What we learned at the Banking Inquiry about Irish Nationwide's lending

I am trying to understand why Irish Nationwide crashed. We got very interesting insights into their lending strategy and practices yesterday. I have summarised these by topic. I am focusing on the strategy, rather than on the breaches of regulation, the remuneration and other stuff.

They were not competitive on home loans
Irish Nationwide felt that the home loans market was "too competitive" since the arrival of Bank of Scotland. They couldn't compete because they refused to offer tracker mortgages, 100% mortgages, self-certified mortgages or mortgages at low margins. Branch managers were given targets for home loans as they felt that they needed more of this business. (Fingleton, Walsh and Purcell)

The move into development finance
Irish Nationwide has been criticised on the grounds that it had moved away from the core purpose of a building society - providing home loans - to being a commercial lender.

In the late 80s, very little building activity was taking place. The Building Societies Act 1989 allowed Building Societies to get involved in facilitating home building. This was a key purpose of the Act. It was government policy for Building Societies to put their money to work in this manner. (Fingleton and Walsh)

The focus was on land acquisition and short to medium term lending
INBS was deliberately focused on a very narrow part of the market. It would lend money to a developer to buy a site and they would fund the planning permission process. When planning permission was received, the developer would go to another lender for the, much riskier, and longer term, construction finance.

This was much less risky because

• They knew what planning permission they would get - they were not wildly speculative
  
• The average term loan term was 30 months

This is confirmed by note 16 in the 2008 Annual Report:


Most UK lending was non-recourse, most Irish lending was full recourse
In the UK, they would not give personal guarantees. As it happens it wouldn't have made that much difference whether the loans were recourse or not. It was a contributory factor, but not a major issue.

They stopped lending in December 2007
At a board meeting in December 2007, they agreed that the market was just too risky and stopped lending other than to finish off existing projects where they had given commitments.
From the Annual Report - loans dropped from €12.3 billion in 2007 to €10.5 billion in 2008.

They were doing over 50% of their lending in London
The Irish market was too competitive. By the time NAMA took over the loans, the London market had begun to recover.

Walsh warned the Financial Regulator to take action in May 2008
Michael Walsh met with Pat Neary and Con Horan in May 2008 and warned them that the lenders generally were facing a liquidity crisis and that leadership was required to stop them lending.

The Financial Regulator took no action.


Irish Nationwide had plenty of liquidity on the night of the guarantee
Irish Nationwide had €3.5 billion of cash in September 2008. They had already anticipated the problems and had taken steps to improve liquidity

• They had stopped new lending in December 2007
  
• Because their lending was short term, around €5 billion was due to be repaid over the following 12 months.
• They had a campaign under-way to build up their deposits.

Breaches of the sectoral sending limits
(A lender is only supposed to have a certain proportion of their lending to any one sector e.g. development finance, Residential Investment Property, Hotels, unsecured loans etc.)

The sectoral lending limits which were appropriate for other lenders were inappropriate for Irish Nationwide. Other lenders had much bigger and more diversified lending books, so they might have more development finance than Irish Nationwide, but it would be a much smaller percentage of their book.

Irish Nationwide breached these limits and discussed them with the Financial Regulator, but the discussions "petered out". ( Stan Purcell)

Their treasury operation was not a profit centre
It was used solely to back up their lending operations. They hedged interest rate and currency risk.

Less factual, more judgement type stuff

We expected a soft landing and so did virtually everyone else
Fingers: In my 38 years with the Society, I had gone through 3 recessions. I did not expect the predicted slowdown to be any worse than these. Neither did anyone else.

We accepted the consensus of a soft landing of a 20% fall. We would have welcomed that.

These forecasts came from CB, ESRI, Academia, journalists, World Bank.

Prior to May 2007 GE, all parties were planning on increased spending.

We were a prudent lender
Michael Walsh's evidence:
The Society was much more prudent than other lenders. Average loan duration was 30 months.

We were a net supplier of funds to the interbank market.

We had €3 billion on the night of the guarantee.

We had more conservative lending growth rates than AIB, Anglo, BoSI and Ulster.

We had no exotics, no structured products, and treasury was not a profit centre.

We were the first lender to adapt to the changed environment, and in Dec 2007, the board decided to minimise lending and build liquidity.

Irish Nationwide was solvent on the night of the guarantee
According to the accounts, they had €1.5 billion in reserves on the night of the guarantee which was a higher reserve ratio than any other lender. That was sufficient for a loan book of €10.5 billion.

PwC did a further study after the guarantee and concluded that we were solvent.

Irish Nationwide only became insolvent when NAMA discounts crystallised the losses
From Walsh's evidence:
Mc Sharry: Were the NAMA valuations fair?

Walsh: I can't answer that. I can't reconcile the valuations . Between April 2010 and Sept 2010, the write-down more than doubled.

I spoke to my successor in relation to our largest loan, and they had an offer of twice what NAMA paid for the loan.

And in response to Kieran O'Donnell: I can't rationalise the €5.4 billion. We had €8.4 loans. We had €1.2 billion of own funds. So we had €7.2 billion.

If we had stopped lending a year earlier than we did, we would have survived
I think both Fingers and Michael Walsh said this

The NAMA valuations were ridiculous as has been shown by subsequent sales of the loans

Nama valuation €80 - realised €200: €120
Nama valuation:€12m; Realised: €100: Gain €88m
Nama valuation:€165 sold for: €255 Excess €85m


When NAMA calculated UK discounts, London prices were on the rise already.

