - which was operating from the Irish Financial Services Centre in Dublin - and David Drumm, chief executive of Anglo Irish Bank.
Depfa and Anglo have since become bywords for bad banking with taxpayers picking up the tabs for their reckless lending. The cost to the Irish taxpayer of bailing out Anglo is now about €30 billion and rising, while the cost to the German taxpayer of
bailing out Depfa amounts to about €100 billion.
And, of course, it is also striking that the other Irish and German banks that lobbied for the legislation have all since had to be propped up at taxpayer expense.
But back in 2006, bankers were calling the shots. Depfa’s Bruckermann demanded a meeting with Cowen to discuss an ‘‘urgent issue’’ relating to the proposed changes in the legislation.
He warned that, ‘‘any delays in their introduction will have serious negative impacts, both for our business model, and for the reputation of the ACS market and Ireland’s international financial profile as a whole’’.
Depfa was among the banks that wanted the so-called 50 times rule to be removed in the new legislation.
The rule was a prudential measure which prevented banks from issuing more than 50 times their own funds in so-called ‘covered bonds’ (see panel).
The bankers were arguing that the 50 times limit was too conservative.
The bankers had already won the argument in Germany where the limit had been removed in 2005 legislation, legal sources explained. The IBF had been making the case that Ireland risked losing business back to Germany if Ireland failed to relax the rules. It seems that, in this respect at least, Ireland was simply falling in step with the Germans’ new, lower regulatory standards.
Drumm, the €3 million-a year Anglo boss, also wrote to Cowen in October 2006 letting him know that Anglo was one of the major players behind the push for the legislative changes.
‘‘Anglo Irish Bank is a key sponsor of the proposed changes to the Irish ACS Act, in particular those provisions relating to the inclusion of commercial mortgage loans," Drumm wrote.
‘‘I understand that the Department of Finance to date has been very supportive of the proposed changes to the Act. I am concerned, however, that the timetable for the proposed changes has fallen behind schedule and that the changes are now unlikely to be enacted in 2006."
The disclosure that Anglo Irish Bank was a key sponsor of the legislation is interesting, given that Anglo declined to comment last year when this newspaper enquired whether the bank had lobbied for the introduction of the legislation.
Just why the state-owned bank chaired by former Fine Gael leader Alan Dukes withheld this information from the public is not clear.
By October, the bankers’ tone in their dealings with the Department of Finance had hardened compared with six months previously when Bank of Ireland chief executive Brian Goggin had led a charm offensive.
In May, the €4 million-a year Bank of Ireland boss had been so delighted with the reception he got from the finance minister that he wrote to Cowen a few days late to thank him in the most effusive terms.
‘‘I can honestly say that I find it hard to remember when I have had as enjoyable, insightful and stimulating few hours’ discussion," Goggin said.
‘‘You raised a particularly interesting issue, indeed challenge, on the question of influencing or at least informing the debate on where and how we take forward this great project that is modern Ireland, a place that is so very different and has so much greater potential than earlier generations could have dreamed of," he said.
Goggin promised to give the issue further thought. In the meantime, though, he enclosed a note for Cowen on the success of the earlier ACS legislation which, he argued, had promoted ‘‘a very positive image of Ireland abroad’’.
But by October, the bankers were getting worried they wouldn’t get their coveted new legislation ahead of the 2007 general election.
On the very day that Breslin, the harried civil servant, wrote that he was under siege from the bankers, a new front was opening in the battle to get the legislation passed.
On Friday 13 also, Sean Dorgan, the chief executive officer of the IDA wrote a letter to Cowen pointing out that the country’s reputation for delivering necessary changes promptly would ‘‘be damaged’’ if the legislation wasn’t passed.
‘‘Our understanding is that a great deal of work has gone into the preparation of this bill and that it will raise no controversy," Dorgan assured Cowen.
Later that month, Cowen received another letter on the matter, this time from his boss. Taoiseach Bertie Ahern reminded Cowen that he (Ahern) had effectively promised the banks the legislation would be delivered.
But the Financial Regulator still wasn’t for turning. Marion Ryan, an official with the Financial Regulator, sent an e-mail to William Beausang, assistant secretary of the Department of Finance.
She made it clear that the Financial Regulator wanted a detailed proposal addressing the risks of issuing bonds backed by commercial mortgages, such as the tendency for mortgage defaults to occur in clumps, high loss severities when default rates were high and the repayment capacity of commercial mortgage borrowers.
Peter Geissel, director of group treasury at Anglo Irish Bank, responded on November 1 seeking to allay the regulator’s concerns.
But the Financial Regulator still wasn’t happy. Later in November, Frank Brosnan, deputy head of banking supervision at the Financial Regulator, wrote to Breslin at the Department of Finance saying that further elaboration was required on the industry’s proposals for commercial mortgages.
At the end of November, the Financial Regulator’s Brosnan again wrote to Beausang ‘‘to record our disappointment that many of the valid points raised by the Financial Regulator in recent correspondence were not reflected in this latest draft’’.
Brosnan queried a proposal to allow a building society to be covered by the legislation and an amendment allowing for the removal of a 15 per cent geographical limit on the number of foreign mortgages that could be used to back the bonds issued by the banks under the proposed legislation.
In January 2007, Mary Burke, head of banking supervision at the Financial Regulator, wrote to Beausang protesting, among other things, at the late inclusion of the proposal to allow building societies to be included in the legislation.
The records suggest this proposal was being included because the EBS Building Society had wanted it.
The documents which we have obtained under the Freedom of Information Act suggest the Financial Regulator was voicing concerns about the new legislation, but that Cowen and his department were bowing to the bankers.
In February 2007, Cowen published the legislation which he said ‘‘helps provide a very competitive source of funding for mortgage lending by financial institutions and it is the method by which our major mortgage lenders raise a considerable proportion of the funds they use for mortgage lending’’.
The bankers got their way on the main issues for which they had lobbied. Commercial mortgages were allowed to be used to back the covered bonds; the 15 per cent geographical limit was removed; the building society provision was included; and the 50 times rule was dropped.
The legislation was enacted in April 2007 - just a month before the general election - despite protests from Labour’s finance spokeswoman Joan Burton that it was being rushed through without adequate briefing for the opposition on the rationale behind it.
In another curious twist, the Dáil record shows that Tom Parlon, Minister of State at the Department of Finance, who steered the bill through the Oireachtas, said in response to a question from Burton that the Financial Regulator was ‘‘involved in drafting the bill, cleared and passed it and is satisfied with the bill.’’
A spokesman for the Financial Regulator said this weekend: ‘‘We are satisfied that all our concerns were accommodated to our satisfaction, as reflected in the final act and our secondary legislation."
Once the bankers had got their way, they went back on the charm offensive.
On April 10, 2007, the IBF’s Pat Farrell wrote to Parlon and to David Doyle, secretary general oft he Department of Finance, expressing the bankers’ ‘‘sincere thank you’’ for their support.
The use of covered bonds to raise funds on international markets is perfectly legitimate. Indeed, covered bonds enjoy a very good reputation, largely because they had for centuries been well regulated since they were first used in Germany where they are known as Pfandbriefe.
But the Irish covered bonds legislation raised eyebrows both because it demonstrated the extent to which competition was driving countries to relax the rules and because it was perceived in some quarters to have been conceived at least in part for the benefit of one player - Anglo.
The legislation also facilitated the supply of more funding to the banks at a time when they were already overly reliant on wholesale funding.
It paved the way for banks to lend even more into an already overheated property market, effectively putting more air in to an enormous property bubble just before it burst - leaving first the banks and then the country teetering on the brink of insolvency.
Ironically, the explanatory memorandum issued by the Department of Finance to accompany the bill seemed very reassuring. ‘‘The bill will not give rise to any additional costs to the exchequer," it said.

Panel: Covered Bonds Explained:

A covered bond is a bond backed by assets such as public sector debt or mortgage loans. The bonds remain on the issuing bank's balance sheet.
The Asset Covered Securities Amendment Act 2007 included a provision that allowed banks to issue covered bonds backed solely by commercial mortgages.
Under the previous 2001 Act, the bonds could only be backed by residential mortgages or public sector debt.
Given that Anglo Irish Bank was not a residential mortgage lender, the move opened up a new source of funding for Anglo.
The other banks already had access to the covered bond market because residential mortgages were covered in the 2001 legislation.

Are depositors in the firing line?

2011-02-14T03:10:00.000-08:00

13 February 2011

By Kathleen Barrington

Back when Central Bank governor Patrick Honohan was still an academic, he wrote a paper highlighting how certain measures added greatly to the cost to the taxpayer of sorting out banking crises.
‘‘Our empirical findings reveal that unlimited deposit guarantees, open-ended liquidity support, repeated recapitalisations, debtor bailouts and regulatory forbearance add significantly and sizeably to costs,” he wrote.
So, it is little wonder that governments and regulators who adopted such emergency policies in the initial stages of the crisis are now changing tack in favour of bank resolution measures that limit taxpayers’ exposure. But the resolutions being adopted aren’t always confined to the populist idea of ‘burning the bondholders’.
Some are also ‘burning the depositors’ - that is, failing to repay them in full.
Last Sunday night, the Danish government decided that some depositors in the small, insolvent Amagerbanken should contribute to the cost of bailing it out.
Depositors learned that they would be losing 41 per cent of any amount they held on deposit over the statutory guarantee limit, which amounted to about €100,000.
Amagerbanken said that, of its 100,000-plus customers, about 700 would be affected. In banking parlance, the 700 unfortunate depositors were being asked to take a haircut of 41 per cent, alongside the bondholders.
This manner of resolving banking crises is relevant here, given that Fine Gael finance spokesman Michael Noonan referred in general terms to the Danish model on television last week. However, he did not mention that depositors in Amagerbanken were going up in flames alongside the bondholders.
Just ask yourself: how would you feel if an elderly relative had €200,000 on deposit to pay for a nursing home, only to find that €41,000 of it was being applied to fund the bailout of the bank to whom she had entrusted her savings?
But perhaps you would feel less bad about your relative losing €41,000 if you felt that it would eliminate the need for further tax hikes to pay for bank bailouts and cuts in social welfare benefits for the needy?
Financial news agency Bloomberg reported that Denmark was dealing with Amagerbanken under regulations introduced in October, which are designed to ensure taxpayers don’t have to meet the entire bill when lenders fail.
The debate in Ireland is gradually shifting.
Whereas, previously, the idea of burning the bondholders was seen in establishment circles as a remote possibility being championed by irresponsible economist eggheads and headline-seeking journalists, it is increasingly being seen as a way out from under the country’s intolerable debt burden.
The debate is now less about whether to burn the bondholders, but rather about how they should be burned - and whether we should burn them with the approval of our European partners or run the risk of taking unilateral action.
Dermot O’Leary, chief economist with Goodbody Stockbrokers, said last week that the country could not continue to bear the burden of the banking sector liabilities.
He suggested persuading the EU that we should not repay €21.5 billion in outstanding unguaranteed bank debt.
‘‘We believe there should be a form of risk-sharing with taxpayers and bondholders to address the banking crisis above and beyond what we have seen already,” he said.
Accountancy firm Mazars has also weighed into the debate, with the publication of a paper on special resolution regimes for banking crises.
Given that Mazars has advised the Financial Regulator on previous occasions, the paper is likely to be getting the attention of the authorities here.
The paper said that the Memorandum of Understanding between the government and the IMF and EU authorities contained a commitment that Ireland would publish bank resolution legislation by the end of March.
It said that, in the dying days of 2010, the government enacted the Financial Institutions Stabilisation Act, which has some features of a resolution scheme.
The paper also examined the special resolution mechanisms adopted in other countries, including Denmark.
And while it doesn’t come down in favour of one country’s solution over another, it floats the idea that a special resolution mechanism should operate outside the provisions of normal insolvency legislation, and should be empowered to take control of the bank, including closing it for a short period to make an assessment of the position.
The authorities would then reopen the bank and proceed to deal decisively with the positions of the various creditors, effectively providing a haircut for creditors in order of ranking.
In other words, the creditors would be repaid only a percentage of what they were owed.
The first losses would be suffered by shareholders followed by subordinated bondholders, other unsecured creditors, senior bondholders and so on.
The question of whether we should burn the depositers if we burn the bondholders is not being asked publicly, though it is a relevant one, given that Minister for Finance Brian Lenihan has long argued that depositors rank equally with bondholders under Irish law.
Currently, the first €100,000 of your deposit with an Irish-based bank institution is guaranteed under the deposit guarantee scheme. If your deposit is over €100,000, it may be covered by the separate eligible liabilities guarantee (ELG) scheme which is currently scheduled to expire on June 30 this year.
The ELG scheme covers deposits held with AIB, Anglo Irish Bank, Bank of Ireland, EBS, ICS, Irish Life & Permanent and Irish Nationwide.
Given that the shareholders in all the Irish banks have already been wiped out, while the subordinated bondholders have also taken a hit, it is reasonable to ask whether Irish depositors could eventually find themselves in the firing line alongside the senior bondholders if a new government decides that, in these desperate times, it must find new ways to ease the burden on the taxpayer.

How FitzPatrick sent a €600m deposit book waltzing to Vienna

2011-02-07T02:18:00.000-08:00

06 February 2011

By Kathleen Barrington

The more you learn about Anglo Irish Bank’s €600 million Austrian deposit book, the more you wonder why Sean FitzPatrick decided to sell it in September 2008, a time when Anglo was in dire need of deposits.
The accounts for Anglo Irish Bank (Austria) AG, which have now been obtained by the Insider, contain new information which shows that the Austrian bank was deposit-rich, highly liquid and strongly capitalised.
Anglo’s Austrian operation had total deposits of €570 million at the end of September 2008. But, unlike the parent bank in Dublin, Anglo Austria had lent very little of the depositors’ money to borrowers. Much of the cash it had received from depositors was placed with financial institutions, including the parent company in Dublin.
The directors’ report, written in both English and German, makes clear that ‘‘lending remains a small part of overall activity and is only done according to the strict credit policy of the bank’’.
Loans to ordinary commercial customers amounted to just €34.4 million. This represented ‘‘the private client loan book, and its moderate size reflects the fact that this is an ancillary service used by some clients’’.
As well as being rich in liquidity (in contrast to its parent, which was starved of it), Anglo’s Austrian bank was also exceedingly well capitalised. On September 30, 2008, Anglo in Austria had €92 million in capital, almost five times the actual requirement of €19.1 million. The bank’s capital ratio was a very strong 39 per cent at the financial year-end.
The bank was also profitable, delivering an 18 per cent increase in pre-tax profits to €13.54 million for the year to September 30 2008.
In short, the accounts make it clear that the Austrian operation was providing a source of funding for Anglo in Dublin - just what the latter needed at the time.
The accounts also make clear that the Austrian operation was of such importance that during 2008, eight of the Anglo top brass sat on its supervisory board.
They included FitzPatrick himself, former finance director Willie McAteer and former chairman Peter Murray. These eight far outnumbered the two Austrians sitting on the management board.
The accounts state that while there was extreme upheaval in the financial system as the credit crunch mutated into a systemic collapse of the banking system, Anglo Irish Bank Austria was ‘‘probably less impacted than most other financial institutions’’.
Yet, on September 4, Anglo signed ‘‘a binding agreement’’ to sell the Austrian operation to the Swiss Valartis Group, known in Austria for its sponsorship of snow polo in Kitzbühel.
Anglo announced the sale of the Austrian private bank in the midst of a liquidity crisis - just three weeks before the government introduced the bank guarantee scheme to prop up our troubled banks.
FitzPatrick effectively sent nearly €600 million in deposits waltzing out the back door to Vienna, even as he was extending the begging bowl to politicians, regulators and competitors in Dublin in a desperate attempt to obtain funding to prop up the parent bank, which was teetering on the brink of insolvency.
In fact, as we have pointed out before, Anglo Irish Bank was so keen to get rid of its Austrian deposits that it lent Valartis €24 million to help fund the €141 million purchase price. The deal was finalised in December 2008, three months after the Irish taxpayer guaranteed the entire Irish banking system and just weeks before Anglo was nationalised by the government.
One effect of the sale is that almost €600 million in deposits that were formerly held with Anglo Irish Bank’s Austrian office are now on deposit with Swiss Bank Valartis - far away from the prying eyes of the unfortunate Irish taxpayers who have been left footing the bill for FitzPatrick’s disastrous rule of Anglo.
Extraordinarily, neither Minister for Finance Brian Lenihan nor Anglo is prepared to offer any assurances to the taxpayer that none of the €600 million in Austrian deposits is owed to Anglo, to Nama or to other lending institutions propped up by the Irish taxpayer.
Anglo Irish Bank has also declined to comment on the whereabouts of a €22 million deposit which FitzPatrick and another former Anglo director still held with Anglo Irish Bank shortly after the end of September 2008.
Details of the deposit are contained in a little-noticed note in the 2008 accounts of the Dublin parent bank. The note states that shortly before September 30, 2008, FitzPatrick and another former director withdrew deposits of €22 million which were used to repay their loan balances with the bank.
It says the amount was subsequently redeposited ‘‘shortly after the year end following the redrawing of loan facilities’’.
This suggests that FitzPatrick and the other unnamed director still had €22 million on deposit with Anglo shortly after September 30, 2008, when the government introduced the bank guarantee scheme.
Anglo also declined to respond to a question from this newspaper as to what proportion of the €22 million was FitzPatrick’s, and for what purpose the deposit had subsequently been applied.
Drury Communications, the public relations agency that is paid by state-owned Anglo Irish Bank to field media queries, said that, ‘‘because there are a number of investigations ongoing (including criminal investigations), the bank has been instructed not to comment or provide any detail to media on anything that could form part of the investigations’’.
At the time of going to press, FitzPatrick, who was declared bankrupt last year, had not responded to a letter posted to his home address seeking a request for comment.
Public attention has focused on the huge loans that some directors held with Anglo which, in FitzPatrick’s case, were partly concealed by parking them temporarily with Irish Nationwide Building Society at year-end.
However, the details about the large deposits held by directors have barely attracted attention even though the sums involved are also very large. For example, the parent company’s accounts reveal that 12 Anglo directors had as much as €140 million on deposit with Anglo during the year to 30 September 2008.
But the accounts reveal the remaining ten directors held at most €38 million on deposit with Anglo, during the 15 months to December 2009.
The accounts also show that only €8 million in directors’ deposits were held with the bank on December 31, 2009.

Misleading lenders caused this crisis - and could do so again

2011-01-31T08:17:00.000-08:00

30 January 2011

By Kathleen Barrington

It was August 2004. The O’Connors were worried about keeping up with the mortgage, and bills were piling up.
So when Gertrude O’Connor answered the phone and a loan officer from sub-prime lender Ameriquest Mortgage introduced himself, she listened to his pitch about refinancing and rolling their credit card bills into a new mortgage.
She explained that she and her husband were retired. Duane O’Connor was 67, and collected a pension and a social security cheque. He couldn’t work because he suffered from a rare disease.
Gertrude was 66 and received social security, as well as a cheque from the county to cover her in-home care for their 36-year-old son Brad, who had been disabled in a car accident.
The salesman said Ameriquest could help and the closing costs for the loan would be less than $9,500. The O’Connors were later told they’d been approved for a 30-year loan with an initial interest rate that would stay locked for the first three years.
Their payments would be $3,440 a month. Gertrude said she wouldn’t pay any more than 8.5 per cent interest.
Ameriquest put together a loan application that made the O’Connors appear to be better risks both to the company’s loan underwriters and to the investors who would buy securities backed by their loans, such as knocking 20 years off their ages and stating that Gertrude had worked for two years for a healthcare company when she was simply in receipt of a grant for nine months.
Soon after the signing, the O’Connors learned that the loan was different from what they had been told to expect.
The settlement costs weren’t $9,500 - they amounted to nearly $17,000 of the $400,500loan. The interest rate was higher at 10.166 per cent.
The rate was fixed for just two years. After that, it could climb as high as 15.75per cent. The O’Connors’ loan was transferred into a pool of loans called Ameriquest Mortgage Securities Inc Asset-Backed Pass Through Certificates, Series 2004-R11.
Germany’s Deutsche Bank acted as the trustee. Swiss bank UBS served as the lead manager and book runner, meaning that it structured the deal and its bond salesmen sold the securities to investors. US investment banks Goldman and Merrill Lynch acted as ‘‘co-managers’’ helping UBS to sell the bonds.
The O’Connors’ mortgage was one of more than 8,500 Ameriquest loans that UBS packaged into the deal in November 2004. About 27 per cent were stated income or limited documentation mortgages, an indication that Ameriquest had done little checking to see whether borrowers could afford the loans.
Many borrowers had high debt-to-income ratios. Four out of five mortgages in the pool were 2/28 adjustable loans, which meant that they started with a two-year teaser rate and then began zooming upwards for their 30-year terms.
Most of their rates could climb as high as 13.5 per cent after their initial two-year fixed-rate period.
UBS took some steps to protect investors from the risk of default mainly by putting in extra collateral - that is, a greater dollar value of mortgages than the total dollar value of the securities to be sold, the idea being to offer investors a cushion.
The three credit rating agencies - Moody’s, S&P and Fitch - gave the securitisation a AAA safety rating.
Many leading financial firms, including JPMorgan, John Hancock Insurance, Fidelity Investments and Citigroup, bought pieces of the deal.
This account of how bad mortgage-lending infected the entire US financial system is contained in a book on the sub-prime crisis written by Michael W Hudson, who is a staff writer at the Centre for Public Integrity, a non-profit organisation. It recounts how, three years later, in 2007, Ameriquest (which was America’s largest sub-prime lender) collapsed, leaving a trail of destruction behind it.
The legacy of this kind of lending was homeowners struggling with unaffordable mortgages, investors exposed to lousy investments in mortgages, and ultimately taxpayer bailouts to restore confidence in a damaged financial system.
We highlight these extracts from Hudson’s book in a week when the Financial Crisis Inquiry Commission, set up to investigate the causes of the 2008 US financial crisis, found that shoddy mortgage lending, the excessive packaging and sale of loans to investors, and risky bets on securities backed by the loans were among the main causes of the banking crisis (though a number of Republicans on the commission have offered dissenting views).
The Financial Crisis Inquiry Commission found that ‘‘the greatest tragedy would be to accept the refrain that no one could have seen this coming and thus nothing could have been done. If we accept this notion, it will happen again’’.
It went on: ‘‘The crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire. The captains of finance and the public stewards of our financial system ignored warnings and failed to question, understand and manage evolving risks within a system essential to the wellbeing of the American public. Theirs was a big miss, not a stumble.”
Hudson is one of the journalists who had long been sounding warnings which the public stewards of the US financial system failed to heed. His message in his latest book is clear: the financial crisis is rooted in the mis-selling of mortgages to hard-pressed consumers.
It is a message that needs to be met with a policy response both in the US and here -namely much better protection for consumers at the point of sale of financial products.

