Oireachtas Joint and Select Committees
Wednesday, 29 April 2015
Committee of Inquiry into the Banking Crisis
Nexus Phase
Ciarán Lynch (Cork South Central, Labour)
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As we have a quorum, the Joint Committee of Inquiry into the Banking Crisis is now in public session. Is that agreed? Agreed.
Can I ask members and those in the public Gallery to ensure that their mobile devices are switched off at today's proceedings? We begin today's session 1, public hearing and discussion, with Mr. Michael Buckley, former group chief executive, and Mr. Eugene Sheehy, former group chief executive, Allied Irish Banks. In doing so, I'd like to welcome everyone to the 21st public hearing of the Joint Committee of Inquiry into the Banking Crisis.
This morning we will hear from Mr. Michael Buckley, former group chief executive, and Mr. Eugene Sheehy, also a former group chief executive of Allied Irish Banks. Mr. Michael Buckley retired as group chief executive and as director of AIB Group in June 2005. He has been director of AIB since 1995. Mr. Buckley is also a former managing director of the AIB Poland division and of the AIB capital markets division.
Mr. Eugene Sheehy joined AIB in 1971 and spent almost 20 years in retail banking, including branch manager appointments in a number of Dublin branches. He was appointed general manager retail operations in 1999, managing director AIB Republic of Ireland in 2001, and chief executive officer of AIB's USA division in 2002. He assumed responsibility as group chief executive with effect from 1 July 2005, a position he held until his retirement in 2009. Mr. Buckley, Mr. Sheehy, you are both welcome to today's proceedings.
Moving on to the formalities of today's business, I wish to advise the witnesses that by virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of their evidence to this committee. If you are directed by the Chairman to cease giving evidence in relation to a particular matter and you continue to so do, you are entitled thereafter only to a qualified privilege in respect of your evidence. You are directed that only evidence connected with the subject matter of these proceedings is to be given.
I would remind members and those present that there are currently criminal proceedings going on and ongoing and further criminal proceedings are scheduled during the lifetime of the inquiry which overlap with the subject matter of the inquiry. The utmost caution should be taken not to prejudice those proceedings.
Members of the public are reminded that photography is prohibited in the committee room. To assist the smooth running of the inquiry, we will display certain documents on the screens here in the committee room. For those sitting in the Gallery, those documents will be displayed on the screen to your left. Members of the public and journalists are reminded that these documents are confidential and they should not publish any of the documents so displayed.
The witnesses have been directed to attend this meeting of the Joint Committee of Inquiry into the Banking Crisis. You have been furnished with booklets of core documents, these are before the committee and will be relied upon in questioning and form part of the evidence of the inquiry.
So if I could now, to begin proceedings, ask the clerk to administer the oath or affirmation to you.
Ciarán Lynch (Cork South Central, Labour)
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Okay, so I now invite Mr. Buckley, followed by Mr. Sheehy, to make their opening remarks to the committee. Mr. Buckley.
Mr. Michael Buckley:
Thank you, Chairman. I very much hope I will be of assistance to the committee today in its important work.
I joined AIB as head of investment banking early in 1991. And subsequently, as I said, I served as managing director of AIB Capital Markets and then as managing director of the Poland division. In October 2000 I was appointed group chief executive designate and I formally took over as group CEO in June 2001. My successor was designated in March 2005 and I retired at the end of June 2005. From the date of my retirement onwards, I had no further involvement in the management and board of AIB group. As I was retiring ten years ago, I can honestly say that I had no premonition, let alone any evidence, that a liquidity and credit crisis was building internationally or that when that major crisis crystalised late in 2008, that AIB would be so vulnerable to it and ultimately would only survive through taxpayer support. I deeply regret what happened and the damage it inflicted on the lives of so many.
There are two interlocking parts, Chairman, to the account I want to give of my time as CEO of AIB. They are in my written witness statement. I'm just summarising them here. I'm going to start with the business strategy in general and as it applied to the Republic of Ireland in my time. And second of all, I want to talk about risk and credit management. First, the business strategy. In 2001 the business environment was fraught. It was in the wake of the dotcom crash, then 9/11 and we had the added challenge in Ireland of foot and mouth disease. As a result, the strong period of growth that started in the second half of the 1990s slowed for, I think, about two years, but from early to mid-2003 the economy returned to its catch-up growth spurt. There had been a 1 million person increase in the population between 1971 and 2001. The labour force had increased by 400,000, or 32%, in the ten years up to 2001. The number of people in employment had risen by about 400,000 also, or 49%, in the same ten-year period. Such a rate of demographic growth and change hadn't been seen in the history of the State and the numbers continued to grow through the whole period of my time as CEO. That meant the potential for many new customers and strong demand from that growing customer base across the whole range of financial products in a very low interest rate environment. I think that context is very important.
In 2001, investors saw AIB as a federation of banking franchises with varying growth prospects but without any distinctive common thread to its brands. They saw our main market, the Republic of Ireland, as dynamic but their view was that other banks operating here had more exciting growth prospects. The strategy we set out in response to those factors, was to position ourselves to build one distinctive model of doing retailing and commercial banking that could be applied to each country in which we operated. And that model was to focus on growing the total value of each good customer relationship based on having best products, best service and best people.
In our largest business here in Ireland we believed that we hadn't been fully exploiting our greatest strengths, those were that we had between 30% and 40% market share of all personal current accounts and all business working accounts but a much lower market share of most individual product categories. So the strategy was to get better at responding to customer needs across the whole product spectrum.
I've mentioned the very strong demographics so building our relationships with good customers in the property and constructions sectors was a logical part of the strategy, but so too was building a stronger presence in the growing health insurance market and meeting the needs of our growing customer base in deposits, mortgages and investment products. When I presented that strategy to the board in 2001, I said that if we were successful in executing it we could have an aspiration of doubling our profits over the next five years. In some of the documents I've been given that aspirational outcome has been incorrectly represented as the strategy itself. In fact, the medium-term forecast and annual budgets presented to the board throughout my period are focused somewhat more modestly on achieving double digit earnings growth overall on a consistent basis. So doubling profits in a five-year period was never actually a budgeted target.
Property and construction lending grew strongly during my time, most of the material I have been sent about that looks at growth trends across the whole period of 2001 and 2009 in percentage terms. That in my view is misleading because the starting base was actually quite low. In money terms the entire group exposure to property and construction during my four years was about €6 billion in mid-2001 and it grew to about €19 billion, this is in euro, by mid-2005. And within those overall totals the figures for the Republic of Ireland were that it grew from €4 billion to €11 billion.
I have no evidence that at that level we had materially outrun the demand arising from deposit and demographics nor did I have a view coming to me from my credit professionals that standards were slipping at the time. On the contrary their view to me throughout and to the board was that credit quality was stable and strong.
In any business you're trying to keep a fairly wide range of shifting factors in good balance so towards the end of 2004, as a result of the fact that loan growth had been significantly outpacing deposit growth, I began to focus on the increasing loan-to-deposit ratio and on the proposal from myself and my management team, the board put in place at that stage targets, one for the simple loan-to-deposit ratio and the second for an adjusted loan-to-deposit ratio. That was done to begin to slow down the rate of credit growth to a level closer to the growth rate for deposits and also to help ensure that internal capital generation was positive.
I'm going to turn now to my second main aim in the period mid-2001 to mid-2005; which was improving our risk management capability. That was partly for strategic reasons, it was partly also because we had three massive regulatory projects to implement; Basel II, Sarbanes-Oxley and the new IFRS accounting standards, and, thirdly, because I had to deal with two major crisis management events during my time - the fraud in our Allfirst subsidiary in 2002 and the FX charging issues identified in Ireland in 2004. Collectively, all of those factors required the single risk and finance support organisation to be built across AIB Group which had always been heavily divisionalised. That was a huge five-year project as I saw it. In the wake of the Allfirst fraud we commissioned separate independent reviews and reports on treasury operational risk, credit risk, policy frameworks across all of those things to get assurance that they were fit for purpose and we constructed a series of projects to implement the recommendations arising. The general message in those reports was that within each division there were no major issues but that we needed to establish common standards across the whole group.
During 2002-03 we recruited an experienced chief risk officer, reporting directly to me, to build that single organisation. We put in place a single group-wide treasury organisation. We again recruited externally an experienced head of internal audit to build a group-wide capability and we enlarged the mandate and scope of the compliance function across the group. We devoted massive resources both to the regulatory projects and to remediation programmes arising from Allfirst and from the FX charging issues in 2004.
Implementation was still going on when I retired, including a wide range of actions designed to change those aspects of culture and practice in the bank that were obstacles to colleagues at any level feeling free to raise any issues that concerned them. And that was a strong personal mission of mine. I have a couple of final things to say, Chairman. First of all, turning to credit policies, delegated authorities and exception management, Deloitte had carried out a very detailed policy and process review, I think towards the end of 2002 if my recollection is right. What they found was that there were "well established processes, policy and delegated authorities based on skill and experience, that grading and monitoring systems accommodated early identification and management of deterioration of credit policy, that there was a system of credit review independent of business reporting lines and written policies pertinent to current business." That's the end of the quote. Their recommendations mainly had to do with ensuring consistency across all of our divisions. The delegated authorities to divisional credit committees were relatively modest during my time. They were increased somewhat towards the end of 2004, but not dramatically, and exceptions to large exposure policy were infrequent. The month before I retired, in May 2005, Standard & Poor's raised our long-term credit rating to A+. In their announcement, the agency said:
The rating on AIB reflects its leadership position in its main market, the Republic of Ireland, strong credit risk management, good underlying financial performance and sound liquidity. They also reflect AIB's ongoing initiatives to improve its risk management procedures and control frameworks.
That is the end of the quote. Thank you Chairman.
Ciarán Lynch (Cork South Central, Labour)
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Thank you very much, Mr. Buckley. Mr. Sheehy.
Mr. Eugene Sheehy:
Chairman, members of the committee, thank you for affording me the opportunity to outline my views on the banking crisis. At the outset, I want to say I'm very sorry for what happened and my role in these events. I know a lot of people were let down and feel very angry, deservedly so. I draw no comfort from the extraneous factors that contributed to the crisis. I take personal responsibility for my actions and omissions. Public apologies on many occasions have not diminished the deep disappointment that I feel on a daily basis. Chairman, in my written statement I have addressed the themes that the inquiry requested me to focus upon including property risk concentrations, liquidity, business planning, remuneration, regulatory relationships, delegated authorities and the bank guarantee. Conscious of time and that these themes will be covered during my evidence, and in light of evidence given to the committee last week, I will confine my verbal remarks to a summary of the evidence contained in my written statement concerning the bank guarantee. I have been asked to make a statement on the appropriateness of the guarantee. Though we did not make the decision, I will describe my role on the night and this role is described in detail in my contemporaneous notes, of which you have a copy.
Together with our counterparts from Bank of Ireland, we asked for a meeting with Government. At that meeting, we requested a four bank guarantee, but not the blanket guarantee that was ultimately provided. We were in Government Buildings for over six hours, our presence at the meeting was not continuous, and we were dismissed from the decision makers' room on four occasions. At the first session we described what was happening in our business, and how our liquidity was being positioned. That day had been a tumultuous one on global financial markets. To stabilise the Irish banking market, we asked for a four bank guarantee. This was not a new idea. You will have copies of minutes of an AIB bank board meeting of the night before, in which I am quoted, "The authorities expect that two financial institutions will fail (unless white knights emerged) and would guarantee the obligations of the other institutions on a temporary basis", recorded in the AIB minutes the day before the guarantee. We were dismissed from the room while our request for a guarantee was considered.
At the second session we attended, we were told that Anglo was about to default. The Government wanted us to give Anglo a loan to get them through the week so that they could be decisively dealt with by the weekend.
We refused initially and were dismissed and were asked to reconsider our position. Working over the phone with colleagues back in Bankcentre we mobilised resources and looked into every possibility to come up with a response that would meet the Government's needs. At the third session, we said we would give Anglo €5 billion until the weekend. On notice at this stage that Anglo was about to default, we refused to go on risk for Anglo. Our offer was conditional on a Government guarantee for this Anglo loan. This solution appeared to be acceptable to the Government and we said we would start moving assets to have the funds ready by Wednesday morning, and that in itself was quite a complex and intricate business.
The meeting reverted to the four bank guarantee and its form. We made suggestions regarding duration of the guarantee - we wanted a longer one than the one-year one proposed - and also on the merits of including bonds ... of which we were in favour of. We were dismissed while a drafting process was undertaken and during this interval our input was sought on ... in bilateral sessions regarding treatment of subsidiaries, for instance, our Polish business, and on what basis would be ... what basis would be used to determine the price of the guarantee. When we were called back for the fourth session, there was a short discussion about a solvency statement being issued with the guarantee. We didn't think it was necessary and after discussion, the Government decided not to include that reference. We returned to the room and at 3:30 a.m. we were told we were no longer needed. When we saw the guarantee document for the first time the following morning, we could not understand why Anglo and Irish Nationwide were included. All our discussions that night were based upon a premise that Anglo was to be taken down. We did not think they would be part of the guarantee, in fact, we were at that time, in response to a Government request, risking our own liquidity to keep Anglo afloat until the following weekend.
From our perspective, a four institution guarantee was appropriate and necessary for a number of reasons. Firstly, an Anglo default was absolutely certain to result in an immediate across-the-board agency downgrade for all Irish institutions and an immediate worldwide risk aversion for all Irish institutions. Secondly, in Great Britain where we had high street branches and €10 billion in retail deposits, we could expect an immediate run on our deposits. Thirdly, given the Irish public's reaction to Northern Rock, a very minor player in this market, during their crisis in 2007, you could deduce from that it was certain that there would be panic on the streets and that our branches would not be able to cope.
In the absence of a statutory mechanism to deal with a failing bank, the options were to nationalise, liquidate or guarantee. There was no contingency plan nationally to deal with Anglo or at EU level to deal with the crisis in general. In the absence of alternatives, the default option was a four bank guarantee for the remaining four institutions, not the blanket guarantee ultimately given. This, I believe, offered the best chance to cope with the fallout about to be triggered by the imminent liquidation or nationalisation of Anglo and Irish Nationwide. The lessons from two weeks previously were fresh in everybody's mind. Solutions that didn't convince the markets invited misfortune. This was amply demonstrated when the US authorities allowed Lehman's to fail. The decision did not restore market discipline and within days the US Government had to rescue many institutions - huge institutions - and introduce a €700 billion TARP, the troubled asset relief programme. These events contributed hugely to initiating the meltdown in global liquidity.
I wrote up my notes of the minutes ... my minutes of the meeting a couple of days afterwards and absent hindsight observations that ... I have made some in this statement ... they are a contemporaneous record of events on the night as I saw them. Since I submitted my statement a month ago, I have been furnished with another record of events on the night from a Department of Finance source, which has been quoted at the committee. Comments are attributed to me that I cannot remember making. There was absolutely no evidence of any discussion of AIB's solvency on the night, in either my note or that of Dermot Gleeson's. We were asked for an update on what was happening in our banks which we gave. We were asked to provide funds to cover Anglo until the weekend which we agreed to provide. We were asked about the form of guarantee. We gave advice on duration and the instruments that could be included.
