by Shane Ross
The Irish business was run from Bank of Scotland’s Edinburgh base. As the Bank of Scotland had no retail outlets in Ireland, all mortgages and accounts were put through mortgage brokers.
Some of the shell-shocked bankers of Ireland were initially slow to respond. John Smyth, the boss of First Active, smugly asserted that he was not going to ‘lose any sleep’ over the dramatic 3.99 per cent rate. Ten days later he reduced introductory rates for first-time buyers to 3.99 per cent. But he kept his variable at 5.25 per cent.
Others were not as sanguine. Within two weeks both AIB and Bank of Ireland took fright. They saw the invader as a real threat. AIB matched the Bank of Scotland’s variable rate of 3.99 per cent while Bank of Ireland cut its own to 3.95 per cent.
A full-scale mortgage war had broken out, and the effect on the banks’ share prices was dramatic. On the day that their profits were threatened by the rate cuts, a billion pounds was wiped off the value of AIB and Bank of Ireland on the stock market. Bank of Scotland had upset the settled lives of Ireland’s bankers.
As the price war raged all the lenders were forced to cut out the fat. Margins on their mortgages (the difference between the borrowing and lending rates) dropped from 2.4 per cent to just 0.5 per cent.
The banks reacted in different ways to the narrowing of their margins on home loans. Tracker mortgages took off. All the lenders shovelled money at potential customers, making up in volume what they were losing in margins.
Lower rates meant that borrowers could afford to borrow more – as they now had to pay back less each month on their mortgages. At the same time, standards began to slip. Lending criteria were quietly relaxed. Where buyers might previously have been allowed to borrow about two and a half times their annual income, bankers began to make loans of three or four times income. Sometimes applicants for mortgages were encouraged by bank salesmen to state on their applications that they would take paying guests in their houses to top up their incomes, even if they had no plans to do so. Mortgage terms were extended from the normal 20 or 25 years to 35- or even 40-year terms. Buyers could now afford to borrow even more, because the longer term of the loan meant that monthly repayments would again be reduced.
All of this was widely seen as great news for consumers. Cheaper mortgages meant more disposable income. That was true in the short term, but the longer-term reality was that bigger loans and looser lending criteria meant higher house prices and a greater debt burden on borrowers. By 2006, 70 per cent of first-time buyers in Dublin were taking out mortgages with a term of over 30 years. Some borrowers saddled themselves with debt stretching well into their seventies.
The final, but most inflammable can of petrol thrown on the raging property furnace was the 100 per cent mortgage: a loan for the entire selling price of the house. First Active led the way in introducing these lethal loans in 2005. Others followed suit, including Bank of Ireland, EBS, Permanent TSB and Irish Civil Service Building Society.
A few held back from the madness of the 100 per cent loan, including AIB, Irish Nationwide and National Irish Bank. But elsewhere 100 per cent mortgages took off. In 2006, 36 per cent of first-time buyers took them out.
Bank of Scotland (Ireland) was also hell-bent on competing with Ireland’s major banks in products other than mortgages. It rapidly became just like them. In 2005 it bought fifty-four ESB shops to form a branch network and began offering deposit and current accounts. The next year it changed its name to Halifax and began to sponsor The Late Late Show. Its product range expanded to include personal loans, buy-to-let mortgages and Ireland’s cheapest credit card.
Above all, it entered commercial property.
After losing its position as the market leader in the mortgage market, Bank of Scotland (Ireland) launched a crafty public relations campaign to distance itself from the other banks: it promised product after product to suit the Irish punter, in keeping with its supposed pioneer spirit. Chief executive Mark Duffy railed against the banking establishment, demanding changes to the prohibitive cost of switching banks and positioning himself as the retail banking customers’ champion. ‘The dynamics of the Irish banking market are undergoing a sea change at the moment… the cosy club will finally be laid to rest,’ he claimed in September 2004. That year the Bank of Scotland walked away with more awards, including ‘Company of the Year’ from the Sunday Times and Enterprise Ireland. It also won predictable plaudits from mortgage brokers – predictable because the Bank of Scotland was using the mortgage broking channel to market its mortgages.