The Monster: How a Gang of Predatory Lenders and Wall Street Bankers Fleeced America and Spawned a Global Crisis, by Michael W Hudson, is published by Times Books

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Lenihan silent on issue of Anglo’s Austrian depositors

2011-01-24T07:20:00.000-08:00

23 January 2011

By Kathleen Barrington

Minister for Finance Brian Lenihan has refused to provide assurances that none of the owners of €600 million-worth of deposits held in Anglo Irish Bank’s former Austrian subsidiary owes money to the nationalised bank.
Lenihan said a bank could not disclose information about its customers, as this data was protected by client confidentiality. Anglo Irish Bank announced the sale of its Austrian subsidiary to Swiss bank Valartis on September 5, 2008.
The announcement did not disclose that the deposit book contained €600 million of deposits, a matter which was subsequently disclosed in a little noticed note in Anglo’s 2009 accounts.
It has since emerged that Anglo was pleading with Taoiseach Brian Cowen as far back as April 2008 that it was in dire need of deposits.
The bank also sought to artificially boost its balance sheet at its 2008 year end to give the impression it was retaining deposits, even though it is now known that deposits were by then haemorrhaging out of the bank.
In a statement issued in response to questions from this newspaper, Lenihan said last week that it was ‘‘normal course of business for a bank to dispose of their non-core assets, especially where there is the potential to make a profit - the disposal of non-core assets is part of the approach that has been adopted since then by the European Commission, in relation to the restructuring of various institutions across Europe."
Anglo’s 2009 accounts stated that it realised a profit of €49 million from the sale of its Austrian private bank to Valartis.
The accounts also revealed that Anglo provided Valartis with a €24 million loan to part-fund the purchase price of €141 million.
Last week, Anglo declined to provide assurances that none of the owners of the deposits owed the bank money. The bank cited client confidentiality.

Mugging the mortgage holders

2011-01-24T02:33:00.000-08:00

23 January 2011

By Kathleen Barrington

Traditionally, the rule for evaluating whether a borrower is borrowing too much is that no mortgage loan should exceed two and a half years’ income.
However, by 2005, a widely used standard for home mortgage lending in the United States was the so-called 28/36 rule: the mortgage payments should be no more than 28 per cent of a borrower’s income, and all debt payments should be no more than 36 per cent of the borrower’s income.
The effect of the 28/36 rule was that it allowed mortgage lenders to lend more generously when interest rates were low.
Professor Robert Shiller of Yale University commented as far back as 2005 that it was notable in the US that many lenders extended the original 28/36 rule to adjustable rate mortgages (ARMs) - which in Ireland we call variable rate mortgages -whose interest rates were only temporarily low, subject to increase after one, three or five years.
‘‘The lending institutions that make these loans - or the institutions that buy the loans from them - are at risk of suffering massive defaults on these loans some years after they were made,” Shiller warned in the 2005 edition of his book, Irrational Exuberance, which predicted the US house price crash.
‘‘But officers at these institutions, calculating their own personal career advantage in bringing in more business today, often do not seem to worry about that possibility.”
And so it proved. It was called the sub-prime crisis, it triggered the international credit crunch and the resulting depression.
In the US, it appears that lenders and borrowers have at least partially learned the lesson that selling mortgages at low introductory rates is a dangerous road to go down.
Many Americans are now reverting to the long-term fixed rate mortgages, often for 30 years. The advantage is that the cost of those mortgages more accurately reflects the true cost of the mortgage over the full term.
This prevents borrowers from overpaying for houses when interest rates are unusually low, only to be left with a very large monthly repayment and negative equity on their homes when interest rates rise.
But even though the Irish house price crash happened on a truly awesome scale, Irish banks have continued to sell variable rate mortgage products to consumers since the crisis erupted in the late summer of 2007.
Consumers who bought houses while interest rates were at historic lows over the last few years are in line for some nasty interest rate shocks, as lenders push up their rates in an effort to plug the holes in their balance sheets, while the European Central Bank is also likely to put up rates at some stage. The news that Permanent TSB is set to raise its variable interest rate by 50 basis points from next month means that the standard variable rate payable by its borrowers will be a whopping 4.7per cent, even though ECB rates remain unchanged at 1 per cent.
There have also been reports that banks are poised to withdraw the few remaining fixed-rate mortgage products in the market.
This column has long argued that consumers should be encouraged to buy products that fix mortgage repayments over the longer term and ideally over the full term of their mortgage - assuming such products are available on acceptable terms.
This would provide certainty about future mortgage repayments and avoid the problem of consumers overpaying for houses when interest rates are low, only to be left with high mortgage repayments on large loans when interest rates increase.
We recently highlighted the Danish system as one which Irish policymakers should investigate as the Danish financial system is seen as having weathered the recent financial crisis rather well.
But the Irish Banking Federation (IBF) has argued that Irish consumers generally appear disinclined to commit to long-term, fixed-rate mortgages, while the few consumers that bought fixed-rate mortgages have clamoured to extricate themselves in order to take advantage of falling short-term interest rates.
It also argued that the certainty of a fixed rate over the duration of the mortgage term comes at a cost. It said the typical rate on a Danish 30-year fixed mortgage could be as much as 175 per cent higher than the one year fixed equivalent.
The IBF further argued that, while the Danish market was not twice the size of the Irish one, the foreclosure/repossession rate was seven times greater.
But some of those arguments seem disingenuous. One of the reasons Irish consumers have avoided long-term fixed-rate mortgages is because the premium being charged by Irish lenders has often been higher than in other countries. Last week, you could get a 25-year fixed-rate mortgage for 3.5 per cent in France, which sounds attractive.
The IBF argument - that the long-term interest rate is higher than the one-year equivalent - is certainly true, particularly when interest rates are at historic lows, but that ignores the fact that low interest rates mask the true cost of finance over the full term of the loan.
The effect of this is that consumers tend to overpay for houses when rates are low, as they fail to grasp the true cost of the long-term risk they are taking.
The IBF argument that foreclosure rates in Denmark are higher is also true, but then the rate here would be far higher if it weren’t for the government moratorium on repossessions.
We suspect the real reason the banks are hostile to long-term fixed-rate mortgages is because they limit the opportunities for banks to dip into the consumer’s pocket to rebuild their badly damaged balance sheets.
Remember, every 1 per cent increase in the interest rate generates €1.4 billion in additional revenues for the banks, revenues which come straight out of the consumer’s pocket, according to figures supplied by Goodbody economist Dermot O’Leary.
The mugging of the Irish mortgage borrower has wider consequences for the total economy, as the more consumers shell out on their mortgages, the less they will have available to spend on goods and services resulting in greater pressure on businesses.
Rising mortgage interest rates could also push more borrowers into default resulting in more demands from the banks for taxpayers’ money to plug holes in their residential mortgage books.
It is notable that credit rating agency Moody’s last week reported that the performance of Irish prime residential mortgage backed securities (RMBS) market continued to deteriorate during November 2010 The securities represent about €40 billion of Irish mortgages that have been bundled up and sold to investors, such as pension funds.
Moody’s found that 5.68 per cent of these were delinquent for 90 days or more, more than the October figure, while 1.62 per cent of the loans were delinquent for more that 360 days, also an increase on the October figure.
The rating agency expects the unemployment rate to continue rising to 13.9 per cent by the first quarter of next year. It warned that a combination of government spending cuts and tax increases would reduce household disposable incomes and constrain borrower’s ability to maintain their mortgage payments.
To the extent that the mortgages remaining on the balance sheets of the Irish banks are similar to the ones sold to investors, this is a very worrying problem indeed.

€600m Anglo deposits that got away

2011-01-17T02:12:00.000-08:00

16 January 2011

By Kathleen Barrington

Brian Cowen should explain why Anglo Irish Bank was allowed to sell a €600 million Austrian deposit book to a Swiss bank, at a time in 2008 when he knew that Anglo Irish Bank was in dire need of deposits.
This question is all the more pressing in the light of revelations in The FitzPatrick Tapes, the excellent new book by Tom Lyons and Brian Carey.
While much of the focus has been on the book’s revelations of two new contacts between Cowen and former Anglo Irish Bank chairman Sean FitzPatrick - notably a March 2008 telephone conversation and a July 2008 round of golf - the book also gives details of what was discussed at a previously disclosed dinner which Cowen attended with the directors of Anglo in April 2008.
That dinner took place just five weeks after the St Patrick’s Day Massacre, when Anglo Irish Bank suffered a massive fall in its share price on international markets and a subsequent serious flight of deposits.
According to the book, the Anglo directors told Cowen over dinner that the property market had crashed because of the credit crunch. Former chief executive David Drumm repeatedly voiced concerns to Cowen about how difficult it was to hold on to deposits and raise new funding in the crisis.
Anglo was so desperate for deposits that it was pleading with Cowen to ask the National Treasury Management Agency to put taxpayers’ money on deposit with the bank.
‘‘David did ask about the NTMA,” FitzPatrick told Lyons. ‘‘Anglo wanted Cowen to have a word about it [the NTMA] placing some of its money on deposit with the bank. He said he’d look into it.”
A month later, Department of Finance officials met with Michael Somers, chief executive of the NTMA. The meeting recorded that the NTMA had placed €300 million in deposits with the main banks.
However, it appears from remarks given by Somers in later media interviews that the NTMA intervention was not particularly useful to Anglo, as the NTMA was hesitant about placing more than €40 million with FitzPatrick’s bank.
That same summer, Drumm, still spooked by the spring-time run on Anglo’s deposits, held two meetings with Rabo Ireland - a deposit-rich bank - to discuss merging the two entities. Such a merger would have helped resolve Anglo’s deposit problem at a stroke.
Not surprisingly, Rabo, which would have been aware of Anglo’s high-risk property lending, turned Drumm down.
Such was the scale of the problem, that Anglo sought artificially to boost the deposits on its balance sheet in both its half-year and end-of-year accounts.
The crucial customer deposits figure was artificially boosted by €7.2 billion at the year end using funds that controversially came from Irish Life & Permanent. The move gave investors in Anglo shares false assurance that the bank was retaining its deposits, even though the bank was by then losing them by the bucketload.
The book says that Drumm and other Anglo officers met with Con Horan, the prudential director of the Financial Regulator on September 20, 2008. Anglo told Horan it was facing an appalling funding situation: the bank had lost €5 billion in deposits over the previous week.
We also know from the Freefall documentary last September, that Anglo’s funding problem was so critical that FitzPatrick and Drumm on September 29 pleaded with Bank of Ireland to buy Anglo - to no avail.
The book does not report on the curious fact that Anglo Irish Bank had earlier that month announced that it had agreed to sell its deposit-rich Austrian private banking subsidiary to listed Swiss banking group Valartis - an issue first highlighted in The Sunday Business Post last September.
The sale of Anglo’s Austrian deposit business was technically completed the day after FitzPatrick resigned as chairman of Anglo in December 2008 after his concealment of his massive Anglo loans became public.
The €600 million deposits are now hidden in Austria, which is famous for its tough bank secrecy laws, effectively ensuring that it would be very difficult for the authorities to identify the depositors.
It is strange that neither Cowen nor the Regulator appears to have stood in the way of the sale of a €600 million deposit, when FitzPatrick and Drumm had been moaning to them for months about the flight of depositors, and pleading for public and private funds to plug the gap.
The apparent official indolence on this matter is surprising, especially when you consider that in 2002, Maurice O’Connell, the former governor of the Central Bank of Ireland, was happy to state publicly, at a dinner held in FitzPatrick’s honour, that he recalled meeting FitzPatrick to discuss his original acquisitions of banks in Vienna and Geneva.
‘‘I now began to realise that little Anglo Irish Bank wasn’t so little anymore,” O’Connell said on a commemorative DVD which FitzPatrick showed to Lyons.
‘‘And then they acquired a box in Croke Park and I said, from now on, I must be nice to these people!”
Successive regulators appear to have been so nice to Anglo that they didn’t bother asking any hard questions about why it was flogging a €600 million deposit book when it was so badly in need of deposits.
Indeed, cash-strapped Anglo was so keen to get rid of the deposit book that it actually lent Valartis €24 million to part-fund the acquisition.
Last September, when Labour’s finance spokesman Joan Burton asked whether the matter was being investigated, Minister for Finance Brian Lenihan played down the matter.
Lenihan said in response to Burton’s query: ‘‘The bank has advised that the particular private banking business was not a core activity of the bank, was not particularly profitable and that there was a significant operational risk running the operation at a distance.
The bank feels it important to point out that it did keep a branch in Austria. I am informed that there is nothing in the records of the bank or the nature or timing of the transaction to suggest that the sale of the subsidiary was other than the normal course of business.”
But surely the biggest operational risk facing the bank at the time was its liquidity problem.
Surely the timing of the deal when the bank was effectively on the brink of insolvency was highly abnormal.
And finally, surely the taxpayers bailing out Anglo deserve a more detailed explanation of why this €600 million got away.

2011-01-10T03:08:00.000-08:00

Time for a new mortgage model

09 January 2011

By Kathleen Barrington

The fact that eurozone inflation rose in December at a faster rate than expected has fuelled speculation that the European Central Bank (ECB) might consider raising interest rates sooner than anticipated.
That would be bad news for Irish mortgage-holders, who would face mortgage interest repayment hikes at a time when many are already struggling under the weight of pay cuts, higher taxes and unemployment.
Irish consumers are among the most exposed to rising interest rates, as they have generally taken out variable rate mortgages.
That means their monthly mortgage repayments go up when interest rates rise. The issue is not so great a concern in Britain and Australia, where central banks continue to control their own interest rates. These can be set in accordance with national needs.
But Ireland and Spain face the problem that their interest rates are set by the ECB, which has to consider the picture in the eurozone as a whole.
The Insider first drew attention to the problem of Irish consumers’ vulnerability to rising interest rates as far back as March 2006, when house prices were very high and interest rates very low.
At the time, we suggested that the authorities should encourage the supply of long-term, fixed-rate mortgages, to protect consumers from the consequences of rising interest rates.
The beauty of the long-term fixed-rate mortgage is that it gives the borrower a more accurate picture of the true long-term cost of the mortgage and should, therefore, prevent the borrower from overpaying for houses when interest rates are temporarily low. But the authorities did little to encourage lenders and borrowers to protect themselves from the risk of rising interest rates, either through fixed-rate mortgages or other mechanisms.
It was entirely predictable that consumers who had taken out big mortgages to buy expensive homes would suffer when the ECB subsequently raised interest rates. Indeed, house prices first began to fall in early 2007 after the ECB raised its rates several times.
The ECB only slashed rates again when the credit crunch subsequently took hold.
But many Irish mortgage-holders did not get the benefit of the ECB cuts, as the banks failed to pass on the ECB reductions in full.
Indeed, many lenders pushed up the price of variable mortgages last year, as they sought to rebuild their badly-damaged balance sheets.
The only ones spared were those on tracker mortgages, who got the full benefit of lower rates, due to the legal protections offered to people whose mortgages track ECB rates.
But holders of tracker mortgages will suffer when the ECB raises interest rates again. That will no doubt lead to another bout of handwringing, headlines about higher repossession rates, and talk of a Nama for the little people.
In fact, what we really need to do is find a sensible way to protect the system from the kind of boom/bust cycle we have just experienced.
The debate about how to protect consumers, investors, lenders and taxpayers from future financial implosions is already in full swing elsewhere.
One strategy attracting attention is the Danish mortgage model.
George Soros, the speculator-turned-philanthropist, has highlighted the merits of the Danish solution which he is now marketing on a worldwide basis through a company called Absalon, a partnership between VP Securities and Soros Fund Management.
The Insider understands that representatives of the Absalon project will be meeting with the Irish government, the Central Bank and the commercial banks this week to market the Danish solution.
Absalon says the Danish way of financing housing through mortgage loans has proven its efficiency and reliability for more than 200 years. It is notable that the Danish mortgage market proved its robustness from a borrower’s, investor’s and lender’s perspective during the credit crunch.
Alan Boyce, the financial markets expert who spearheads the Absalon project, said that Ireland should seriously consider copying the Danish mortgage system.
‘‘Ireland would not be in the trouble it is in if it had something like the Danish system. After a big blow-up is the perfect time to build the financial architecture to make sure it does not happen again,” he says.
Last week, Dr Michael Lea of San Diego State University delivered a paper to the American Real Estate and Urban Economic Association, in which he examined what could be learned about mortgage finance from other countries. Lea highlighted the Danish model.
The system is based on the so called Principle of Balance.
This means that when the borrower obtains a mortgage loan, the mortgage credit institution issues the corresponding number of bonds in an open bond series. These mortgage bonds are attractive to investors such as pension funds as there has never been a default.
The borrower can refinance the loan at par (face value) if rates fall.
But if rates rise, the borrower can buy the bonds corresponding to his or her loan at a discount, and present them to the credit institution to repay the mortgage.
This feature has several important benefits. It allows an automatic reduction in the size of loans when interest rates rise and reduces the probability of negative equity, Lea argues.
Lea points out that Danish borrowers exercised this option in significant numbers in 2006 and 2007 when interest rates were rising, which may have reduced the likelihood of negative equity when house prices fell in 2008 and 2009.
The underwriting of Danish mortgages is strict. The maximum loan to value is 80 per cent and the borrower’s income is fully documented.
As in Ireland, the lender has recourse to the borrower’s income and other assets if the borrower defaults.
Traditionally, Danes have bought long-term fixed rate mortgages, though the proportion of variable rate mortgages has increased in recent years.
However, the Danes hope that borrowers will not face large problems when interest rates go up because the mortgage banks have been quite restrictive when granting people variable rate mortgages.
They insist that the borrower should be able to pay the cost of a fixed-rate mortgage at the time of granting the variable mortgage.
Danish mortgages are funded through the issuance of covered bonds. Individual loans are funded by selling the loan into a larger bond series.
The direct link established between the borrower and the bond market facilitates redemption of the bond in the future. Lea reckons the Danish system has performed well throughout the crisis, while the International Monetary Fund has noted that the Danish banking system fared well despite a housing boom.
Now that we are staring down the barrel of Jean-Claude Trichet’s interest rate gun, Minister for Finance Brian Lenihan’s new year resolution should be to find out more about the Danish mortgage model, and see if it could work here.
He could start by giving the Absalon people a hearing.

UniCredit Bank Ireland reclassified €3bn of assets

2010-12-22T09:50:00.000-08:00

IFSC firm reclassified €3bn of assets

19 December 2010

By Kathleen Barrington

UniCredit Bank Ireland plc, a wholly owned subsidiary of the giant Italian bank UniCredit, was among the banks that availed of emergency amendments to accounting rules introduced at the height of the 2008 financial crisis.
The Irish subsidiary, which is based at the International Financial Services Centre (IFSC) in Dublin, reclassified about €3 billion of assets.
This meant that those assets did not have to be valued at market prices which were then in turmoil.
‘‘Clearly the turmoil in global financial markets deepened significantly during the course of 2008 rendering the group’s operating environment very difficult. In the absence of a properly functioning market for credit assets, the group reclassified €3billion of assets from held for trading to loans and receivables," Ronan Molony said in his chairman’s statement.
UniCredit Ireland showed a profit after tax of €133.6 million in 2008 compared with a profit after tax of €38 million the previous year, the accounts reveal.
The notes to the accounts state that UniCredit Ireland availed of an amendment to International Accounting Standard IAS 39 made by the International Accounting Standards Board in October 2008.
The accounts state the company reclassified financial assets which it no longer intended to sell, to loans and receivables as they are not actively traded and the group said it planned to hold these assets.
‘‘These financial instruments have a minimal recent history of selling due to significantly reduced liquidity and market turmoil," the accounts stated. UniCredit Ireland continued to avail of the accounting treatment in subsequent reporting periods.

