The 2004 AGM would become known as the battle for the Burlington—even though there was always only one winner: Michael Fingleton.
A frustrated Burgess had decided to up the ante and run for election to the board of directors. For an institution growing so rapidly, its board remained small, with only five members. ‘I wanted to continue to highlight the issues,’ Burgess said. ‘By standing for election you are not expecting to get elected but you do get to write to the members, and you get to speak at the AGM.’
Burgess knew that the society was moving ever closer to being sold, and he was determined to stop Fingleton from cashing in. It was speculated that the society was worth about €1 billion; it was widely rumoured at the time that Fingleton would bag €15 million of the proceeds.
Two sources with direct knowledge of the sale of the society said that Fingleton was careful never to put in writing how much he hoped to make. ‘Chatting informally, we believed the number Fingleton hoped to pocket was much bigger than this,’ a source said. ‘He may well have been looking for €50 million when you include earn-outs and so on.’ Burgess was determined, however, that he should get no more than any other member.
The society’s employees were fully behind Fingleton getting a big pay-day, as they were being promised 15 per cent of the eventual sale price. ‘I wasn’t happy about that, as it reduced our money,’ Burgess said. ‘The employees were firmly on Fingleton’s side. They spoke at the meetings about how wonderful Fingleton was. They were annoyed at me because if they were getting €150 million between them—how many was there? It could be €300,000 each. The big incentive was “When we demutualise you are going to get a lot of money”.’ With the average salary of the society at €30,000, this was a huge carrot for its employees—and a massive incentive not to challenge Fingleton, despite his demands and bullying. Members too did not care for Burgess, who was so against the man who promised a windfall, so he was easily defeated.
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In January 2005 KPMG was again asked by the society, on the instructions of the Central Bank, to carry out a review of internal audit or what controls the society had on its lending. The regulator was concerned at the rapid growth of the society’s commercial loan book at a time when the position of internal auditor, an essential brake on bad lending, was vacant.
The report began by describing some of the half-measures the society had taken over the previous five years to improve things, before again listing a long series of failings.
Internal audit, the report concluded, ‘could be improved.’ It ‘lacks the experience and business knowledge to provide a real and robust challenge to some of the more complex areas including commercial lending, treasury and IT.’ It noted that the society did not use computers to help it analyse risks, while the ‘test samples’ it used to gauge how well the society was lending were ‘not representative.’ Internal audit was ‘weak’ at following up when it found something wrong. It also commented that ‘certain members of the internal audit team lack credibility with management.’ This was perhaps not surprising, given that ‘only one member of the internal audit team has a recognised internal audit qualification . . . Most of the credibility issues arise because the internal audit section is perceived to be very young with limited business experience.’ The section, the report found, did not co-ordinate its work with any of the areas that it would normally be expected to, such as compliance or mortgage audits. Incredibly, the acting internal auditor, Killian McMahon, did not attend crucial committee meetings, including the credit, provisioning and asset liability committees. Nor was he even included in the circulation of the agenda or minutes of those meetings, effectually leaving him in the dark. This was not McMahon’s fault and he was praised in the report as having a ‘good grasp of the business’ and being a ‘breath of fresh air,’ with a ‘commercial focus’. Otherwise the report was damning.
Despite its many deficiencies, the society was not doing enough to change things. The KPMG report noted that training was not directed towards the development of individuals’ competence. Even more remarkably—as the society would discover to its cost when it turned out to have lent tens of millions to the rogue solicitor Michael Lynn, among others—‘internal audit have not developed a fraud awareness policy.’
As the society careered its way through the boom, KPMG noted that the management had held a workshop to ‘identify and assess the key risks being faced by the society.’ But the remedies being proposed were clearly cosmetic, to do enough to get the regulator off the society’s back.