In February 2005 Phil Flynn was outed as a director of another company, an outfit without quite the same kudos as the Bank of Scotland. Chesterton Finance, an unregulated moneylending service based in Ballincollig, Co. Cork, was being investigated by the Criminal Assets Bureau. Flynn was on Chesterton’s board. Its boss, Ted Cunningham, was arrested and charged with laundering more than £3 million sterling stolen in the £27 million theft from the Northern Bank in Belfast the previous December. (In April 2009 Cunningham was sentenced to ten years’ imprisonment for money laundering.)
Flynn resigned as chairman of Bank of Scotland (Ireland) immediately. It would hardly be appropriate for the chairman of a division of a publicly quoted bank to be linked to the armed robbery of £27 million from one of its rivals. The Bank of Scotland moved to distance itself from Flynn, but it later transpired that they gave him €240,000 in compensation for loss of office.
Flynn was not charged in relation to Chesterton or the Northern Bank robbery. ‘I have no involvement, good, bad or indifferent, in money laundering, full stop, for the republican[s] or for anybody else. And if I’m proven wrong, I’ll run up and down the street naked for you,’ he said at the time. In what appeared to be a fit of petulance by the Gardaí, he was brought to court for possession of a pen gun. Technically, possession was illegal. Flynn agreed to donate €5,000 to charity.
Following Flynn’s resignation, the bank appointed Maurice Pratt as chairman. Pratt had been a successful marketing director of the supermarket chain Quinnsworth, but since then his marketing edge had been blunted. He had become the ultimate insider, appearing on boards galore, including those of IBEC, Eircom and Brown Thomas.
Pratt looked on as Duffy steered Bank of Scotland in a strange direction for self-proclaimed champions of the small customer. The bank caught the Irish disease. It rapidly pursued commercial property interests like a stag left behind by the herd. In 2006, when nearly every Bank of Scotland (Ireland) press release was trumpeting new consumer products and branch openings, in the background the invaders were quietly going bananas, lending to property developers.
Duffy’s decision to chase Anglo into the property jungle was hardly a surprise, as Duffy had originally sprung from the Anglo stable. Furthermore his bank’s parent, HBOS, was by far the worst offender in the binge of property speculation in the UK.
Duffy’s bank funded much of the €288 million Burlington Hotel deal with Bernard McNamara. It tied up a €1 billion securitization agreement with Liam Carroll on the Cherry-wood site on the south side of Dublin. Other prominent clients included Pat Doherty’s Harcourt Developments, Joe Moran’s Manor Park Homes and an assortment of key property magnates. Duffy had arrived as a player in the most dangerous game in town.
Astonishingly for a bank that had entered Ireland to disrupt the mortgage mafia, mortgages accounted for only 24 per cent of the Bank of Scotland (Ireland) loan book; fully 21 per cent (and rising) was in construction and property development loans. By the end of 2007 the numbers had reached staggering levels. Mark Duffy had bet more than half the bank – 56 per cent of all loans – on the crumbling property market. Bank of Scotland’s property lending now stood at over €16 billion, nearly eleven times its exposure in 2001. More than half of this was lent to developers. Duffy was a long way from being the punter’s champion.
The Bank of Scotland had gone native. Worse still, it was late into the game. It bought at the top of the market. Bank of Scotland’s whirlwind inter
vention in the Irish market had shown that competition in the banking sector is a double-edged sword. It had brought cheaper financial products to consumers but, combined with chronically weak regulation, it led to irresponsible lending that would eventually create a national crisis.
Duffy retired with an undisclosed golden handshake in February 2009. The bank had recorded a €250 million loss. The price tag associated with the loosening of standards in the Irish mortgage market – a loosening that had been partly provoked by Bank of Scotland’s bold entry into the market – would be much, much higher.