Little festive cheer for Irish shoppers as supermarket chains profit

2010-12-20T03:44:00.000-08:00

19 December 2010

By Kathleen Barrington

Do not be fooled into thinking that a little extra competition in the groceries market has delivered much in the way of value for consumers as we approach Christmas.
The reality is that while the prices of certain goods may have fallen from great heights, Ireland still has the second highest grocery prices in the EU.
Irish food prices are 29 per cent higher than the average in 27 EU countries, according to figures from Eurostat published earlier this year. The figures related to 2009, a period in which Ireland was in the midst of the deepest recession in the EU.
It was difficult for retail sector analysts to definitively identify whether the higher prices were down to higher costs or profiteering. Grocers tend to talk about higher costs, while consumers suspect higher profits are being made.
The easiest way to resolve the debate would be to look at the accounts of the grocers selling in the Irish market, and compare their margins with the margins of those operating in other EU markets.
However, Dunnes Stores, Superquinn, Aldi and Lidl do not publish their accounts, while Tesco’s Irish results aren’t separately broken down by its parent company.
The suspicion has always been that Irish grocers don’t publish accounts because the profits they make are embarrassingly large. But, in the absence of clear financial information about their performance, analysts are left to speculate on the basis of other indicators.
One indicator is the juicy dividend which Dunnes Stores directors paid themselves earlier this year. Dunnes Stores (Northern Ireland) is the exception to this culture of secrecy, as it publishes its accounts for its operations in Britain and the North (though not for the Republic).
The accounts showed that Christmas came early this year for Dunnes Stores directors Margaret Heffernan and Frank Dunne, as they were paid a dividend of £11.9 million
(€14.3 million) for the 12 months to the end of January 2010.
During that period, pre-tax profits rose slightly to almost £28 million (€33.4 million), while turnover increased 3.7 per cent to £194.6 million (€232.6million), according to the account information obtained by the Irish Times.
Those figures would tend to suggest that Dunnes Stores did very well in 2009 - though analysts have cautioned that the businesses in the Republic and the North are not entirely comparable.
This is because the business in the North has a greater home ware and clothing component which results in higher margins, while the economic downturn there was less acute.
Another indicator that times are good for supermarkets here is that Tesco has briefed British stock market analysts about how well it has done in Ireland.
At the half-year stage of 2010, Tesco said Irish sales were up by 7.7 per cent on the comparable period the previous year, while it had enjoyed market share gains and ‘‘strong profit performance’’.
British stockbroker Shore Capital subsequently noted that Tesco made greater profits in Ireland than in any other part of its retail empire, with the exception of South Korea.
The stockbroker said last month that Tesco Ireland’s profit margin would rise in the current financial year to more than 7 per cent - a very generous margin in the retail sector.
German discounters Aldi and Lidl have brought some welcome competition to the grocery sector and, between them, now command almost 10 per cent of the Irish grocery market.
But successive surveys have shown that, while they maybe undercutting the competition here, they are also charging more for groceries in Ireland than in other markets they operate in.
John Ruddy, editor of Checkout magazine, which monitors trends in the grocery sector, said that supermarket prices here were more expensive, but were the result of a much higher cost base.
‘‘Even when we take €1 off the minimum wage, it will still be 8 per cent higher than in Britain. We also have a lot of legacy costs, where everyone in the whole manufacturing and supply chain has traditionally received a slightly larger cut, so it’s unfair just to blame the Irish retailers for high prices," he said.
Irish purchasing power remains relatively high in an EU context. Figures published by Eurostat last week showed that Irish purchasing power remained at 27 per cent above the EU average in 2009, down from 47 per cent above the EU average in 2007.
However, British food prices are 3 per cent below the EU average, even though British purchasing power is 12 per cent above the equivalent EU figure.
The National Consumer Agency engages in occasional price surveys in order to encourage consumers to shop around.
But it has failed to provide consumers with up-to-date comparative grocery price information, which is an ambition of the agency’s.
Last year, it sought to engage with the main grocery retailers to develop an online prices database, but noted that ‘‘the retailers’ current pricing systems do not allow for the provision of sufficiently detailed grocery price data in a common format that would be useful to consumers’’.
The agency appears to have backed-off from forcing such transparency on grocers. In its latest annual report, it said that it had reason to believe a number of retailers were either considering or actively developing online grocery shopping websites, which would complement those already operated by two of the multiples, Tesco and Superquinn.
‘‘If a sufficient number of retailers in Ireland operate online grocery sites, it is likely that a commercially-driven price comparison site may be developed, drawing on information from these websites.
The agency will monitor this situation. Should no such commercial venture emerge in due course, the agency may examine the options for such a site itself."
In the meantime, though, it appears that our supermarkets remain masters of what the grocers call price-flexing, and what consumers might call confusion pricing.
This means that, when the price goes down in one area, adjustments are made in other areas to offset the lost revenue.
Tesco, in particular, is seen as a master of the skill of price flexing.
The savvy investor will know that it makes sense to invest in companies which enjoy pricing power and wide margins.
Unfortunately for Irish investors, however, our domestically-owned retailers are privately held - leaving only Tesco as representing a potential opportunity to hedge against the cost of the Christmas shopping.

Bad time for a punt on gambling

2010-12-13T07:24:00.000-08:00

12 December 2010

By Kathleen Barrington

Minister for Finance Brian Lenihan may rue the day his party allowed casino banking to get out of hand in Ireland, but that hasn’t stopped him gambling on making the country a low-tax centre for the betting industry.
Lenihan appears to have bowed to requests from the likes of Independent TD Michael Lowry to offer the industry a new licensing framework.
Lowry, who agreed to support the budget at the last minute, had made no secret of the fact that he wanted the government to introduce legislation allowing for the establishment of casinos such as the one proposed by businessman Richard Quirke, a constituent of his in North Tipperary.
Quirke has already obtained planning permission for a €460 million 6,000-square metre casino and 500-bedroom hotel. However, to proceed further, he needs legislative changes, as there is no legislation in place governing the establishment of casinos.
In last week’s budget, Lenihan signalled that ‘‘work under way by the Department of Justice has been progressing on a proper licensing regime which will serve to protect vulnerable people."
A spokesman for the minister played down the suggestion that the move was to please Lowry, saying the initiative came from the Industrial Development Authority which wanted a framework to cover betting exchanges such as Betfair and Betdaq.
Online sports betting firm Betfair last month announced plans to create up to 100 jobs at a new Dublin office.
Lenihan has also proposed that all bookmakers taking bets from Ireland will pay 1 per cent duty on those bets, as betting shops currently do.
‘‘The minister is hopeful that by including the high-growth area of the betting sector, particularly given the increasing prevalence of smart phones, the tax base from betting will be boosted significantly.
In a full year it is expected that the tax yield could grow up to €20 million," briefing material for the budget stated.
‘‘Just as important is the positive signal this measure will convey to international betting operations that have expressed an interest, in or have already invested in, Ireland.
‘‘A location with an appropriate licensing framework coupled with relatively low taxes provide real investment and employment opportunities in this sector.
The details will be contained in the Finance Bill and the proposed amendments to the Betting Act."
Ireland has already benefited from the arrival of certain US companies since the US Congress in 2006 passed the Unlawful Internet Gaming Enforcement Act, which made it illegal for financial institutions to transfer funds between punters and online-gambling sites. The hope is that the country could attract some of those companies to locate here.
Take Pocket Kings, for example. The US company provides technology and marketing consulting services to the online poker industry and to Full Tilt Poker, one of the fastest growing poker sites worldwide. It moved to Ireland in 2006. By 2008,it was reporting pre-tax profits of €8 million on sales of €47 million, according to the latest accounts filed in the Companies Office.
The accounts reveal that founder director Raymond Bitar and director Deirdre O’Shaughnessy shared emoluments of €1.3 million. Bitar is an American entrepreneur with a background in securities trading.
Pocket Kings already employs 221 people at its headquarters in Cherrywood, Loughlinstown, the accounts reveal.
More than half are employed in information technology and marketing roles, with the balance made up of administrative staff.
The company did not respond to a request for comment. But its website states that Pocket Kings is ‘‘a young, growing and ambitious company, and our success depends on our employees. ‘‘We believe that hard work should be rewarded, which is why we offer highly competitive salaries and a benefits package that is second to none.
We reward performance, initiative and loyalty, and many of our benefits increase in value over time because we believe that employees who dedicate themselves to growing our business should share in our success," the site states.
The claim is borne out in the accounts which show that, when directors’ pay is excluded, the company paid out salaries of €14 million giving an average salary of €63,000 per employee.
The prospect of Ireland attracting more well-paid jobs in the gaming and casino sector is being dangled in front of politicians and the public as a way of increasing employment and tax revenues at a very difficult time for the country.
The government in 2008 published the review group’s report Regulating Gaming in Ireland: Report of the Casino Committee.
The committee, chaired by Michael McGrath, a barrister and licensing expert, recommended that consideration should be given to licensing casinos.
It also recommended examining the possibilities of providing a legislative framework for the regulation of online or remote gaming. Pocket Kings was one of the companies that made submissions to the committee.
Then justice minister Michael McDowell didn’t act on the committee’s recommendations after receiving the report.
However, current justice minister Dermot Ahern set up another review group last year, this time staffed only by civil servants who work in the gaming and lotteries department of the Department of Justice.
The objective of the Ahern review is to put in place a ‘‘modern responsive code that recognises the fact that some people gamble and enjoy gambling and at the same time acknowledge that there are inherent dangers involved that need to be addressed, not least in terms of problem gambling."
The view among supporters of legislating for casinos and other forms of gaming is that attempts to ban them are doomed.
They point out that many casinos already operate in Ireland under the guise of private members’ clubs.
They argue that it is better to legalise, tax and regulate the industry rather than have it go underground.
Supporters also point to the size of the industry.
The Economist magazine recently said that the legal gambling market amounted to about $335 billion globally in 2009. Nearly two thirds of that came from lotteries and casinos, while online gambling accounted for just over $25 billion.
Supporters also cite the success of the International Financial Services Centre (ISFC) in attracting foreign banks to Ireland and point to the employment and tax revenues that the IFSC has attracted.
However, those arguments appear far less compelling given the failure of bank regulation in Ireland and the fact that some of the foreign banks that located in the IFSC have gone spectacularly bust.
Then there is the question of betting and gaming being considered socially undesirable because of concerns about gambling addiction, a not insignificant issue given that the country is still in recovery from a bout of property addiction.
However, these issues do not appear to have weighed on Lenihan last week. It seems that after a decade of betting the ranch on banking and property, he sees no reason not to give the gambling industry a go, especially if it keeps Lowry happy.

Whistling down the wind?

2010-12-06T03:19:00.000-08:00

05 December 2010

By Kathleen Barrington

Pressure is mounting on the authorities here to explain what action they took after liquidity breaches by a major financial institution, located at the International Financial Services Centre in Dublin, were brought to their attention by a whistleblower.
A number of international and domestic news organisations are investigating the story after the whistleblower posted details of his claims on the Guardian and New York Times websites. The postings came just as Ireland was at the centre of global media attention, due to our need for an €85 billion bailout from the IMF and the EU.
The whistleblower formerly worked as a risk manager at the IFSC subsidiary of a leading European bank. He claims that in 2007, there were serious breaches of liquidity regulations amounting to billions of euro at the subsidiary.
The risk manager was particularly concerned because the rules stated clearly that any breaches were punishable by a fine or a jail sentence. He says he reported his concerns to the Financial Regulator at the time, but eventually resigned in order not to incriminate himself. He has not obtained employment since.
His allegations were earlier this year highlighted by The Sunday Business Post, the Irish Times and Germany’s Süddeutsche Zeitung, after they were first raised in the Seanad by Senator David Norris, who took the view that the risk manager had honourably resigned.
However, the risk manager remains unhappy at the failure of the government and the regulator here to offer an adequate explanation of what action they took after he reported the breaches.
The risk manager has for months been asking various members of the Opposition to press the government for full answers to his questions, which he feels were inadequately answered when Norris raised the matter.
Labour Party finance spokesperson Joan Burton took up the issue in the Dáil on November 25 after a meeting with the risk manager.
Minister for Finance Brian Lenihan responded that the Central Bank of Ireland was subject to strict confidentiality requirements and consequently did not share information with his department, ‘‘unless the issue gives rise, for example, to some broader financial stability issue’’, which ‘‘did not arise in this instance’’.
He confirmed, however, that in response to Burton’s question, his department had been informed by the Central Bank that an overnight liquidity breach was reported by an institution at the time referred to in the media reports enclosed with Burton’s question.
Lenihan added that the Central Bank had followed up on this liquidity breach with the institution, which rectified the position to the satisfaction of the Central Bank at the time.
The Central Bank also required an external review of liquidity reports submitted to it and the related control environment, he said. This review did not identify material issues relating to breaches of the required liquidity ratios, other than on the date highlighted by the institution, he added.
Lenihan said that the Central Bank imposed liquidity risk management requirements on all credit institutions, and that compliance with these requirements is monitored by a combination of on-site and off-site review and inspections.
He said that all credit institutions were required to complete an annual internal audit review and submit this report to the Central Bank.
He said an external auditor must notify the Financial Regulator if the auditor had reason to believe there were material defects in the financial systems and controls of an institution, or material inaccuracies in any financial returns submitted to the Central Bank.
‘‘The Central Bank of Ireland has confirmed that this matter has now been fully investigated and the Central Bank is satisfied that all liquidity risk management requirements have been complied with, and appropriate steps necessary to prevent any recurrence of this issue have now been taken by the institution concerned."
The risk manager, who wishes to remain anonymous, but who is known to The Sunday Business Post, is not at all satisfied with this response. Writing on his newly established blog, he said the regulator’s own definition of a material breach referred to a 1 per cent deviation from a prescribed ratio.
‘‘The breach reported to the regulator exceeded the regulator’s own benchmark by 1,900 per cent (yes, one thousand and nine hundred per cent), and amounted to billions of euro," he wrote.
He asks whether Lenihan doesn’t find it puzzling that a breach of such magnitude could occur overnight, and what scale of breach would Lenihan deem to be of significance to ‘‘broader financial stability’’.
He wants Lenihan to confirm that the relevant European regulator was notified of the liquidity breach at the bank. He wants to know what the response of the relevant regulator was. And he wants Lenihan to inform the Dáil who carried out the external review and what were its findings.
In another strange twist, he also asks why the Financial Regulator’s liquidity requirements document issued in June 2009 refers to the already-existing liquidity regulations as ‘‘new’’.
He also wants Lenihan to explain why no administrative sanction procedures or prosecutions were initiated.
The IFSC operation at the centre of the risk manager’s allegations is the Irish subsidiary of a leading European bank. The parent bank previously denied to this newspaper that its Irish subsidiary was the one referred to by Norris in the Seanad.
The story is of interest to a wider European audience, particularly to Germany, due to a perception that light touch regulation at the IFSC was a major contributory factor to the problems experienced by a number of German banks which had operations there.
If Irish taxpayers wonder why the EU has imposed such harsh bailout terms on us, then the IFSC is part of the answer to that question.
The Germans are picking up the tab for more than €100 billion in losses, partly attributable to the activities of subsidiaries of German banks located in the IFSC.
The Germans were understandably furious with us even before they had to contribute to the funds to help us bail out our own banks.
For example, Michael Somers, the former head of the National Treasury Management Agency, is on record as saying that he was receiving ‘‘quite a lot of flak’’ from the German delegates at the IMF World Bank meetings as far back the autumn of 2008.
Few in Ireland paid much attention when our government refused requests from Germany for a contribution to the bailout of IFSC-based bank Depfa, even though the full bill for bailing out Depfa might have landed entirely at the door of the Irish taxpayer, had it not been for the fact that it had been taken over by another German bank, Hypo Real Estate - headquartered in Germany - just before it collapsed.
Against that background, it is not surprising that the whistleblower’s allegations have attracted international attention.
He says that, within three days, his blog had attracted 4,000 hits, including 750 from German-speaking countries.
Given the mounting international interest in the whistleblower’s allegations, it will be interesting to see if the government can continue to dodge questions on what was going on at the subsidiary where the whistleblower worked, given the way they have handled him and the few politicians and journalists who have raised questions on this matter.

Merkel bashes the bondholders

2010-11-29T06:55:00.000-08:00

28 November 2010

By Kathleen Barrington

German chancellor Angela Merkel seems to be talking sense. Last week, she reiterated her proposal that new buyers of eurozone bonds should accept liability clauses starting in 2011.
The German government has proposed that in the event of a sovereign debt crisis - such as the one being experienced in Ireland - the clauses would result in the payment period for government bonds being extended. If the solvency problem continued, additional steps would be considered, including ‘‘further extension, interest rate cuts and a reduction in the nominal value’’ on the bond, according to a German government paper obtained by Bloomberg.
Merkel is seeking a solution for a very serious problem: namely, that there is no incentive for banks and pension funds to lend sensibly to borrowers if there is an implicit guarantee that they will always be bailed out by the taxpayer - even at the expense of impoverishing a nation, as is happening in Ireland.
The European institutions that lent our banks and our government $509 billion never bothered to consider the risk, because they assumed there was no risk to them.
They relied on their well founded belief that governments were so terrified of the bond markets that they would bend over backwards to keep bondholders happy - even at the expense of alienating their own citizens.
The governments would want to keep the bondholders happy because they would want to ensure future access to the bond markets at reasonable rates.
This is precisely what has happened in Ireland.
Taoiseach Brian Cowen and Minister for Finance Brian Lenihan first kow-towed to the banks when they guaranteed their liabilities, then kow-towed to the bond markets by raising sovereign debt to repay most of the bank bondholders.
They were motivated by a not unreasonable fear that they would, in future, be punished - either by being locked out of the markets altogether or being charged such punitive interest rates that the country could not afford to borrow.
The problem in Ireland is, unfortunately, so severe that we ended up with the worst of both worlds.
We are repaying most of the bank bondholders with taxpayers’ money, and we are shut out of the sovereign bond markets anyway because the markets have effectively judged that we cannot shoulder the sovereign debt burden we have already assumed, let alone new burdens.
In that regard, we appear to have been badly let down by Jean-Claude Trichet, president of the European Central Bank, who has also done the bidding of the bond markets by his insistance that no European bank should fail. Ireland must repay the bank bondholders by issuing sovereign debt.
Now that the sovereign debt markets have dried up, we have to borrow more from the European Financial Stability Facility and the International Monetary Fund; more money that will have to be repaid by Irish taxpayers.
But Merkel now wants to call the bluff of the bond markets.
There was a predictable reaction from the bond brigade last week when they complained that Merkel’s proposals would cause further nervousness.
The fact that these proposals have spooked bond markets may be bad news in the short term, as it has driven up the cost of money for borrowers, including Ireland.
But it could end up being good news for European citizens in the medium term, as bondholders digest the realpolitik of what Germany is proposing: namely, that in future there will be no such thing as a free lunch for bondholders in the eurozone.
What’s not to like about requiring the boys in the bond markets to take a little risk for once?
Why should they continue to get away with reaping fat bonuses when they lend recklessly, secure in the knowledge that European citizens will do (or be made to do) almost anything - increase retirement ages, cut the minimum wage, close hospitals, slash the salaries of teachers, nurses and police - just so that they will be paid back?
Merkel isn’t about to let a good crisis go to waste. She is using the crisis as an opportunity to change the rules of the game. She is also betting that lenders ultimately need sovereign borrowers if they are to make money, and that they will continue to lend to the eurozone once the new rules are in force.
She has merely proposed that in future, those bondholders need to understand that when they lend to European borrowers they will be subjected to European rules, which would ensure that they share in some of the risks that they are taking.
The German Finance Ministry document obtained by Bloomberg said the ‘‘blanket’’ introduction of standardised collectiveaction clauses for all government bonds issued in the 16-nation euro region would be ‘‘unproblematic’’, and ought to begin next year.
Merkel’s plans for a permanent crisis-resolution mechanism for the euro region from 2013 sparked a bond sell-off after European Union leaders last month agreed to consider the German proposals.
The Irish government was unhappy that Merkel’s remarks drove up the interest rate the markets wanted for the risk of holding Irish government bonds and the bonds of other peripheral states.
Finance ministers meeting in Seoul, South Korea on November 12 subsequently explained that ‘‘any new mechanism would only come into effect after mid2013 with no impact whatsoever on the current arrangements’’.
They made clear that any permanent mechanism would not apply to outstanding debt. But Merkel hasn’t given up in her battle with the bond markets, even if they put up the cost of money every time she says boo to them.
Her repeated calls for the bondholders to share some pain has put her on a collision course with Trichet, who fears it could damage the euro and prevent countries taking the necessary action to cut their deficits.
But if the European Union allows business to continue as usual in the bond markets, there will be nothing stopping lenders making the same reckless lending decisions that got us into such difficulties in the first place.
Merkel appears to be the only one standing up for the interests of European taxpayers and, for that, she deserves our gratitude - even if the move is coming a bit late for Ireland.

Ireland back in Britain’s pocket

2010-11-22T07:33:00.000-08:00

21 November 2010

By Kathleen Barrington

The image of the tricolour flying over trophy London properties may just have clouded our bankers’ vision to the reality that they were selling us out to the British.
For the fact of the matter is that, far from throwing off the yoke of our former oppressors during the boom years, our bankers have left us owing British lenders €186billion which we will struggle to repay.
The sum we owe the British is greater than the €175 billion we owe the Germans, according to figures published by the Bank for International Settlements in Basel earlier this year.
The realpolitik of this situation is only gradually dawning. For it would appear that the Germans have been leaning on the British to contribute to the cost of bailing out Ireland - and that the British have agreed, in principle, to contribute.
The British are willing to share the burden of bailing out the Irish banks because British banks have the largest exposure to Ireland both at bank and pension industry level; and because they have close economic, political and historical ties with the country.
George Osborne, the British Chancellor, said last week that he had pledged British support of up to £7 billion for any EU bailout of Ireland and its banking sector.
‘‘Ireland is our closest neighbour," Osborne said, ‘‘and it’s in Britain’s national interest that the Irish economy is successful and we have a stable banking system.
Britain stands ready to support Ireland."
But the spectre of Taoiseach Brian Cowen and Minister for Finance Brian Lenihan being forced to take the Queen’s shilling so we can continue to shop in Tesco won’t play well with Irish voters.
And that’s before Cowen and Lenihan get down to the nasty business of disclosing their plans for four years of hairshirt budgets, to ensure the British and other lenders ultimately get paid back.
But it isn’t just a political nightmare for the Soldiers of Destiny that Cowen hitched the Irish taxpayer to Anglo and the other toxic Irish banks on the night of the bank guarantee.
British prime minister David Cameron also finds himself in the politically difficult position of considering asking British taxpayers, who are already reeling from the severity of Britain’s own austerity programme, to contribute billions to an Irish bailout.
It can only be a matter of time before the British start asking about the cost of picking up the tab for the reckless lending in which the Irish banks and the Irish subsidiaries of British banks engaged.
That could have the effect of piling the pressure on the British politicians to get the Irish to pay back the money they have lent us as quickly as possible.
Few in Britain appear to appreciate the extent to which their taxpayers were already on the hook for toxic Irish lending even before there was any talk about an EU, IMF or British bailout for the Irish banking sector.
Cormac McCarthy, the outgoing chief executive of Ulster Bank, dumped £27.5 billion of dodgy Irish loans with the British Asset Protection Scheme last year.The effect of this is that the British taxpayer is carrying the risk if the Irish borrowers fail to repay their loans.
Mark Duffy’s Bank of Scotland (Ireland) received about £4.5 billion in new capital from its British parent, Lloyds, before it decided to pull out of Ireland after discovering that 90 per cent of its commercial property loan book was impaired.
Lloyds is part-owned by the British taxpayer.
Of course, the primary responsibility for the reckless lending done by British banks in Ireland lies with the boards and managements of their British parent banks.
However, we Irish citizens expected the Irishmen who headed the Irish subsidiaries to show greater sensitivity to the question of whether Irish borrowers could afford the huge debt burdens they were assuming.
We expected the Irishmen and women at AIB, Bank of Ireland, Anglo Irish Bank, Irish Nationwide and EBS to resist the temptation of lending recklessly to their fellow countrymen and countrywomen with money borrowed from the British and elsewhere. We also expected our political leaders to keep our banks in check.
But, blinded by the lure of fat bonuses, our bankers wrapped themselves in the green flag and somehow persuaded the political and regulatory establishment that they were helping to right historical wrongs when they loaned the likes of Derek Quinlan the money to buy trophy assets at home and abroad.
However, even as Quinlan’s staff were raising the tricolour over the Savoy Hotel in London, our banks were becoming deeper and deeper in hock to the British and other lenders.
The final insult came when the bankers persuaded the politicians that the only way to save Ireland was for the Irish taxpayer to guarantee the huge debts that our banks owed to foreigners.
That fateful decision has compromised our sovereignty, and threatens to reduce our Taoiseach to the role of a debt collector for foreign powers.