We gave advice on duration and the instruments that could be included. We were asked for our views on Anglo and Irish Nationwide, we said they should be nationalised. This fact is recorded in both my note and that of Dermot Gleeson. This fact is further collaborated by the note from the Department and I quote "Minister asks FR, did they agree with AIB, Bank of Ireland, that two need to be nationalised first. FR did not agree."
If I said the words attributed to me in the Department of Finance note, they could only have been in the context of what would have happened to the system if no remedial action was taken. There was absolutely no issue about AIB solvency at that time.
Chairman, in conclusion I spent 38 years in AIB, operated at many levels and I knew the organisation very well. I was proud of what the bank had achieved over the decades. I always viewed my job when I became CEO as one of stewardship, responsibility to staff, customers, shareholders and the public in general. It was my wish that in due course I would hand on the job to somebody else with the bank in good shape. That I failed in that responsibility, for me is a matter of eternal regret and sorrow.
Thank you, Chairman.
Ciarán Lynch (Cork South Central, Labour)
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Thank you very much, Mr. Sheehy, and thank you again, Mr. Buckley. I am sure other members will over the course of the morning return to some of the matters you raised about the guarantee, but as we are aware the guarantee was a response to a crisis, it wasn't the instigating factor of the crisis and that's what I would like to delve into now, if you don't mind.
Mr. Buckley, in your opening statement, can you confirm to the committee, that is what you're telling the committee, that you left AIB in a fundamentally sound position when you departed?
Ciarán Lynch (Cork South Central, Labour)
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Okay. Thank you very much. In that regard so, Mr. Sheehy, could you maybe explain to us as to what actually happened under your watch that led to AIB having to go in to a bailout programme and be guaranteed?
Mr. Eugene Sheehy:
Yes, Chairman. I fully agree with my colleague that in the middle of '05 the outlook and the condition of the bank was very positive and that continued, in my view, for a number ... a couple ... of years after that. It was only when the market began to unravel, both internationally ... one way I look at it is, there was an international context, there was a national context, and there was an institution specific context. And, all three of those dimensions changed for the worst in ... from the middle of late 2007 onwards. There were reasons for it and I'll only address the institution specific ones. Obviously, everybody is familiar with the context as you had in the Context Phase.
When the market turned negative we were ... we found ourselves overexposed in property in the Republic of Ireland and specifically certain types of property in the Republic of Ireland. Our expectations as to how those assets would behave in a downturn didn't pan out. The stress tests we relied upon, while there were one in 25 year stress tests weren't equipped for a one in a hundred year stress, and as a consequence post-2009 as the market continued to display very severe write-downs, the bank's capital position became compromised and it required support from the State. Earlier of course, it had got support in relation to the guarantee, so that would be my explanation of how it came to be.
Ciarán Lynch (Cork South Central, Labour)
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Alright and we'll deal with that as the morning now goes on. Our first lead questioner is Deputy Kieran O'Donnell. Deputy, you have 25 minutes.
Kieran O'Donnell (Limerick City, Fine Gael)
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Thanks very much, Chairman. Welcome to Mr. Buckley and Mr. Sheehy.
Mr. Buckley, can I just ask a question of your time? During your tenure, like a number of major control issues arose and you mentioned Rusnak, Faldor and the foreign exchange, the incorrect interest charges for offshore accounts. How would you reconcile that with the governance standards that you would have outlined each year in the annual reports?
Mr. Michael Buckley:
I think, Deputy, we were ... first of all we were very clear about any control failures that happened during that time. I mean ... so that's the first point I'll make. When the Allfirst treasury fraud occurred over in Baltimore we immediately ... within I would say 36 hours of first hearing that there was an issue, I was on the radio first thing in the morning sizing it, and very quickly then we said we would bring in independent investigators, which we did, of the highest quality, to investigate it thoroughly, and we promised at the very beginning that we would publish all of the findings of those investigations. So, first of all, I think that's a very important governance statement because we were making a promise to shareholders and to customers and to our own people that nothing would be brushed under the carpet, and that is a path that we followed two years afterwards when the FX charges issue came up.
Kieran O'Donnell (Limerick City, Fine Gael)
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How would you explain that these three scandals arose at the time they were reported as such, arose in a ... over a two year period?
Mr. Michael Buckley:
I think that to some extent that was a coincidence but it would be foolish of me to say that that was totally a coincidence. I think there were some very important common threads between them. The thing I would say is that a common thread between them is that, to take the FX charges and related things first of all, those issues, by and large, referred back to the 1980s up to the early 90s, and the subsequent investigations found that in most cases the particular issues that had been brought to the regulator's attention and, via the regulator, to our attention, had been dealt with, by and large, during the course of the 1990s so there was a large element of history about them. To me, they were probably ... the FX charges was probably the most upsetting part personally to me of my time as CEO because it said that there was stuff going on there that, in terms of the values and principles that I would have had, that were contrary to those principles. Now ... but we did tear up the floorboards. I mean, I remember when the FX charges thing came up first, I was on television, and I said those very words. I said, 'This information about that issue has gone to the regulator and what we are going to do is not only to investigate that as far as it goes but we will tear up the floorboards on every issue of charges that we know about and we'll try to find anything that we don't know about", and we made a promise to customers that we would remediate every case of customer detriment, which we did. So that's ... I think that's the governance part of-----
Kieran O'Donnell (Limerick City, Fine Gael)
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On that point, like, the Rusnak came to prominence in '02, Faldor case in '03, the foreign exchange rate setting came in '04.
Kieran O'Donnell (Limerick City, Fine Gael)
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So I mean, I suppose to borrow an Oscar Wilde phrase, for one to happen would be unfortunate, two is careless. So clearly people were not taking account of the investigations that were going on in the other areas. So how do you finally account for that? And you might also explain to me as well in terms of property lending, that during your tenure, post '04, so '04 and '05, you had an increase in property lending of 6% in '03. You had 48% of an increase in '04, and you had 52% of an increase in '05, just before Mr. Sheehy took over.
Kieran O'Donnell (Limerick City, Fine Gael)
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And that's significantly higher than your two main competitors at the time, Bank of Ireland, which was 24% and 23%, half of that amount virtually, and Anglo were at a figure of 35% and 38%. So you might explain how we have these sequence of events whereby you had these various defrauding of customers happening and, at the same time, '04 and '05, you had this rapid explosion in property lending under your watch, Mr. Buckley.
Mr. Michael Buckley:
There ... thank you Deputy. I think there are several questions there, if you don't mind I'll answer them separately, is that okay, Chairman? So first of all, if I take the Allfirst one, that wasn't a case of defrauding customers; it was a case of defrauding the bank.
There was no customer detriment involved there. Second of all, in the FX charges, and I include other things in that as well in that particular area, in the principal issue there that gave rise to that whole scandal, there was no customer detriment. What had happened was, we as a bank, were required to get written approval in the mid-90s, I think it was 1996 or something like that, for our foreign exchange charges. We had failed to do that. The investigation then found that actually our charges in the marketplace were no worse than any other bank, so therefore we were not disadvantaging customers. Despite that, we went and remediated and refunded every customer that we could find. The third element, Faldor, was a situation where there was no customer detriment. This was a question as to whether, how will I say, a particular legal entity - an investment vehicle - had been given preferential treatment by our investment management arm. It wasn't anything about customer detriment.
Kieran O'Donnell (Limerick City, Fine Gael)
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Could you move on to the loans then?
Mr. Michael Buckley:
Yes, absolutely. Yes, there were very big increases in that year and a half period or so before I finally retired and I would say there were two reasons for that. One, as I said in my opening statement, the economy was beginning to recover from a pretty tough few years after the dotcom, and we got ... there was a sort of catch-up spurt I think.
Kieran O'Donnell (Limerick City, Fine Gael)
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You were significantly ahead of your competitors.
Kieran O'Donnell (Limerick City, Fine Gael)
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Was it endemic in the culture of AIB?
Mr. Michael Buckley:
But, if I may say so, there is nothing wrong with lending for property and construction development. I mean, in 1998 our loan book for property and construction, depending on whether you count in or out our US subsidiary, was somewhere between 12% and 15% of our total book. So we had a long history in lending and we were quite comfortable that we were an experienced lender to property and construction.
Kieran O'Donnell (Limerick City, Fine Gael)
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Can I just move on to Mr. Sheehy? Just on the whole issue, I am taking the property side. You would have very much breached the prudential lending limits in July '06. How do you reconcile that, because you were effectively, by the end of 2006 you were breaching these limits significantly and by 2008 you were way ahead. You were ... effectively, you could have about 250% of own funds in two related sections. You were at 390%. How do you reconcile that Mr. Sheehy?
Ciarán Lynch (Cork South Central, Labour)
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I will just make a short intervention. When you are responding to this, there is some documentation that actually relates to that. I will reference it as you are making the response so it can just go up on the screen. Okay.
Kieran O'Donnell (Limerick City, Fine Gael)
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It is B2, Vol. 1, page 6.
Kieran O'Donnell (Limerick City, Fine Gael)
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You are familiar with it.
Mr. Eugene Sheehy:
Yes. So yes, there were guidelines and they were breached and advised to the board, and discussed at the board and discussed at management generally. What was happening ... if that happened in total isolation of what was happening overall in terms of regulation, I would say the bank was ignoring a guideline, but that wasn't the case. We weren't ignoring the guideline. We were talking to the regulator about the guideline and the regulator was talking to us about the emerging solution to risk concentrations which-----
Kieran O'Donnell (Limerick City, Fine Gael)
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Taking that context, Mr. Sheehy, at the end of 2008, you were far in excess. You were breaching the guidelines on one sector, we'll say, which should have been 200%, you were at 275%. The two sectors should have been at 250% and you were at 390%. Was the regulator in agreement with this, satisfied with this?
Mr. Eugene Sheehy:
Well, you are picking two different points in time now. The '06 reference was ... okay, we were up against and going over, and the way these things were being measured was going to be changed under Basel II.
The '08 data point is at the end of a period where the market has stopped functioning correctly, so you weren't getting-----
Kieran O'Donnell (Limerick City, Fine Gael)
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You were getting to the top of the hill?
Kieran O'Donnell (Limerick City, Fine Gael)
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No, I'm asking how did the regulator view that?
Mr. Eugene Sheehy:
Well, we were in discussion with the regulator about it - there's evidence of that in the bank documents - and we were working jointly at the time on the Basel II model and how that would look at sector concentrations, so that was a big issue because it was a totally different way to look at risk concentrations where in-----
Kieran O'Donnell (Limerick City, Fine Gael)
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There are two questions, Mr. Sheehy.
Kieran O'Donnell (Limerick City, Fine Gael)
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No. 1-----
Ciarán Lynch (Cork South Central, Labour)
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Give the witness time to respond when he-----
Kieran O'Donnell (Limerick City, Fine Gael)
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-----why you breached it-----
Kieran O'Donnell (Limerick City, Fine Gael)
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-----and, No. 2, what view did the regulator take?
Ciarán Lynch (Cork South Central, Labour)
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Allow Mr. Sheehy to respond.
Mr. Eugene Sheehy:
Okay. We breached it and it was ... as soon as it was identified, you know, it was reported and discussed with the regulator, so, if you like, it was a breach in open sight, it wasn't something that was hidden. The regulator acknowledged the breach, didn't remove the limit, you know, but at the same time acknowledged that we were working on the Basel II process, which was going to look at it in a different way.
If I could just briefly explain, Basel II, the approach to credit concentration in Basel II is totally different. It is not by looking at a definition of an asset class, it looks at all individual credits and applies different stresses and measures to them and attaches a risk weighting to them which leads to a calculation, so it was really as different as chalk and cheese, the way this system was moving towards it. In the meantime, we were in breach and we were talking to the regulator.
Kieran O'Donnell (Limerick City, Fine Gael)
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Should you have breached the limits?
Kieran O'Donnell (Limerick City, Fine Gael)
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And can you explain, Mr. Sheehy, why, under your tenure, between '05 on, your development loans, property and construction loans, you had a 52% rise in '05; '06, 41%; '07, 32%; way in excess of your competitors in Bank of Ireland, which were 23%, 23% and 22%, virtually ... significantly less. And, looking at it, that even with Anglo in 2005, you had 52% of an increase and you had ... Anglo had 38%. So, can you explain how you ... Mr. Buckley says you had ... you were a bank that lent to property, but how did you foster this culture where you had this rapid escalation in property and construction lending?
Ciarán Lynch (Cork South Central, Labour)
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Mr. Sheehy.
Mr. Eugene Sheehy:
I note the comparators you're making and I'm only going to talk about a comparison between ourselves and Bank of Ireland because that's the only equivalence. They were a retail commercial bank; so are we. There was a slight difference in our customer base. We were much heavier than they were in the SME sector and property and construction was widespread. We had, you know, in the ... we had very large customers and then we had 650 customers who had property and construction loans of over €1 million, so it wasn't ... it was very broadly spread and reflected our franchise and the nature of our franchise.
Kieran O'Donnell (Limerick City, Fine Gael)
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Well, except, Mr. Sheehy, it made you-----
Ciarán Lynch (Cork South Central, Labour)
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Sorry, I need to let Mr. Sheehy time to respond.
Mr. Eugene Sheehy:
I'm just following up on something my colleague, Donal Forde, said the other day. We kept pace with our customers. We didn't grow market share in that case. Point-to-point, you will get different percentages moving around. Some of the examples you gave are different end financial years.
Kieran O'Donnell (Limerick City, Fine Gael)
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Correct, I accept that, but generally.
Kieran O'Donnell (Limerick City, Fine Gael)
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And how do you view that in the context that you were so exposed to property that it has meant that €20 billion of taxpayers' money has ended up going into AIB? And you're on record as saying that you'd rather die than take equity.
Mr. Eugene Sheehy:
Yes, I can address that particular statement if you want. That was in October 2008, in a public meeting, and an individual asked me, you know, "Are you about to have a rights issue?" Now, it's very simple rules in corporate governance about what you do if you're a public company. There's also lots of documents you will have seen that we were adequately capitalised at the time. If a board had decided to raise funds in a share placement with customers, you would have to immediately announce that.
At the time we were looking at capital, and we had a whole range of mitigants that we thought we could apply. We were a long, long way from ever having to, at that stage, ask shareholders to pay up. At the time there was an active shorting in the market, and a huge amount of speculation on bank shares in Ireland that were being played out of London and New York. I had to be very definite and honest in my response. Sorry, I lost the first part?
Kieran O'Donnell (Limerick City, Fine Gael)
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Twenty billion euro of taxpayers' money gone into AIB.
Kieran O'Donnell (Limerick City, Fine Gael)
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As a result of this jumping, we'll say, into property and at such a rapid rate.
Ciarán Lynch (Cork South Central, Labour)
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The question is: there was a rate of growth in AIB; was that worrying? And did that result in a €20 billion requirement of the Irish State to actually assist AIB as a consequence of that rapid growth and the management related to it?
Kieran O'Donnell (Limerick City, Fine Gael)
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Can I just move on to the guarantee? And you made reference to your quote that the ... it's on AIB C3b, Vol. 2, page 29, which is the minutes of the Department of Finance. And you said: "People we've been dealing with for decades pulling back. One month we would be funding bank overnight. Bad if it can't even get that disaster bankruptcy." Are you disowning that statement?