7. Poodles and Spoofers
Bankers had seized unchallenged power in the Ireland of early 2007. Their influence had mushroomed in parallel with the growth in Ireland’s prosperity. Their tentacles were everywhere, not just in fuelling the construction frenzy or in their life-or-death power over small businesses. They were also by far the biggest ingredient on the Dublin Stock Exchange, accounting for 47 per cent of the ISEQ index of Irish shares. Construction-related companies such as CRH, Kingspan, McInerney, Abbey and Grafton – who thrived on the credit the banks fed to developers – also comprised a massive share of the index, which peaked on 21 February 2007 at 10,041. The property bubble achieved maximum inflation at almost exactly the same moment, with the price of the average home reaching an all-time high of €311,078 in February.
Just as they had peaked in tandem, Irish property and Irish shares fell together. By Christmas of 2007 the ISEQ had plummeted by 44 per cent. House prices were down 8 per cent, and would fall a lot further.
Ireland’s stock market had been one of the best performers in the world in 2006, rising 28 per cent and beating major indices like the Eurostoxx 50, London’s FTSE, New York’s NASDAQ and the Dow Jones Industrial Average. Such stardom reflected the outside world’s view of Ireland as a magic economy. Foreign investors piled into Irish shares as a way of grabbing a slice of the Celtic Tiger action. When investors bought Irish shares they generally bought banks; and when they bought banks they bought property.
Bankers obligingly supplied the market with bullish comments about Ireland, the economy and their own shares. The same bankers also kept two house-trained poodles in their kennels. The first poodle, Ireland’s sycophantic stockbrokers, indulged in the most shameless puffing of bank shares imaginable.
Since the eighties, Ireland’s two biggest banks had owned Ireland’s two biggest stockbrokers: Bank of Ireland owned Davy and AIB owned Goodbody. In November 2006 Davy’s management engineered a buyout of the company. They were now theoretically free of the Bank of Ireland monkey on their back, but they remained brokers to the same bank, enjoying all the accompanying lucrative corporate spin-offs. Nobody in the broking world recalls anything but a favourable circular by Davy about Bank of Ireland when Davy was a fully owned agent.
Davy was the most powerful broker in Ireland with an unbeatable portfolio of global clients. External investors will have read constant glowing reports about Bank of Ireland shares from them, in which their ‘price target’ for the bank’s shares – ostensibly the price the brokers see the share reaching – was nearly always pitched above the market level. Some clients will have taken the reports seriously.
Two weeks after the buyout, Bank of Ireland shares stood at €16.00. Davy upped their price target to €18.25. Even as late as February 2008, after Bank of Ireland stock had tumbled to €9.59, Davy wrote: ‘A low-risk balance sheet and cheap valuation provide a safe place to hide… This is a low-risk bank.’
They remained strong supporters all the way down, setting price targets above market levels in every report. Even as the shares hit 89 cents at the start of 2009, Davy launched another lifeboat, saying they were worth €1.50. On 5 March 2009, Bank of Ireland hit a new low of 12 cents.
An identical pattern played out with AIB. Its agreeable stockbroking subsidiary, Goodbody, was never found wanting when writing a circular about its parent. They recommended the shares as a ‘Buy’ in August 2006 at €19.94, again in November 2006 at €21.81 and in December at €21.50. In 2007 both their reports were ‘Buy’ recommendations. The message was repeated in 2008 when their four reports all emerged with a ‘Buy’ tag. In February 2009, when the shares had tumbled to just 52 cents, Goodbody’s analysts finally lost their nerve and changed the designation from a ‘Buy’ to a weaker ‘Add’. The simple word ‘Sell’ was not in their vocabulary. It would have been the right word to use in nearly all instances. When their analyst, Eamonn Hughes, was asked if Goodbody had ever issued a sell notice on AIB he said, ‘I don’t know if we even keep records going back that far.’
Goodbody’s proud motto is ‘independent and international’.
Any investors who took Goodbody’s advice about AIB would have lost their shirts. Many did. The same applied to Davy’s advice on the Bank of Ireland.
Both brokers were part of the hype surrounding the Irish economy, the banks and property. It was nearly impossible to unearth any home-grown, objective views on bank stocks. Potential investors received a drip-drip of highly subjective, often compromised information, all of it boosting the banks.
Brokers were constantly seeking corporate business from the same public companies on whom they were writing investment circulars. A bearish circular would not enhance their chances of the spin-offs.