The irresistible, indefatigable lure of other people’s money

2010-11-15T02:13:00.000-08:00

14 November 2010

By Kathleen Barrington

One of the most interesting chapters in property developer Simon Kelly’s book, Breakfast With Anglo, is the one entitled Other People’s Money.
It charts how Kelly became tired of dealing with Anglo Irish Bank, as money was becoming harder to extract and the bank was getting harder to deal with because of the scale of the business and the numbers involved.
He envied the likes of financier Derek Quinlan, whose Quinlan Private operation invested equity in deals on behalf of wealthy individuals.
‘‘He could do any deal he wanted because he had the firepower of OPM: other people’s money," Kelly wrote. ‘‘Peering into that world, I quickly became envious of the nature of their OPM. It didn’t talk at all. It was just money, with no personality or baggage. The money seemed to beg to get into some of the deals, but once it was in, it was in, it had to keep quiet and stay in the background."
It wasn’t just that the developer got money from investors effectively for free, compared with paying fees and interest for a bank loan. The developer and his agent could actually charge the investors for the privilege of investing.
‘‘As I began to look at their model, I was quickly attracted to the fee structure: ‘2 and 20’,as it is called in the hedge fund business. The promoter gets 2 per cent of the capital value of a project as an annual management fee, and on top of this he also gets 20 per cent of the profits,’’ Kelly wrote.
Kelly and his father Paddy entered into a joint venture with corporate financier Niall McFadden’s Boundary Capital to tap the OPM market with a considerable degree of success - at least in the early stages, before the Kelly property empire came crashing down.
Kelly admitted that he gained an early mover advantage by adopting the OPM model. But he noted that the arrival of the stockbrokers, led by Davy and Goodbody, also brought a lot of new investors and money into the property business.
Kelly described how ‘‘the power of OPM, combined with apparently limitless bank facilities, threw a wave of liquidity into the market’’.
‘‘Another developer who had recently discovered OPM was starting to make his mark all over Dublin. Bernard McNamara had been handed the keys to any site on the market, with Davy Stockbrokers providing the equity, and he went on a monster spending spree."
As has been highlighted on these pages previously, Davy investors who backed McNamara in his plans to develop the €412 million Irish Glass Bottle deal have seen their entire investment wiped out.
But there were plenty of other, similar OPM deals being touted to investors at the height of the boom, many of which have fallen below the media radar.
I just happened to be reading Kelly’s book when a bundle of documents relating to a property investment scheme operated by Goodbody Stockbrokers landed on my desk.
The documents show how Northern Ireland property developer John Farmer, of the Orana Group, got access to OPM when he successfully tapped a property investment fund established by Goodbody.
Goodbody clients invested £27 million (€31 million) in the Northern Ireland Property Fund in a joint venture with Orana. Goodbody charged a 4 per cent commission on all funds invested.
The figures suggest the stockbrokers made £1.1 million in commission from the £27million (€31 million) put up by investors at the outset.
In addition, Goodbody charged a management fee of 2 per cent per annum on the funds under management. Given that the fund drew down borrowings on top of the equity, the fees being charged by the enlarged fund are likely to have been substantial.
The documents also show that Orana Group’s operational entity in the North was to be paid a management fee of £175,000 per annum.
Goodbody was also entitled to 15 per cent of investor profits once the internal rate of return on the fund surpassed 15 per cent. Unfortunately, that never happened. Private clients of Goodbody Stockbrokers saw their entire £27 million investment wiped out.
Last year, Goodbody told investors it had written down the value of their investment to nil due to the fall in asset values and the level of outstanding debt. One investor has complained to the Financial Services Ombudsman (FSO) that she was mis-sold the investment, a claim that is hotly disputed by Goodbody.
Solicitor Owen Swaine, who is acting on her behalf, alleges the management fee structure ‘‘created a conflict of interest between Goodbody Stockbrokers and our client’’.
‘‘If the fund had proceeded in accordance with the letter sent to our client dated December 6, 2005 which indicated a fund of up to £50 million and assuming a fund of £50 million, Goodbody Stockbrokers would receive a management fee of £1 million per annum," he claimed in the complaint to the ombudsman.
‘‘However, it should be noted that the fund increased its gross assets to in or about £250 million which, in turn, would have generated a management fee of £5 million per annum for Goodbody Stockbrokers."
Goodbody is expected to deny the borrowings were greater than initially disclosed. It is also expected to argue that Swaine’s client was a seasoned and successful investor, and that she was given the opportunity to consider investments other than property. It will say the documentation she received prior to making the investment was clear and unambiguous as to the nature of the investment and the risks attached.
It will be a matter for the FSO to decide on the merits or otherwise of the complaint lodged by Swaine.
But whatever the outcome of that particular case or the many others winding their way to the ombudsman, Kelly’s book serves as a powerful reminder to investors of just how attractive their equity was to project promoters.

Lowry gambles on legal change

2010-11-08T02:07:00.000-08:00

07 November 2010

By Kathleen Barrington

The government is under pressure to introduce legislation under which developer Richard Quirke could apply for a licence to operate a Las Vegas-style casino in Co Tipperary.
Independent TD Michael Lowry is making no secret of the fact that he wants certain changes to the Gaming Act that would enable Quirke’s proposed €460 million casino and resort to be built in his North Tipperary constituency.
On the very day that Jim McDaid resigned his Dáil seat, leaving the government with a majority of just three - including two independents - the former Fine Gael minister was being quoted making the case for Quirke’s casino.
‘‘It is encouraging and exciting to see a positive project of this size and versatility being built in North Tipperary," Lowry said in a press statement.
‘‘I am delighted to have assisted with this development. The impact of The Tipperary Venue to North Tipperary and the region will be immeasurable."
Lowry subsequently told this newspaper he was looking for confirmation from the government that a legislative framework would be put in place to apply for a casino licence, though he insisted he was not making a demand, merely arguing his case in a sensible way.
Quirke is a garda turned businessman who owns Dr Quirkey’s Good Time Emporium, a slot machine arcade on Dublin’s O’Connell Street. Besides his gaming activities, Quirke made about €30 million when he sold the Carlton Cinema on the same street a few years ago.
Quirke operates his gaming activities through a company called Dublin Pool and Juke Box Company.
He was not available to explain why auditors Savage Manley & Co raised a red flag over the 2009 accounts when they issued what is known in accountancy jargon as a ‘‘qualified opinion arising from limitation in audit scope."
The auditors noted that they had planned and performed ‘‘our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or other irregularity or error.
‘‘However, with respect to the computerised systems of control over machine income, the information available to us was limited, because the reporting function in relation to same was not fully functional throughout the entire period subject to audit.
‘‘Despite the fact that alternative manual systems of control were implemented by the company we were unable to obtain sufficient appropriate audit evidence upon which to form our opinion in this regard."
The accounts do make clear that Quirke’s company is making a lot of money.
Pre-tax profits rose to €5 million last year compared with €1.8 million the previous year, allowing Quirke and his wife Ann to share directors’ remuneration of €1.1 million.
Now Quirke wants to get a new business up and running after receiving planning permission from North Tipperary County Council for a 6,000 square metre casino and a five-star hotel.
The decision by the council to approve a 500-bedroom hotel at a time when there is a glut of hotel rooms in the country may come as a surprise, though it is not hard to see why any county would welcome a possible 2,000 jobs.
The National Asset Management Agency (Nama) did not object to Quirke’s casino propos al even though more hotel rooms would likely further devalue the hotel loans that Nama holds on behalf of the hard pressed taxpayer.
But while the local authority and Nama have not blocked his way, Quirke still faces the possibility of an appeal to An Bord Pleanála against the local authority’s decision.
Quirke also needs changes to the Gaming Act, as there is currently no legislation in place governing the establishment of casinos, leaving him in the unhappy position of having planning permission for a casino when casinos are prohibited under the Gaming and Lotteries Act 1956.
Fortunately for Quirke, the government needs Lowry on board if it is to get its budget through the Dáil and avoid a general election.
Also fortunately for Quirke, Minister for Justice Dermot Ahern has indicated that he plans to loosen Ireland’s gambling laws.
Indeed, last year Ahern commenced a major review of gambling, even though a previous review ordered by former justice minister Michael McDowell had been published as recently as 2008.
Ahern asked the Casino Gaming Control section of the Department of Justice to bring forward a draft bill for a revised gambling code.
But the department last week refused to release the 70 submissions it had received on the subject, insisting that the only way to obtain them was to make a request under the Freedom of Information Act.
Getting answers to these requests can take weeks or months depending on whether the department accedes to the initial request or refuses it.
A spokesman for the Department of Justice explained the need for a second review of the gambling legislation, less than one year after the first one was published, on the basis that ‘‘a more comprehensive review of gambling generally was needed’’.
‘‘This review would incorporate all forms of gambling and would be tasked with making recommendations to transform the gambling architecture of the state - many aspects of which had not changed in over 50 years."
It is unclear whether there is public support for legislation to allow for the establishment of casinos given fears about gambling addiction and other concerns.
Then there is the Lowry factor. When I put it to Lowry that the public might be uneasy about his lobbying for legislation under which Quirke could apply for a casino licence, when the circumstances surrounding his 1995 awarding of the second mobile phone licence to businessman Denis O’Brien were still being considered by the Moriarty Tribunal, he responded: ‘‘You would have to be very cynical and negative to ask a question like that."
He added that the ‘‘suspicion and innuendo’’ surrounding the awarding of the second mobile phone licence were not grounded in fact.

Time for banks to wake up and deal with Irish exporters

2010-10-25T10:02:00.001-07:00

24 October 2010

By Kathleen Barrington

Enterprise Ireland (EI) chief executive officer Frank Ryan told last week’s Irish Banking Federation conference on ‘‘the new banking landscape’’ that, over the last ten years, the banks generally hadn’t bothered accompanying his organisation on its trade missions abroad.
The implication was that banks had been too busy lending to buy property in Ireland to bother with entrepreneurial companies that were attempting to crack export markets, or to find out what kind of banking products and services those export led companies required.
John FitzGerald, research professor at the Economic and Social Research Institute, told a similar story.
He recounted how, on a recent trip to Vietnam, he had been disappointed to find Anglo Irish Bank featuring prominently in the local papers.
But he was subsequently heartened when he met a bunch of Irish entrepreneurs who were successfully selling software to the Vietnamese.
One of the Irish entrepreneurs told him, however, that despite the success of his software product, his bank had earlier pulled his credit line.
This had been restored only when he got into his car and drove to Dublin to fight to get it back.
FitzGerald’s message to the bankers is that there is a future after the banking crisis and that it depends to a large extent on helping companies to export their goods and services.
It is a message that carries additional weight now that FitzGerald has been appointed to the new Central Bank Commission.
Noting that our balance of payments was still strong, the professor stressed that no economy has ever gone bust when its balance of payments was in surplus.
FitzGerald and Ryan were singing from the same hymn sheet on where they saw future opportunities for Irish companies and banks. Ryan produced some very interesting statistics to support his case.
For instance, he said, there were now more people employed in companies sponsored by EI than in ones backed by the IDA, which attracts the big foreign-owned multinationals such as Intel, Dell and Microsoft to set up operations here.
The figures are almost 134,000 people employed at companies supported by EI, compared with almost 125,000 at companies supported by the IDA.
The indigenous companies spend about €19 billion in the economy each year. They are also big exporters, selling €12.9 billion worth of goods abroad in 2009, down from €14.3 billion in 2008.
But the good news is that there has been a pick-up in exports by indigenous companies - so much so that Ryan is predicting the sector would recoup 70 per cent of the lost ground by the end of this year.
That would see exports from the indigenous sector back up about €13.8 billion, the levels achieved in 2007 when the boom was in full swing.
The companies sponsored by EI don’t always have the kind of name recognition that companies sponsored by the IDA enjoy.
But many Irish-owned companies can grow to become significant global players. One example is Galway-based Creganna.
The company, headed by chairman Ian Quinn and chief executive Helen Ryan, is a leading supplier of products to medical device and life science companies.
It employs 1,200 people at manufacturing sites in Ireland, the US, Singapore and South Korea.
Private equity firm Permira last month bought a majority stake in Creganna in a €220 million deal that generated some rare positive headlines amid all the doom and gloom.
The encouraging thing is that Ryan indicated there were plenty more where Creganna came from.
He listed several, such as Daon, a pioneer of biometric software, and Norkom, which sells anti-money-laundering software.
Ryan said Irish firms were growing their exports in software, life sciences, clean technology, internationally-traded services such as education and financial services and even construction services, where Ireland had gained experience during the boom.
He also saw opportunities in the food and public procurement sectors.
His message was that things were happening in indigenous industry, and that he expected Ireland to bounce back sooner than people expected.
His message to the banking industry was to be ready and able to support those companies.
Ryan’s requests to the banks were of a very practical nature. He wanted them to engage with EI in relation to reviewing lending decisions for viable businesses.
He wanted to share insights on markets. He wanted the banks to follow EI clients into overseas markets. He wanted to encourage the banks to participate in EI events such as trade missions.
And he wanted the banks to develop financial products to support exporters, such as trade finance and the provision of performance bonds for companies involved in construction activities abroad.
‘‘Are you ready for this? Does your banking offering address their needs?" he asked the assembled bankers.
He also warned the Irish banks that foreign banks would serve indigenous Irish industry if they didn’t.
It would appear, however, that a chastened banking community is heeding the call to action.
Ryan now expects that some of the banks will accompany Minister for Enterprise Batt O’Keeffe on EI’s trade missions to Saudi Arabia this month, and to Brazil in November.

Plugging ICG’s €27m pension hole

2010-10-20T06:20:00.000-07:00

17 October 2010

By Kathleen Barrington

If I were Eamonn Rothwell, chief executive of Irish Continental Group (ICG), this is how I might view my firm's pension deficit.
I would be hoping the government would allow me to invest pension money in Irish government bonds. If the government would only let me, then the hole in my company’s pension fund would look a lot smaller.
That would keep my investors happy, support my share price, and get the Pensions Board off my back.
My company has promised hundreds of employees a defined benefit (DB) pension equivalent to two-thirds of their final salary upon retirement.
The problem is, that promise may be difficult to honour because the pension fund’s investments haven’t been performing well.
That’s partly down to the stock market crash, and also due to the fact that pensioners are expected to live longer.
The actuaries tell me that I have a pension deficit of more than €27 million.
The Pensions Board says companies are supposed to have enough money in the pension pot to meet the accrued benefits of all its members if the scheme were wound up today, even though many of the employees won’t retire for years. It is a lot easier said than done.
It’s all a bit of a balancing act when you are at the helm of a company such as ICG in these recessionary times. I have promises to keep to my staff, but I also have to keep my bankers and shareholders happy.
In fairness, the Pensions Board has, over the years, given companies plenty of leeway to meet the so-called pension fund standard.
But it has been talking a lot tougher lately - so much so that we are in discussions with the trustees of our pension schemes to agree a recovery plan with the Pensions Board. This could involve an increase in payments to the pension fund.
I have 394 employees and I pay them an average of about €54,000 a year.
Last year I put €7.2 million into the pension scheme for my workers - a big increase, compared with the €2.5 million I put in for them in 2008. I also paid a big chunk of money back to our bankers, leaving the company with relatively low debt.
But I have also to look after the interests of my shareholders.
Over the last two years, I returned €49.2 million to them. Given that I am a 16 per cent shareholder, my share of the returned money was €7.8 million.
The €7.8 million came in handy as I took a pay cut last year, after I decided to introduce a pay freeze for everybody.
Overall, my total pay, pension and bonus package was €1 million in 2009, compared with €1.4 million the previous year.
I am not one to shirk the tough decisions.
But it would be a little awkward if I now had to cut pension benefits for staff, especially after praising them for dealing so competently with a fire which occurred in the generator room of the MV Oscar Wilde not so long ago.
However, the Irish Association of Pension Funds (IAPF) and the Society of Actuaries (SoA) have come up with a pretty smart plan to plug the hole.
They reckon it’s the fact that companies are legally required to invest their pension pots in very safe bonds that is causing the problem.
It takes a very big pot of pension money to buy an annuity [an annual income] for pensioners when those safe German bonds are giving such low interest rates - just 2.3per cent last week.
The pensions industry is lobbying for changes in the rules, so that insurers can sell, and pension schemes can buy, a new kind of annuity linked to Irish government bonds which are currently yielding about 6.4 per cent. I know it’s a bit risky to invest in high-yielding bonds, given the sovereign default risk.
But there is no reward without some risk.
The pension experts reckon that, if we could invest pension pots in Irish sovereign bonds, it would improve the performance of many defined benefit pensions by as much as 20 per cent.
So I could get a 20 per cent uplift in the value of my pension fund assets without having to put up another penny. It might even boost the share price, which would be good news for the shareholders (myself included).
The trouble is that the government is still sitting on the fence when it comes to allowing pensions to invest in these bonds. But happily, the Minister for Social Protection, Éamon O’Cuív, last week extended the original November 30 deadline by which company bosses were to have told the Pensions Board how we plan to plug our holes.
That will come as a big relief to all of us company bosses, as 75 per cent of defined benefit schemes are in deficit. And, believe me, there are plenty of them who have far bigger holes to plug than I do.
There are some pretty big deficits in the pensions of the semi-state companies, such as the ESB and the Dublin Airport Authority.
But at least the semi-state bosses don’t have to worry about shareholders dumping their shares for fear the pension hole will prove too costly to fill.
Quoted companies which have big deficits in their pension schemes have more to worry about.
The hole in the AIB pension fund, for instance, amounted to €714 million at a time when the bank is so strapped for cash it is barely lending, never mind plugging pension holes.
I can only marvel at how Glanbia chief executive John Moloney has managed to reduce Glanbia’s hole from €164 million at the end of 2008 to just €86 million at the end of last year, by getting staff to agree to slash pension benefits.
When journalists found out a few years ago that Salvacion Orge, a Filipina beautician working on the MV Isle of Inishmore, was being paid €1 an hour, all hell broke loose and my name was all over the papers.
So I get a sinking feeling that, if I were forced to cut pension benefits, I would attract more negative headlines.
Of course, I am not Rothwell.
But when I asked last week if ICG was in favour of the IAPF and SoA proposal, a company spokesman said that ‘‘ICG would support that process aimed at achieving the sustainability of DB schemes’’. He did not comment on whether it was appropriate to have spent millions of euro redeeming ICG shares while there was a hole in the pension fund.

Pensions industry eyes a gamble on Irish bonds

2010-10-11T10:20:00.000-07:00

10 October 2010

If you see your pension fund sinking like the Titanic, it must be very tempting to try to save the ship by stuffing your portfolio with high-yielding Greek, Irish, Portuguese and Spanish government bonds.
That’s according to Neils Jensen, chief executive of Absolute Return Partners, a British firm with $300 million in funds under management.
‘‘It is one heck of a gamble, but then desperate people do desperate things," he said.
The Irish pensions industry is so tempted that it is currently lobbying the government to be allowed invest in high-risk Irish government bonds in a last-ditch gamble to plug the €13 billion hole in the country’s defined benefit pension schemes.
A defined benefit pension promises its members a certain pension in retirement, usually equivalent to two-thirds of their final salary.
Many pension schemes provide income to pensioners by investing a pot of money accumulated over their working lives to buy what is known as an ‘‘annuity," effectively an annual income.
But employers are finding it difficult to deliver on their promises, as the pot of money available to buy the annuities has shrunk due to the stock market crash and other factors.
This happened at the very time when it takes a bigger pot to buy an income because interest rates are at historic lows and people are living longer.
The result is that 75 per cent of the country’s defined benefit pension schemes are in deficit, according to the Pensions Board.
The schemes had liabilities of €45 billion at the end of 2008 but assets of just €32 billion - leaving a €13 billion hole.
The Society of Actuaries and the Irish Association of Pension Funds want the government to introduce a new type of annuity called a ‘‘sovereign annuity’’ as a way of filling the hole.
Currently, Irish pension schemes buy annuities based on German bonds which are seen as extremely safe, but are giving rock-bottom yields of about 3 per cent.
The industry wants the government to make available a supply of 12-to-15-year Irish government bonds issued by the National Treasury Management Agency.
The idea is that since Irish government bonds are offering 7 per cent, it will take a smaller pot of money to buy the income for retirees.
That in turn will leave more in the kitty for future pensioners and mean that hard-pressed employers will have to pony up less cash to plug the holes in their schemes.
The pensions industry calculates that buying annuities backed by German bonds is 20 per cent more expensive than ones backed by Irish bonds.
It also reckons investing in high-yielding Irish bonds would increase the value of pension funds from about 40 cents to 60 cents in the euro for a typical pension scheme.
In fact, the saving for pension funds would now be substantially greater, as Irish government bonds are now yielding far more than in February, when the industry made the original calculations on which its pleading is based.
The main problem with the proposal is that the interest rate on Irish government bonds is very high because there is a perceived risk that the Irish state might default on its obligations.
The pensions industry suggests that legislation would have to be amended to allow annuity payments to be cut if the underlying government bonds do not perform as anticipated.
In short, if the state were to default, then pensioners would lose out.
But supporters say that if the pension funds cannot invest in higher-yielding bonds, the alternative is that many more employers will have to cut the promised benefits to members or wind them up altogether leaving the country’s future pensioners much worse off in retirement.
In effect, the industry is caught between a rock and a hard place. Jerry Moriarty, chief executive of the Irish Association of Pension Funds, is the first to admit that ‘‘there is no real silver bullet."
Supporters and opponents of the proposal agree it is a high risk strategy.
Where they differ is on the question of whether it was a risk worth taking, while some feel it might be a risk worth taking if certain conditions were attached.
Supporters said it was preferable to invest in risky Irish sovereign debt than to cut pensioner benefits. Some also argued that putting Irish pension money into Irish bonds was in the national interest as it would help the government to raise funds.
They played down the sovereign default risk, making the point that if that were to happen, all bets would be off anyway.
One Irish fund manager said he supported the proposal: ‘‘The general argument is, why buy German and French bonds when you could buy your own. I have sympathy with that."
He considered that the current high probability of default attaching to Irish government bonds was ‘‘plain ridiculous’’.
In any event, he argued: ‘‘If Ireland goes into default, what happens to my pension fund is the least of my problems."
An Irish bond expert said: ‘‘I am broadly in favour of the measures clearly they’re largely in sync with my thesis that pension liabilities should have a solid grounding in fixed income assets."
A US bond expert said: ‘‘Not a bad idea. Intergenerational accounting should be done between the local savers (pension funds) and the local spenders (government today).
This will improve the chances that the debt gets paid back."
But he agreed the move made Irish pensions riskier.
‘‘Pension accounting is like drinking alcohol. If you want to be safe, you don’t get much of a return (buzz). If you want to reach your compounding goal (or get drunk) then you need to take some more risk (drink moonshine).
There are no safe pension funds in the world that are fully funded with 8 per cent return assumptions."
A German bond expert gave a mixed verdict: ‘‘I think it’s a bad idea from the accounting perspective and needs strict limits from the investment perspective of the pension system.
The only clear beneficiaries are intermediaries and the government [which doesn’t need to tap the euro bailout fund]."
‘‘Where I agree is that the German bond is a too low benchmark (including for German pension liabilities), but they rather ought to switch to some weighted EU average," he added.
The German expert also worried about pension funds putting too many eggs in the Irish sovereign bond basket. ‘‘When, if not now, is diversification needed? So this purchase programme should be calibrated and strictly limited," he said.
Jim Stewart, a pensions expert based in Trinity College, said: ‘‘I think the proposal has great scope for large windfall profits for the pensions industry.
It would help reduce the deficit on pension schemes which are required to buy annuities. But most do not."
One Irish fund manager, who admitted there was a big debate raging in the pensions industry on the proposal, said: ‘‘I would not be happy to see that, loading up on further risk in Ireland."
An Irishman who previously worked for a London hedge fund which made profits shorting Anglo Irish Bank shares said he disagreed with the industry proposal.
‘‘It would be seen as a mechanism to reduce contributions to defined benefit pension schemes.
The benefits are obvious, but the actual accounting and actuarial issues would say this is a bad step."
Several experts suggested that the longer term solution to the pension problem was to close down defined benefit schemes or maintain them at a lower level, to improve the savings rate or to increase the retirement age - or a combination of those solutions.
In the meantime, though, Jensen points out that Ireland is not alone in adopting a ‘‘casino solution’’ to its pension problems. Spain’s €64 billion pension fund, Fondo de Reserva, recently disclosed that it expected to have 90 per cent of its assets tied up in Spanish government bonds by the end of the year.
‘‘Let’s just hope that for the sake of millions of Spanish workers that the pension fund knows what it is doing.
Unfortunately, Murphy’s Law has an unpleasant habit of popping up at the most inconvenient of times," Jensen said.
Ireland’s pensioners will be hoping that our government and pensions industry knows what they are doing as they don’t want to find out the hard way if what can go wrong, will go wrong.