Kieran O'Donnell (Limerick City, Fine Gael)
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Had ye a liquidity problem? Did AIB-----
Ciarán Lynch (Cork South Central, Labour)
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I just asked Mr Sheehy to deal with the statement first and then we'll move on to the next question.
Mr. Eugene Sheehy:
So I said it in my opening statement, I can't remember saying that, and I said that, you know, that kind of language could have been used in relation to the systemic issue of, if the system, the entire banking system, as a result of the imminent Anglo default, was allowed to continue, liquidity would have kept on shortening and shortening and shortening. And if that happened, banks that are solvent, bank that have more assets than, you know, surplus assets, can go out of business because they just can't get cash.
Kieran O'Donnell (Limerick City, Fine Gael)
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And are you saying AIB did not have a solvency problem on the night of the guarantee?
Kieran O'Donnell (Limerick City, Fine Gael)
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And on the night of the guarantee did AIB go in with a guarantee, I suppose, an outline, a draft of a guarantee?
Kieran O'Donnell (Limerick City, Fine Gael)
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What was the outline of that? What was the outline of your guarantee you were looking for?
Mr. Eugene Sheehy:
The outline of the guarantee, and I don't recall whether it was a written one or not, would be: stabilise the situation immediately. The 20 ... that day globally was unbelievable and it was clear that worse things were to come internationally. So stabilise the situation. However-----
Kieran O'Donnell (Limerick City, Fine Gael)
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The specific form of a guarantee you were looking for?
Mr. Eugene Sheehy:
Well remember we have a guarantee eight days before already, a €100,000 guarantee, €200,000 for a kind of a household limit. So it wasn't ... this was to some degree an iteration of a series of steps that the State was trying to take to stabilise the situation. What we didn't know on the day when we went in was that there was an institution-specific problem which would have exacerbated and multiplied to a huge degree all the other problems we thought we had when we went into the meeting.
Kieran O'Donnell (Limerick City, Fine Gael)
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And if you were looking for both Anglo and Irish Nationwide to be nationalised?
Kieran O'Donnell (Limerick City, Fine Gael)
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Did ye have further discussions, communications with Government or officials in the Financial Regulator after the guarantee was put in place on the night of the guarantee?
Mr. Eugene Sheehy:
There were discussions in the days that followed, but frankly it ... the entire focus in the days after the guarantee were coping with what was happening globally in London and seeing how the guarantee bedded in. Our big issue actually in the days that followed the guarantee was that pricing for deposits priced up to the sovereign and there was no distinction between strong or weak institutions.
Kieran O'Donnell (Limerick City, Fine Gael)
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Can I ask you ... yes, can I ask you in the context of AIB C3b, Vol. 2, page 45, Project Omega, what was Project Omega?
Kieran O'Donnell (Limerick City, Fine Gael)
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Finance.
Kieran O'Donnell (Limerick City, Fine Gael)
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Okay.
Mr. Eugene Sheehy:
If the Minister asks you, you do look at something so we engaged in the normal corporate finance mark-up process for 60 or 70 pages of it. A fair bit of it was boilerplate stuff actually. It's not ... it wouldn't be a very heavy document. It was discussed at my forum the group executive and dismissed and resolved that it would not be pursue. And our conclusion was then reported to the board. It was not discussed by the board.
Kieran O'Donnell (Limerick City, Fine Gael)
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Not discussed by the board. Why not?
Kieran O'Donnell (Limerick City, Fine Gael)
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Okay. And did the board accept that?
Kieran O'Donnell (Limerick City, Fine Gael)
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So it was it was made known to the board.
Kieran O'Donnell (Limerick City, Fine Gael)
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Specifically. And in that ... this is a presentation to the board ... did you make this presentation, Mr. Sheehy?
Kieran O'Donnell (Limerick City, Fine Gael)
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But it wasn't...
Kieran O'Donnell (Limerick City, Fine Gael)
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And can I ask you, put in there, it said: ''In addition any transaction should only be undertaken following full due ... and would require significant Government support. Were the Government ... the Minister for Finance was he ... had he made put forward to you that they would be willing to provide support if AIB took over Anglo?
Kieran O'Donnell (Limerick City, Fine Gael)
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And did you go back to the Minister to say that would not happen, that ye were not...?
Kieran O'Donnell (Limerick City, Fine Gael)
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The final thing I want to check is on remuneration. And, Mr. Sheehy, your salary peaked in 2006 at €2.4 million per annum.
Kieran O'Donnell (Limerick City, Fine Gael)
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Total compensation, but €1.3 million of that was a bonus, right. The question I want to ask is: how could you justify such a salary? And it would appear that the remuneration scheme for higher executives was brought in under your watch, Mr. Buckley, so that you had a situation up to '04 where the bonuses weren't crazy relative to salary up to '04, but from '04, '05 on-----
Ciarán Lynch (Cork South Central, Labour)
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Maybe ... don't apply a judgment-----
Kieran O'Donnell (Limerick City, Fine Gael)
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Can I ask-----
Ciarán Lynch (Cork South Central, Labour)
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Sorry Deputy, don't apply a value judgment to the figure. Mr. Sheehy's job is to explain the judgment of the figure.
Kieran O'Donnell (Limerick City, Fine Gael)
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Mr. Sheehy, can you explain how you ended up on a salary of €2.4 million per annum and how can you justify that? And was your remuneration policy ... did it build in any element of risk in terms of a judgment of property transactions?
Kieran O'Donnell (Limerick City, Fine Gael)
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If I-----
Ciarán Lynch (Cork South Central, Labour)
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Deputy, if you ask a question, you have to allow the witness time to respond.
Kieran O'Donnell (Limerick City, Fine Gael)
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Well you'll appreciate time is limited.
Ciarán Lynch (Cork South Central, Labour)
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I do and that's why I'd ask you to keep your questions short.
Mr. Eugene Sheehy:
I would say they were not justifiable, period, okay, no matter what time you're looking at it. How were they constructed? There's a number of components, as you know. There's a salary, a bonus and there's a long-term incentive and there's ... I believe we had a robust policy around it. Large elements of the policy never worked, you know, the long-term incentives never worked because the goal ... the targets were too high. I had a personal policy of reinvesting all my bonuses in AIB stock. But, look, there's no way you could tell anybody in the street that these were acceptable levels of pay. That's a fact.
Kieran O'Donnell (Limerick City, Fine Gael)
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And the can you justify a salary of €1 million a year, a basic salary at that level in '06-'07?
Kieran O'Donnell (Limerick City, Fine Gael)
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You had a basic salary-----
Kieran O'Donnell (Limerick City, Fine Gael)
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Correct, you were just short of €1 million.
Kieran O'Donnell (Limerick City, Fine Gael)
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Well I think it's splitting hairs, Mr. Sheehy.
Ciarán Lynch (Cork South Central, Labour)
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Deputy please, please ... Sorry, Mr. Sheehy and Deputy, please questions to the Chair and responses to the Chair.
Please allow the witness to answer without a value judgment being applied. Indeed the committee in its final report will apply its own value judgments. Mr. Sheehy.
Mr. Eugene Sheehy:
Thank you. Just in general on remuneration. You know, there was a number of components to it and they were scientifically constructed. We had three external consultants who looked at it. And their methodology was to bring you into a peer group and a reference group and that was probably the biggest driver of the pay policy. I never asked and I don't know of any colleagues who ever asked the remuneration committee for a pay increase. It was kind of mechanically devolved out of a system of peer references.
And if you look at the Nyberg report you will see that AIB was much, much lower ... rather than ... of the peer group, in terms of size. So, there was a science to it. There wasn't executives going up, banging the door saying "I want more pay". It never happened. But the actual amounts that we were paid were too high ... I mean, when I came from the States I was paid a lot less over there, but they had a totally different philosophy about long-term compensation, so you could make a lot of money in the States as a bank executive if you stayed in an institution for a long time, because there was a huge upside in stock. Here there was ... actually it turned out, no upside in long-term compensation because the bar had to be ... was ... CPI plus 10% compound which is virtually impossible ... actually impossible to make, so they never vested it. I think once in ten years there might have been a small vesting. So there was flaws in the design, too much influence by peer reference, but there was no clamour among bank executives, the people who reported to me directly, for more pay.
Ciarán Lynch (Cork South Central, Labour)
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Thank you. I just want to clarify with you a couple of matters ... just finishing off that point. Very simply, Mr. Sheehy, looking back at what was the financial standing of the bank during that period, was the level of your remuneration, bonus and reward merited?
Ciarán Lynch (Cork South Central, Labour)
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I just want to clarify one thing with you, just to assist the committee and it is going back to that note of 30 September that Deputy O'Donnell related to - it is coming up on the screen in front of you. To your view, is that an accurate account of the evening's records? You are familiar with that document?
Ciarán Lynch (Cork South Central, Labour)
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I can only account, in fairness to yourself, Mr. Sheehy, the parts of those notes and those records, that it should be to yourself. I know there are records there in regards to Mr. Burrows, Mr. Hurley and others, but there are a number of points that refer to you. Do you consider that to be an accurate account?
Sean Barrett (Independent)
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Go raibh maith agat, a Chathaoirligh, and welcome to our visitors from AIB. What was proposed on the night of the guarantee was a four-bank guarantee. Was that for deposits only and how much would that guarantee have cost?
Mr. Eugene Sheehy:
Our proposal was for a four-bank guarantee. Clearly when you are discussing nationalisation, liquidation or default of an institution, that's not part ... that institution isn't part of the future, that's part of the past that has to be dealt with. We argued, I certainly argued, that the bonds should be included and the reason for that was if you looked at the mistakes that were made in the US around Lehman's and the inconsistency from day to day of the regulatory response, not only in the US but in Europe and in the UK - where we knew ... we found out subsequently there was secret loans being given to banks - you had to be clear about the message you were giving to the market. Clarity is very important. If some of those instruments weren't covered, our investor relations desk would have 100 calls within one minute about "Define exactly what you mean here". So the definition and the clarity were important.
It is worth pointing out that on the night, AIB had no bonds or subordinated debt instruments that would in any way have been enhanced by the guarantee. None. We had perpetual debt, which is irrelevant for a timed guarantee and we had dated debt, the earliest of which fell due in 2013. So there was no agenda from our point of view of getting something extra.
The pricing of the guarantee on the evening wasn't discussed. Now, we did have a reference, if you looked at the €100,000 guarantee for individuals which was introduced on 20 September, and that had a 20 basis point price on it. In the bilateral discussions that we had around pricing of the guarantee I was pushing for an FDIC model which is the US model about ... you price the guarantee relative to the risk you are taking, and the risk you are taking is based on a formula, called a CAMEL formula, which takes in capital, liquidity, management risk. It would take a bit of working to do but there was a model for pricing of guarantees that's the biggest model in the world, used by the FDIC in the US.
Sean Barrett (Independent)
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So you had two organisations left out. Were there any other differences between what the Government actually did and what you were proposing, apart from leaving out two banks?
Mr. Eugene Sheehy:
We didn't propose anything. We gave advice on ... in response to questions we were asked. We said we needed a guarantee, the system needed a guarantee of some type, because of what had happened that day and what was absolutely certain would happen over the coming days. And after that then for instance, when it came to the duration, there was a one-year duration proposed. The way the markets operate one year is actually a product, you know, 90 days is a product, there are buckets of time-based funding instruments and one year is one year for one day. It just becomes technically very difficult to do anything with a one-year guarantee, so we recommended a two-year guarantee and subsequently the European Commission came out and said that that was the only type of instrument that would have had a chance of working, less duration would not have worked.
Sean Barrett (Independent)
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But we don't know the difference between the cost of what you were proposing and what the costs turned out to be for the Government's proposals, is that right?
Mr. Eugene Sheehy:
The cost of the guarantee ... I don't know what ... I don't think it costs the State anything. The issue for the cost for the State arose when the assets of the banks fell short. I mean, the guarantee ... there was several billion in fees paid for the guarantee and it was eventually retired.
Sean Barrett (Independent)
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The regulator proposals of the McDowell report earlier in that decade ... did the banks support those or oppose them?
Sean Barrett (Independent)
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It was a proposal for a separate regulator and it was opposed by the Department of Finance and the Central Bank. There was quite a controversy at the time, probably under Mr. Buckley's term I suppose.
Ciarán Lynch (Cork South Central, Labour)
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Are you familiar with the document that Mr. McDowell, the former Attorney General, was bringing forward at the time? If you are not, I will just move on to another question.
Mr. Eugene Sheehy:
I wouldn't know the detail of it but if the question is about, you know, was the regulatory structure appropriate which ... I mean we had dealings, and I had dealings, with the FR from the time. I had some dealings with them before I left to go to the US, I had a lot of dealings with them when I came back. At the time, certainly from mid-2005 on, the focus was on consumer-related issues, as a knock-on I think from the issues that Deputy O'Donnell raised - you know, the governance issues. So there was a big focus on that, and then it was immediately kind of replaced by the three big programmes: SOX, Basel and IFRS, which totally consumed the regulator's energy and our energy, certainly through 2006 and most of 2007. So it was a ... I think the regulator at that time was taxed with a huge amount of oversight in what was happening in the market.
Ciarán Lynch (Cork South Central, Labour)
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He was described as "hopeless" in a document which was sent to you. Was that a widely held view in AIB?
Ciarán Lynch (Cork South Central, Labour)
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Dermot Gleeson ... I just need you to attribute that, Senator ... Dermot ... Mr. Gleeson's commentary of last week.
Mr. Eugene Sheehy:
It wasn't my view. As I say, I had a lot ... I had a lot of contact with the regulator and his team. I found them to be tough enough people to deal with. When all the regulatory stuff came down on the SOX, Basel, and IFRS, I know that, where I could call on battalions and experts to come in and help me out, I thought they were dreadfully under-resourced ... is my view, during ... in trying to cope with that weight of change ... technical change. I recall Mr. Gleeson's statement and I've spoken to him about it and he regrets saying it. He says it was in a fit of pique in those hours and days after the guarantee. But I found the regulator and his team to be diligent, hardworking public servants who always acted with integrity.
Sean Barrett (Independent)
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The question of property was raised by Jim O'Leary, an economist from NUI Maynooth, at the board meeting on 13 January 2004 ... at your board. What resulted from that query by Mr. O'Leary?
Ciarán Lynch (Cork South Central, Labour)
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Who's this question to, Senator?
Ciarán Lynch (Cork South Central, Labour)
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No, who are you making the question to? Mr. Buckley or Mr. Sheehy?
Sean Barrett (Independent)
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Mr. Buckley, I think, was in charge at that time.
Ciarán Lynch (Cork South Central, Labour)
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And the reference on that question there, if you have it?
Ciarán Lynch (Cork South Central, Labour)
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Thank you.
Mr. Michael Buckley:
I believe I remember, Senator, what you're talking about. Yes, I think what happened, Senator, was that Jim O'Leary, at a board meeting in, as I recall it, sort of May-June sort of time in 2004, asked for a presentation about property and construction lending from a strategy, credit quality, etc., point of view, and a detailed presentation was made to the board in October of that year, which covered all of the ... which covered all of those issues, the business strategy, where we had got to, volume growth, and credit quality. And I recall that the presentation was made by, I think, three people. One was the executive responsible for that sector, for lending to that sector from a business development point of view, another was the head of credit in the Republic of Ireland division and the third person was a senior executive from the group credit committee. And, after a wide-ranging review of our activity, our strategy, etc., the credit officers there were asked were they happy with credit quality, did they believe that the risk mitigants that were present in the portfolio were appropriate, relative to the size of the portfolio, and they answered "Yes" to all of those questions. So, in other words, they said that at that point in time, which was, as I recall, October 2004, that the quality ... the credit quality of that book was sound as far as they were concerned. And, I think ... sorry, my recollection is that after the usual questions and challenges that the board expressed itself as being happy with what they had been told.