It's very easy to criticise the lending practices in hindsight, but there was no public criticism of it at the time. Quite the reverse in fact. Shane Ross lauded Fingers for his ability to generate profits, while criticising the conservative lenders such as Bank of Ireland and AIB.

I put down a motion of no confidence in Fingers at the 2003 AGM as I was sure that he was not fit to run a major bank. But that was because of his treatment of small borrowers. Not because I felt his commercial lending was reckless.

I stood for election to the board of the Irish Nationwide in 2003 or 2004. Fortunately, I wasn't successful. I have always wondered had I been elected, would I have argued that the lending was reckless. I am not sure that I would have. I would probably have been more focussed on the consumer lending.


They claim that they were prudent in their home loan lending
All three of the witnesses gave convincing evidence that they felt that the home loans market was too competitive - INBS refused to do 100% mortgages or tracker mortgages.

What is odd though, is that INBS ended up with the highest level of mortgage arrears of the bank lenders. So their home loan lending was not prudent.

This would tally with their historic practice of being a sub-prime lender before we had heard of the term "sub-prime". They lent based on the value of the property rather than on loan to income.

They did lend in excess of 100% LTV on a non-recourse basis for site acquisition in exchange for a profit share
It's strange that they made a virtue of having refused to grant 100% LTV mortgages on family homes, yet they gave non recourse loans in excess of 100% for the acquisition of sites.

While property prices were increasing, this was extremely profitable business. In 2007, they had €297m in net interest income (interest received less interest paid) and €137m in fees and commission income.

But when property prices fell, the borrower was able to walk away from these loans without any liability. The full loss fell on the Irish Nationwide.

I gather that this was the main criticism of the Nyberg report. They were more a venture capital fund than a lender. This was totally inappropriate to a deposit taking institution. This very high risk lending would require much more capital and very long term sources of finance to enable them to ride out any downturn.

Recourse or non-recourse lending
As Fingers pointed out, this didn't make much difference.

If the borrower has no assets, the ability to sue for any shortfall is worthless.

It makes a difference only where the customer has plenty of net assets. And most customers were insolvent.

What contribution did the lack of legal paperwork make?
Fingers claimed that all the paperwork was in order and that they used top firms of solicitors to make sure that they were.

However, this conflicts with remarks from his successor, Gerry McGinn:

Fighting a firestorm of toxic loans

"Irish Nationwide took “short cuts” in the race to lend among the Irish banks over 13 years of increasing asset values, he said, and failed to have ever had to rely on proper security or documents because the rising property market always meant there was “an out” for the banks."

And a report on the home loans

Missing Irish Nationwide titles hamper sale of €1.8bn in loans



They expected a soft landing
So did the vast majority of experts. INBS had more than enough reserves to cushion against a price fall of 20%. Had I been on the board, I think I would have asked to see the implications of a 20% fall. I doubt if I would have asked to see the implications of a 60% fall in prices and a complete freeze in the credit markets.

So was INBS solvent on the night of the guarantee?

This is impossible to answer. It certainly was solvent on paper. Any reasonable valuation of the loans would have resulted in it being declared solvent. The subsequent detailed study by PwC in 2009, confirmed that it was solvent.

But the huge drops in prices in the two years after the guarantee tipped it into insolvency.

INBS were the first to anticipate the problem and stop lending
The INBS board took a decision to stop lending in December 2007. They were the first to do so. But it was too late at that stage. Had they made the decision a year earlier, they probably would be still going today.

And that is the big problem. It's very hard for any bank to stop lending. It's very hard to leave a party when the craic is at its highest.

The NAMA haircuts do seem to have been excessive

To be fair to NAMA, it would have been very difficult to put a value on many of the loans. To be fair to the INBS, the haircuts were massive and probably excessive.

Fingers gave examples of loans which were subsequently sold at a huge profit to NAMA.

However, they are just arguing about the quantum. If INBS had not sold its loans to NAMA and had been nationalised instead, they probably would not have lost as much, but they would have ended up insolvent anyway.

Too much power in the hands of one man - There was, in effect, no credit committee
the MD did not attempt any of the 27 credit committee meetings. Dara Dalyattended only 2 of the 27 meetings. There was a quorum of 2 on only 4 occasions.

BB can you clarify the Nama crystillisation as I don't understand what it means.

All I'm hearing from Fingleton is that everything was hunky dory. So in effect if they were left alone they would have been fine. Is it possible.

In relation to his pension pot, and reading the papers. Does he have it still, you said he invested in Irish bank shares and would basically have lost everything (which if he did, I could well see why he'd hold onto the 1 Million bonus)

Hi Bronte

I don't know the exact figures, but say INBS transferred €8 billion of loans at nominal value to NAMA. But NAMA paid only €3 billion for them. Therefore INBS had to show a loss of €5 billion. They only had €1.5 billion in reserves, so this bankrupted them. Of course, it will be argued that they were only worth €3 billion at the time. But Fingers and Walsh would argue that subsequent events showed that they were worth far more than €3 billion.

Bronte said:

In relation to his pension pot, and reading the papers. Does he have it still, you said he invested in Irish bank shares and would basically have lost everything (which if he did, I could well see why he'd hold onto the 1 Million bonus)

Click to expand...

We don't know. I have some vague recollection that there was a court case by Ulster Bank against him and he had not disclosed the pension pot in his schedule of assets. But I can't find that report now.

I have moved the pension discussion to this thread

Fingers' pension pot