AIB mysteries still unexplained

2010-10-11T05:15:00.000-07:00

10 October 2010

By Kathleen Barrington

It was heartening to hear the new Financial Regulator, Mathew Elderfield, apologise to former AIB internal auditor Eugene McErlean for the way he was treated by the regulatory authorities when he raised concerns about bank overcharging and other matters.
The apology was made when Elderfield appeared before the Economic and Regulatory Affairs Committee last week.
It comes eight years after McErlean was scapegoated for the Rusnak rogue trader affair at AIB, when, it appears, the real reason AIB wanted to get rid of him was because he knew the bank was overcharging its customers and engaging in mysterious dealing in its own shares through its Goodbody Stockbrokers subsidiary.
Elderfield’s apology follows an earlier apology from former AIB chief executive Eugene Sheehy when he appeared before the committee. It is to the great credit of the committee, chaired by Michael Moynihan, and including Senator Shane Ross and Fergus O’Dowd, that it has successfully campaigned to have McErlean vindicated.
The committee used its powers to hold the bank and the regulator accountable after McErlean and the media had hit a brick wall when seeking answers about why McErlean was effectively forced out.
To recap: we learned from the committee hearings that in the summer of 2001, McErlean completed a branch-wide special audit report into fees and charges at AIB. He found a major overcharging problem.
He sent his report to AIB senior management and to the then Financial Regulator, Liam O’Reilly.
He also sent a report entitled ‘Special Investigation Goodbody Stockbrokers - Trading in AIB Shares’ to the regulator, in which questions were raised about the legality of a device used to trade in AIB shares through offshore locations in blacklisted tax havens Nevis and Vanuatu.
The committee also heard that, in May 2002, McErlean had provided the regulator with a written estimate that AIB had overcharged its customers by up to €75 million and that the bank had failed to begin a programme of repayment to customers.
Last week’s apology from Elderfield raises serious questions for O’Reilly. These include whether O’Reilly took adequate action on receipt of McErlean’s overcharging allegations or whether he took action only when another whistleblower raised the matter with RTE a few years later in 2004.
Another is why it was that the Financial Regulator’s2004 investigation found only €35million of overcharging at AIB, even though O’Reilly was in possession of estimates from McErlean that the figure was up to €75 million. Elderfield said last week that €88 million had now been refunded to AIB customers.
O’Reilly, who resigned as a director of Irish Life & Permanent earlier this year, could not be reached for comment last week.
The significance of the apology issued by Elderfield last week should not be underestimated.
It was generously and graciously phrased, and it left no doubt that McErlean had been doing his job properly and that he had been badly let down by the regulatory authorities.
Elderfield said it was his opinion that ‘‘some matters could have been better handled by the public authorities involved’’ and added that he was ‘‘sorry for any unintended distress caused for Mr McErlean’’.
He added that McErlean was a ‘‘serious individual who is clearly committed to seeing improved standards of compliance in the financial services industry’’, and that he was grateful to McErlean for the actions he had taken to raise his concerns with the regulator.
Yet the fact remains that the Financial Regulator has never published the Deloitte & Touche report it commissioned into overcharging at AIB.
Nor have we yet received an adequate explanation as to why Goodbody was trading in AIB shares using mysterious offshore locations.
The Financial Regulator should now publish the Deloitte & Touche report on overcharging and tell us what on earth AIB and Goodbody were up to.
Then there is the matter of putting McErlean’s considerable talents to good use. McErlean has not obtained full-time employment since leaving AIB in 2002, though he was recently appointed to an EU committee on derivative trading after his candidature was championed by Transparency International.
A qualified solicitor, McErlean worked with the Industrial Development Board in the North. In 1991, he joined First Trust, an AIB subsidiary in Belfast, where he served as solicitor, company secretary and compliance officer. In 1996, he was appointed group compliance officer at AIB and was appointed the bank’s internal auditor in 1997.
McErlean remained in that job until his departure in 2002, which was announced on the day that AIB published a report into the Rusnak rogue trader affair at Allfirst, its US subsidiary bank.
That announcement created the impression that McErlean was connected with the rogue trader affair, even though Gary Kennedy, AIB’s then finance director, was on record earlier as saying that McErlean had no responsibility whatsoever for Allfirst.
The government in recent months appointed Kennedy to the board of Anglo Irish Bank.
If the government and the regulatory authorities want to help restore confidence in our banking system, they should move to appoint people such as McErlean to the boards of our banks and regulatory authorities.
Come to think of it, how about appointing him to the board of AIB, where there are now plenty of vacancies following the departures of a further two non-executive directors last week?

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Name the good guys and the bad

2010-10-05T00:24:00.000-07:00

03 October 2010

By Kathleen Barrington

Wouldn’t it be great if Peter Nyberg, the Finnish expert appointed by the government to investigate the banking crisis, could tell us who the good guys are?
Wouldn’t it be useful to have the names of any non-executive directors, auditors, regulators or public servants who got it right, even if they were overruled by their superiors or by a louder majority?
The government has asked Nyberg’s banking commission to identify the main causes of the banks’ serious failure to implement and adhere to appropriate standards and controls in both corporate governance and risk management in the period from January 2003 to January 15,2009.
He is examining the six institutions covered by the banking guarantee - AIB, Bank of Ireland, Anglo Irish Bank, Irish Life & Permanent, Irish Nationwide and EBS.
Nyberg has also been asked to examine the adoption by the boards of Anglo and Irish Nationwide of business models and strategies and the implementation by their senior managements of business and lending practices which resulted in those institutions experiencing severe financial stress.
He is also to investigate whether the external auditors of the six covered institutions commented in their audit reports or other communications to the boards on the standards and controls operated by the banks, both from a corporate governance and risk management perspective and on their business models and lending practices.
Last but not least, Nyberg must also examine the main causes for the failures of the Central Bank and Financial Services Authority of Ireland (CBSFAI) in respect of the covered institutions, and the relevance any advices or directions given by the Department of Finance to the Authority in relation to its supervisory role.
So far, the boards of the Irish banks have proven relatively impenetrable to anyone seeking to find out whether anyone at the top shouted stop.
In the absence of any leaks suggesting that questions were raised by dissenting directors, the public has been left with the impression that the boards of our leading financial institutions were teeming with the proverbial ‘‘grunt a month’’ directors who assented to whatever management proposed before retiring for long lunches.
Nyberg, however, will have the powers to get his hands on bank documents that have not been available to journalists, politicians and others asking how it all went wrong.
He is already reported to have sought a vast amount of information from the banks, including the minutes of board meetings going back to 2003.
It is a useful starting point, but Nyberg must also be aware that the minutes of meetings are not always a reliable guide to what was actually said.
He may need to interview both the executive and non-executive directors who attended those meetings if he is to get a full picture of the debate that preceded the adoption of those minutes.
Let’s hope that Nyberg also interviews the senior risk officers at the banks to establish their view on the extent to which the boards forced compliance with both the spirit and the letter of any credit policies that they had adopted.
And let’s hear if any risk officers actually said no to their boards and managers when asked to sign off on risky lending.
In his report earlier this year, Central Bank governor Patrick Honohan noted that the Financial Regulator had found substantial departures from credit policy during inspections of the banks, though the Regulator failed adequately to follow up on its concerns.
The general public has an interest in knowing who applied pressure to depart from credit policy; who resisted such pressure; which regulatory staff uncovered the departures; to whom they reported their concerns; and why those concerns were not acted on.
The focus on the auditors is also welcome. Shareholders in banks are rightly concerned that auditors appear to have given the banks a clean bill of health even as they were engaging in very high-risk lending, though it is entirely possible that some auditors raised red flags which managements and boards ignored.
In particular, the question of why Ernst & Young failed to uncover the concealment by former Anglo chairman and chief executive Sean FitzPatrick of up to €122 million in loans he took out with the bank over a period of eight years demands answers.
Then there is the mystery of why the auditors either didn’t spot, or were unable to prevent, the managements of our banks from engaging in shoddy lending practices, such as failing to obtain adequate security for loans and failing to verify the ability of certain borrowers to service their loans.
Of course, one of the biggest mysteries of all is why the Regulator failed adequately to bark and bite as a watchdog should.
We still don’t fully understand whether the Regulator simply trusted the banks too much, was unduly deferential, or was ordered off the pitch by the Department of Finance and its political masters.
The Honohan report did suggest that intrusive demands from regulatory staff could be and were set aside after direct representations were made to senior regulators, though he did not name names.
Honohan also noted that a proposed regulatory requirement for bank directors’ compliance statements came to naught following industry lobbying and concerns expressed by the Department of Finance, though again no names were named.
Nyberg will have access to records that weren’t available to other investigators. Let’s hope he uses his report as an opportunity to name the good guys as well as the bad guys.
Then, let’s hope the authorities promote the good and fire the bad.
For we are in desperate need of leadership from people in whom we can place our trust.

Learning lessons from the stage

2010-09-28T10:14:00.000-07:00

26 September 2010

By Kathleen Barrington

You have to hand it to the folks at the Dublin Theatre Festival for persuading Ulster Bank to sponsor a programme so in tune with the zeitgeist that it includes a number of plays touching on banking and financial scandals.
Launching the event in July this year, Ulster Bank chief executive Cormac McCarthy said that the bank was ‘‘very proud to be continuing its association with the festival in 2010 as it goes from strength to strength.
This year’s programme is an ambitious and varied line-up displaying the best in homegrown and international theatre talent’’.
I don’t know if he was referring to Lucy Prebble’s Enron at the Gaiety, which follows ‘‘a group of flawed men and women in a narrative of greed and loss, reviewing the tumultuous 1990s and casting new light on the financial turmoil in which the world finds itself today’’, as the festival programme put it.
He may also have been referring to Henrik Ibsen’s John Gabriel Borkman at the Abbey, which tells the story of a once great, wealthy, powerful and revered banker who gave up love for success and was handsomely rewarded, only to end up disgraced and destitute after a financial scandal.
Coincidentally, by the time the festival launch took place, McCarthy had signalled his intention to exit stage left after playing a big role in overseeing Ulster Bank’s scandal-free, but nonetheless spectacular, fall from grace.
McCarthy announced his impending departure after Ulster Bank had racked up losses of £368 million in 2009, on top of losses of £689 million the previous year; had announced a major redundancy programme; and had transferred about £27.5 billion in dodgy loans to the British Asset Protection Scheme, roughly equivalent to our own National Asset Management Agency (Nama).
McCarthy, who earned as much as €1.4 million a year in the good times, will forever be remembered as the man who pioneered the 100 per cent mortgage in Ireland and the main lender to Sean Dunne, who spent €375 million acquiring land for his ill-fated redevelopment scheme in Ballsbridge.
The Enron production at the festival promises to be extremely interesting, given that many of us are obsessed with understanding the banking crisis and understanding how a country which, only a few short years ago appeared to be on top of the world, is now in economic freefall.
Enron was the Houston energy company which collapsed spectacularly in 2001, after it emerged that its profits had been wildly overstated due to dodgy accounting practices at the firm.
Former chief executive Kenneth Lay and senior executive Jeffrey Skilling were, in 2006, found guilty of conspiracy, wire fraud and a number of other charges.
Another executive, Andy Fastow, pleaded guilty to conspiracy, money laundering and other charges, while Enron’s now-defunct auditor, Arthur Andersen, was indicted over the shredding of tons of Enron-related documents.
But what the Enron play offers is ‘‘not a lecture on corporate madness, but an ultra-theatrical demonstration of it at work’’, according to the Guardian.
Prebble has been praised for creating plausible people and creating in Skilling a lesson in self-delusion. She said that her ‘‘aim was to show the theatricality of business and the illusions on which it thrives’’.
‘‘Jeffrey Skilling had a messianic zeal and believed he could change the world by creating a virtual economy.
Andy Fastow, his chief finance officer, was a fan of fantasy films and sci-fi, and gave Enron’s shadow companies names like Raptor and Talon - an idea I seized on, so that on-stage raptors become a scary, sinister way of showing how Fastow’s ideas had spun out of control," Prebble said.
Similarly, a US review of a 2010 production of John Gabriel Borkman said the play was not so much about the detail of Borkman’s wrongdoing, rather about the impact of such wrongdoing on family and psyche.
Of course, none of the bankers at the very top of our financial institutions during the boom years has been formally charged with breaking the law, even though many commentators believe former Anglo Irish Bank chairman Sean FitzPatrick was wrong to conceal for years the scale of his borrowings from Anglo by parking his loans with Irish Nationwide at year end.
There are also serious questions to be asked about the manner in which the Anglo balance sheet was artificially boosted with the use of deposits from Irish Life & Permanent, and the manner in which some of Sean Quinn’s interest in Anglo was offloaded to the famous ‘golden circle’ of investors.
But it is worth remembering that those controversial activities were emphatically not the reason why Anglo failed, the banks went bust and the economy went down the tubes.
The main reason the banks went bust was due to a combination of reckless lending - much of which happened in clear public view, while nobody in authority cried ‘stop!’ - coupled with the effect of the international credit crunch.
Watching FitzPatrick on television as he attended a personal bankruptcy hearing at the High Court last week, it was hard not to feel at least some sympathy for a man who has fallen from such great heights to become public enemy number one; and even a grudging admiration for the fact that he has at least stayed around to face the music when others have quietly moved offshore.
This is not an attempt to absolve him of his share of responsibility in bringing about the banking crisis, or to play down the significance of his dodgy dealings. Incidentally, the fact that he was smiling as he ran the gauntlet of the photographers outside the Four Courts appears to have been misinterpreted by some.
Anyone who ever met FitzPatrick will tell you that he always had a winning smile.
It would quite simply be second nature to FitzPatrick to keep the sunny side up in public. Indeed, it may have been an irrationally exuberant outlook that prevented him from seeing the writing on the wall for his bank and for the economy - until it was too late.
At the very least, the offerings from the Dublin Theatre Festival are likely to get us thinking about whether our senior bankers were merely cartoon villains or whether they also had something of the tragic hero, brought down by an excess of pride or ambition that drove them to the top in the first place, a phenomenon which our friends in the theatre world prefer to call hubris.

Unwelcome attention for the IFSC

2010-09-20T10:28:00.000-07:00

19 September 2010

By Kathleen Barrington

The soaring cost to the German taxpayer of bailing out Hypo Real Estate is likely to place renewed focus on Ireland’s low corporation tax rate, at the very time when the government is trying to protect the rate from attack by the European Commission.
HypoReal Estate is to Germany what Anglo Irish Bank is to Ireland, a property lender that has become a huge financial burden on the taxpayer.
Hypo is making headlines again after it emerged last week that it is to get another €40 billion in guarantees from the German taxpayer.
The Munich-based bank is now underwritten by the German state to the sum of €142 billion.
The decision to expand the guarantee has prompted the kind of media scrutiny in Germany that the soaring cost of the Anglo bailout has attracted here.
And that’s not good news for Ireland, which is already seen in Germany as having played a significant role in the downfall of Hypo Real Estate.
Just as the Irish government ended up nationalising Anglo, the German government also ended up nationalising Hypo in 2009.
The move resulted in shareholders writing off their investment in Hypo and the German taxpayer guaranteeing Hypo’s losses.
The initial trigger for Hypo’s problems was the inability of its Dublin subsidiary, Depfa, to raise financing when credit markets froze after the Lehman Brothers collapse in September 2008.
Depfa was based in the IFSC and was initially regulated by the Irish Financial Regulator.
The perception in Germany is that Depfa had moved to avail of our lower corporation tax and our light-touch regulatory system. Depfa was taken over by Hypo in 2007,which brought the Dublin subsidiary onto the balance sheet of Hypo and back under the supervision of the German regulator, Bafin.
This meant that the enormous bill for rescuing Depfa landed at the door of Germany’s taxpayers, whereas it might otherwise have landed at ours.
The German media have naturally been taking an interest in why the German taxpayer is picking up the tab for problems partly caused by a subsidiary located in lightly-regulated, low-tax Ireland.
A programme broadcast on Germany’s ZDF channel earlier this year told viewers that Depfa was one of several German banks that had moved to Ireland to take advantage of low taxes and lax regulation.
The reporter noted that it ‘‘is an open secret that the rules here are not exactly strict.’’
The cameras zoomed in on Depfa’s offices at the IFSC and on the National Convention Centre, which was funded with the help of a €280 million Depfa loan to the Irish government.
The government was in a public private partnership with Johnny Ronan’s Treasury Holdings, the developer of the convention centre which opened for business earlier this month.
A German expert examining the Hypo debacle told the Insider he was shocked by Depfa’s huge borrowings.
Though Depfa’s main business was lending to low-risk public sector projects such as the National Convention Centre, he was shocked to find that Depfa’s high risk capital markets division made a big contribution to the bank’s revenues.
He was also shocked by the ultra-thin margin in Depfa’s core business. He concluded that Bafin should never have let Depfa back into Germany under those conditions.
It would be wrong to lay the blame for Hypo’s problems entirely at the door of Depfa, however.
Under its former chief executive, Georg Funke, Hypo separately engaged in the kind of daft property lending in which Anglo also engaged.
For example, Hypo lent more than $8 billion to finance US real estate projects during the property bubble.
According to Business Week, the projects included the Landmark, a luxury condominium and retail development near Denver, and a stalled hotel-condominium project in Phoenix. It also provided funding for the W South Beach Hotel & Residences in Florida and the Trump International Hotel & Tower in Hawaii’s Waikiki Beach. About 67per cent of the US loans are either on a watchlist or non-performing.
Funke has also potentially increased the bill for the German taxpayer by taking legal action against the bank for his early dismissal.
If Funke’s legal action is successful, he could be in line for a €3.5 million payout.
The Sueddeutsche Zeitung newspaper noted last week that Germans were shocked two years ago when they woke up to the news that their government had guaranteed a bank that most of them had never even heard of.
Last week’s disclosure that the government was giving a further €40 billion guarantee to Hypo, coupled with Funke’s legal action, is likely to attract renewed media scrutiny of Hypo, including the role Ireland played in its downfall.
This renewed scrutiny will be coming at a time when there is a fresh threat to our corporation tax rate. The European Commission earlier this month expressed concern that different corporation tax rates in member countries distorts competition.
The proposal could resonate in countries such as Germany, which lost out on corporation tax revenues when profitable German banks moved to Ireland, but now gets to pick up the huge tab after one of them imploded spectacularly.