Sean Barrett (Independent)
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Because in the group internal audit report in March 2006, which is B4, page 6, Chairman-----
Ciarán Lynch (Cork South Central, Labour)
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Of?
Sean Barrett (Independent)
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Of Vol. 1. What that states ... the audit ... 2.5 years, virtually, later than when Jim O'Leary made his comment in January 2004, the audit in 2006:
The audit did not include an assessment of property related credit quality. In addition we did not raise an issue around the management of concentration risk at a Group level as this was raised in a previous audit of the Credit Framework in 2005.
Given that we now know this is what brought the bank down, wasn't it a remarkably complacent response to the concerns of Jim O'Leary?
Ciarán Lynch (Cork South Central, Labour)
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Yes, please. Yes.
Mr. Eugene Sheehy:
Senator, if you ... it's important that I just describe how internal audit works. We agree ... I agree with them, and the chairman of the audit committee agrees, every year on a work programme, you know, what are we going to ... what do we need to look at this year? So the work programme ... so we would have asked them to follow this work programme to check out and validate that processes within each function were being carried out. And after that they rate the problems and typically they do find issues and problems there and you can see there's a rating chart - material, significant, important, and minor. If you look at this report, there wasn't any material problems identified and these factors are worked out as a money function - how much could it cost if it went wrong? But the observations, you know, I think are fair. We are ... we always needed to be given a view from fresh eyes in a process - what was going on there and what do we need to concentrate on? So we would always take these results from the audit as a call to action.
Sean Barrett (Independent)
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Thank you. Because on B2, Vol. 1, page 19, in May 2007, Dr. Alan Ahearne was making the same concerns to the board ... that property prices were 30% overvalued.
Mr. Eugene Sheehy:
Yes, we had a seminar where Dr. Ahearne and John FitzGerald attended and there was a general discussion about that. And, that would have informed our own internal stress-testing model which applied a 30% reduction to residential property as part of our one-in-25 year stress test. So we didn't ignore or dismiss his observations and we took the high end. I mean, Dr. FitzGerald had a lower estimate, but we took the 30% fall, which, of course, would have been unprecedented in experience terms but that was applied in our stress test for residential property. So it was ... his observation was taken on board and applied in the stress test.
Sean Barrett (Independent)
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But the eventual discount from the properties transferred by you to NAMA was 56%.
Mr. Eugene Sheehy:
Yes. Of course the ... not all the property was transferred to NAMA so ... but even still I count ... dismissing that mathematical effect on the percentage, we all know that the decline in property prices was far higher than anybody expected, worse than the one-in-25 year expectation.
Sean Barrett (Independent)
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Mr. Forde told us that the threshold submission to the group credit committee for loan approval was raised from €40 million in 2005 to €75 million in 2006. That's an 88% increase. Did that indicate that this ... we were getting out of touch with ... a property bubble ... to raise the threshold by 88%?
Mr. Eugene Sheehy:
The thresholds and the levels of sanction are driven by a number of factors. There's the absolute amount, which you have quoted. There's the sensitivity of the amount to the grade of the sanction, and you will see in the matrix that the poorer grades weren't increased. So you don't increase the lending sanction for the poorer grades; you do for the better grades. And there's also the link between the sanction amounts and own funds. You know, how much can you put on risk of your own funds? There was no increase in the amount of risk you could put on own funds because own ... I'm talking about equity, because that had increased in the same period, so that was capped at 2.1% of own funds. The worst performing grades were not increased. So it wasn't a ... the numbers look significant but it was a fairly logical thing to do at the time.
Sean Barrett (Independent)
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Could I draw attention, Chairman, to B1, Vol. 1, page 62?
There's increase in exposure to a company from €789 million to €991 million where the large ... the group large exposure policy limit was €150 million. So the increase alone at one board meeting was greater than the limit and the eventual ... the new limit was six times what the original one was. Again, did that not illustrate a lending policy which was becoming reckless?
Mr. Eugene Sheehy:
I absolutely reject reference to the word "reckless". If you look at that reference there to, on page 62 ... that discussion was supported by a 64 page submission on that credit. It was quite detailed. It's a very large number, but there were very large deals going on at the time. It was participation in a syndicated loan actually. The methodology used there was that when loans went over certain limits, they went to the next level of authority. And they carried with them the approvals and arguments that the various levels prior to that had made. In this case, when we looked at it and it went to board, there was a lot of support. The individual had enormously, much higher net worth, there was professional evaluations, there was in overall, I think, a loan-to-value of around 50% in the entire exposure. So there was ... logically it made sense at the time.
Sean Barrett (Independent)
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Yes. The name is redacted. Do we know if this one went to NAMA?
Mr. Eugene Sheehy:
Yes. And I'll just ... could I make one reference from the comptroller and auditor's report on NAMA in 2014? And he says:
There is an apparent inverse relationship between the level of debt and the relative impairment charges for individual debtors at the end of 2012. The rate of impairment for those debtors who owed over €1 billion or more where their loans were acquired was just over 4%. While those whose debts were less than €75 million at acquisition, the impairment was around 21%.
I couldn't have anticipated that at the time and neither did NAMA at the time, but sometimes the bigger relationships because of the diversification that they had, you know ... typically they would all have had significant UK exposure-----
Ciarán Lynch (Cork South Central, Labour)
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Five minutes now, Senator.
Sean Barrett (Independent)
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The decision to pay the dividend of €270 million on 26 September 2008 ... that seems incredible in retrospect.
Ciarán Lynch (Cork South Central, Labour)
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Sorry, that's a leading question, just ask for some ... we all know how much was paid. And I'm sure Mr. Sheehy has a view on it now.
Mr. Eugene Sheehy:
First of all, the decision to pay the increased internal dividend was not taken on 26 September 2008. The dividend was paid on 26 September 2008. The decision to pay the dividend was taken in July 2008, for the half year ended June 2008. This is two months prior to Lehman's and the general collapse of the markets. In addition, the question implies that the dividend was ... extra dividend was €270 million. The dividend ... the interim dividend is always smaller than the final dividend. Generally it is a kind of two thirds, one third split. Our interim dividend for the previous half year, June 2006 was 27.2 cent per share. We have 878 million shares, that was increased by 2.8 cent per share, a total cost of €24.58 million. So the €270 million that was paid on 29 September, approved in July, was made up of €270 million, of which €24 million was the increase.
Why did we make that decision? First of all, if the decision was being made in September, no dividend would have been paid. In the post-Lehman's world, no dividend would have been paid. All bets were off at that stage. So when we declared a dividend, communicated it to market ... that notice is filed on the Stock Exchange. It is now a mandatory, contractual obligation to pay the dividend, so you have no leeway to change your mind after you declare it. It is contracted. Shares are bought on the market, either ex or cum dividend from the date you make the declaration.
We wouldn't have paid the dividend in September, if that was when we were making the decision so that's my answer there.
Sean Barrett (Independent)
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Could I just return, finally, Chairman, to B5 on page 5? It's a question on which Deputy O'Donnell has raised but these references are a year later and a year closer to the crisis. The payment to the four executive directors was €6.4 million, of which yours was €2.1 million. Was there still no evidence that this was a banking model which was going to cost the taxpayers a lot of money very quickly?
Sean Barrett (Independent)
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This is '07. The document is B5 and the page number is five. And the payments ... the total are Mr. Doherty, €1.663 million; Mr. Forde, €1.394 million; Mr. O'Donnell, €1.273 million; and Mr. Sheehy, €2.105 million. And the total, €6.435 million.
Sean Barrett (Independent)
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Thank you very much. Thank you, Chairman.
Ciarán Lynch (Cork South Central, Labour)
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Okay, was there much discussion on this matter, Mr. Sheehy? Did it ... was it decided over one board meeting or a series of meetings?
Ciarán Lynch (Cork South Central, Labour)
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Yes.
Mr. Eugene Sheehy:
-----is decided by a separate committee of the board who are advised generally in the absence of the CEO. The CEO would come in when, obviously not when you're there ... not when your own pay is being decided. And the way it worked was, there would be a review of the financials, a review of general governance and behaviour you know did you meet all those criteria . And then a presentation by ... at the time we used a firm called Kepler.
Ciarán Lynch (Cork South Central, Labour)
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A presentation to the senior board or at that board?
Ciarán Lynch (Cork South Central, Labour)
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The remuneration committee, okay.
Ciarán Lynch (Cork South Central, Labour)
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And this would be decided over one board meeting or over many when it would come up?
Ciarán Lynch (Cork South Central, Labour)
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I would understand that the remuneration committee would be looking at this quite extensively because that's their job but the board would be the board that would sign off on it. How long would the board give to considering this issue then, because ultimately they have to sanction it?
Ciarán Lynch (Cork South Central, Labour)
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Okay.
Ciarán Lynch (Cork South Central, Labour)
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Okay.
Ciarán Lynch (Cork South Central, Labour)
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I am aware of how the structure is. And at the senior board level, was there any dissenting voice there? Somebody says look, maybe this is too much this year, maybe there's ... you know, we need to kind of make a measured approach. There's a lot of concern out there. Maybe we should defer it. Any of this-----
Ciarán Lynch (Cork South Central, Labour)
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I just want to deal with a couple of issues there just before we tidy up before the break. This relates to the quality of the business model, setting process, just to tidy up there from some of the questions that may be outstanding before we go for a break.
We will be referring to core documents AIB B2, Vol. 1 and that is AIB reference 01278, page 19, paragraph two. What I want to explore with you, Mr. Sheehy, here is the development of the bank's business strategy. I would imagine that this is one of the main responsibilities of the board and try to maybe establish with you how much board time was being taken up with regard to the strategy.
And the sort of time that was devoted to discussing the development of the sustainable business strategy. So maybe just to begin with that question, how regularly and how often was the business model that was being operated under your tenure being discussed at board level?
Mr. Eugene Sheehy:
Chairman, you'll see from the board minutes that there was in almost all board meetings a business presentation. What we tried to do, given the diversity of the business, was to bring a business to the board every month and say here's this business this is how it's going. So all the businesses were run through, you wouldn't get through them all in one year, what their strategy was, what the market conditions were and that included a property business as you know there was ... they did two or three of those presentations. So the board wanted and demanded to meet businesses and to get a strategic view of where those businesses were going. So that was an ongoing process and part of the planning process. In relation to the overall strategy of the board ... the board obviously got the annual budget and it got a rolling five-year plan as well and to some degree they were linked to remuneration.
Ciarán Lynch (Cork South Central, Labour)
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It's not really on the remuneration issue I'm talking to you, Mr. Sheehy, it would be in regard to the concentrations in property sector lending this is a sustainable business model was there commentary on the board, like we've heard testimony from other witnesses here about what's called the "grow-fast model". Was people saying that we're now begin to mirroring the grow-fast model, that our concentration levels in particular sectors, particularly property, are maybe growing beyond what would be the traditional approach that we've taken? Was there any ... because our examination records are not indicating that, so maybe there's something that we're not seeing that you could tell us this morning that would demonstrate that these concerns were being expressed at AIB level ... at senior board level.
Ciarán Lynch (Cork South Central, Labour)
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I'm sure it was discussed and maybe it was discussed in the context that "We're going to have another bumper year this year, that our growth is going to be X and all the rest of it and that our lending targets are being reached", if there were targets in place and so forth, but was anybody at board level saying there is a concern here with how the business model is developing?
Mr. Eugene Sheehy:
Well ... those questions were all asked in the context of the credit report, you know the, the half-yearly credit report. Just in ... to put a bit of context on it, Chairman ... the Republic of Ireland business accounted for 43% of the group profits and the property division in the Republic of Ireland accounted for 25% of ROI's profits. So you're talking about between 13% and 15% of the group profits related to this part of the bank that caused, you know, our demise, effectively. So the board had a lot of things to look at but they did look at the property concentration and general what's the view on the market, what are we hearing from our customers, what's the macro indicators. That was a constant, as you can imagine, a constant part of the dialogue of the board.
Ciarán Lynch (Cork South Central, Labour)
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Okay, maybe jump forward a couple of years so, and I want to refer to the ... because I'm still looking at the adequacy of board oversight in regard to internal controls and to ensuring that risk was properly identified, managed and monitored which is what we're talking about now. And I'll go to core document AIB B17 ... B1 ... page 79 and 80. And this relates to EC, under EC treaty rules the bank was obliged to submit a restructuring plan to the EU Commission and this was finalised in April 2010. It was further updated in 2011 and further revised again in 2012. Now the question I'm putting to you here, Mr. Sheehy, in it's revised 2012 EU restructuring plan, paragraph 3.9, AIB acknowledges that its decision to expand into property was misguided and that its risk management and internal governance systems were not as effective as they should have been in controlling this risk. Now could you please comment upon this and maybe come to them in regard to your earlier comments to me as well.
Ciarán Lynch (Cork South Central, Labour)
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So would you believe that, going back to our earlier discussion on the earlier question, that at board level, was there enough attention being paid or was there enough cognisance of the concerns that may have been operating in the banking model operated by AIB at that time?
Ciarán Lynch (Cork South Central, Labour)
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And would you see the comment you just made to me as then being congruent with the position that AIB acknowledges its decision to expand into property was misguided and that its risk management and internal governance systems were not as effective as they should have been in controlling this risk?
Ciarán Lynch (Cork South Central, Labour)
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Which an examination of that period as opposed-----
Ciarán Lynch (Cork South Central, Labour)
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Okay but you would see that ... both your position and this position as being congruent?
Ciarán Lynch (Cork South Central, Labour)
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Okay, thank you very much. I now propose that we take a break and that we return at 11.25. Is that agreed? Agreed.
Ciarán Lynch (Cork South Central, Labour)
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Okay. Everyone back in the room and seated and, this is to remind myself as well, with their phones readjusted to flight mode. We will resume business, okay? All right. So, I am now bringing the meeting back into public session. Is that agreed? Agreed. And just one other matter there, Mr. Buckley, before I bring in Senator O'Keeffe, is if I could just come to yourself, maybe just to explore and get some understanding of the access ... the relationships had ... the access and relationship particularly how ... the relationship that AIB had with the Financial Regulator, the Central Bank and the Department of Finance, okay. And a ... the nature and the appropriateness of that relationship between the Central Bank, the Department of Finance and the banking institutions, in this specific case, AIB. What did you see, Mr. Buckley, as the main purpose and indeed the main outcome of the round-table discussions held with the Central Bank post-publication of the financial stability reports from 2004 onwards?
Mr. Michael Buckley:
Chairman, I don't have a very clear recollection of those round-table events or of their connection with the financial stability report. I do remember one, and there may only have been one in my time of those meetings, I do remember one meeting to which all of the chief executives and local managing directors of the banks were invited by the chairman of the Central Bank. I think I have alluded to something I said at it in my ... in my ... in my written statement and my recollection at that meeting, if I am right, if that is the meeting you are alluding to, or one of those meetings, is that it was a meeting at which the chairman of the Central Bank would've gone through that report and would've asked those in the room to ... whether they had any comments or whether they had any issues, would've talked about the banking market in very general terms.
