Vultures Circle the Irish Banks

This week is crunch time for the Irish banks and the international venture capital vultures are circling. And when those guys start offering you money you really know you are in trouble! From a position just a few weeks ago of insisting that they do not need recapitalizing, the Irish banks have now accepted the unavoidable reality. Without an injection of funds on a massive scale they will be finished. And that is not something the government here can allow to happen. We reached crisis point last week, with some bank shares falling through the floor. At the beginning of last year Bank of Ireland shares were above €18. On Monday of last week they fell below €1. In fact for a while they were down to just 83 cents. That gives you some idea of the catastrophic fall in value and the resulting capital problem faced by all the banks here, because the rest of them are nearly as bad. What has happened is that international investors have lost faith in the Irish banks. They know that the banks will have to write off billions in bad property loans and that dividends will be non-existent for years to come. So they have been dumping Irish bank shares as fast as they can. They don't buy the bluff from the banks about being able to manage the bad debts without getting fresh capital, which of course will dilute the value of shares held by existing shareholders. Thanks to the Irish government guarantee, all deposits in our banks are secure so there are no lines outside Irish banks of people looking for their money back. But what is happening is that the Irish banks have stopped lending, even to worthwhile businesses. Their attitude is to batten down the hatches and wait for the storm to blow over. They have gone from throwing billions at speculative developers a few years ago to refusing working capital to established businesses here with good records. The bottom line is that now they will not take a risk on anything. No matter how good your new business idea is, you won't get the capital. Even if you have been in business for years, you will find it very hard to get funds to tide you over a cash flow problem or to expand into a new area. Lending had dried up. And the effect of that on an Irish economy already under severe pressure because of the global recession is disastrous. So the government has to act. Bank of Ireland shares falling below the psychologically important €1 barrier last week was the spark. But it was coming anyway. This week or next week we will see a major realignment in the ownership and structure of the Irish banking system to cope with the situation and get new capital in. The government has run out of patience, and the bank bosses have run out of excuses. There is sharply divided opinion here on exactly how this should be done, and the sight of the venture capital vultures circling in the air over Dublin makes a lot of people here very nervous. The first option is for the state to make a major investment in the banks, up to the €10 billion or more in fresh capital that the banks need to get through this mess. But borrowing that will be very difficult and perhaps impossible. Given the collapse in tax revenue here and the amount of borrowing we will have to do for day to day spending by the state over the next few years, the idea of borrowing even more billions to invest in Irish banks is a non-starter. It would push state borrowing to a completely unacceptable percentage of GDP. Fortunately, there is another solution. At the height of the boom here one of the best things the government did was to start salting money away in a national pensions reserve. That fund is now over €20 billion. We could take €10 billion out of it and invest it in the banks. But it's not as simple as that. Most of the pensions reserve money is invested in the markets, and as we all know they are way down and it's not a good time to sell shares. So if we cash in €10 billion right now to put into the banks we will lose a fortune. There is probably a billion or two in the reserve fund that is fairly liquid, but that is not nearly enough to recapitalize the banks to the extent that is necessary. Which brings us to the other option. The venture capital vultures. I won't say the sky over Dublin is dark with them, but this weekend there were two or three groups expressing some interest in investing billions into the Irish banks. The most prominent is a financial consortium made up of two big American private equity players, JC Flowers and the Carlyle Group, who have joined up with a number of oil rich sovereign wealth funds from the Middle East to make the pitch. This group, called the Mallabraca consortium, is being fronted by a couple of Irish businessmen, and they are using former Taoiseach (Prime Minister) Bertie Ahern to open doors for them. This group is the main player at the moment, although that could change. The two Irishmen involved are Nick Corcoran and Nigel McDermott of Cardinal Asset Management (they used to work for financier Dermot Desmond). Also involved, according to The Irish Times, is Bryan Turley of Dublin firm Sorrento Asset Management, and they are being advised by New York-based investment bank Sandler O'Neill which is also investing in the consortium. If you're wondering about the name, Mallabraca is a townland near Dunmanway in Co. Cork that is the birthplace of the Irish patriot Sam Maguire, after whom the GAA All-Ireland football trophy cup is named. So these guys are pulling on the Irish jersey as fast as they can, but it's doubtful if any of the team of heavy hitters behind them have ever been in Croke Park! The consortium has told the Irish government that they want to buy into Bank of Ireland in a major way (five or six billion), or into a merger between Bank of Ireland and another big financial entity here, Irish Life & Permanent. Such a merged body would end up with a huge slice of the mortgage, life assurance and pensions market here. It also fits in with the desire of the government to see consolidation between some of the banks here. A third Irish bank, Anglo-Irish, could also be included in the merger/investment plan. The consortium has let it be known that it is happy to share the action with the Irish state, which could put in a couple of billion (this neatly dovetails with the amount of cash that the government can get out of the national pensions reserve). And there is lots of additional spin going on, with one paper here reporting that the consortium has told the government it would be able to lend up to €60 billion to small businesses over five years. All of which sounds impressive, although less reassuring is the news that the companies being used for all this - Mallabraca Management Partners and Mallabraca Investment Funds - were registered just a couple of weeks ago! Which leads us to the obvious question. If Irish banks are such basket cases how come these guys want to put money into them? The answer is simple. They think they can make a killing. The Irish Independent dug up some embarrassing views recently expressed by a senior figure in the Carlyle Group, one of the American private equity giants involved in the consortium. He said that distressed investments (like putting money into the Irish banks) can yield returns of between 40 percent and 60 percent within two years, compared with buyouts, which might generate a 25 percent internal rate of return over three to five years. What this clearly shows, of course, is that the spin we are getting about this consortium being in it for the long haul or to help support businesses and the Irish economy is baloney. They're in it for one thing - to make a buck as fast as they can. They will charge huge interest rates on their investment and they will slash and burn as fast as they can to maximize returns before selling out in a few years. My advice to the Irish government is to stay well away from them. The British and American governments have put borrowed billions directly into their banks (like in Citibank over the past few days) and their taxpayers will be shareholders and will eventually get a payback. If the U.K. and the U.S. (and many other countries) can do it, why not Ireland?