The curious tale of Anglo Irish Bank and its Austrian deposits

2010-09-13T02:54:00.000-07:00

12 September 2010

By Kathleen Barrington

Anyone who watched the RTE documentary Freefall last week was left in no doubt that Sean FitzPatrick’s Anglo Irish Bank was insolvent by September 29, 2008 due to a lack of access to bank funding and a flight of depositors.
So why, if Anglo Irish Bank was so desperate for cash, did FitzPatrick, its then chairman, take the curious decision at that time to sell his Austrian private bank, which had long been an important source of deposits for him?
On September 5, 2008, Anglo announced it had agreed to sell its Austrian private banking subsidiary to listed Swiss banking group Valartis.
The press release conveyed the impression that the subsidiary was rather unimportant, pointing out that it contributed just one per cent of Anglo’s pre-tax profits and that it had net assets of just €76 million.
But that impression was at odds with previous messages coming from the bank. In fact, Anglo’s Austrian business was at one stage considered so important that, in 2001, Anglo invited local board member Anton Stanzel to join the main Anglo group board. Stanzel was a former director general of the Austrian Ministry of Finance and a director of Casinos Austria International, the gaming and entertainment group.
The importance of the subsidiary from a deposit-gathering perspective was frequently highlighted in Anglo Irish Bank’s annual reports, including the 2006 annual report. It said that: ‘‘A primary source of funding is the Bank’s personal and corporate deposit-taking operations, located in Ireland, Britain, the Isle of Man and Austria."
Indeed, the 2006 annual report made clear that, far from planning to close its deposit gathering business, Anglo Irish Bank was planning to expand it.
‘‘In early 2007,we will expand this operation with the opening of a new corporate deposit-taking facility in Jersey," the 2006 annual report stated.
Anglo subsequently changed its strategy, and decided to sell its Isle of Man trust operations and its Swiss private bank. It said it was doing this in order to focus on its core secured lending business in Ireland, Britain and the US.
But it is nevertheless surprising that Anglo would have persisted in selling the Austrian business in September 2008, at the very time that it was in dire need of funds due to the credit crunch and the flight of its depositors.
Deposits are generally a cheaper source of funding for banks than borrowing on the interbank market, particularly in the middle of a credit crunch.
Private banks such as Anglo’s Austrian subsidiary typically offer deposit, loan, asset management services and other investment opportunities.
While Anglo has said it did retain its Vienna-based treasury operation, which also gathers deposits, it is clear that the sale of the private bank resulted in the loss of a big chunk of deposits. Indeed, a close reading of Anglo Irish Bank’s 2009 annual report confirmed that the sale of Anglo’s Austrian private banking business resulted in the loss of €600 million in retail deposits.
The report said that Anglo Irish Bank realised a profit of €49 million from the sale of the Austrian operations to Valartis for €141 million. It also disclosed that Anglo provided Valartis with a €24 million loan to part fund the purchase.
In short, FitzPatrick chose to sell an Austrian bank with a €600 million deposit book in September 2008, even though the bank was under enormous pressure on the funding front. Remember, it was in the six months leading up to September 2008 that Irish Life & Permanent controversially assisted Anglo in creating the impression that Anglo’s balance sheet was stronger than it actually was.
Indeed, it seems that FitzPatrick was so anxious to flog the Austrian business that he was even prepared to lend Valartis some of the money to buy the business from him.
So what do we know about the customers of Anglo’s former Austrian subsidiary in Vienna?
Well, the Valartis annual report reveals that the Austrian operation manages about 1.6 billion Swiss francs (€1.25 billion) for about 4,000 private banking clients.
Those clients can now remain very private indeed, far away from the scrutiny of the Irish state which stepped in and nationalised Anglo Irish Bank in January 2009 in the wake of revelations about FitzPatrick concealing large loans from his shareholders.
One of the big advantages of having money on deposit with an Austrian bank is that the identity of depositors cannot be disclosed to the authorities, as Austria enjoys certain derogations from the EU Savings Directive. This was and remains a key attraction for those who deposit funds in Austria. Valartis has indicated that it will continue to vindicate those privacy rights.
‘‘The bank secrecy in Switzerland, Austria and Liechtenstein is an important factor for our private and institutional clients who value the confidentiality and security that bank secrecy offers. The attacks on banking secrecy have intensified. In a world of increasing transparency, but also a diminishing private sphere, we will continue to defend our clients’ rights within the law to privacy and confidentiality," Valartis said in its annual report.
The importance of privacy is also highlighted by Valartis in its brochures. ‘‘Financial privacy is of the utmost importance to many investors. In addition, strict banking secrecy laws make Austria one of the few jurisdictions within the EU able to offer traditional banking confidentiality and privacy."
Valartis made it clear that it wasn’t just targeting Austrians, but foreigners as well. ‘‘We focus on international clients and have many years’ experience working with families and their international structures. We work closely with top lawyers, accountants and tax specialists around the world. Many of our clients use structures such as trusts or offshore corporations since these provide flexible options in terms of asset protection, confidentiality and succession planning."
Let’s hope those clients don’t include any Irish depositors who might owe money to Anglo, to other struggling Irish banks or to the Irish taxpayer.
The decision to sell Anglo’s Austrian subsidiary was subject to regulatory approval by the Austrian regulator. But it appears that neither the regulatory authorities in Austria nor in Dublin placed any obstacles in the way of the deal. The sale of Anglo’s Austrian business was completed on December 19, 2008, the day after FitzPatrick resigned as chairman after his dodgy loan dealing had been uncovered.

The Irish Freakonomics show

2010-09-06T03:43:00.000-07:00

05 September 2010

By Kathleen Barrington

Freakonomics, the 2005 US bestseller, taught us that estate agents sell their own homes for higher prices than the homes of their customers.
Authors Steven Levitt, a University of Chicago economist, and Stephen Dubner, a journalist and writer, examined data covering the sale of nearly 100,000 houses in suburban Chicago - including 3,000 houses owned by estate agents.
They found that although, in theory, the commission charged by estate agents supposedly aligned the interest of the estate agent and the seller, in practice things weren’t so simple.
In the US, a 6 per cent commission on the sale price of the home is typically split between the seller’s agent and the buyer’s agent. Each estate agent then kicks back half the take to their agency. This means that only 1.5 per cent of the purchase price goes directly into the agent’s pocket.
Taking an example, Levitt wrote: ‘‘So on the sale of your $300,000 house, her personal take of the $18,000 commission is $4,500.
‘‘Still not bad, you say. But what if the house was worth more than $300,000? What if, with a little more effort and patience, she could have sold it for $310,000?
After the commission, that puts an additional $9,400 in your pocket. Yet the agent’s additional share - her personal 1.5 per cent - is a mere $150. So maybe your incentives aren’t aligned after all. Is the agent willing to put out all that extra time and energy for just $150?"
When Levitt examined the Chicago data, he found that an agent kept their own home on the market an average of ten days longer and sold it for an extra 3 plus per cent, or $10,000 on a $300,000 house. Selling their own house, an agent holds out for the best offer; selling yours, they push you to take the first decent offer that comes along.
‘‘Like a stockbroker churning commissions, she wants to make deals - and make them fast," Levitt wrote. ‘‘Why not? Her share of a better offer - $150 - is too puny an incentive to encourage her to do otherwise. So her job is to convince you that a $300,000 offer is in fact very good, even generous, and one that only a fool would refuse."
It is worth bearing all this in mind at a time when distressed middle-class borrowers are about to get a lesson in Freakonomics, Irish-style.
It is believed that one of our own leading banks has instructed a leading estate agency to sell a large number of distressed residential properties this autumn.
Neither the estate agency nor the bank in question would confirm nor deny the suggestion that it was poised to put a large number of three and four-bedroom properties on the market at knockdown prices.
However, estate agency insiders have admitted they favour the strategy of getting the market moving again, even at low prices. For although they certainly have an interest in achieving high prices for the homes they sell, they have an even bigger interest in getting the market moving, as they can’t make money at all if no houses change hands.
New data published by the Financial Regulator last week showed that almost 36,500 mortgage holders were now three months or more behind on their repayments. The mainstream banks have so far repossessed only a small number of properties through the courts. The conventional wisdom is that the banks do not want to sell the property and lock in losses at the current distressed levels.
But it may make sense for some banks in certain circumstances - particularly ones wanting to clean up their balance sheets ahead of a possible sale to a new buyer, or ones who want to attract new investors.
For example, let’s say the bank originally gave a borrower a mortgage of €1 million to buy a home valued at €1.5 million in 2006. The borrower can’t make the repayments on the €1 million mortgage, due to a change in his financial circumstances. The bank encourages the distressed borrower to sell the home for €750,000 to a new borrower, to which the bank is prepared to lend a more modest sum.
Let’s say the bank is now willing to lend €400,000 to the new borrower, who has savings of €350,000.The effect of the manoeuvre is that the bank gets a bad loan of €1 million off its books and replaces it with a (hopefully) good loan of €400,000, €350,000 in cash and an unsecured loan of €250,000 of doubtful quality.
Just as there are incentives for estate agents which are not always readily understood by sellers and buyers, there are also incentives at work which will dictate the behaviour of banks. It is likely that bankers will, in the current climate, be rewarded for the amount of money they recover from distressed borrowers, whereas previously they were rewarded for lending in large volumes.
In the case outlined above, the bank is pleased because its balance sheet now looks more attractive to new investors; the new homebuyer is pleased because he has got a bigger home at half the price he would have paid a few years ago; and the estate agent is pleased because he has earned a fee on the transaction.
The big loser is, of course, the original buyer, who feels suckered as he has realised a big loss on his investment; is possibly homeless unless he has other property; and still owes €250,000 to the bank (though at least he doesn’t have to make the mortgage repayments on a €1 million loan for a house that is worth a mere €750,000.)
Some borrowers may, in fact, be willing to surrender their properties in order to get the financial burden of home ownership off their backs, as we saw last week when a Galway man put his newly-built four-bed bungalow on the market, saying he was willing to consider any offer over €1.
There are also other incentives at play which may affect banks’ behaviour unexpectedly. For example, a bank may prefer to lend to the borrower who wishes to buy a distressed asset to which the bank is already exposed. This may give rise to apparent anomalies, where two customers in similar financial circumstances may get entirely different answers from their bank when they seek to raise a mortgage.
The banker may say ‘yes’ to the customer who wants to buy a property on which there is already a distressed loan originated by his own bank; but may say ‘no’ to a customer of identical financial standing if the borrower wants to buy a property from someone who has a performing mortgage or a distressed mortgage with a competitor bank. That’s Freakonomics for you.

Banks shut doors to new homes

2010-08-30T11:38:00.000-07:00

29 August 2010

By Kathleen Barrington

John - not his real name - is a 31-yearold chartered accountant who trained with a Big Four accountancy firm. He has just returned from two years in Australia and is working as finance director of a multinational firm in Dublin.
His fianceé is also a chartered accountant who trained with a Big Four accountancy firm. She too is just back from Australia and is financial controller with a multinational firm.
John says he and his fianceé have a combined s alary of €170,000 a year, giving them after-tax income of €9,000 a month. They recently sought to raise a €290,000 mortgage on a house that was professionally valued at €460,000, a loan-to-value ratio of 63 per cent.
The monthly repayment on the 35-year mortgage is €885 a month after mortgage interest relief for first-time buyers is factored in.
John says he has a personal loan of €30,000, while his fianceé does not have any loans at all.
He says he has an unblemished credit history. He admits his account was overdrawn occasionally as he had to make several visits home to Ireland to visit his mother who was sick.
His fianceé's account generally had a surplus of about €6,000 a month.
John says his parents had always banked with AIB, so he and his fiancée applied to AIB for a mortgage. He says AIB last week refused him the mortgage unless he repaid the €30,000 personal loan. John considered the request ‘‘an absolute farce’’ so he and his fiancée applied to Bank of Ireland for a mortgage.
The Bank of Ireland told them that they would have to prove that they had regular savings in order to raise a loan. ‘‘As of August 25, I would have a current account balance of €5,100 and she will have €5,500," said John.
He considered the request by Bank of Ireland that he show a savings history to be an effective ‘no’ to his mortgage request and has since gone to a broker who advised him that he may be able to obtain a mortgage elsewhere, possibly from Permanent/TSB, Haven or KBC.
John says an Australian bank was prepared to lend him and his fianceé far more than he wants to borrow from the Irish banks, even though he had only lived in Australia for a short time.
When I suggest the lack of credit indicates house prices have further to fall and that he might get a better deal on a house if he waited a bit longer, he explained that he wanted to buy the property, an investment property owned by his father on which there is no mortgage. His father would, in effect, be giving him the equity in the home.
The only thing stopping John from giving his real name is that he does not wish to upset his multinational employer. But speaking in the spanking new offices of the well-known company, the message from this young finance director is clear: despite their repeated assertions to the contrary, AIB and Bank of Ireland are not open for business.
John is clearly angry with the bankers, saying he told them: ‘‘You would be better off telling me you have no money than insulting me."
John is not alone. The new mortgage lending statistics published by the Irish Banking Federation last week painted a grim picture.
They showed that new mortgage lending was down 40 per cent in the second quarter of the year compared with the comparable period last year.
The figures show that AIB, Bank of Ireland, Bank of Scotland, EBS, Haven Mortgages, ICS Building Society, KBC, Irish Nationwide, Permanent TSB and Ulster Bank together lent just €1.3 billion to 7,827 borrowers in the second quarter of this year compared with €2.1 billion to 12,686 borrowers for the comparable quarter in 2009.
In the second quarter of 2006, when the Celtic tiger was in full swing, the banks lent €10.1 billion to 53,449 borrowers.
In short, new mortgage lending is down 87 per cent from the levels reached in the first quarter of 2006. Given that house prices are dictated to a great degree by the availability of credit, the figures suggest house prices may have a lot further to fall.
If house prices were dictated exclusively by the availability of credit, the figures suggest that a house worth €1 million in 2006 could be worth as little as €130,000 today, though clearly it would be hard to find willing sellers at such price levels.
But the new mortgage lending figures also augur poorly for liquidity in the economy as a whole if older people like John’s father are unable to realise any value from their assets due to the inability or unwillingness of the banks to lend to good people like John who want to buy them.
Former banker and financial analyst Peter Mathews knows John personally and is shocked that the banks would refuse a ‘‘no brainer’’ loan application from him and his fiancée. He reckons that John’s experience is replicated all across the country as ‘zombie’ banks are unable to lend.
Despite the billions that have been injected by the taxpayer, he believes AIB and Bank of Ireland remain inadequately capitalised and are consequently unable to lend to get the economy moving again, though others suggest the banks may also be unwilling to lend as they get a risk-free return by depositing their money instead of taking the risk of lending even to strong borrowers such as John.
Mathews has been campaigning for the adequate recapitalisation and nationalisation of AIB, Bank of Ireland and EBS using a combination of taxpayers’ money and a €6.5 billion contribution from the bank’s bondholders in the form of debt forgiveness.
Mathews believes this would allow the banks to begin lending again, that the banks would ultimately become profitable lending to people such as John and that taxpayers would get a return on their investment in a few years’ time when the banks would be sold off to the private sector.
John agrees: ‘‘Nationalisation is the way to go."
One thing seems certain: if the government doesn’t move quickly to address the paralysis in the credit markets, it is likely that a foreign bank or a new player will target low-risk borrowers leaving the Irish banks in which the taxpayer has already invested with all the bad risks and no prospects of recovery at all.

It’s time to cut the financial services industry down to size

2010-08-23T05:20:00.000-07:00

22 August 2010

By Kathleen Barrington

In January of this year, leading fund manager Jeremy Grantham warned his investor clients to ‘‘beware the financial industrial complex’’.
It was an extraordinary warning coming from a man, who as chairman of Boston based GMO, manages more than $94 billion in client assets.
Writing in his quarterly letter to investors, he told his clients that the financial services industry was eating their lunch.
‘‘And to be honest, I’ve eaten my fair share. It was a good lunch."
‘‘Let’s start with the investment industry component. It is so obvious in this business that it’s a zero-sum game. We collectively add nothing but costs. We produce no widgets; we merely shuffle the existing value of all stocks and all bonds in a cosmic poker game," he said.
Grantham indicated that the investment industry was no different from the financial services industry as a whole.
He said that, by 1965, the middle of one of the best decades in its financial history, the US had perfectly adequate financial services.
‘‘Of course, adequate tools are vital. That is not the issue here. We’re debating the razzmatazz of the last 10 to 15 years. Finance was 3 per cent of GDP in 1965; now it is 7.5 per cent.
That is an extra 4.5 per cent load that the real economy carries. The financial system is overfeeding on, and slowing down, the real economy. It is like running with a large, heavy and growing bloodsucker on your back. It slows you down."
‘‘From society’s point of view, this additional 4.5 per cent burden works like looting or an earthquake. Both increase short term GDP through replacement effect, but chew up capital.
All of the extra financial workers might as well be retirees or children, in that they are supported by the rest of the workforce, but they are much, much more expensive."
Grantham’s analysis bears a striking resemblance to that of Joseph Stiglitz, the Nobel prize-winning economist.
Stiglitz has argued that the US financial system created risk and mismanaged capital, all the while generating huge transaction costs, as the sector garnered some 40 per cent of all of corporate profits in the years before the crisis.
He further argued that it was hard to find evidence of any real growth associated with the so called innovations in the financial system, though it was easy to see the link between those innovations and the disaster that confronted the economy.
Things weren’t much different here. Our banks were among the most profitable in the world as they engaged in a reckless lending spree of gargantuan proportions, unleashing new products that encouraged borrowers to take on more debt than they could afford to repay.
The banks raked in big profits in the years preceding the crash, leaving the Irish taxpayer to fund one of the biggest banking bailouts the world has ever witnessed when the borrowers were unable to shoulder their massive loans.
The more they grew, and the more profitable they became, the more people the banks employed. In the ten years from 1997 onward, the numbers employed in banking and insurance rose from 40,400 to 59,500, an increase of almost 20,000 over the decade, according to figures from the Central Statistics Office.
Given that much of this growth in employment is likely to have been based on lending that was totally unsustainable, it seems inevitable - indeed, desirable - that the financial services industry should reduce in size and become less of a burden on the rest of us.
Overall, employment in Ireland has declined by 13.6 per cent from 2.1million to 1.8million, between the peak in the third quarter of 2007 and the first quarter of 2010.
Employment in construction has declined by 139,100 or 52 per cent, employment in industry is down 63,200, employment in the wholesale and retail trade is down 40,100, and agriculture is down 31,100.
But, despite the large number of jobs lost at Ulster Bank and Bank of Scotland earlier this year, overall employment in the financial services area had barely changed at all by the first quarter of this year, according to an analysis by the National Competitiveness Council.
That could be about to change, with the announcement last week that Bank of Scotland, which had continued to employ 850 people here, was poised to close its Irish operations.
Meanwhile the Irish Bank Officials Association is warning that 4,000 jobs are at risk, on top of the 6,000 that it said had been lost in the last 18 months.
The prospect of further jobs losses appears to be worrying the Minister for Enterprise, Trade and Innovation, Batt O’Keeffe, who is leaning on the banks to limit job losses in the sector.
O’Keeffe indicated last week that he had written to the banks asking them to justify any job reductions in the context of the practical requirement to maintain services for business customers to support economic recovery.
But it is unclear whether the rest of us have an interest in maintaining employment in a sector which appears to live off the rest of the economy, rather than contributing to it.
It is unfortunate that ordinary bank officials, who were only obeying orders, will be required to pay the price for a reckless lending spree that was sanctioned by the boards and senior management of the banks, especially when many of the directors and managers are still at the helm - drawing down very generous fees, pay and pensions.
But it is worth recalling that people working in the financial services industry have tended to be laid off on extremely generous terms, compared to the modest statutory redundancy packages offered to many ordinary workers. For instance, Ulster Bank, a division of the bailed-out Royal Bank of Scotland, offered such generous redundancy terms that the offer was over-subscribed.
Having been handsomely paid for their reckless lending, the bankers were offered generous British taxpayer-funded redundancy terms to get off the stage.
Bank of Ireland announced 750 redundancies last month on terms which have yet to be agreed, while AIB is reportedly contemplating layoffs on an even larger scale.
And while the redundancy terms have not been disclosed, it is worth recalling that if our bankrupt banks had been allowed to collapse in the normal way, the bosses and workers would have all lost their jobs and got no redundancy packages at all.
O’Keeffe and the government need to understand that the financial services industry grew too big for its boots both globally and domestically. It needs to be brought back down to a size where it is at the service of the wider economy, not sucking the lifeblood out of it.

Variable rate gambling can be costly

2010-08-16T05:36:00.000-07:00

15 August 2010

By Kathleen Barrington

Now that the banks are pushing up variable mortgage rates for borrowers, it is time to ask yet again why our government has persistently failed to encourage long-term fixed-rate mortgages which might have protected borrowers from the impact of rising rates.
The price hikes being imposed on Irish borrowers will, for the moment, only affect variable rate mortgage holders who do not have tracker mortgages.
The recent hikes by AIB, Bank of Ireland, Permanent TSB, EBS and KBC will push up the cost of those variable mortgages for Irish borrowers even though the European Central Bank (ECB) has held rates at historically low levels. In the case of Bank of Ireland, for instance, the increase will push up the cost of servicing a €300,000 mortgage by about €74 a month.
But all variable rate mortgage holders will ultimately be affected when the ECB eventually pushes up its own rates.
The impact of increasing interest rates hits particularly hard in Ireland, given that about 67 per cent of Irish mortgages are on variable rates compared with an average of just 43 per cent on variable rate mortgages in the euro area as a whole.*
In Belgium, Germany, France and the Netherlands, which represent about 65 per cent of all euro area housing loans, a long-term fixed period is the norm, with fixed rate periods of at least ten years or more.
Many European consumers who are on variable rates are also much less exposed to the risk of rising interest rates than Irish consumers. That’s because in many European countries there is a cap set - either by law or by contract - on the extent to which banks can increase rates. The idea is to protect borrowers from excessively large swings in household interest repayments. The result is that the Irish household sector faces an unusual degree of uncertainty about future monthly mortgage repayments, compared with many other eurozone countries.
The preponderance of variable rate mortgages here also begs the question of whether house prices soared partly due to the very low interest rates that applied in the aftermath of the dotcom bubble bursting at the beginning of the decade, only to start falling when the ECB doubled interest rates in the middle of the decade and eventually crash when the credit crunch hit.
Irish policymakers have paid little attention to this problem. But the British government examined the issue a few years ago when it commissioned Professor David Miles to report on the role of long-term fixed rate mortgages in protecting borrowers from the kind of boom-bust cycles that have characterised the British housing market.
Miles, who is also a member of the board of the Bank of England, found that generally speaking ‘‘most householders would be better off with the very long-term fixed-rate mortgages at any loan-to-income ratio above about three, and the fixed-rate mortgage results in a very substantial gain for those with ratios much above 3.75."
Miles also found that the more you borrowed relative to your income, t he more attractive long-term fixed-rate mortgages were. He said that when householders had a substantial risk of unemployment or a big fall in income, a long-term, fixed-rate mortgage was preferable.
He concluded that a significant proportion of households - though probably not a majority - might be expected to find that the advantages of very long-term fixed rate mortgages make them attractive.
But the problem is that most borrowers make their decision based on the cost of current monthly payments. Matters are not helped by the fact that many lenders offer low, introductory offers to first-time buyers for a period of, say, two years.
This makes the initial payment on variable rate mortgages an awful lot cheaper than for long-term fixed-rate mortgages, giving the consumer yet another reason to choose the variable rate mortgage.
Miles found that more than a half of the two-year introductory mortgage rates on offer in Britain during 2003 and 2004 were priced beneath the cost of funds to the bank, but the banks made up for this by loading charges on to the standard variable rate mortgages of older customers.
‘‘This structure of mortgage pricing is only possible because of a degree of cross-subsidisation between different groups of borrowers who have variable rate mortgages," he said. ‘‘In recent years those paying standard variable rate have been paying up to 200 basis points more on their mortgages than those who have the cheapest variable rates.
‘‘This cross-subsidisation has, as a side effect, meant that fixed-rate mortgages look very expensive to borrowers who focus on the initial rate on a mortgage," Miles explained.
The Irish banks have long protested that there is no demand for long-term, fixed-rate mortgages in Ireland.
But Miles found that in Britain, where the mortgage market closely resembles our own, the pricing strategies used by many lenders and the tendency for advisers not to focus on the risk of interest rate movements were the most likely factors behind the lack of demand.
In short, the introductory rates are deceptive and mask the true cost of the mortgage over its full term, a cost which may be better captured by the monthly payments on a fixed-rate mortgage which is based on the expected price of the mortgage over the full term.
Those who were seduced by low introductory offers can suddenly find themselves struggling when rates rise, especially if the rate rise happens when, as is the case in Ireland, unemployment and taxes are rising while wages are falling in many areas.
Not only does this pile pressure on the consumer, it also fuels the vicious cycle in the economy by taking more money out of the consumer’s pocket at the very time that businesses most need the consumer euro.
The Miles analysis is even more relevant in Ireland than in Britain as we do not have control over our own interest rates due to our membership of the eurozone.
But our politicians, bankers and regulators didn’t take measures to protect consumers from ECB rates that were out of kilter with local market conditions when we joined the euro a decade ago; they wouldn’t heed the Miles report when times were good; and now that times are bad, they are so busy fighting fires that they have all but forgotten about fire prevention.