So, I would have recalled it as a pretty unstructured meeting in itself. If that's answering your question-----
Ciarán Lynch (Cork South Central, Labour)
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And during that time, because I know you retired in 2005, but how would you maybe characterise the bank's relationship with the Financial Regulator in the period from 2003 until 2005? Mr. Gleeson gave a kind of analogy last week about referees and the relationship, that teams on the pitch have a referee. How would you describe your relationship?
Ciarán Lynch (Cork South Central, Labour)
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Mr. Gleeson, my apologies. Mr. Gleeson, yes.
Mr. Michael Buckley:
If I could start in 2002, Chairman. My first big interaction with the Central Bank in its prudential role was in 2002 when we had the Allfirst fraud. As you can see, it has marked my recall of my whole time as CEO, but there I found .... what happened at the stage was that we had to deal with a whole lot of regulatory intervention from the Federal Reserve in New York because, remember the fraud had happened in a US-regulated bank with a subsidiary of ours and the local regulator, and what I found was that there was a very professional, very thorough approach adopted by both of the regulators. They worked together, very closely, we had to sign up a memorandum of understanding, we had to undertake a very detailed programme of remedial action. That programme was given oversight by a man called John Hyman, who had been the previous controller ... one of the previous controllers of the currency in the USA. So, and we worked our way very thoroughly. I put one of my most senior executives full time on making sure we met all the requirements. So, in that case I found the regulator acting, if you like, in its prudential mode, behaved very professionally.
The second thing, I'd say, and I am sorry if I'm taking too long but I just want to give you a balanced account. In the FX charges and related issues that came up during 2003-04 which Deputy O'Donnell has already referred to, I found that the regulator which at this stage was on the conduct side, the customer side of it, was very proactive, was very demanding, rightly, as I would say. And again, I found that we got into that way of independent investigation, independent oversight, we had a former Comptroller and Auditor General involved, we had a former Governor of the Central Bank involved. And I found that that relationship was properly demanding from the regulator.
Now, other than those two big crisis events, I would have interacted with the regulator ... and other than the meeting that you mentioned in the beginning ... I would have interacted with the regulator a couple of times a year when our interim results were coming out and when our annual results were coming out, the process was that myself and my finance director would go in the day before, before we made the market announcement, into the Central Bank and have a meeting with the prudential side of the Central Bank. We would present our results to them, they were ... if you like ... we were open to any questions they would ask us and I suppose my recall of those meetings is that ... and I think I mentioned this in my written statement, that they weren't very demanding, they weren't very probing. So, they are my three bits-----
Ciarán Lynch (Cork South Central, Labour)
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Sure.
Ciarán Lynch (Cork South Central, Labour)
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So, during the visits by the Financial Regulator, did the bank ever contact the ... subsequently then financially ... or contact the Financial Regulator or the Central Bank Governor directly in respect to any issue arising from a supervisory visit from the Financial Regulator to your bank?
Mr. Michael Buckley:
Well, we would have had, I suppose, my recall of all of that time, is that we would have had a huge amount of interaction, largely like to a fairly considerable extent through our head of compliance at the time but that there was continuous interaction on any issue which raised, if you like, conduct problems or where we were investigating issues that had been raised directly or by us with the Central Bank. We would have a lot of interaction----
Ciarán Lynch (Cork South Central, Labour)
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Mr. Gleeson, in his testimony last week, as I said, familiarised or kind of similarised the role of the regulator as being something like a referee. Now, if to develop upon Mr. Gleeson's analogy of ... a sporting analogy, referees in different codes of sport have different responses to them. In rugby, if the captain acts, operates in a very, maybe, described as a gentlemanly sort of role with the referee, and in soccer terms, maybe the players go nose to nose with the referee. What sort of approach did the AIB take, if they had concerns, as to how the refereeing was taking place, and Mr. Gleeson was saying that it was a very competitive market and the referee should have stepped in to calm things down. But players themselves have a responsibility to come to the referee to say ... at any stage, did you go to the regulator's office and say, "The model as it is developing at the moment, is of concern to us and we would like you to make an intervention"?
Ciarán Lynch (Cork South Central, Labour)
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Thank you. Senator O'Keeffe, ten minutes.
Susan O'Keeffe (Labour)
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Thank you, Chair. Mr. Buckley, can I ask you specifically on page 8 of your statement, you say there were periodic requests from the Central Bank Financial Regulator, usually addressed to the chair of the AIB, raising concerns about and asking for reports on the mortgage market and AIB's lending strategy in relation to it. Can you tell us what sort of concerns were being raised at that point? And specifically, the concerns that they were raising.
Mr. Michael Buckley:
Okay, okay. I can remember during my time a couple of pieces of work that the regulator had asked us to do on mortgages and essentially the concerns that the regulator was raising was, you know, were we happy that the level of risk we were taking on in the mortgage market was appropriate. Now, could I give you a little bit of background ... only ... I know you don't have much time.
Susan O'Keeffe (Labour)
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I don't and I just specifically want to know what the concerns were, Mr. Buckley.
Mr. Michael Buckley:
The concerns were generalised concerns about the mortgage market where LTVs in particular were going, loan-to-value ratios and our response - we would have been a bank who was dragged up the curve by the market in terms of LTVs, because the pace was set by Bank of Scotland, by Ulster Bank, other banks like that and I remember very clearly that our reports back to the regulator would say, "Yes we do give some 90% mortgages", of whatever number we would have been using, but we are very careful that our policies in relation to giving those sort of mortgages confined them to either to applicants, who are in a special place by virtue of their jobs and their career prospects, let's say, people in certain professions and second of all, people who were getting significant support from family sources to, in a sense, supplement deposits and things like that, or supplement their repayment capacity.
Susan O'Keeffe (Labour)
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Was the Financial Regulator concerned about anything that AIB was doing?
Susan O'Keeffe (Labour)
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Not specifically-----
Susan O'Keeffe (Labour)
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Thank you. Mr. Sheehy, when Mr. Forde was with us here last week, he said that there were meetings going on all over August and September, that there was rising concern in the bank, there were management meetings at the weekend and so on. So, he said ... I asked "Was there a very clear understanding that things were getting very serious?" "Yes". "For everybody including yourselves?" "Yes". "And that it could be fatal?" "Yes, that's fair enough to say". What would you say to that remark that Mr. Forde made, as a colleague of yours?
Susan O'Keeffe (Labour)
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In that situation, the bank went ahead as discussed earlier and paid the dividend, because it had been agreed ... I think you told us in June, July?
Susan O'Keeffe (Labour)
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Contractually obligated.
Susan O'Keeffe (Labour)
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So, you yourselves were in a declining situation at that time, you were having meetings, you were concerned about the fate of the bank, there was ... but you still had to go ahead and pay the dividend. Have I understood that correctly?
Susan O'Keeffe (Labour)
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Yes, and so that brings us back, I suppose, perhaps to the remark that is attributed to you that night ... that ... about the bankruptcy remark that you've discussed earlier. Is it possible that in that context, you may have been arguing that, well, if we are illiquid, we will be insolvent?
Susan O'Keeffe (Labour)
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You had no concerns.
Susan O'Keeffe (Labour)
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Okay. Why did Bank of Ireland and AIB ask to meet Government rather than Government ask to meet you or, again, have we understood that correctly from the contemporaneous note, that you guys made the request?
Susan O'Keeffe (Labour)
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Why did you make the request?
Susan O'Keeffe (Labour)
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Had the Government made any indication that day or the previous day that they wanted to talk to you?
Mr. Eugene Sheehy:
I think I was talking to officials every day, probably continuously, for 30 days before that. I mean, there was a daily dialogue, there was a daily update on liquidity to the Central Bank. It would be wrong to say there was an event and then a break, it was a continuous contact and dialogue.
Susan O'Keeffe (Labour)
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So, forgive me, I want to go back and clarify the matter about what you actually brought to that meeting because both the contemporaneous notes, yourselves and Mr. Gleeson, you say "We had drawn up an alternative form", and he refers to ... he said, you know, that the Government ... "We had an extensive formula which was eventually adopted later in the night pretty well word for word". They were your contemporaneous notes in 2008, both of you. In 2015 both of you now are arguing that it was, a piece of paper in Mr. Gleeson's case, torn out of a notebook, in your case, I think you said this morning, a slip of paper. So I'm just ... I am confused. I believe other people may also be confused, so if you could clarify your contemporaneous note versus your recollection now.
Susan O'Keeffe (Labour)
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You say "We had drawn up an alternative form" on page 3 of your contemporaneous note.
Mr. Eugene Sheehy:
And that may have happened in the anteroom that we were in. The honest answer ... I cannot remember the piece of paper. We were certainly in dialogue with the Government about technical issues of what should be in, what shouldn't be in, we could have written it out. I have no piece of paper as a record of the night other than my note. If we wrote something down we might have handed it over but it certainly would have been a very informal piece ... if it happened, and I'm not going to try to read into the record something that I'm not sure of. I just don't remember it.
Susan O'Keeffe (Labour)
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What was it you wanted to see Government about then? Why did you want to go ... if it wasn't with something in your hand, and you say it wasn't, then what did you go to do?
Mr. Eugene Sheehy:
Well, we felt that on the day, the 29th, with everything that happened globally, that we needed to see the Government, because we were looking at what was going to ... what could happen if you did nothing. That's the problem. What would happen if you did nothing? The Government had already brought out a guarantee on the 20th, which was quite a substantial increase on the previous one. We had adequate liquidity and when we say that we have enough liquidity 'til the end of October or five or six weeks, that assumes that you never get another cent. That's a kind of a ... you know if you keep on funding that keeps on moving out. But you have to take a point in time. The point in time situation was that if the markets froze totally, and there was no reason for an observer, looking at 29 September, to say "I know what's going to happen tomorrow" because nobody knew what was going to happen tomorrow.
Susan O'Keeffe (Labour)
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You've all remarked, pretty much everyone that's come here before us, that you were all very surprised at the fact that all the banks were included. When you heard all the banks were included on the following morning, did you call anybody, did you ring the Department of Finance, did you have any ... "My God, what's happened, why did you do that? We left thinking it was four and now it's six". Or did you just sit down and go "Well there we are"?
Susan O'Keeffe (Labour)
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No, I'm sorry, with due respect, Mr. Sheehy, I didn't ask you to ... if you'd came out. I asked you if you were on the phone to anybody asking "Why?", "What had happened?", "What had changed?".
Susan O'Keeffe (Labour)
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So you'd argued to have the other two banks excluded but when they were included, you just got on with it?
Susan O'Keeffe (Labour)
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Can I ask you whether you personally ever invested in property?
Susan O'Keeffe (Labour)
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Okay. Were you ever in the Galway tent?
Susan O'Keeffe (Labour)
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You were. Did you ever have hospitality with property developers?
Mr. Eugene Sheehy:
No. I met, I think, two developers in the space of my tenure. One was just a courtesy call to a meeting, somebody who I dealt with when I was a branch manager 20 years before, and the other one was a serious meeting of a developer who owed us a lot of money and I wanted to make the point with the team that things were serious and he would have to-----
Susan O'Keeffe (Labour)
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Finally, Mr. Sheehy, this morning ... you apologised and Mr. Buckley expressed regret, and yet listening to some of the remarks today, I'm still not clear what you're apologising for.
Susan O'Keeffe (Labour)
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You could have stopped it?
Ciarán Lynch (Cork South Central, Labour)
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Deputy John Paul Phelan. Deputy, ten minutes.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Thank you, Chair. Gentlemen, I just want to follow on from that question from Senator O'Keeffe in relation to decisions that could have been made, that Mr. Sheehy has just referenced. Was there any point in your own tenure that you expressed concerns about the concentration of lending in the property and development sectors that you can recall?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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To go back to previous questioning about the guidelines that existed from the Financial Regulator, and, you know, on concentration limits, 200% for a sector and 250% for two related sectors. The constant answer that we've had from other witnesses, including yourselves, is that, you know, a changeover was taking place to Basel II. Did you not, or did you, have any personal qualms about the fact that not only was AIB breaching those sectoral requirements while you were chief executive, but that the breach actually grew once it had been pointed out?
Mr. Eugene Sheehy:
Well, first of all I was glad I was aware of it and that it was formally reported and dealt with, you know, in above-board fashion. I took comfort from the fact that it was in transition and it's not possible to totally ignore the context of what you're doing at the time, which was an absolute change from that model, of a kind of a stock percentage model, to a risk-based model. That was what we signed up for. We were in the process of a formal application to change. We were in constant dialogue about what that involved, how the models would work and the regulator was in touch with us. So, point in time, you know, you can say this was happening but there was also a continuous activity going on, changing from that model to another one, with both sides who were involved in it totally participating.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Outside of the continuous ... I can't remember the exact quote but to paraphrase you, you said that "The issue of sector lending was discussed at board level a number of times". Were there any concrete actions, ever, in your time, from the board of AIB ... decisions on addressing the issue of over concentration in the construction and the property sectors?
Mr. Eugene Sheehy:
Well you can see from some of the board minutes the ... when the credit people reported in the half-yearly reports, they would be asked to come back with more information about residential development, and then there subsequently was a ... there was a presentation on that. So there was a dialogue, requests, requests to come back and that happened.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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But was there ... were there any concrete actions taken following that dialogue which took place over a long period of time or was it just continuous dialogue with no actions?
Mr. Eugene Sheehy:
Well, there are always actions and, you know, in the risk and credit functions and the sector teams there was constant change in terms of trying to develop better MIS, getting more market intelligence about what was happening. So it wasn't a static thing, it's an organic thing, you're constantly changing ... the market is constantly changing, you're constantly trying to grapple with the conditions when the loan was made, the conditions now, you're reviewing the loan, you're looking at the customer's cash flows, so it's ... it's quite an organic and dynamic process.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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But taking that into account, how then did the concentration continue to grow in that sector right up until virtually the edge of the collapse?
Mr. Eugene Sheehy:
Well, towards the back-end of the collapse it was simply the market freezing and that ... there was interest roll-up because there was cash flow problems generally in the second half of '08.
Prior to that, we ... our application went in in January '08 for Basel, which was accepted. The regulator didn't change the sector limits at the same time as they got the application and accepted it, that would actually change those limits, and you can see from subsequent correspondence that they intended to engage in a series of meetings to change those limits all the way up to 2010, but those discussions have never happened.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Can I just change for a second briefly to ask you, Mr. Sheehy, in relation again to your time as chief executive, the targets that were set by the board in relation to earnings per share, did you feel at the time and in the context of where the market was, that they were sustainable?
