OPINION: A difficult but necessary evaluation of property assets must be followed by swift recapitalisation

PROTECTION OF our domestic financial markets through thoughtful but swift decision making led to a level of stability in the market place that was unlikely to have been achieved if we had not moved as we did.

The consequences then would have been of catastrophic proportions in our domestic banking sector which would have had an even bigger contagion effect on the entire Irish economy. By guaranteeing the banks we have avoided this massive threat and should not stand by now waiting for the next threat to arise.

Whether we look at the balance sheets of the international banks or domestic banks there are three steps to be taken that are applicable in either instance in order to get confidence reinstated within the financial community.

Addressing the depositor's dilemma on the liability side of the balance sheet was the first step. The consequences of this step are visible today through the improvement of market confidence and the freeing up of liquidity in the market place that has been assisted by the reduction of interest rates globally.

The second step is to address the asset side of the balance sheet which holds the offending securities and loans which are often referred to as toxic debt.

In Ireland we await the findings of the PricewaterhouseCoopers' study that will hopefully cast light on what is the market value of property or portfolios of properties within the state.

This is a challenging task for anyone to take on, as making a judgement on property values when there is an absence of willing buyers and sellers leaves any valuation suspect. The desire of the market to have an instant solution to current property valuations and provisioning runs in conflict with accounting conventions.

The markets are demanding a methodology of valuing property in line with the way debt securities can be marked to market. Debt securities and loans are very different in their structure which prevents market value assessments being undertaken in the same way.

That the guidance we are receiving from the banks today depicts a continuing increase in provisions over the next couple of years is testament to the fact they are aware of the deteriorating position but are unable to take a substantial general provision, which if taken, would likely relieve market tensions.

A prolonged period of large annual provisions that impacts the bank's results negatively to the extent that the market cannot see any future growth will result in a stagnant low share price.

If the banks can get permission to create a substantial general provision they are more likely to get the market back on side.

Taking the medicine now through recognising the losses immediately rather than deferring them over the next three or four years allows for an immediate recapitalisation in line with the provisioning. A painful quick solution or a possible slow death appears to be the choice.

Somehow a mechanism needs to be created that can reflect a current market value of property so that an accurate assessment can be made as to what is the realistic level of property values on the bank's balance sheets. When this is done we can move to the third step of this process which is the recapitalisation of the banks.

Today the market value of some of the major financial institutions is trading in the region of 20 per cent of their net asset value.

This implies that the market is trading the shares at a substantial discount as it does not believe the asset valuation currently being placed on the assets.

The adjustment factor to bring the share price into equilibrium with the bank's expectations is a credible level of provisioning being recognised to the mutual satisfaction of all parties.

Following this, a programme of recapitalisation is required, be it Government, private or public injections of equity. Faced with an ever increasing requirement by international and domestic regulators the Irish banks must strive to get their primary capital up above 7 per cent. Delays in the recapitalisation process can only translate into reduced lending causing further economic decline.

Selling off assets may be a way to raise capital during these difficult times but a number of questions must be answered before such actions are sanctioned.

It is essential to understand what the overall strategy of any financial group happens to be at this time so the implied consequences of any sale of assets may be comprehended by the shareholders. Survival should not be the sole long-term aspiration. Survival with growth and added value for the shareholders is essential.

Selling off non-strategic assets may not be a bad starting point but if these assets are potentially some of the best revenue generators in the short term, we may be better served keeping them.

The consequence of any asset sales has to be viewed on what can be defined as the residual balance sheet of the bank. Will the market consider the residual balance sheet as weaker or stronger after the sale?

During this depressed time, the sale of good assets at a low price needs to be reviewed in the context of the strategic future of the vendors. In the end a lowly capitalised institution that winds up with a fundamental retail Irish-English footprint might easily be identified as an easy target for one of the surviving UK or European national champions that are acquisitive.

If our vision for the future is survival with scant regard for the unintended consequences of today's actions or delays then perhaps this is an acceptable outcome from the chaotic situation we currently find ourselves in.

On the other hand, creating a vision of having a substantial Irish banking institution in a European context with its headquarters in Ireland appears to be a more ambitious strategy. This suggestion would give the many shareholders a chance to redress the substantial losses experienced over the past 18 months. It should be said that the existing business model for Irish banks appears to be broken and whatever is resurrected to replace it may not be as profitable in the future.

For those bank directors who believe the market is wrong, and perhaps they are correct, it still leaves the shareholder licking their financial wounds inflicted during the current stewardship.

Losses of up to 90 per cent have been experienced during these past 18 months based on the assumption "the market is wrong"!

On the other hand what if the market is not wrong then those loyal shareholders have only a further 10 per cent to lose before everything disappears. Is there anyone within the financial sector responsible for where the shareholders find themselves today or does responsibility only come with success?

Apologies are a poor substitute for capital gains and dividends.

• Michael Soden is a former chief executive of Bank of Ireland