* Housing Finance in the eurozone. ECB working paper. March 2009
* Miles D (2004).The UK Mortgage Market: Final Report and Recommendations, HM Treasury
* Miles D (2005) Incentives information and efficiency in the UK mortgage market, The Economic Journal

Formidable figure could bring change to US financial industry

2010-08-09T12:47:00.000-07:00

08 August 2010

By Kathleen Barrington

Professor Elizabeth Warren of Harvard University is a fascinating character.
She is currently head of the Congressional Oversight Panel, which oversees the US Treasury’s spending of the $700 billion committed to bailing out troubled banks in 2008.
However, she is in the news at the moment because she is among the candidates that President Barack Obama may appoint to head his powerful new US Consumer Financial Protection Bureau.
She is the favourite for the job among US liberals, who see her as a tireless consumer advocate, but she is feared by the financial services industry. Warren is the author of a number bankruptcy law case books and a former senior adviser to the National Bankruptcy Review Commission.
In 1997,this commission identified lending practices that were putting families at risk of bankruptcy and recommended legislative changes designed to curb abuses by both borrowers and lenders.
Warren is also co-author of a number of popular books including The Two Income Trap: Why Middle Class Parents are Going Broke.
It may seem surprising that a book about people going bust would resonate with the generally upbeat US public back in 2003, when the US economy seemed to be doing reasonably well.
It may have had something to do with the recognition factor, as the book highlighted the huge increase in consumer bankruptcy in the United States, especially among women.
The figures were staggering.
Whereas in 1981, about 69,000 women had filed for bankruptcy, by 1999 the figure had jumped to nearly 500,000.An estimated 1.6 million children would, in 2003, go along for the ride when their parents declared bankruptcy - or more kids than would get braces on their teeth that year, as Warren so memorably put it.
The book, co-written with her management consultant daughter Amelia Warren, concluded that the increase in bankruptcy was partly down to the fact that when mothers entered the workforce ‘‘they ratcheted up the price of a middle-class life for everyone, including families that wanted to keep Mom at home’’.
This was not a right-wing argument that mothers should stay at home, rather a recognition of the fact that two incomes chasing homes drove up the cost of homes for everyone, with especially devastating consequences for single parents, divorced people and couples where one earner becomes ill or unable to work.
The book also examined how the dropping of legislative ceilings on interest rates for consumer loans and mortgages freed the lending industry to charge more for loans.
It noted the decision to drop 80 per cent mortgages in favour of high loan-to-value mortgages meant that families could get all the mortgage money they ever dreamed of to ‘‘even if the price tag was more than they could reasonably afford."
Warren warned in her book about the dangers of subprime lending and refinancing homes to pay down other bills, telling readers unambiguously: ‘‘Don’t do it."
Furthermore, she argued that if a family did not have the income to qualify for a loan at a reasonable rate, they should not get that loan.
‘‘They would be better off renting an apartment and putting whatever extra money they have into savings accounts rather than paying double the market rate for a mortgage," she wrote.
‘‘If the private market cannot meet the needs of all communities, then it may be necessary for the government to step in and provide alternative sources of credit.
The point worth emphasising is that overpriced credit is no solution. Getting robbed to buy a home or to get a cash advance is still getting robbed, and it should be illegal."
Warren was also clear in her view about how the reliance of politicians on the financial services industry for funding meant it was particularly difficult to change practices in the banking industry.
The chapter detailing Warren’s 1998 encounter with then first lady Hillary Clinton makes for fascinating reading.
Clinton indicated she wanted to talk about an article Warren had written in the New York Times sharply criticising a bill that was making its way though Congress.
The bill proposed to undercut bankruptcy protections for families in financial trouble.
Warren persuaded Clinton that the bill would dismantle bankruptcy protection for families, forcing single mothers to compete with legions of credit card bill collectors for an ex-husband’s income and making it more difficult for families to hold on to their homes.
Clinton concluded that it was the job of the Democrats to ‘‘stop that awful bill’’, according to Warren.
With Clinton’s support, the Democrats slowed the bill’s passage through Congress. And when Congress finally passed the bill in October 2000, President Bill Clinton vetoed it.
‘‘But the story doesn’t end there. The banking lobbyists were persistent. President Clinton was on his way out, and credit card giant MBNA emerged as the single biggest contributor to then president Bush’s campaign.In spring 2001, the bankruptcy bill was reintroduced in the Senate, essentially unchanged from the version President Clinton had vetoed the previous year. This time freshman Senator Hillary Clinton voted in favour of the bill.
‘‘As New York’s newest Senator, it seems that Hillary Clinton could not afford such a principled position. Campaigns cost money, and that money wasn’t coming from families in financial trouble.
Senator Clinton received $140,000 in campaign contributions from banking industry executives in a single year, making her one of the top two recipients in the Senate. Big banks were now part of Senator Clinton’s constituency.
She wanted their support, and they wanted hers - including a vote in favour of ‘that awful bill’."
Warren’s views should carry weight now because she, in effect, foresaw the potentially devastating consequences of lending to people who could not afford to repay.
The penny only dropped with bankers and politicians in 2007,when US sub-prime borrowers began to default on their mortgages in such large numbers that it triggered the banking crash and depression from which the global economy is still struggling to recover.
Warren’s key message is that consumers need the same kind of protection when buying a financial product as when buying a microwave oven.
If Obama takes the brave step of choosing her to head his new Consumer Financial Protection Bureau, she may yet do for the financial services industry what Ralph Nader did for the motor industry and our own former health minister Micheál Martin did for the tobacco industry: make them a whole lot safer for the rest of us.

Social partnership comes at too high a price

2010-08-02T11:49:00.000-07:00

01 August 2010 By Kathleen Barrington

It was a widely accepted tenet of the boom years that social partnership had brought a level of industrial peace that allowed the economy to thrive.
But with the economy now in freefall, the consensus on which social partnership rested has been falling apart.
Many in the business community are asking whether the industrial peace delivered by social partnership came at too high a price leaving the country saddled with a high cost base it can no longer afford.
The business community focuses in particular on the cost of running the public sector, which it sees as a burden the private sector has to shoulder.
The government last year slashed public sector pay and imposed a pension levy on public sector workers in response to the economic crisis.
Many public sector workers believe they were treated unfairly by the government and that they are being forced to pick up the tab for reckless lending and borrowing by the private sector - notably bankers and developers.
But many private sector workers envy the job security enjoyed by public sector workers and point to rising unemployment levels experienced by private sector workers.
A paper published by the European Central Bank earlier this summer examined the role of government wages as a determinant of economic stability and competitiveness in the euro area.*
Its findings and conclusions make for interesting reading from an Irish policymaker’s perspective. It found a strong link between public and private wages in most euro area countries.
It found that in a number of countries this interrelation between public and private wages coincided with strong public wage growth and competitiveness losses.
The government wage bill accounts, on average, for almost a quarter of total public spending in the euro area. However, this figure is subject to substantial cross-country variation.
Some countries such as Austria and Germany record ratios well below average, while others such as Ireland and Portugal, reached almost 30 per cent.
A comparison of public and private sector wages for the euro area as a whole revealed that the average public wage has, over a 40-year period, always been noticeably higher than the average private wage.
It found that since the beginning of European Monetary Union (EMU) in 2000, it was possible to identify two groups of European countries.
The first group, comprising Portugal, Ireland, Italy, Greece and Spain has seen significantly faster public wage growth than private wage growth, and to a greater extent than for the euro area aggregate.
It found that Ireland had seen the largest increase since the start union. By contrast, the second group, consisting of Belgium, Germany, France, the Netherlands, Austria and Finland, has seen relatively little change in the ratio since 1999.
Furthermore, a number of euro area countries recorded public wage growth far in excess of both domestic private wage growth and the average public wage growth in the euro area.
Portugal, Italy, Ireland, Greece and Spain are prominent examples. In most of these countries private wage growth has also been much higher than the euro area average.
In fact, Ireland tops the league table of 11 countries surveyed when it comes to increases in public sector pay. Irish public sector wages grew by 110.8 per cent in the years 1999 to 2008 - just ahead of Greece. Ireland was second in the league table of 11 countries when it came to growth in private sector wages which rose by 60.3 per cent over the nine-year period.
The country with the biggest increase in private sector wages over the period was none other than Greece.
It is noticeable that the countries with the biggest public sector wage growth - notably the PIIGS countries of Portugal, Italy, Ireland, Greece and Spain - are also increasingly the ones which bond investors fear may struggle to meet repayments on their mounting public sector debt.
The authors of the ECB paper say their findings underpin the need for prudent public wage policies supported by strong domestic fiscal frameworks and appropriate wage-setting institutions in order to enhance economic stability and competitiveness in European Monetary Union.
They say governments should be cautious that wage setting and employment policies do not lead to negative repercussions on fiscal and economic performance.
They say there appears to be a need to strengthen fiscal discipline and to reduce the risk of pro-cyclicality in government wage expenditure.
They suggest that strict domestic fiscal rules and medium term budgetary frameworks could be effective tools to constrain the volatility and pro-cyclicality of this spending item. In addition, reforms to labour market institutions may be needed to avoid institutional biases towards pro-cyclicality, including from indexation, which ties government wages to inflation.
Second, given the interrelation between government and private sector wage developments, they say policy-makers would be well advised to adopt a prudent approach to government sector wage setting to mitigate the risk of competitiveness losses in the private sector.
In particular, they suggest reforms in labour market institutions, such as moving towards less coordinated wage bargaining and more decentralised wage setting, may further reduce the risk of adverse government wage spillovers and also facilitate wage adjustment in the private sector.
They predict the implementation of such reforms may well be associated with political opposition: ‘‘However, the double dividend of greater economic stability and a lower risk of intra-euro area competitiveness losses should encourage policy-makers to undertake the necessary adjustments."
It is unclear whether the Croke Park agreement hammered out between the government and the trade unions is the kind of deal the authors of the ECB paper had in mind.
The deal effectively sets a floor on the wage adjustments in the public sector as it guarantees no further public sector pay cuts or compulsory redundancies for four years in return for productivity concessions by 250,000 government employees.
* Public wages in the euro area. Towards ensuring stability and competitiveness. ECB Occasional Paper available on the ECB website.

We must heed banking warning

2010-07-26T02:27:00.000-07:00

25 July 2010

By Kathleen Barringtom

Imagine if a public health doctor visited your local school and said he found your children were displaying a set of symptoms generally regarded as predictors of a very serious illness or even death within three years, what would you do?
Would you whisk your children down to the GP for a thorough examination?
Would you canvas a second opinion from a consultant?
Would you follow their advice to stop engaging in behaviour that triggered the symptoms?
Or would you simply cross your fingers, focus on the positive and hope for the best?
In the financial world, the credit ratings agencies play a role roughly equivalent to a public health doctor in a school.
Their job is to assess whether or not the patient is showing symptoms which may herald serious financial health problems down the line. It is up to the patient’s parents to decide whether or not to act on those findings.
In 2005, international credit rating agency Fitch devised a set of diagnostic tools for assessing bank systemic risk, effectively the health of the global banking system.
The diagnostic tools were designed to give an indication of the likelihood of systemic stress occurring within a three-year time horizon.
There were two main indicators, known as the banking system indicator and the macroprudential indicator. The latter highlighted ‘‘vulnerability to potential systemic stress that often follows periods of rapid credit growth associated with asset price bubbles and/or major currency appreciation. Such episodes can lead to outright crises’’.
By February 2006, Fitch was reporting that there had been ‘‘a general increase in bank systemic risk in the last six months’’.
More than 40 per cent of countries were by then exhibiting ‘‘either ‘moderate’ or ‘high vulnerability’ to potential systemic stress due to rapid lending growth combined with strong real exchange rate appreciation and/or asset price growth’’.
Six countries exhibited the highest level of macro-prudential vulnerability (MPI 3) compared with just two on the first examination. Among the new countries displaying worrying symptoms were Iceland and Ireland.
‘‘Of these, Iceland is the most extreme case, with huge credit growth and major real exchange rate, equity and property price increases. The picture in Ireland is similar in nature though not in degree," Fitch stated.
Fitch produced another report in September 2006. It showed that Iceland and Ireland were still registering an MPI 3 score.
The report explained that the indicator ‘‘seeks to highlight, in as objective away as possible, the existence and severity of a set of macro-economic circumstances that has been shown to anticipate a majority of past episodes of banking system distress and, in some cases, full-blown systemic crises.''
The people principally responsible for protecting the health of the financial system at the time were then finance minister Brian Cowen and his department, the Central Bank under then governor John Hurley and the Financial Regulator under then chief executive Patrick Neary.
Last week, the Insider asked these three agencies whether the 2006 Fitch reports had been circulated in their organisations, who read them, what their reaction to the content of the reports was, and what action they then took.
A spokesman for the Central Bank and Financial Regulator confirmed the authority had received the report. ‘‘As with any reports from a range of sources, including ratings agencies, this report would have been noted and formed part of the Central Bank’s ongoing analysis."
It is believed the authority routinely met with representatives of the ratings agencies to discuss the Irish economy, while the excessive credit growth issues identified by Fitch were noted in the Central Bank’s 2006 Financial Stability Report alongside the perceived strengths of the system.
It is true that Fitch’s banking system indicator painted a healthier picture of the patient than the macro-prudential indicator.
And it would appear from the Central Bank’s 2006 report that the authority may have preferred the positive reading to the negative one. In medical terms, it ignored the patient’s very high temperature, because the patient’s pulse was normal.
A spokesman for the Department of Finance said it did not have any records relevant to the Insider’s query. However, he added that, as the officials in the section had changed over time, they were not aware if the reports had been considered by previous staff without writing up a report. He added it was primarily an issue for the Central Bank.
With the benefit of hindsight, we now know that the Fitch MPI indicator was spot-on when it came to predicting the vulnerability of the Icelandic and Irish banking systems which have suffered the most spectacular crashes.
Worse still, the banking patient has become so ill that it has infected the entire economy, resulting in another credit rating agency, Moody’s, downgrading the country’s credit rating last week.
The effect of the downgrade is to drive up the cost of borrowing for the government, as lending to Ireland is now seen as riskier than previously. Moody’s cited three reasons for the downgrade to Aa2:
1. The government’s gradual but significant loss of financial strength, as reflected by the substantial increase in the debt-to GDP ratio and weakening debt affordability (as represented by interest payment to government revenue).
2. Ireland’s weakened growth prospects as a result of the severe downturn in the financial services and real estate sectors and an ongoing contraction in private sector credit.
3.The crystallisation of contingent liabilities from the banking system reflected in the cost of recapitalising the banks and the cost of buying their loans through the National Asset Management Agency.
What the Moody’s report is telling us is that the patient is getting a whole lot sicker, despite the brutal treatment administered by Taoiseach Brian Cowen in terms of tax increases and spending cuts.
Worse still, the medical bill for treating the patient has soared to about €25 billion to recapitalise the banking system on top of the cost of buying €81 billion in toxic loans from the banks at about 50 per cent of their face value.
The Financial Times Lex column put it well last week when it noted that the Moody’s downgrade was ‘‘an unpleasant reminder of how far the country is from a sustained recovery even as it administers a brutal austerity package’’.
Cowen last week focused on Moody’s assertion that the outlook for sovereign debt rating is now ‘‘stable’’ and blamed the pervasive negativity of the media’s reporting of the economy.
But this is the kind of selective interpretation of the facts that got us into trouble in the first place.
The truth of the matter is that Moody’s considers the patient sicker now than previously, while the man who would have you believe that being stable but sicker is good news was running the Department of Finance four years ago, and either didn’t read, or failed to heed, the Fitch report warning that the banking system was at risk.

Take commission out of the picture

2010-07-06T01:08:00.000-07:00

04 July 2010

By Kathleen Barrington

It is just a year since the Financial Services Authority in Britain announced it was set to ban commission-based financial advice in a move that was seen as sounding the death-knell for the old style financial adviser industry.
There has since been no sign that the FSA is letting up on its proposals to ban financial advisers from receiving commission on products they sell to consumers, though it remains to be seen what happens now that the new chancellor of the exchequer, George Osborne, has said he will abolish the FSA and give most of its powers to the Bank of England.
If the proposals survive intact under the new regulatory regime, they could result in dramatic changes for product providers and financial advisers.
The FSA’s move was seen as heralding a big shake-up in the business model of the financial adviser industry which generates about 80 per cent of its revenue from commission.
The FSA proposed to demolish the existing payment structure in the industry where manufacturers of products pay commission to incentivise advisers to recommend them.
The watchdog was concerned that many consumers find the advice of so-called independent financial advisers is severely compromised.
This is because the majority of financial advisers earn their income from commissions paid by product manufacturers, such as insurance companies, to sell products such as investments and pensions.
The financial advisers get paid only if they sell a product and what they get paid will vary from product to product, creating an incentive for them to sell what generates the highest commission for them.
There has been a raft of mis-selling scandals in Britain, notably of endowment mortgages and pension products.
Here in Ireland we are all too familiar with the mis-selling of mortgages and investment products, with many investors paying so much commission to intermediaries that they start off their investing life with a serious handicap.
Often the mis-selling does not become apparent for years.
There are currently a number of cases relating to the alleged mis-selling of endowment mortgages in the 1990s winding their way through the courts.
The products were unsuitable for many consumers, but generated fat commissions for banks and brokers, as much as 95 per cent of the first year’s premium in some cases.
It is clear that many products sold during the boom years were sold by bankers, mortgage brokers, insurance brokers and stockbrokers seeking either to meet their sales targets, in the case of the banks, or to earn commissions in the case of the brokers.
Now, many property buyers, pensioners and investors are losing out as they find themselves invested in often expensive products which are not suited to their needs.
For instance, there have been many well documented cases of mis-selling to the elderly, such as selling them investment products that tie up their capital in their old age when they may need ready access to funds for medical or other reasons.
The suspicion is that the elderly are often badly advised because there is generally no commission or less commission available for advising the elderly customer to put his money on deposit which may often be the best advice.
The system also often fails to tell consumers about products that may be far more suitable to their needs simply because the commission the intermediary stands to make on advising the consumers to buy the best product is either non-existent or too low.
For example, many investors are never advised to invest in Exchange Traded Funds (ETFs) because they don’t pay commission. Instead, investors are funnelled into far more expensive managed funds.
It is striking that data published earlier this year showed that British private investors account for only 10 per cent of all investments in ETFs, despite the fact that such funds have been available to retail investors for ten years.
The ETFs cost 150 basis points less than their commission paying equivalents, but investors will rarely get to hear about them through the broker channel as it is currently constructed.
Rory Gillen, a former stockbroker, has tried to plug the gap in the Irish market with his InvesRCentre website.
The site seeks to inform investors about investment products that are not promoted by the typical investment intermediary or stockbroker because they pay less commission or no commission at all.
The website informs investors about many investment opportunities which they will not generally hear about from other financial advisers.
There is no such thing as a free lunch, however. Gillen charges €149 a year for a subscription to his website and has signed up about 450 customers so far.
The challenge for him is to persuade potential clients that it is advice worth paying for.
It is a big challenge in circumstances where many investors fail fully to appreciate that they are already in effect paying for conflicted advice through the commission-based system.
The Financial Regulator will shortly review the Consumer Protection Code, a powerful document that is designed to protect consumers at the point of purchase of a product. It should take a leaf out of the FSA’s book and seek to ban commission once and for all.

© Thomas Crosbie Media 2010.