The accountants looked at sample file reviews of commercial loans and found that ‘recommendations by internal audit do not state the risk to the business or assess the potential impact of the risks.’ In a clear reference to Fingleton’s unchallenged dominance, it concluded that the ‘testing of authority levels were not clearly evidenced or prioritised.’
Reports on commercial loans tended to be ‘very long’ and rambling, in a manner that meant that ‘key messages were not clearly evident or prioritised.’ There was ‘no evidence’ of any follow-up of recommendations KPMG had made many times to try to curb risky lending.
Worse still, internal audit only assessed the risks of giving new loans: it never looked at what happened to old ones when Fingleton changed, for example, the interest rates being charged or allowed additional draw-downs. The sample files KPMG was given access to were only for the Republic. This was a massive flaw in its methods of work, as the lax practices in the society’s Belfast branch were let slip under the radar. How the society was lending billions to low-profile London developers from there simply wasn’t looked at.
KPMG also reviewed Irish Nationwide’s treasury function. This is the engine room of any bank: it ensures that the bank remains liquid and has enough money to trade. Its most important function is ensuring that it is never at risk of going bust by the amount of money going out exceeding its capacity to meet that demand.
In an eerie premonition of what was to come, KPMG produced a damning assessment of the society’s treasury arm. ‘There was no evidence of specific tests in respect of funding requirements and counterparty concentrations,’ it found. The society tested its liquidity ratio at the end of every month but never looked at its day-to-day level.
KPMG made a number of other technical points, all showing a catastrophic weakness in the society’s engine room. These cracks, identified clearly in 2005, would doom the society three years later, when the credit crunch came.
In total, KPMG interviewed twenty senior people in Irish Nationwide when preparing its report, including all the members of the audit section. Afterwards it published quotations (unattributed) from senior figures, including Fingleton, on their views of internal audit, the most vital brake for slowing the society down and making it lend better.
IA [internal audit] need more oomph or gravitas.
Overall I have been disappointed with the quality of IA staff.
I would like IA to be more street-wise.
Training has been piecemeal with no overall strategy.
IA are lacking in confidence and hide behind the detail in their reports.
IA need to improve knowledge of processes in order to be more challenging.
I do not place any value on the work performed by some of the audit team and they need more mainstream business experience.
There is a skills deficit in the areas of treasury, commercial lending and IT.
There is a question mark over IA’s understanding of key risks and processes.
The accumulation of all these factors left the society vulnerable as it expanded rapidly. There were simply no systems for stopping Fingleton running riot.
Yet again Walsh and his board digested the report, as did the Financial Regulator, but only superficial changes were made. Instead of taking up KPMG’s legitimate criticisms, Michael Walsh—a former professor of banking—wrote an extraordinary letter on 1 February 2005, dismissing the regulator’s fears. In his twenty-page letter he defended the socie
ty against the array of concerns put forward by the Financial Regulator, Liam O’Reilly, about the conduct of the society. The regulator, Walsh said, was ‘not justified’ in trying to curb its rampant lending. The society, he claimed, had an ‘exceptionally strong balance sheet,’ which could weather any storm.
He admitted that it had ‘found it difficult’ to hire good people. He blamed this on the ‘perception in the recruitment market’ that the society would soon come under new ownership. (He made no reference to the domineering character of Fingleton, who had driven away potential challengers, such as Maurice Harte.) Walsh denied that the society had no succession plan. He claimed that Stan Purcell, its finance director, and Gary McCollum, manager of the society’s British operations, were both ‘potential in-house candidates’ for taking over.
He then dismissed the regulator’s concerns about the society’s rapid expansion into commercial lending. ‘We operate in a niche market with high net worth customers who have a proven track record of success,’ he insisted. (Concentration of risk from lending too much to too few people was an idea that was well established in banking long before 2005 but was clearly not on the radar of the former banking professor. This was later one of the factors behind the society’s collapse.)
Walsh insisted that there were adequate controls to monitor this lending to its high-rolling clients. All loans over €635,000 were approved by the credit committee and ‘recommended to the board for final approval.’
