September 8, 2010

Ireland Moves to Split Up a Troubled Lender

By LANDON THOMAS Jr.

The Irish government, bowing to market fears that its escalating banking losses might cause it to seek a bailout, said Wednesday that it would split the troubled Anglo Irish Bank into two entities, one of which would eventually shut down.

The move represents a backtracking of sorts for the government, which has said that it would be more expensive to close Anglo Irish, which is weighted with bad loans incurred during Ireland’s debt-fueled real estate boom, than to keep it going as a smaller institution.

But a recent deposit run, as well as a sharp rise in government bond yields to 6 percent — a level that some analysts consider “unbearable” — has forced the government to act.

Last week, Anglo Irish said that the cost to the government of supporting the bank would be 25 billion euros, or $32 billion. But that figure has been rejected by analysts as well as the rating agency Standard & Poor’s which, in a recent report, said that it would cost as much as 35 billion euros.

The increasing uncertainty over Anglo Irish’s losses and the extent to which the deeply indebted Irish government will be able to finance them have rapidly become a Europe-wide concern.

Greece’s financing costs are now 11.7 percent, and spreads, or risk premiums, widened again Tuesday on reports that the country’s largest bank, the National Bank of Greece, would raise 2.8 billion euros — sparking concerns that the banking sector will need to raise more capital than originally expected.

In Portugal, while the government was able to raise just over 1 billion euros at a debt auction Tuesday, it had to offer a yield of 5.9 percent for bonds due in 2021, up sharply from 4.1 percent in March.

A crisis in Europe this spring was set off by Greece’s disclosure that it would have trouble refinancing its debt and led to a 750 billion euro rescue package from the European Union and the International Monetary Fund.

The current bout of nerves has less to do with liquidity — Ireland has enough capital to finance itself through the second quarter of next year — than the willingness and capacity of governments to pay for the sins of bankers.

“Governments are on the line globally for their banking systems,” said Aziz Sunderji, a credit strategist at Barclays Capital. “And this is being reflected in the yields. It is not a liquidity issue, it’s a solvency issue.”

In an era of global banking excess, Anglo Irish was perhaps one of the most reckless lenders — funneling the bulk of its loans into the country’s real estate market. When the market crashed, so did Anglo Irish, prompting a government takeover.

Of the 75 billion euros in loans on Anglo Irish’s books when the government stepped in, only 12 billion euros are said to be performing, according to bank management.

The government said Tuesday that Anglo Irish would be split into a recovery bank that is to be either sold or run down, and a funding bank that will be owned by the government.

“Resolution of this, our most distressed institution, is essential to the promotion of confidence and stability in our financial system,” the Irish finance minister, Brian Lenihan, said Tuesday.

As most economists, inside Ireland and out, will say, Ireland is not Greece. It has a cash cushion of close to 40 billion euros, part reserves and part from its pension fund. Even with the current interest rates, its financing cost, about 3 percent of gross domestic product, is manageable.

And as the I.M.F. made clear in a recent report that questioned the notion that some indebted countries in Europe might be better off defaulting, restructuring Ireland’s debt would do little to close its primary deficit, which excludes interest payments, of about 10 percent of G.D.P.

But the increasing burden of Irish banking losses, which some economists say could push Ireland’s debt-to-G.D.P. ratio to 115 percent, has become a difficult millstone for the government, which guaranteed not just the deposits of its banks, but bondholders as well — a move that remains extremely controversial.

The panic relapse has caught European officials by surprise. Having cobbled together a bailout package for Greece as well a broader rescue fund, they did not expect such levels of fear and uncertainty — especially as European growth has done better than expected on the strength of Germany’s strong performance.

“I have to admit this puzzling to me,” said Paul de Grauwe, an economist in Brussels who advises the European Commissionpresident, José Manuel Barroso. “If anything the fundamentals have improved.”

But for many investors, Germany’s robust growth underscored the increasing north-south divergence and the possibility that a stagnating economy like Portugal or Ireland may not be able to generate sufficient income to close deficits or that mounting bank debts will become unaffordable.

According to widely read research by Barclays Capital, for a country to borrow at a 6 percent rate of interest is “unbearable” and represents a prelude to a bailout or rescue — especially if it cheaper borrowing is made available from the rescue fund.

In the case of Greece earlier this year, the country quickly began to lose the confidence of the markets once its borrowing costs surpassed 6 percent.

“Its déjà vu all over again — but this is different from Greece,” said Daniel Gros of the Center for European Policy Studies in Brussels. If Ireland’s banks “can’t refinance themselves the numbers get very big very quickly,” he said.

Mr. Gros pointed out that loans to depleted Irish banks from the European Central Bank are about 40 percent of the country’s G.D.P., a dynamic that he believes to be unsustainable and will ultimately lead to Ireland seeking assistance from the Europe and the I.M.F.

“I think things are going to get worse,” he continued. “And over time, the E.C.B. will have to refinance a very large part of the Irish banking system.”