Mr. Eugene Sheehy:
You will see from my written statement that in September '05, I changed when I wrote to the divisions for the planning cycle. There was a five-year rolling view of EPS growth, which was 12% compound, and I moderated it at that time. I stated why I wanted to moderate it. There are all sorts ... there is a mathematical reason, obviously it gets harder to grow on growth. That is one thing. The UK was beginning to soften. We had the three big regulatory projects coming down which were going to cost ... they did cost in excess of €200 million. There was salary cost pressures all the way through the bank because of competitive forces and funding was getting more expensive, so I took it down from 12% to 10%, which is the same as putting an average growth back from 15% to 12%. So I did moderate it because it wasn't sustainable and just as a by the way, changing that measure of five-year plan eliminated the possibility, if those plans were met, of all the LTIPs, the long-term incentive plans, vesting. They couldn't vest because the plan now was less than the minimum hurdle required for them to vest, which was CPI plus 10% compound.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Can I ask you in relation to the night of the guarantee and the quote that was put by the Chairman and Deputy O'Donnell in relation to the memo? You have more or less ... well you have said that you can't recollect using the phrase. Would it be in your view, or not, a fair statement to say that an official of the Department of Finance who obviously took that memo could have interpreted your comments on the night to mean that there were bankruptcy issues facing AIB in the immediate term on that particular night?
Ciarán Lynch (Cork South Central, Labour)
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The document that was displayed earlier, Deputy Phelan. Yes, okay. Fine.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Can I ask, did you see Mr. Gleeson's testimony to the committee?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Is there anything in it that you disagree with?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Was there ever a time when you were working with him, when he was your chairman, that he overruled a position that you held on lending concentrations within the bank or on the general direction of the bank?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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And was there any point in your time that you yourself held the view that sectoral concentrations in construction and development were too high and you wanted to take the bank in a different direction?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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I briefly wish to turn to Mr. Buckley. You stated, and this reference was made earlier - B1, Vol. 1, page 16. It is the Jim O'Leary quote again, which was from a minute from 13 January 2004. You said that there was a presentation to the board following on from that in October 2004. Was it customary that it would take nine months to act on a reservation expressed by a pretty senior economist who was a member of the board, who raised significant concerns in ... at the start of 2004?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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You can. Yes.
Ciarán Lynch (Cork South Central, Labour)
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Yes.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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It is a redacted page.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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It is B1, Vol. 1, page 16.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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The only thing that's not redacted is the reference to Jim O'Leary's comment.
Mr. Michael Buckley:
Okay. I ... so what the minute says is on the suggestion of Mr. O'Leary it was agreed that policy in respect of lending to the building and construction sector should be reviewed by the board in the near future. So, I would just say that what it doesn't say is that Mr. O'Leary expressed serious concerns about our approach to property and construction. He wanted a presentation, a complete presentation, so that-----
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Do you believe it was satisfactory that ... I have only four seconds left-----
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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-----that it took nine months for an action to be taken on what was an issue being flagged at least at that time?
Mr. Michael Buckley:
Sure. But I don't know that it was being flagged in such an urgent way that it required a presentation the next month. I don't know, Deputy. I mean, I think you make a fair point. I just don't remember why it took eight or nine months but when it came it was an incredibly detailed presentation, which is maybe one part of the explanation, and the credit people as well as the business development people were there together so that everybody on the board could get a sense of the balance.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Were there actions taken on foot of the presentation?
Ciarán Lynch (Cork South Central, Labour)
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Your final question now, Deputy.
Mr. Michael Buckley:
Well, when the presentation was made, there was an opportunity for the board to discuss any aspect of it, and the board did not look for any change in policy or anything of that nature as a result of the presentation, and that includes the person who asked for the presentation in the first instance.
Ciarán Lynch (Cork South Central, Labour)
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I just want to-----
Ciarán Lynch (Cork South Central, Labour)
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-----just return to the issue of the earning per share there that Deputy Phelan raised with you. Would it be fair to say, just as an outsider, who may be analysing a bank's performance, that the earning per share that a bank would be delivering would be a key performance indicator by which investors might actually judge the relevant attractiveness of a company as an investment opportunity?
Ciarán Lynch (Cork South Central, Labour)
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Top of the pyramid, you reckon, yes.
Ciarán Lynch (Cork South Central, Labour)
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Okay. So in that regard, was it your view that the levels of earnings and the ... in earning per share growth targets set by the board, given the maturity of the market, what was your view on that? You were setting quite significant targets as to what the return should be in this, which would be attracting investors.
Ciarán Lynch (Cork South Central, Labour)
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Okay.
Mr. Eugene Sheehy:
At the time the market ... we would have been coming in at below the averages in the market. We weren't as fast growing as the medians and that was another one of the reasons why the long-term incentive plans never vested. So, the commentators and investors would have regarded our guidance to the market as moderate.
Ciarán Lynch (Cork South Central, Labour)
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And was the earning per share in terms of how the dividend would be arrived at, was that driven or did it have a reliance on the property and construction lending that AIB were engaging in? How related or relevant would it have been to that?
Mr. Eugene Sheehy:
The property and construction was obviously a component of it but, you know ... so 43% of profits came from ROI, one quarter of them came from the Irish property book. No matter what way you look at it, it wouldn't have been significant enough in a weighting to drive the number significantly. I mean, we were actually growing faster throughout this period in capital markets and Poland than we were in Ireland.
Ciarán Lynch (Cork South Central, Labour)
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Okay, thank you. Deputy Joe Higgins.
Joe Higgins (Dublin West, Socialist Party)
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Gentlemen, can I ask you if you're aware of the testimony of Professor Bill Black to the inquiry?
Joe Higgins (Dublin West, Socialist Party)
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Yes. In his testimony, Professor Black, who was a renowned regulator and prosecutor of financial institutions that failed in the United States, said that there was a recipe which banks followed which ... that if banks followed, which would "produce the worst losses and is most likely to cause hyper-inflated bubbles" and that recipe includes grow like crazy, and he mentions 25%, and he mentions growth way ahead of economic growth nationally, and also make terrible quality loans.
And Professor Black, you will have seen, said three sure things follow: record profits from the institution, then, quote, second: "Under modern executive compensation the senior leadership will promptly be made wealthy" and three, catastrophic losses. Now, gentlemen, can I ask you both, in view of the fact that Allied Irish Bank's growth in 2004 in its balance sheet was 25%; 37.5% in 2005. The bank made record profits in those years. The remuneration of senior personnel was at record levels and then there followed a huge crash. Do you recognise Professor Black's analysis in terms of Allied Irish Bank and do you agree with it?
Mr. Eugene Sheehy:
Thank you, Deputy. I think most of Professor Black's observations were based on his US experience, and he did make references to liar loans and the like. In general terms, you know, he is trying to transfer the ... his US observations into the Irish market. When you look at, you know, what he said, if you do grow loans and there is a market crash, which is a one-in-100-year event, banks are going to suffer greatly. Banks absorb the risk between short money and long money and when there's a problem of that nature, it will materialise in falling asset values and problems for banks. So, in general, I agree with his observations. In AIB, our economy was, in those years, held up as probably the highest-performing economy in the world. Our demographics were totally different to the market that he was drawing reference to. So, some of his analogies, you know, are right, but I think the basis from which he is extrapolating one observation to another is fundamentally unsound because it was a different, totally different, economy.
Joe Higgins (Dublin West, Socialist Party)
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Yes, briefly, thanks.
Mr. Michael Buckley:
-----talk about my time in respect of that. I'll be very brief. The point I would make, I've made it in my opening statement, which is that in the period that I'm talking about, up to this time, 2005, you know, we were in - we, as in the economy - was in a big, big catch-up phase. I mean, you can't ignore the fact ... sorry, one can't ignore the fact that the population did increase by a million over that period of '71 to 2001; that the labour force had increased by 32%; that the employed population had increased by 49%. I mean, people had to be housed, they had to go shopping. They were moving into urban areas from the country on a continuous basis, so I think the Irish economic situation was a bit different to, if you like, the model that ... I haven't read his testimony, but-----
Joe Higgins (Dublin West, Socialist Party)
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Can I put it to you, gentlemen, that already by the 1990s there was a substantial body of study of banking crises internationally, which had all the features, virtually, of what happened in Ireland? Mr. Black, for example, supplements ... or his analysis is supplemented by an article written in 1993 by two Berkeley professors, one of whom, George Akerlof, in a Nobel laureate. I don't expect you or I ... my question isn't predicated on you having read this article. It is referred to by Professor Black in his evidence. The article in question, "Looting: The Economic Underworld of Bankruptcy for Profit", lays out precisely the strategy I have discussed. I quote from that article:
Our theoretical analysis shows that an economic underground came come to life if firms have an incentive to go broke for profit at society's expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations. Bankruptcy for profit occurs most commonly when a government guarantees a firm's debt obligations.
That was in 1993. Mr. Sheehy, could I ask you why, considering the substantial body of literature that exists and analysis, which I don't have time to go into, why were you chief regulators, or risk officers, and indeed yourselves, as senior officers, were you aware of this analysis of banking crises? Even Sweden, a few years before you came in to-----
Ciarán Lynch (Cork South Central, Labour)
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Deputy, I'm going to have to allow time for a response as well for the questions made.
Joe Higgins (Dublin West, Socialist Party)
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Yes. Why would you not have been aware of this, or were you?
Joe Higgins (Dublin West, Socialist Party)
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I was just quoting the-----
Mr. Eugene Sheehy:
Yes, but you quoted it to me and you framed the question from that quote. That is not the case, never was the case. The people in the bank that I had the privilege of working with, by and large, almost entirely, totally committed to doing a good job and having a long career in the bank. That was what people ... that's what motivated people. I've never met anybody in the bank, or in any of ... most of the other banks that I've met who had anything other than a long-term, stable, repeat business, grow your market share, stay there for the long haul, that's the way people operated in the bank and all the records and all the references in any of the documents you'd have seen would confirm that.
Joe Higgins (Dublin West, Socialist Party)
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Mr. Sheehy, Professor Black says that there is a perverse incentive for senior executives to increase the balance sheet because it's linked to their salary and bonuses. The record of AIB, annual reports will show, that your remuneration substantially increased, along with a substantial increase in the balance sheet growth. Was Professor Black correct?
Mr. Eugene Sheehy:
He wasn't. As I explained earlier on, the remuneration of the chief executive officer - me, when I was there - was based on market comparisons and norms. I told the remuneration committee and the board - and they knew it very clearly, as did the director, as did the chairman - that I wanted my salary to be the lowest in its peer group, relative to the size of the bank, and that's in the Nyberg report, page 7, there's a chart of it there. So, there was no relationship, none whatsoever, between my salary and the size of the bank's balance sheet. That's a fact. You can look up the remuneration committee notes. You can look up the terms of the remuneration committee. The factors that went into it, the discussions at the board, there is no connection or validity to what you're asserting.
Joe Higgins (Dublin West, Socialist Party)
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Mr. Sheehy, between 2005 and 2009 you earned, in salary and bonuses, €7.6 million, which would take an industrial worker 190 years to earn. In view of the apology you made and the mistakes that were made, which you said, did you consider giving a contribution-----
Ciarán Lynch (Cork South Central, Labour)
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Last question, Deputy.
Joe Higgins (Dublin West, Socialist Party)
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Did you consider giving a contribution to the taxpayer from that amount of money? And, lastly, you were obviously a substantial lender to homeowners, owner-occupiers. The fact that the price of a home was increasing by the equivalent of the average industrial wage each year from '96 to 2006, putting young people, by common consent, in a dreadful situation of up to 40-year mortgages, unsustainable loans-----
Ciarán Lynch (Cork South Central, Labour)
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Deputy, ask your questions, please, because you're going to run out of time and the Deputy won't have time to respond.
Joe Higgins (Dublin West, Socialist Party)
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-----did that ever occur to you, as a moral issue, the difficulties that young generation was being put in by the profits that were being made?
Mr. Eugene Sheehy:
Well, there's ... you're asking me five questions, I'll try to ... I paid tax on everything I earned. I made a voluntary reduction in my pension after I left. In relation to the creditworthiness of first-time buyers, we followed a strategy of not following the market. We had, I think, 151,000 mortgages; 2,660 were 100% finance, which is less than 2%; the market was 8%. We monitored, on a monthly basis, what a standard application coming into our counter would be, vis-à-visall our competitors and it was always the lowest. We changed it a little bit towards the end and, if you looked at the published information as at 31 December 2010, in AIB, the 90-day-past-due rate for mortgages, and that's ... 90 day past due is not an opinion, it's a fact - you have to be 90 day past due to be 90 day past due - was 2.5%, which was by far the lowest in the market. Subsequently, it changed when the bank merged with EBS, who had a different rate, but I think the mortgage process in AIB was best in class. The numbers substantiate that.
Joe Higgins (Dublin West, Socialist Party)
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Do you agree that the level of-----
Ciarán Lynch (Cork South Central, Labour)
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Deputy, you're completely and totally out of time, and I need to come back to a question now that we need to ask, which is related to this. And that is the appropriateness or the credit policies operating ... because the grow-fast model ... or whether a sustainable model is in place, a bank will always want to be profitable and the ... as does any other business ... and to do that it has to grow its business, and in banking terms that means issuing loans. Mr. Sheehy, if I could put the issue of AIB Group's large exposure policies, this is the GLP as it's referred to, and the limits as to whether there were hard limits or soft limits ... and how exceptions would be granted. And, it could be suggested that exceptions were sanctioned regularly by sub-board committees. Could you explain to the committee what processes and actions were taken to monitor - and I'm referring to core document AIB 2, pages 25 and 35 to 37 - so if you could explain to the committee what processes and actions were taken to monitor and remediate the regular approval of exceptions to the group large exposure policy limits? This would be, kind of, "There is exceptional circumstances here, loan shouldn't be granted, but let's look at it again and maybe grant it"?
Ciarán Lynch (Cork South Central, Labour)
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Okay.
Ciarán Lynch (Cork South Central, Labour)
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I stand corrected.
Ciarán Lynch (Cork South Central, Labour)
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Yes.
Mr. Eugene Sheehy:
But anyway, the group large exposure policy ... clearly there was a stratification of risk and levels, and it was built on a principle of the loan originator and the loan sanctioner being separated. So what the escalation of sanctioning - if you go through the various committees - meant was that in each case, first of all, you were going through the committee process because the loans were getting larger, and that's a fact. And, you know, we talked about a big loan earlier on. But to me there was a benefit of ... in this process, which was you got fresh eyes at each level, and feedback and interaction. So the group large exposure policy, and the passing on of when people went over certain limits into their next level was, I think, is a positive process in looking at risk. It's a positive process. It can look, because the loans are bigger, as just some kind of a default thing that as it gets bigger it just goes up and gets approved. That's not the case. As it goes up, it gets further and further interrogated before it's approved.
Ciarán Lynch (Cork South Central, Labour)
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Mr. Daly, in his testimony to this inquiry last week, gave a testimony as to what he saw the banking model actually was, and, as has been stated here this morning, when the whole thing came crashing ... the debt for AIB, regardless of any other bank's behaviour, was approximately €20 billion. And I'm asking you to comment upon Mr Daly's testimony when he says:
While internal bank lending documentation may indicate that the loan-to-value ratios were, typically, less than 100% when the loan was drawn, the reality, in many cases, was that a developer's equity contribution was in the form of a rolling-up of unrealised, paper profit from other developments. This was presented as an equity position. Rarely, if ever, was it in the form of cash.
So basically what Mr Daly is implying there ... that as a development was under way, its equity was growing probably beyond the original valuation of the purchase or development at the site; therefore, the equity then could be offset against a new development. He then goes on to say:
In effect, therefore, the banks were providing all of the real cash funding for both acquisitions and development. It's safe to say that quite often the borrower's paper equity position never paid for an acre of land or concrete or scaffolding or a worker's wage at the end of the week. The safety zone of borrower equity usually existed only on paper. The result is that the borrower was typically not the first to lose. In the event of a crash the banks stood to take 100% of the losses, and that's what happened.
