ANALYSIS-Bank wind-down would threaten Irish debt, ratings

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Sunday September 05, 2010 04:16:09 AM GMT

* A gradual wind-down may appease public opinion

* Govt could be left plugging Anglo's funding hole

* A compromise solution may be agreed upon

* Treatment of senior bondholders key

By Carmel Crimmins and Andras Gergely

DUBLIN, Sept 3 (Reuters) - A wind-down of Anglo Irish Bank [ANGIB.UL], even on a gradual basis, is fraught with risk for Ireland's sovereign rating and debt but political necessity may force Dublin to take the plunge.

Fears the nationalised lender could tip Ireland into a worse financial crisis have gathered steam in recent weeks and with Irish borrowing costs close to euro-era highs, pressure is mounting on Prime Minister Brian Cowen to suture a running sore.

Anglo's new management has proposed carving out a small functioning bank via a "good bank/bad bank" split, which would allow it to access cheaper central bank funding and reassure depositors, reducing the state's funding burden.

But keeping Anglo open sticks in the gut of an electorate already sickened at having to shell out 25 billion euros for its reckless property lending while facing yet another round of tax hikes and spending cuts in this December's budget.

Conscious of their wafer-thin parliamentary majority, government ministers have been signalling a shift away from the "good bank/bad bank" split towards an eventual wind-down.

"Given the amount of bad press it (the government) has been getting because of this whole Anglo issue it may be politically better to close the institution down," said Dermot O'Leary, chief economist with Goodbody Stockbrokers.

"But it is difficult to know, without access to the kind of information that Anglo and the government have, whether it is economically the best option."

UNCHARTED TERRITORY

On the face of it, shuttering Anglo would bury once and for all a national millstone that has saddled Ireland with the worst budget deficit in Europe and triggered a fresh sovereign credit downgrade from S&P last month. [ID:nLDE67O0YY]

But shutting Anglo down in the short term -- a 6-12 month period -- is hardly an option: according to Chief Executive Mike Aynsley, it would actually increase the cost to the taxpayer by 17 billion euros over and above the estimated 25 billion euro bill. (See factbox [ID:nLDE682076] for details of the impact of different scenarios for Anglo.)

Even closing Anglo down gradually is risky.

While a 10-20 year timeframe would avoid a fire sale of its assets it still risks panicking depositors, which could create a short-term funding hole that would have to be plugged by the state and the European Central Bank and possibly trigger an unaffordable blowout in Irish sovereign borrowing costs.

At around 356 basis points, the premium investors demand to hold 10-year Irish debt rather than benchmark German Bunds remains just 10 bps below last month's record highs, suggesting extreme investor nervousness. <IE10YT=TWEB> <DE10YT=TWEB>

In the event of an Anglo wind-down, investors would become "vulture-like" with counterparties less willing to fund or trade with a non-viable lender.

Under Eurostat accounting rules, in that situation Anglo's liabilities would also be added to the general government debt.

With Standard & Poor's already warning it could downgrade Ireland again and calling its own 35 billion euro estimate for the Anglo rescue bill conservative, investors would give Irish bonds an even wider berth if Anglo was being closed.

The gamble for Cowen and the European Commission, which has the final say on Anglo's future, is they will not know what damage an "orderly" wind-down will wreak until they do it.

"There is no test run for this kind of thing," said O'Leary.

COMPROMISE SOLUTION?

Anglo's management has recommended that after the bank transfers around 36 billion euros of shaky property loans to a state-run "bad bank" its remaining 38 billion euros portfolio should be largely wound down in its own "bad bank" with a rump of 20 percent of the assets kept to create a business lender.

Carving out a niche business bank gives Anglo a banking licence that enables it to tap cheaper funding and encourages depositors, both corporate and retail, to stick around.

A local newspaper reported that the EC may be opposed to allowing Anglo to reinvent itself as a player in the small and medium business sector because allowing a state-funded bank to do so would be anti-competitive. [ID:nLDE67S03L]

Given the political problems with having Anglo relaunch itself, analysts say Brussels and Dublin may come up with a compromise solution in which the "good bank" would have a banking licence but no real business mandate.

It would exist to manage down the good loans, retain deposits and avoid an adverse accounting impact on debt figures.

"Does it really matter whether that 20 percent is an actual wind-down or it's got a 'open for business' sign over it? I don't think it does," said Stephen Lyons, analyst with Davy Stockbrokers.

"Anglo would say that depositors are more likely to keep their money in a bank that is actually open for business."

Whatever solution Ireland and Brussels agree upon, they will have to tread carefully with bondholders, Lyons said.

Defaulting on senior note holders could jeopardise other Irish banks' ability to access term funding during a crucial period of refinancing and also cause a painful spike in sovereign borrowing costs. [ID:nLDE67I0RG] (Editing by Mike Peacock)

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