From October 2004 Walsh claimed the society had a specialist commercial lending administration section ‘to enhance the formal control of lending by regular compiling of information and reporting on large exposures including fee sharing arrangements.’ He assured the regulator that even more steps were in train to safeguard against bad lending. These included ‘up to date reporting on the entire loan book on [a] formalised and regular basis,’ and ‘regular visits to large projects.’
In addition there was the function of ‘supplying the board with quarterly reports that will monitor and assess the risks on large exposures,’ and a complete review of its information technology to ensure that information on lending was only a push of a button away. All this, he said, would be completed by 31 March 2005.
(The reality, however, was that none of this was done adequately. Instead the society was allowed to career out of control for another three years.)
Walsh dismissed concerns put forward by the regulator and KPMG that the society was ill prepared to handle the fall-out if one of its larger clients went bust. In his letter he insisted that it had ‘sufficient expertise to deal with loans in difficulty.’ In the previous thirty years, he said, ‘we have been through three recessions and we have not suffered any material loss in this area of activity.’
He dismissed KPMG’s concerns that the society would struggle badly if the credit markets dried up. Only that January he said it had raised €750 million from European banks, money that had to be repaid in three years. (Again Walsh failed to see the danger of borrowing short from the money markets to lend long to developers, who could take far more than three years to get projects to the point of sale.) Instead he boasted how the society was the darling of German and French banks. ‘We were offered funding of €1 billion in one day,’ he said. ‘This is clearly an endorsement by the financial markets of the society’s performance and business strategy.’
Walsh also dismissed concerns that the society was getting in over its head in various mega-deals. The regulator was wrong to be worried, he insisted. A €109 million deal with the London property investors Giris Rabinovitch and Sheikh Sagir Bin Sagir Al Quassime, a member of the United Arab Emirates royal family, was not too risky for a small Irish building society. The society, Walsh said, would earn fees of €20 million from backing the two men on property deals in London. (In the two pages he dedicates to these borrowers he repeatedly mentions the society’s projected profits while making no mention of what security or recourse the society had if anything went wrong.)
The society ‘disagreed’ with concerns that being in joint ventures with developers could lead to ‘conflicts of interest’. The society, Walsh said, was making big profits from its joint ventures with developers like Gerry Gannon and Seán Mulryan, and the regulator was wrong to be concerned about its growing exposure to just two men. For example, he said, the society ‘feels strongly that it is not correct’ that the regulator wanted it to add up its total exposure to Seán Mulryan’s Ballymore Properties by adding in both normal lending and joint-venture lending. Loans to joint-venture partners were given in a ‘proper manner’ and were ‘vetted at the highest level of the society with the principals of our joint venture partners.’ He also defended the society’s habit of rolling up interest rates for its developer pals. ‘The society is not taking a “punt”,’ Walsh insisted.
He admitted that the society had lost €1 million of its members’ money when it went out on its own and built a housing estate in Dungarvan, Co. Waterford. The site, he said, was not only ‘too remote’ but had also been devastated by a ‘freak tide’.
He also objected to attempts by the regulator to curb the society’s lending by insisting that it keep more capital on its balance sheet. ‘The society is concerned with this increase,’ Walsh said. ‘The increase does not reflect the performance of the society, is not commercially justified and will undoubtedly affect our credit rating.’
He concluded: ‘The board is satisfied that the society is run in a professional manner as evidenced by the consistent and strong performance with an unbroken record of increased profitability over 30 years.’
This rejection by Irish Nationwide’s most qualified board member of every concern put forward by the Financial Regulator would cost the taxpayer dearly. The society was ill prepared for curbing its recklessness as the final years of the boom approached.
Chapter 6
FOUR YEARS THAT PRIMED THE BOMB (2003–7)
There was a certain self-satisfaction among politicians, bankers and property developers as 2002 came to a close. They believed they were invincible: the ‘Celtic Tiger’ was immortal and the prosperity they now enjoyed was really all due to their own great efforts.