Credit unions wary of regulator's plan

2010-06-27T12:22:00.000-07:00

27 June 2010

By Kathleen Barrington

The President of the Irish League of Credit Unions is heading to the World Council of Credit Unions conference in Las Vegas next month.
Mark Bailey, and the five other league officials who will accompany him on the trip, wouldn’t dream of betting credit union funds on the gambling tables in the Nevada desert.
But it is clear that James O’Brien, Registrar of Credit Unions, fears the league is already gambling with its members’ futures by opposing particular regulations he wishes to impose on the sector, which has total assets of €14.5 billion.
In recent months, O’Brien and Jonathan McMahon, the new assistant director general for financial institutions at the Financial Regulator, have been beating the drum about the mounting problems faced by the credit union sector, as the economic environment has deteriorated.
They have talked about solvency concerns at 20 of the country’s 414 credit unions. They have indicated that an astonishing 14 per cent of credit union loans are in arrears.
They have insisted that credit unions make certain provisions against possible bad loans.
They are examining the loan books of 100 credit unions.
They have also questioned the adequacy of the league’s €119 million Savings Protection Scheme (SPS).
It was bad enough that the regulator raised concerns about solvency and bad debts at the country’s credit unions.
But things became heated when O’Brien bowed to political and credit union pressure to allow credit unions to reschedule loans to facilitate borrowers in difficulty, but then attached onerous conditions in relation to the accounting for such rescheduled loans.
O’Brien took the view that, if the borrower needed to reschedule his loan, the loan was effectively impaired.
He wants the credit unions to make a big provision whenever a loan is rescheduled, to take account of the fact that the loan has deteriorated.
However, the greater the amount of provisions a credit union takes, the less money is left over to pay dividends to credit union members and the lower the interest rate the credit union can promise new savers.
The credit unions have argued that they should not be unduly penalised for allowing troubled borrowers time to get out of their difficulties.
But sources have said the regulator was of the view that a large proportion of rescheduled loans will ultimately default, based on an analysis of historic default patterns.
He felt he could not allow the credit unions to throw sand over bad debt landmines, which could ultimately blow up - giving depositors and taxpayers a very nasty surprise.
He wants credit unions to build buffers against possible future bad debts, rather than masking the scale of the bad debts and paying out dividends as usual.
The league has flip-flopped on the issue. It initially appeared to support the regulator’s move, but rowed back after it digested its full implications.
There was alarm in the credit union movement once it became clear that O’Brien wanted credit unions to make big provisions for possible bad debts on rescheduled loans.
This alarm was only heightened when the Central Bank Reform Bill proposed to give the credit union regulator certain new wide-ranging powers.
The league has since lobbied intensively on the issue, both to have the scale of the provisioning watered down and to prevent the regulator getting additional new powers.
The lobbying appears to have enjoyed some success, prompting Minister for Finance Brian Lenihan to hint that he might do a bit of flip-flopping himself, though the outcome will not be clear until the next version of the Central Bank Bill is published.
Last week, the regulator published a consultation paper on stabilisation support for credit unions, which basically took a pot shot at the league’s prized €119 million SPS.
The SPS - which is owned and operated by the league - was, until September 2008, the only protection afforded to members of credit unions for their savings.
However, the credit unions are now covered by the Deposit Guarantee Scheme introduced by the government in September 2008.
This means that 100 per cent of each members’ savings is guaranteed up to a maximum of €100,000, putting the taxpayer in the frame if a credit union were to fail.
The SPS wasn’t just a savings protection scheme, however. It was also designed as a stabilisation support for credit unions that got into difficulty, and has been successfully used for that purpose in the past.
The league is proud of the fund and reckons it was a great shame the banks didn’t have a similar fund.
However, the SPS is not regulated and is not under regulatory control; it also doesn’t cover credit unions that aren’t members of the league.
The Financial Regulator has never seen a set of accounts for the SPS and is unclear as to how the €119 million in the fund is invested and how liquid it might be in the current climate (though the league said that more than 50 per cent of the fund was on deposit and could be realised within three months).
The regulator also fears that credit unions might rely on the fund to delay the resolution of problems at credit unions that might be better wound up or merged with stronger members.
In any case, relative to the size of the credit union sector, the fund is tiny.
Last week, the regulator pointed out that the €119 million fund represented less than 1 per cent of the €14.5 billion total assets in the credit union sector, while there are 22 credit unions that each has total assets greater than the size of the fund.
‘‘We doubt whether the current arrangements would be able to cope with a widespread problem, or indeed a series of individual problems over a sustained period of time, in the sector," the regulator stated in a consultation paper published last week.
The regulator set out a number of options, including the establishment of a statutory scheme under Central Bank control to replace the SPS. It has sought comments by August 16.
It will be interesting to see how credit unions and other interested parties respond to the regulator’s proposals.
For while everyone agrees, in theory, that the country needs tougher financial regulation and that the taxpayer needs to be protected from having to fund any future bailouts, the practice tends to make the regulated entities very uncomfortable indeed.
It also has the effect of making the politicians worry about the political consequences of making the kind of tough decisions that could put them on a collision course with the powerful credit union movement and its borrowers.

Soros urges more regulation

2010-06-20T10:14:00.000-07:00

20 June 2010

By Kathleen Barrington

Financier George Soros gave an interesting speech earlier this month in which he offered advice on the lessons to be learned from the global financial crisis.
Many of these will resonate with observers of the Irish banking crash.
The man who famously broke the Bank of England earning an estimated £1 billion (€1.2 billion) during the currency crisis of the early 1990s has emerged as a philanthropist who is advocating reform of financial markets in order to prevent future banking crises.
Soros was of the view that one of the major lessons to be learned from the financial crisis was that the financial authorities had to accept responsibility for preventing bubbles from growing too big.
Another lesson was that if you wanted to control asset bubbles, it was not enough to control the money supply; you must also control the availability of credit.
He suggested the use of certain widely accepted tools such as margin requirements and minimum capital requirements.
More controversially, however, he also suggested inventing new tools and reviving others that had fallen into disuse, such as limiting lending to particular sectors of the economy, such as real estate or consumer loans, especially if the sector was overheating.
‘‘Market fundamentalists consider that kind of intervention unacceptable, but they are wrong.
When our central banks used to do it we had no financial crises to speak of.
The Chinese authorities do it today, and they have much better control over their banking system.
The deposits that Chinese commercial banks have to maintain at the People’s Bank of China were increased 17 times during the boom, and when the authorities reversed course the banks obeyed them with alacrity."
Soros also suggested that in order to prevent systemic risks, regulators had to monitor the positions of participants in order to detect potential imbalances.
That meant that the positions of all major market participants, including hedge funds and sovereign wealth funds, needed to be monitored.
He suggested that regulators must raise the risk ratings of securities held by banks and that this of itself would ‘‘probably discourage loans, which is not such a bad thing’’.
Soros said derivatives performed many useful functions, but they also carried hidden dangers.
He said that, while the securitisation of mortgages was supposed to reduce risk through geographical diversification, it effectively introduced a new risk by separating the interest of the agents from the interest of the owners.
Regulators needed to fully understand how these instruments worked before they allowed them to be used and they ought to impose restrictions to guard against those hidden dangers, he argued.
‘‘For instance, agents packaging mortgages into securities ought to be obliged to retain sufficient ownership to guard against the agency problem."
Soros was also of the view that credit default swaps (CDS) were particularly dangerous, as they allowed people to buy insurance on the survival of a company or a country while handing them a ‘‘licence to kill’’.
‘‘CDSs ought to be available to buyers only to the extent that they have a legitimate insurable interest," he said.
Soros said that the financial authorities had extended an implicit guarantee to all institutions that were ‘‘too big to fail’’ and that they must therefore impose regulations that would ensure that the guarantee would not be invoked.
‘‘Too-big-to-fail banks must use less leverage and accept various restrictions on how they invest the depositors’ money.
Deposits should not be used to finance proprietary trading. But regulators have to go even further. They must regulate the compensation packages of proprietary traders to ensure that risks and rewards are properly aligned."
The views of Soros are likely to carry considerable weight with international policymakers, as there is no doubt he has a deep understanding of the dynamics of global financial markets.
They are also likely to resonate with policymakers here, given that both reports into the banking crisis - by Central Bank Governor Patrick Honohan and international experts Klaus Regling and Max Watson - identified over lending to the property sector and the reliance on wholesale funding as key factors in the emergence of the Irish property bubble and the subsequent banking crash.
If the kind of regulatory policies suggested by George Soros were to be adopted by global regulators, including our own, they would likely alter the banking and property landscape here in fundamental ways.
The moves would probably result in a reduction in the size of the global financial services industry, which many other leading thinkers (such as Nobel prizewinning economist Joseph Stiglitz) have argued has in any case become too big.
They have said it has, in effect, drained too much from the economies it was originally supposed to serve. This would likely have knock-on consequences for employment here in both the domestic and international financial services sector.
In addition, any permanent reduction in the supply of credit and any permanent limits on the amount of credit which could be lent for property investment purposes would further delay any hoped-for recovery in the domestic property markets for potentially a very long time indeed.
Of course, the banking industry is likely to fight back against initiatives such as those proposed by Soros and the bankers may yet win the day.
But the wise investor needs to factor in the possibility that the financial crisis of the last few years could yet change the regulatory, banking and property landscapes in fundamental ways that could radically alter the assumptions on which investment decisions will rest.

Cowen’s Act fuelled banks’ folly

2010-06-13T10:15:00.000-07:00

13 June 2010

By Kathleen Barrington

Just before the general election of May 2007, the then finance minister Brian Cowen rushed through legislation which enabled mortgage lenders to raise even more funds on international markets to fuel their reckless lending spree.
In February 2007, Cowen published legislation which he then said ‘‘helps provide a very competitive source of funding for mortgage lending by financial institutions and it is the method by which our major mortgage lenders raise a considerable proportion of the funds they use for mortgage lending’’.
The legislation was enacted in April 2007, a month before the general election, despite protests from Labour’s finance spokeswoman Joan Burton. She said it was being rushed through without any adequate briefing for the opposition on the rationale behind it.
The initial trigger for introducing the Asset Covered Securities Amendment Act was to ensure that securities issued in Ireland would comply with new EU rules on capital requirements.
But the legislation also included a provision that allowed banks to issue certain bonds - known as ‘covered bonds’ - backed solely by commercial mortgages. Under the previous 2001 Act, the bonds could only be backed by residential mortgages or public sector debt.
The 2007 move was music to the ears of commercial mortgage lenders, particularly Anglo Irish Bank, as it meant they could raise new money by issuing securities backed by commercial mortgages.
Given that Anglo Irish Bank was not a residential mortgage lender, the move opened up a new fundraising mechanism for the specialist commercial property lender, as it could now raise new funds by bundling its commercial mortgages and selling them to investors.
The other banks already had access to the covered bond market because residential mortgages were covered in the 2001 legislation.
In late 2006, while the Irish legislation was still in the process of being updated, Anglo had seen an opportunity to set up a British covered bond programme, backed by its British commercial mortgage assets. Anglo Irish Bank’s London branch became the first non-British issuer of British covered bonds.
This was seen as a big deal at the time as Anglo’s British lawyers Allen & Overy boasted that it was ‘‘the first British covered bond backed by commercial (rather than residential) loans’’.
However, one securitisation expert in London told this column that investor appetite for the bonds was not initially as strong as had been hoped, as there was no formal legislative framework to support the covered bond issue by a non-British bank. Cowen’s act addressed those concerns, because it provided Irish legislative support for the issuing of covered bonds backed by commercial mortgages.
Bonds issued under the legislation were seen as potentially more attractive to investors because the legislation contained specific measures designed to control risk including, for example, independent oversight of the commercial mortgages backing the bonds.
Anglo Irish Bank planned to issue about €10 billion worth of bonds under the new Irish legislation.
Eventually, however, it issued only about €4.3 billion worth of bonds which are independently rated AAA by both Moodys and Fitch credit rating agencies.
Anglo Irish in Britain managed to issue about €5.4 billion of ‘structured’ covered bonds in Britain backed by commercial mortgages.
The term ‘structured’ is used to describe covered bonds issued outside the legislative framework.
Britain has since brought in new legislation to govern the British structured covered bonds, however, it is only available to British domestic banks, so Anglo’s British programme remains outside the new British framework.
The covered bonds have been and remain an important source of funding for Anglo since 2007, throughout the credit crisis.
It is clear that Cowen’s move to amend the legislation in 2007was designed to help banks raise more funds to lend, and that Anglo Irish Bank was one of the main beneficiaries of the changes he introduced. However, Anglo declined to comment when asked whether it had lobbied for the amended act.
The fact that this move came at a time when the property market was already massively overheated is a good example of how Cowen helped pump-prime the supply of foreign credit to banks such as Anglo at the very time when his fiscal policies were already fuelling demand.
Central Bank governor Patrick Honahan’s report on the banking crisis published last week pointed the finger of blame at the government of which Cowen was a member.
Honahan said ‘‘the growing construction boom was fuelled by the increasing reliance of Irish banks on wholesale external borrowing at a time when international financial markets were awash with cheap investable funds. This greatly increased banks’ vulnerability to changing market sentiment and ultimately triggered their downfall’’.
He said the difficulties of the Irish banks - whether in terms of liquidity or solvency - were directly attributable to their over lending for land and property investment, much of it through heavy short-term wholesale foreign borrowing.
‘‘Without the latter, the banks would not have been as vulnerable to the world-wide liquidity crisis which intensified throughout 2008," he said.

Europe’s banks may be coming close to another liquidity crisis

2010-06-06T11:15:00.000-07:00

06 June 2010

By Kathleen Barrington

At a time when investors in Bank of Ireland are considering whether to exercise their rights to buy shares in the troubled bank by Tuesday’s deadline, it is worth bearing in mind that some global investors still reckon that European banks, including ours, will face another liquidity crisis this summer.
There is already evidence from Spain that the global banking crisis is far from over, as the Spanish government in recent weeks was forced to rescue CajaSur, a small savings bank controlled by the Catholic Church, while four other savings banks are to amalgamate.
There has also in recent weeks been a sharp rise in the rate at which banks lend to each other on the inter-bank markets, though it has not approached the sky-high level which prevailed at the height of the crisis in 2008.
At home, the government last week became the majority owner of EBS after the building society failed to secure private investment.
The government was forced to inject €100 million into the society and committed itself to providing a further €775 million in the absence of investor interest.
Increasingly, global investors are focusing on the fact that the European banking sector as a whole has grown in excess of GDP for so long that ‘‘it has become bloated and truly outsized relative to the underlying economies’’, ac cording to research by New York hedge fund Argonaut Capital Management, which was circulating in investment circles in Dublin last week.
This is particularly true of Ireland, where the banking system’s assets accounted for 700 per cent of GDP in 2007, the highest percentage of 14 countries analyses.
It is worth noting that, in the United States, the banking system’s assets represented slightly more than 100 per cent of GDP.
The European banking system became bloated because European banks became reliant on wholesale financing, rather than on retail and corporate deposits.
In 2008, the gap between the amount of loans issued by European banks relative to their deposit base reached more than three trillion euros.
When the banking crisis hit in 2008, many European banks, including Ireland’s, found they had no access to wholesale markets. They turned instead to the European Central Bank, which plugged the gap to the tune of about €1 trillion, according to figures produced by Barclays bank.
But Argonaut reckons that European banks will have to issue about €950 billion worth of paper for the year, of which about €350 billion had already been raised at the time it was researching the European banks in April.
That is even more than the banks raised in the bubbly years of 2005, 2006 and 2007. It notes that even during the ‘‘frothiest years for the banks, they never raised more than €700 billion in senior funding’’.
The fear is that many European banks could face a liquidity crisis similar to what happened in 2008. One worrying example is Washington Mutual, the US bank which had a loan to deposit ratio of 127 per cent before it was eventually seized by regulators and sold to JPMorgan in 2008.
‘‘This is how a bank faces a liquidity crunch. Have some assets of questionable quality and have a heavy reliance on other people’s money to fund them. When they pull the plug or charge an extremely high interest rate, you are then unable to pay your bills, your maturing debtor your depositors’ withdrawals. Your bank’s stock and credit rating gets in deep trouble," Argonaut said.
Dozens of European banks entered this year with extremely high loan-to-deposit levels. The Irish banks, for example, have loan-to-deposit ratios of 155 per cent, though others, such as the Portuguese, have even higher ratios.
The question is what options are open to European banks with high loan-to-deposit ratios. One option is that banks choose to refinance their debts at higher prices.
This would likely impact negatively on bank share prices, as margins would compress.
Another option is for banks to delever, that is to pay off debt by selling assets, a move in which the Irish banks are already engaged to some extent.
Alternatively, the banks could go to the European Central Bank for funding, creating a huge demand for ECB liquidity.
Argonaut’s research puts the case for shorting European bank shares primarily on the basis of their high loan-to-deposit ratios at a time when they desperately need to refinance huge amounts of debt.
‘‘Current trends indicate that banks all over Europe - and not just in the problem areas of Greece, Spain and Portugal - are coming up on another liquidity crisis," said Argonaut Capital.
‘‘This summer should see a potent combination of asset quality pressures and an increasing need for funding drive the banking system into a difficult position.
‘‘Couple that with the many overextended balance sheets in the sector as a whole, and we should see a lot of casualties."
If the hedge fund is right, it means that European banks could be forced to raise lots more capital, face margin contraction or even fail.
Of course, the Financial Regulator has banned the shorting of Irish bank shares, but that doesn’t mean that investors won’t sell their Irish bank shares if they agree with the argument that Irish banks are still vulnerable to a further liquidity crisis.
Anyone who agrees with the hypothesis of the hedge fund would find it difficult to justify buying Bank of Ireland shares by Tuesday’s deadline to exercise their rights.
But investors may calculate that the ECB will do all in its power to defeat what it may consider to be Anglo-Saxon speculative attacks on the European banking system.
Irish investors may also consider the fact that Bank of Ireland has emerged as the least bad of the Irish banks and the one which, on the evidence so far, the government is most likely to support through thick or thin.
Irish brokers are generally advising investors to exercise their rights on the basis that it is a chance to buy Bank of Ireland shares cheaply.
The question for investors though is not so much whether Bank of Ireland will survive in the medium term or whether the shares are cheap on a long-term view, but whether it is currently the best place to put their hard earned cash in light of the fact that this credit crunch appears far from over.

An Australian lesson in insurance company failure

2010-05-30T13:59:00.000-07:00

30 May 2010

By Kathleen Barrington

In the autumn of 2008, a London-based insurance underwriter told me that Quinn Insurance would face difficulties because it was under-pricing the risks it was writing in the British and Irish insurance markets. In plain English, he reckoned that Quinn Insurance wasn’t charging consumers and businesses enough to meet future claims.
The underwriter, who did not wish to be identified, advised me to go and buy a book about the collapse of Australian insurance company HIH. He told me that if I read the book, I would be better placed to understand the potential implications of the under-pricing of risk.
There were already, in the autumn of 2008, plenty of reasons to fret about what was going on at Quinn Insurance, which had been in the headlines for all the wrong reasons in the preceding months.
For starters, Quinn Insurance had had no rating from a credit rating agency since July 2008.Before this, it had enjoyed only a relatively lowly Baa2 rating from international credit rating agency Moody’s.
Its founder Sean Quinn was losing his shirt betting on Anglo Irish Bank shares, putting himself under enormous personal financial pressure during 2007 and 2008.
Several businesses had complained in the courts and in the media that Quinn Insurance was dragging its feet in relation to some big insurance payouts.
Other People’s Money: The Complete Story of the Extraordinary Collapse of HIH by Australian journalist Andrew Main arrived in the post towards the end of October 2008.
This was about the same time as the Financial Regulator announced it had fined Quinn Insurance and Sean Quinn personally a combined €3.45 million for serious regulatory breaches.
The book described how HIH, which collapsed in 2001, had mistakenly priced its premiums too low, because it had persistently underestimated how much it would need to keep back for reserves.
The mounting problems at HIH had been disguised by the fact that as its liability shortfall got worse, it had sold more and more policies, so that it looked as though it was actually making money.
The book also explained that HIH was able to hide trouble by the use of accounting treatments to obscure the fundamentally unprofitable nature of the business. It also highlighted how Standard & Poor’s, the leading credit rating agency, had downgraded HIH’s vital claims paying ability from AA to A.
‘‘Few moves are more guaranteed to shrink the interest of corporates seeking insurance, particularly if they hope to see a payout on any future claims," Main wrote in the book.
Main also highlighted how the company had, towards the end, delayed paying out on insurance claims due to cash flow pressures.
In March this year, the newly appointed Financial Regulator Mathew Elderfield secured the appointment of administrators to Quinn Insurance after discovering a €448million black hole in the insurance company’s accounts.
Against that background, it was noticeable that Elderfield mentioned last week he had been in contact with the Australian regulator about the HIH collapse, though he did not say why.
Elderfield talked about the issue of ‘‘substitutability’’ if the loss of an insurer left such a gaping hole in a market as to cause disruption to economic activity.
‘‘My friends at the Australian regulator tell me that this happened after the failure of HIH caused construction activity to stutter due to loss of cover.
But I suspect that this is a relatively narrow concern, where there is a very concentrated market and that normally competitors will quickly fill any gap," he said in a speech delivered to the Insurance Institute of Ireland last week.
Elsewhere in his speech, Elderfield noted that ‘‘insurance companies typically fail in a very different way from banks, more slowly. True, life companies can experience a run of sorts, through early redemptions, but the balance sheet structure and, in particular, liquidity characteristics of an insurance company are inherently different from a bank."
‘‘Large insurance companies with extensive retail customer bases highlight the need for robust compensation scheme arrangements that will operate effectively on a cross-border basis and where costs are borne fairly between different participants, and without posing an undue burden on already stretched public finances, " he added.
On the very day that Elderfield was talking about insurance company failure, Richard Ward, chief executive of the Lloyds insurance market, told the Dublin Chamber of Commerce that it was shrinking its Irish business because of predatory pricing by insurers in this market. ‘‘We don’t believe it’s in anyone’s interest to have risks priced inappropriately," he said.
Last week, I again spoke to the London underwriter who had advised me to buy the book about HIH. He said that Quinn Insurance’s under-pricing of risk had continued during 2010.
He worried that other insurance companies may also have under-priced risk and he questioned whether any of the companies purported to be interested in buying Quinn Insurance from the administrators would show themselves willing to assume many of the risks Quinn had already insured.
He said the problems were particularly serious in the writing of liability and construction risks.
He cited one case where he claimed Quinn Insurance had this year quoted a price of €160,000 for a particular risk when rival Allianz had priced €600,000 for covering the same risk. He indicated that the Allianz price was far more realistic.
The big question, though, is whether other insurers have also been under-pricing risk in the Irish market.
Could it be that just as the bankers followed the lead set by Anglo on the commercial lending front, some of the insurance companies followed the lead set by Quinn Insurance when it came to the pricing of risk?
Let us hope the answer to that question is no.