Is that what happened in AIB?
Mr. Eugene Sheehy:
No. I understand exactly what Mr. Daly was saying. And if you look at a loan application, where an individual could have been in business for 20 years in a trade, i.e. property construction, and has developed a net worth in that business, there are a couple of options open to the individual. They could say, "I'll cash out here and take my cash off the table," and try to continue on with non-recourse lending ... trying to get that ... "Or I'll leave everything I have in the business". By and large, to my recall, almost all of the developers we'd have dealt with left everything in the business. Now, then you come to the kind of intellectual argument about is leaving everything in the business the same as committing to the business? It is. I mean, if you have made money over decades and you leave it all in the business, and that is then recognised by the bank as equity, not cash, but as equity, I think that's entirely correct. And I'll just go ... add a little bit to it. I mean, when I was a branch manager I dealt with a lot of SMEs and start-up businesses, they never had cash. People who go into business rarely have cash, because when you go into a town you'll see banks lined up on one side of the street, you won't see "private equity" or "vulture fund" over somebody's door. The banks provided equity for people who wanted to ... provided cash for people who wanted to take risks. And, by and large, that came from a trust-based, personality-based decision, a personal guarantee from parents or supporters. So, you can imagine if everybody ... and we had nearly 40% SME customers and builders ... if the bank had a view that we would not back anybody unless they had hard cash, and disregard their equity, the person coming to the bank who wanted to start a business, had a house worth €150,000, a mortgage of €75,000, wanted to get seed capital to start off, and we said, "You know what? Go away, we don't recognise that." Society wouldn't be-----
Ciarán Lynch (Cork South Central, Labour)
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In fairness, Mr. Sheehy, that's not the question I'm asking you.
Ciarán Lynch (Cork South Central, Labour)
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No, no, what Mr. Daly is implying is the exposure that your practice actually created. It's not that you're giving a few bob to an SME here, or a video shop here, or a health club here. What you were doing was giving compound lending into one sectoral area, one loan after another, after another, that led to an exposure. So a developer built the shopping centre, the equity value in that - no cash transaction - maybe increased by 20%. That 20% then - no cash transference - was used as a notional concept to securitise a new loan to build another development. This was all construction. This wasn't SMEs, this wasn't some guy setting up some carpet shop down the road, these were developing loans that ultimately resulted in all these major borrowers having to go into NAMA with massive loans that your bank had provided. So this is an exposure issue. And what Mr. Daly is indicating in his statement - and Mr Daly may well be back before the committee and we'll get further clarification from himself, and we may call other witnesses back as well - is that the business model operated by banks was creating an exposure in property without any down payment or cash being made. The securitisation was notional equity. Does that reflect the business model that AIB were using? And did it create an exposure?
Mr. Eugene Sheehy:
It wasn't a business model. It did happen. And most of the uplift in valuation came from the investment side property. So, if you somebody who was a residential developer, but they had a successful let investment property, you would take an uplift value in that and pass it on. But I agree with Mr. Daly, you know, that it would've been a lot better off if the structure ... the industry structure in Ireland around property, had more private equity, you know, and I think that's happening now. It would have been far superior, and it did increase the bank's exposure, the fact that we released funds on the basis of valuations of uplift.
Ciarán Lynch (Cork South Central, Labour)
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Thank you. Deputy Michael ... Senator Michael D'Arcy.
Michael D'Arcy (Fine Gael)
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Thank you, Chairman. Mr. Buckley, the AIB loans transferred to NAMA, had a discount of 56%. Were you surprised and can you comment on that reduction, please?
Mr. Michael Buckley:
I wouldn't have had a view, to be honest, because I didn't know the circumstances, you know. This was, I don't ... I forget when those loans were transferred to NAMA, it was probably 2011, so six years after I retired. I wouldn't have had a basis for determining really whether those loans were transferred at fair value or not fair value, so I'm sorry.
Michael D'Arcy (Fine Gael)
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The reason I ask you Mr. Buckley was because you had 53 months in as CEO or thereabouts and I think Mr. Sheehy you had a little bit less.
Michael D'Arcy (Fine Gael)
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Yes. You seem very arms length in relation to everything. In relation to AIB.
Michael D'Arcy (Fine Gael)
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Mr. Buckley have you ... did you have any retail banking experience in Ireland?
Michael D'Arcy (Fine Gael)
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Did Mr. Forde, who was appointed head of retail Ireland, have any retail banking experience?
Michael D'Arcy (Fine Gael)
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And, Mr. Sheehy, how long were you in retail Ireland?
Michael D'Arcy (Fine Gael)
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You came up through the system.
Michael D'Arcy (Fine Gael)
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Mr. Buckley, did you agree with Mr. Gleeson's statement that retail banking Ireland ... the retail banking sector of in the Republic of Ireland bankrupted the AIB?
Michael D'Arcy (Fine Gael)
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He made that statement last week-----
Ciarán Lynch (Cork South Central, Labour)
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Yes indeed and if Mr. Buckley is aware of it he might wish to give a comment.
Michael D'Arcy (Fine Gael)
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Are you aware of it?
Michael D'Arcy (Fine Gael)
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You didn't follow last week's ... Mr. Gleeson's-----
Ciarán Lynch (Cork South Central, Labour)
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I need you to be specific in your questions rather than ... did someone tune in last week then open up a line of questioning. So follow a line of inquiry please, Senator.
Michael D'Arcy (Fine Gael)
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Deputy Higgins quoted Bill Black and Bill Black said that one of the aspects that are crucial for the structure of the banks was "grow like crazy.'' Okay. You say, ''Grow fast.'' That was the term that was used.
Michael D'Arcy (Fine Gael)
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I'm sorry. AIB ... and I'm putting it at the both of you gentlemen. ''Grow fast''. And the figure I want to give you -----
Ciarán Lynch (Cork South Central, Labour)
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I need you to be referencing now if you are using comments now back and forth and to put a question to somebody maybe to comment upon it rather than give them the dialogue and then put a question on it.
Ciarán Lynch (Cork South Central, Labour)
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Yes.
Michael D'Arcy (Fine Gael)
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Let me go at a different line of inquiry then, Chairman. In 2001 you were appointed CEO. And at that stage then Mr. Sheehy the head of retail was moved to the States.
Michael D'Arcy (Fine Gael)
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Figures that we have for AIB's growth rates were 29-----
Ciarán Lynch (Cork South Central, Labour)
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Please ...
Michael D'Arcy (Fine Gael)
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Briefing document 1, Nexus 1.
Pearse Doherty (Donegal South West, Sinn Fein)
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No, it's a briefing document.
Michael D'Arcy (Fine Gael)
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It's a briefing document-----
Ciarán Lynch (Cork South Central, Labour)
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Sorry, my apologies.
Michael D'Arcy (Fine Gael)
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It's a briefing document-----
Ciarán Lynch (Cork South Central, Labour)
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Has it been supplied to the witness, has it?
Ciarán Lynch (Cork South Central, Labour)
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Has it been supplied to the witness?
Michael D'Arcy (Fine Gael)
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Well the figure that we were given, Mr. Buckley, was 29% per annum or from '01 to '08 ... compound.
Ciarán Lynch (Cork South Central, Labour)
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If the witness isn't familiar with it, Senator, and if it hasn't been supplied to the witness I'd like ... there is a due process situation here. So maybe if you can ... you're quite willing and prepared to ... and you're quite free to respond to it ....
Michael D'Arcy (Fine Gael)
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I'll move on then Chairman.
Ciarán Lynch (Cork South Central, Labour)
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Okay, so then if you could just quote core document AIB B1, page 13, item 6 - 14 to 1917 - that may actually be sufficient.
Ciarán Lynch (Cork South Central, Labour)
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Yes. I really would be ... if documentation is going to be provided at these hearings that they come through the system so that we can actually have them -----
Michael D'Arcy (Fine Gael)
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That document that was available to me was available to the witness as well-----
Ciarán Lynch (Cork South Central, Labour)
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Okay if you could just cite what it is so now and we will use it
Michael D'Arcy (Fine Gael)
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I'm using the AIB briefing document.
Ciarán Lynch (Cork South Central, Labour)
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Okay.
Michael D'Arcy (Fine Gael)
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That 29% increase, Mr. Buckley ... there seems to have been a change in AIB's strategy, which was to grow fast. Could you comment upon that?
Mr. Michael Buckley:
In my opening statement this morning I ... among the things I said was ... a point I made that if you rely on percentage numbers when you are looking at growth rates ... I'm talking about lending now ... that it may be misleading. Because ... in my time at the beginning of my time our actual exposure to property and construction overall started at the number of €6 billion ... this was for the whole group and it went up during those four and a bit years to €19 billion. And on the Irish side of it within that number it went from €4 billion to €11 billion. And I said this morning that ... and I would repeat it again .. that in the context of the demographic situation to which I alluded which was unprecedented in the history of the State, that I felt that at that point we were not significantly running ahead of what was required in terms of infrastructure in the country. So the percentages don't ... how do I say ... I don't work off the percentages. I mean what kills a bank is pounds, shillings and pence lent rather than percentages lent so that's really my answer. I hope it ... it meets your question.
Michael D'Arcy (Fine Gael)
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It doesn't really but-----
Michael D'Arcy (Fine Gael)
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Mr. Sheehy, you made the point that the bank took too much risk. In relation to-----
Michael D'Arcy (Fine Gael)
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Mr. Buckley, did the bank take too much risk in your time?
Michael D'Arcy (Fine Gael)
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From '01 increase of the balance sheet for your period to mid-2005-----
Michael D'Arcy (Fine Gael)
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€6 billion to €19 billion, a trebling of the loan book in your period.
Michael D'Arcy (Fine Gael)
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That was the numbers.
Michael D'Arcy (Fine Gael)
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Can I ask Mr. Buckley also were senior management conflicted by the bonus system and the remuneration that Deputy O'Donnell discussed earlier? And were the focus upon earnings by share and the document I am quoting is AIB B1, Vol. 1, page 45, 31 March 2015.
Michael D'Arcy (Fine Gael)
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The Good Times - AIB (1988 to 2007). AIB B1. Vol. 1-----
Michael D'Arcy (Fine Gael)
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It says, "Reported EPS [earnings per share] Growth 2003: AIB: 3%-----
Michael D'Arcy (Fine Gael)
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-----Anglo 30%."
Mr. Michael Buckley:
Sorry. I misunderstood you. It's a document written in 2009 looking back over the whole period from 2001 to 2009. I mean the page you are refer to says reported EPS growth in AIB, in 2003, 3%, and EPS growth forecast 2004, 6%. They are small numbers particularly relative to those produced by the bank that is lined up underneath the AIB numbers.
Michael D'Arcy (Fine Gael)
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Can I ask Mr. Buckley ... you say that ...
Michael D'Arcy (Fine Gael)
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You say that you didn't think the bank took on too much risk in your period as CEO. Was there any reckless lending occurring? And was that reckless lending rewarded by AIB?
Ciarán Lynch (Cork South Central, Labour)
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Reckless is leading now. You can ask as to the quality and the-----
Michael D'Arcy (Fine Gael)
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But can I qualify last weeks-----
Ciarán Lynch (Cork South Central, Labour)
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Yes, please.
Michael D'Arcy (Fine Gael)
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Mr. Donal Forde who was head of retail did say that there was reckless lending.
Ciarán Lynch (Cork South Central, Labour)
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Sorry, unless you are using a quotation from somebody, Senator, I need you to pull up the document and say that is somebody saying that like, you know.
Michael D'Arcy (Fine Gael)
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I did say that, Chairman.
Ciarán Lynch (Cork South Central, Labour)
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Yes but we reference it and produce it.
Michael D'Arcy (Fine Gael)
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I don't have the reference in front of me.
Mr. Michael Buckley:
First of all, I did watch his testimony. I don't think he used the phrase "reckless lending", but that's a matter of record. The second ... what I would say is that ... looking at this from my point of view, for that period that I am talking about - I had absolutely no evidence, nor is there evidence in any of the core documents that I have got and received, that there was reckless lending or anything that could be described as reckless lending during those years, 2001 to 2005. That's a categorical answer, no evidence whatsoever.
Michael D'Arcy (Fine Gael)
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Just to finish off, Chairman. Are you satisfied, Mr. Buckley, that AIB was properly ran during your tenure as CEO?
Mr. Michael Buckley:
It was run to the very best of my ability and my colleagues. That's not to say that there weren't issues and I have talked about them when asked during the morning, and we did our best at all times to fix any issues that arose at the time and to do it a very open and transparent way vis-à-vis our customers and vis-à-visour regulators. So, there were issues. There were not issues relevant, I think, to the core of what this committee is enquiring about and we did our best to fix them. And there was no evidence, is no evidence, in any of the books I've got that there was reckless lending, or anything that could be approaching reckless lending, in my time as CEO.
Eoghan Murphy (Dublin South East, Fine Gael)
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Thank you, Chairman. Thank you to both the witnesses. Mr. Buckley, if I may I wanted to talk to you about the new accounting standard, IAS 39, that was introduced in January 2005. Mr. Forde told us that he had a view at the time that this new accounting standard wasn't an appropriate formula. Did you hold that view?
Eoghan Murphy (Dublin South East, Fine Gael)
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Was this discussed with management in the bank and with the board at the time in AIB?
Mr. Michael Buckley:
It was very definitely discussed with ... amongst senior management. It was discussed with the auditors, in my time. And I can't refer you to a board minute where it was discussed but I would be morally certain it was discussed with the board. It would have come up as part of our views about why we had to implement this particular regulatory requirement, etc., and the difficulties it would cause us.
Eoghan Murphy (Dublin South East, Fine Gael)
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And did you discuss this then with other banks as well? I mean, was this discussion happening in the banking system as far as you were aware?
Eoghan Murphy (Dublin South East, Fine Gael)
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If you could, yes.
Mr. Michael Buckley:
Well, traditionally in banking, you know, people working in banks know that there are good times and bad times, and that there are cycles, that there are lending cycles. And the old way of dealing with all of this was in the good times, you put aside money for the bad times. And what this was doing, essentially, this new accounting standard was saying, "No, you can't put away money in the good times to help you deal with the bad times".
Eoghan Murphy (Dublin South East, Fine Gael)
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Thank you. We have had evidence in relation to cross-cyclical provisioning. I'm sorry, I wasn't sure what you wanted to discuss. Were you aware that the Spanish banks at the time were not implementing this new accounting standard?
Mr. Michael Buckley:
I was and that was because the regulator had somehow been able to take a view, which somehow we - it would seem our regulator couldn't - that irrespective of that accounting standard which was coming in 2005, that they would put additional provision and requirements on the banks. My view would have been, you know, if that could happen here .. but we were told - I can't remember why - we were told it couldn't happen here.
Eoghan Murphy (Dublin South East, Fine Gael)
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So you communicated this to the Financial Regulator?
Eoghan Murphy (Dublin South East, Fine Gael)
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And, sorry, the nature of that communication ... would it have been a formal communiqué from the bank? Would it have been in a meeting-----
Eoghan Murphy (Dublin South East, Fine Gael)
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And, Mr. Sheehy, in your period then?