Even shares in Anglo Irish Bank earned plaudits from Irish brokers, right up till their delisting from the market. Davy, as broker to Anglo, remained believers to the last. They were believers in 2005, when they set a price target of €11, nearly two euros above the price on the day. They were believers in 2007 when the shares stood at €16.88 and they targeted a level of €18.50. And they were believers in late 2008 when the shares languished at 85 cents as they set a deathbed target of €3.00. A few weeks later the shares were delisted as the price hit the deck at 22 cents.
Foreign brokers were slow to detect the rot in Irish banking, but at least they were not so one-eyed as the big Irish brokerages. As early as November 2006 the French investment bank Société Générale sounded a warning. In a research note headed ‘Going, Going…’ SocGen pointed out the disproportionate dependence of Irish banks on property, warned of ‘clouds gathering’ over AIB and reduced Ireland’s premier bank’s rating to ‘Hold’ (often regarded as brokerspeak for ‘Sell’). Worse still, it downgraded Bank of Ireland to a blunt ‘Sell’. At precisely the same time, Davy and Goodbody were advising punters to pile in.
The bankers’ second pack of house-trained poodles barked even louder than the stockbrokers. Every bank and brokerage worth its salt employs a chief economist whose main purpose is to comment on the economic outlook through the mass media. The chief economists came into their own as opinion formers during the boom, when there was a hunger everywhere for news of the Celtic Tiger. The bankers’ hired guns were more than happy to satisfy the appetite. Their analysis of the Irish economy was mostly, but not in all cases, upbeat. The media eagerly sought their opinions, often presenting them without a health warning.
The career of Jim Power demonstrates the dangers. As chief economist at Bank of Ireland until 2001, Power told me that he became ‘increasingly fed up with the lack of independence allowed in my work. I was under constant pressure to deliver the bank’s line. They wanted me to voice a consistent politically correct message. They were intent on not upsetting the government. It really angers me, looking back. In my last two years I was constantly getting into difficulty.’
Power recalls giving a paper at a weekend conference in which he suggested that ‘social partnership was becoming a mere vehicle for the public-service unions’.
‘On Monday morning,’ he continued, ‘I was called up to the top floor in Baggot Street headquarters and slapped across the wrist by the then chief executive of Corporate and Treasury, Brian Goggin.’
Power landed in trouble again after he addressed the economic and financial affairs subcommittee of the House of Lords on 17 October 2000 about the European single currency. At the committee Pow
er expressed his view that the euro was creating an inflationary bubble in the Irish economy. He says, ‘I did not believe that the Irish government was capable of managing an economy within the single currency.’
He was to be proved right.
Power’s independence from his banking employers did not go as far as permitting him to predict a property crash, but it did land him in hot water when he attacked social partnership, so beloved of the banking hierarchy. He handed in his resignation the day after his address to their lordships.
Power’s replacement, Dan McLaughlin, was an inveterate bull, known for the unusual intensity of his economic optimism even in the days when almost everyone was optimistic. His optimism was unaffected by the evidence of a housing bubble.
In March 2007, when the property market had just peaked, the Bank of Ireland line on property was made clear. In a statement the bank coolly asserted that ‘the Irish housing market is cooling off in the “soft” manner as predicted’. Wishful thinking from a bank with an abundance of mortgages.
McLaughlin – who earned a PhD in economics from Queen Mary College in London, and who carries the prefix ‘Dr’ in his public appearances – was still happy about the prospects for the Irish economy as late as November 2007. At the launch of the Bank of Ireland’s quarterly review he insisted that, ‘The government’s fiscal position is not one to prompt concern. The Minister for Finance has announced a spending total for 2008 which is virtually identical to that signalled twelve months earlier, and tax revenue is forecast to exceed day-to-day spending by €6.0 billion, which hardly suggests the need for revenue-raising measures.’
Far from there being a surplus of tax over expenditure, the opposite occurred in 2008. Day-to-day spending outpaced revenues by nearly €4 billion. In October 2008 the government introduced an emergency Budget stuffed with ‘revenue-raising measures’. In April 2009 they were forced to repeat the same medicine.