When we look back across the wreckage of the most expensive banking collapse in a developed economy and try to establish when it went wrong, all roads lead to 2003. If we analyse the banking, economic and exchequer figures, the entirely sustainable growth and prosperity of the late 1990s stalled in 2001 and 2002 and morphed into debt-fuelled fantasy from 2003 onwards.
Writing in 2003 in the annual report of Irish Nationwide for 2002, Michael Fingleton summed up what he wanted everyone to believe about the years ahead. ‘In the present weakening economic climate the society is fully conscious of the dangers of sacrificing credit quality in pursuit of greater market share and greater profits. Our policy continues to be cautious and prudent and we fully support and acknowledge the frequently repeated warnings of the Central Bank against aggressive lending and inappropriate credit expansion.’
It didn’t work out that way. Compound average loan growth from 2003 to 2006 was 40 per cent per year—second only in the Irish banking system to Anglo Irish Bank, which came in at 43 per cent. When the governor of the Central Bank, Patrick Honohan, wrote his assessment of the banking crisis and of what went wrong it covered the period from 2003 to 2008. Many Irish banks had taken a somewhat cavalier attitude towards lending for property, but it was only after 2003 that it became downright dangerous. Mike Soden, the former chief executive of Bank of Ireland who resigned in 2003, tells how it took Bank of Ireland two hundred years to build its assets to €100 billion by 2003, but it only took until 2007 for it to reach €200 billion.
The deregulation of euro-zone money markets meant that Irish banks could obtain access to enormous amounts of money to lend on to house-buyers, credit-card owners, businesses, property developers and just about everyone else. Given the tiny size of the Irish economy relative to the euro zone, in a sense an infinit
e supply of European money was available to Irish banks—and they used it!
Traditionally, Irish banks lent to borrowers the money they held on deposit from their savings customers. In 1997 only 5 per cent of the money lent had not come from deposits. The banks began moving away from this approach and relying more and more on wholesale funding—borrowing from other banks—to finance the loans they made. In 2003 the figure breached 30 per cent for the first time, and the loan-to-deposit ratio hit 142 per cent. It kept on climbing as bankers, high on the drug of bonuses, encouraged by government policy and let loose by the regulator, became addicted to wholesale money. By 2007 nearly half their funding was coming from the wholesale market, up from 5 per cent a decade earlier.
Also in 2003, lending by Irish banks to the property market broke through the 30 per cent mark for the first time. This was to climb steadily until 2007. Figures compiled by Klaus Regling and Max Watson for their investigation into the causes of the banking collapse show that in 2006, 77 per cent of Anglo Irish Bank’s loan book was on commercial property. The figure for Irish Nationwide was 75 per cent. By 2006 Irish Nationwide had lent nearly 7½ times its own capital or funds to property developers.
Also in the mix were loans to ordinary house-buyers. As bank lending was taking off, the 100 per cent mortgage arrived in Ireland. Rising prices left many young couples priced out of the housing market.
Middle-class children could depend on their parents stepping in with deposit money. In September 2004, in what now seems unthinkable, the National Economic and Social Council put into a draft report a plan to help less well-off first-time buyers get on the ladder. For someone on the average industrial wage a typical deposit then equalled a year’s earnings, compared with one-third in 1989. The NESC proposed that the government should step in and introduce measures that would help younger lower-income people who are ‘not in a position to acquire housing deposits from parental gifts or other sources of wealth’ to bridge the affordability gap. It suggested that the state could intervene by either introducing tax relief on savings for a deposit or lending buyers a 10 per cent deposit in exchange for a 10 per cent stake in the property, to be repaid later. ‘This would provide the effective opportunity to secure a 100 per cent mortgage on a property, something financial institutions seem reluctant to do,’ the draft report said.
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