Mr. Eugene Sheehy:
Yes and I've two views on it. I was on the board of a US bank at the time and they decided to ignore it and the regulator over there said, "You're supposed to do it, but in actual fact you can ignore it" and that's what happened over in America. Here, when like ... I agree with everything Mr. Buckley said, it's a totally nonsensical accounting standard from a banking point of view. It may be appropriate for other industries but for banking it was totally nonsensical. There was a board discussion during my period there. I haven't seen it noted but I did talk to an official in the bank who would have been an executive director at the time and we did discuss it. And we discussed whether we should go to the regulator with our concerns and given that no European country other than Spain had deviated from it, we decided there was no point. Now, I then tried to research what had happened in Spain and why it happened in Spain and there is a very particular reason. For historical reasons, Spanish banks were required to hold very large shareholdings in large Spanish companies. When their tier 1 was being calculated, the equity value of those holdings, which are basically stocks and shares, were included in their total capital. That didn't meet the international standard for tier 1 because of its volatility so the Spanish authorities were able to make the case that, "We have this historical volatile piece of capital in our banks balance sheets - we need the extra comfort of not changing", in effect and having cross cyclical provisions to bolster their resilience.
Eoghan Murphy (Dublin South East, Fine Gael)
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Sorry, just to clarify, Mr. Sheehy. Did AIB go to the regulator or not?
Eoghan Murphy (Dublin South East, Fine Gael)
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No, AIB did not go to the regulator?
Eoghan Murphy (Dublin South East, Fine Gael)
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Mr. Buckley, do you recall expressing these concerns to the regulator?
Eoghan Murphy (Dublin South East, Fine Gael)
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But given maybe the level of concern that you expressed just previously. Banking institutions were talking about this, you were talking about it, the bank ... why wouldn't you express it formally to the regulator if it was a nonsensical standard?
Eoghan Murphy (Dublin South East, Fine Gael)
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You knew that the regulator knew that this was an accounting standard that the banks had a problem with?
Eoghan Murphy (Dublin South East, Fine Gael)
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Okay, thank you. I will move on then please, Mr. Sheehy, in relation to NAMA's evidence to us last week. They gave us evidence on the extent to which banks were tending to collect income that was going to the debtors and not to the bank once the crisis began - about rental income from office blocks, from shopping centres - and this was in the millions. They gave us two figures. They said that 20% of income from investment assets were being mandated to the banks but 80% of income was being diverted away. And NAMA said that nobody seemed to be following up on it. NAMA then went after this income themselves. Is it the case in AIB that no-one was following up on this income?
Mr. Eugene Sheehy:
Well, I was long gone before any assets were transferred to NAMA so I really can't answer it, so I don't know. I accept the evidence obviously, if that's what they say, but I wasn't there.
Eoghan Murphy (Dublin South East, Fine Gael)
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So you can't have a view on it.
Eoghan Murphy (Dublin South East, Fine Gael)
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In relation to relationships then, you mentioned earlier that your own relationships with, say, large developers, people taking large loans, that you had none yourself. So those loans would be made by people underneath you?
Eoghan Murphy (Dublin South East, Fine Gael)
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And how did you keep track of how those relationships were developed, how they began, how they were managed?
Mr. Eugene Sheehy:
Well, these relationships ... in AIB, almost all of our relationships were historically based, you know - we didn't go out looking for new relationships. So these were customers that had been with the bank for a long time. So those relationships were managed and evolved over time. Customers got loans, they paid them back, more loans, they paid them back. So there was a confidence level there. There was a constant change in personnel at the bank. We changed the way these relationships were managed by centralising the management of these sector teams, moving it away from the front line. There is always ... the nearer the banker is to the customer, the greater the risk. That's just a golden rule in banking, okay. So you try to set up structures, processes, reviews and procedures that interject between that risk.
Eoghan Murphy (Dublin South East, Fine Gael)
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What does it tell us about the impairment on the loans that were transferred to NAMA ... that the greater impairments were on the lower level of loans, the lower in terms of value?
Mr. Eugene Sheehy:
I was surprised when I saw that in the comptroller's report. I don't know of the cases but it didn't ... it may stand to reason when you look back at it, the bigger the operator, the more likely they were to have non-Irish assets in their portfolio. That would be one definite fact. The bigger the portfolio, the more likely you would have a good chunk of investment property pre-let. So the most problematic asset was residential development land. So the bigger you were, the smaller the proportion that is likely to be in the portfolio. So I think that's probably the cause of that.
Eoghan Murphy (Dublin South East, Fine Gael)
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My final question, and again it's relating to Mr. Forde's appearance before us. Mr. Gleeson said that the Republic of Ireland division brought the bank down. They are his words. And you were chief executive of the group at the time. Mr. Forde told us that in January-February '09, he was completely removed from discussions at executive management level and board level and then, without objectives or direction in terms of a work agenda in his new position, nine months later he then left the bank. What happened there?
Mr. Eugene Sheehy:
Mr. Forde reported to me and I decided, and I communicated with him in ... you know, it was a difficult communication. I have had, and I still have, great respect for him and all his professional abilities. I felt it was time for change in the ROI division. We needed to totally reorganise the amount of resources we were going to deploy around the problem and I had to change some personnel. My plan was that I would give Donal a strategic role, because we had so many strategic issues in front of us, and I had such regard for his abilities in that area - he was head of strategy before - that I was confident he could do a great job for us there. However, at that time, I was tasked with so many changing agenda items that I never really got round to give him the direction and accountabilities that I should have had.
Eoghan Murphy (Dublin South East, Fine Gael)
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And was anyone else redeployed at that time?
Eoghan Murphy (Dublin South East, Fine Gael)
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At management level?
Mr. Eugene Sheehy:
At management level, yes. I mean, there was hundreds of people pulled in out of the business to get onto the cases, particularly trying to get the data right, trying to get the accounts reviewed. Accounts are normally reviewed, by arrangement, quarterly or half-yearly or annually. We now had to try to review everything ASAP. So there was a ... almost every aspect of the way the bank did its business was changed in those months.
Eoghan Murphy (Dublin South East, Fine Gael)
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Thank you.
Ciarán Lynch (Cork South Central, Labour)
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Mr. Sheehy there, Deputy Murphy had raised the NAMA loan book with you. Could I maybe ask you, just to round that off, in relation to the loans acquired from AIB by NAMA, the overall discount rate amounted to 56% eventually. Would you like to comment upon that discount and do you think it was a high or low figure? Was the 56% haircut that was applied justified?
Mr. Eugene Sheehy:
There were no loans transferred when I was there because the process hadn't started. Now, I was surprised at the level. I had been expecting, you know, from the ... some statements by the Minister, and when you take into account the first loss position in all these loans was what the customer input was and then there was the bank's LTV ... basically the bank's LTV, and then there was going to be another drop after that, and I honestly thought when I was leaving that the number was going to be 30%, that range. So I was surprised when I saw it. However, I don't know exactly what the process was. The market absolutely collapsed at that point. There was no market. And you could actually, technically, make the point: why had they any value at all? There was no market. You know, if you used IFRS 39 it must have been very difficult to arrive at a number. So I was surprised but the market was so bad, I suppose, nothing will surprise me.
Ciarán Lynch (Cork South Central, Labour)
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Okay. Thank you. Deputy Pearse Doherty. Deputy, ten minutes.
Pearse Doherty (Donegal South West, Sinn Fein)
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Go raibh maith agat, a Chathaoirligh, agus cuirim fáilte roimh an bheirt chuig an coiste fiosrúcháin. Can I just ask you, to start off with, Mr. Sheehy, to your knowledge, was there a practice of restructuring criticised loans, you know, for example, agreeing to moratoriums, interest-only, interest roll-up or extensions in the terms and conditions in the period of 2006 to 2008?
Mr. Eugene Sheehy:
Restructuring loans, both criticised and uncriticised, is absolutely standard practice. A customer comes in, change of circumstances, "This is what I thought was going to happen; it's not happening", and the bank would look at it. Sometimes it would refuse the request; sometimes it would go along with it but it's standard practice.
Pearse Doherty (Donegal South West, Sinn Fein)
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That's fair enough. In normal times it's standard practice in banking to do this. In relation to that period, 2006 and 2008, did you see an increase of the type of restructuring in the way that I've outlined for large property ... commercial property exposures?
Pearse Doherty (Donegal South West, Sinn Fein)
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And would this ... by restructuring the loans, would this put these loans ... would they move them from a category of criticised to uncriticised loans?
Pearse Doherty (Donegal South West, Sinn Fein)
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That's not the question. Which ... by doing this, by rolling up interest, by restructuring them, does it move it from a category of criticised loan to a performing loan?
Pearse Doherty (Donegal South West, Sinn Fein)
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But it moves them-----
Pearse Doherty (Donegal South West, Sinn Fein)
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But it moves them out of criticised.
Pearse Doherty (Donegal South West, Sinn Fein)
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Yes. Okay. In-----
Pearse Doherty (Donegal South West, Sinn Fein)
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Okay. In relation to the position of your bank in the run up to September ... or during September 2008, the liquidity pressures that institutions were facing, but in particular AIB ... did the liquidity pressure for AIB ease during the second part of September 2008 or did it further tighten?
Mr. Eugene Sheehy:
From 15 September onwards, i.e. the Lehman bankruptcy, everything got worse. Prior to that I would say, you know, the market was tightening but it was ... we were able to get, you know, adequate funding and we had a good ... as I say, we always had a good piece of leeway in front of us because you know the liquidity hurdles that we ... there was two regulatory hurdles. We were comfortable there.
Pearse Doherty (Donegal South West, Sinn Fein)
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But from the 15th, liquidity starting to tighten. Is that your evidence?
Pearse Doherty (Donegal South West, Sinn Fein)
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Okay. The reason I ask you that is ... and I reference Vol. 2, AIB, C3b as core documents here, and we're on page 50. In the minutes of the board meeting that was held in Baltimore, Maryland, USA, it's reported ... and you reported your interactions with the Central Bank and the Financial Regulator since 7 September. This meeting took place on the 17th, so two days after you report that liquidity pressures increased at that point. You say that there was a systemic need for term debt of up to €15 billion in the Irish market. You go on to say that AIB would breach its regulatory liquidity ratio by the end of October 2008 if market conditions did not ease and term funding became available. It goes on to say Central Bank has been informed of that. The chairperson goes on to indicate that in the absence of a response from the regulators to the systemic funding problem, the matter would be pursued at a political level. The reason I ask you this here is you're making it clear in this board minutes that AIB would have a liquidity problem at October if circumstances didn't change or pressures didn't ease. You've confirmed to the committee that pressures not only didn't easy but actually tightened. So was it the case that AIB was running into a severe liquidity problem?
Mr. Eugene Sheehy:
We were in better shape than most. Now, when I say ... when you say October, as I said earlier on, we have the liquidity requirements, the regulatory requirements, and you always have a date which is point in time versus the end date, and that assumes nothing happens in the meantime. There was always going to be funding in the meantime so that date would keep on moving out, but there were real concerns after Lehman's that even offering better prices on term debt would have no effect because people were running to avoid risk everywhere. So we didn't know what was going to happen. The term debt of €15 billion was the kind of money that would be rolling over, kind of three and six month money that would be rolling over, and if that didn't materialise or roll up, it would have had to be replaced somewhere else.
Pearse Doherty (Donegal South West, Sinn Fein)
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The point I'm making is, the minutes reflect, is that if pressures ... liquidity pressures didn't ease, you would breach liquidity ratios by the end of October.
Pearse Doherty (Donegal South West, Sinn Fein)
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Yes, if they didn't ease. You have informed the committee that liquidity pressures didn't ease, indeed what happened after this meeting is they tightened. So the question I put to you is, was AIB facing a seriously liquidity problem in October or after that point?
Mr. Eugene Sheehy:
I believe we were facing a manageable liquidity problem. We had, you have to think of the way our funding was made up, I mean we ... half of our resources were in retail deposits. We were very stable there. And we also had a huge amount of assets that we could turn into self-funding assets. So we would have had to change things to be better equipped, but we could have done it.
Pearse Doherty (Donegal South West, Sinn Fein)
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But you also say in these notes that this matter would be pursued at a political level. This is how serious the matter obviously was being reflected at the board meeting.
Pearse Doherty (Donegal South West, Sinn Fein)
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Okay, so two weeks later you had, or within two weeks you had the meeting with the Taoiseach and the finance Minister looking for a guarantee for your bank and three others.
Pearse Doherty (Donegal South West, Sinn Fein)
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Okay, the notes ... the memo that you took on 2 October, is there any reason for this committee not to judge them as true and accurate reflections of what happened on those nights?
Pearse Doherty (Donegal South West, Sinn Fein)
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So you don't dispute anything in the memo.
Pearse Doherty (Donegal South West, Sinn Fein)
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You may not remember or recall certain events but the memo is correct.
Pearse Doherty (Donegal South West, Sinn Fein)
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So can I ... can I ask you a question in relation to the memo that you took? First of all you say, and this is the same book, page 37, "The Government submitted a form of guarantee, copy attached."
Pearse Doherty (Donegal South West, Sinn Fein)
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Do you have the copy of the form of guarantee that the Government submitted?
Pearse Doherty (Donegal South West, Sinn Fein)
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What did you do with it?
Pearse Doherty (Donegal South West, Sinn Fein)
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Yes.
Pearse Doherty (Donegal South West, Sinn Fein)
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No, it's just ... let me maybe clarify this here.
The Government submitted a form of guarantee, copy attached, which in our view, while inspirational in terms, is not what we were all looking for and fell short of lack of specificity. We had drawn up an alternative which included language that was more specific.
So it is very clear from this memo that you took a number of days afterwards that this is not the guarantee that was announced.
Pearse Doherty (Donegal South West, Sinn Fein)
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So the memo that you took, did you just keep it for yourself personally? Or did you give it to AIB or-----
Pearse Doherty (Donegal South West, Sinn Fein)
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Okay, so it's clear from this memo that there was a copy of the draft guarantee attached.
Pearse Doherty (Donegal South West, Sinn Fein)
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And that's not ... that's just not to be found at this point in time to your knowledge?
Pearse Doherty (Donegal South West, Sinn Fein)
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Okay.
Pearse Doherty (Donegal South West, Sinn Fein)
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Okay and we had drawn up an alternative form, and again the alternative form is not available to anybody at this point in time either.
Pearse Doherty (Donegal South West, Sinn Fein)
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And in relation to the point where, I think it was the fourth interaction, which was the bilaterals, you say that:
there were also issues in the Government's draft which we were uneasy about relating to the attestations by the Financial Regulator that the system was solvent and that all banks were solvent. We felt that there was clearly a risk in this statement. Subsequently the Government deleted this reference.
So did you see a piece of paper that included a reference, in the Government's guarantee, saying that the banks were solvent?
Pearse Doherty (Donegal South West, Sinn Fein)
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Verbal?
Pearse Doherty (Donegal South West, Sinn Fein)
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Okay.
Mr. Eugene Sheehy:
And the reason ... the reason, there was a very specific reason why, I can speak for myself, I was against including that, was that, you know, in market communications you have to be very specific about what you are communicating. This was a liquidity guarantee, it didn't, the solvency issue wasn't relevant as far as I could see-----
Pearse Doherty (Donegal South West, Sinn Fein)
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Yes that's quite interesting, because you say it now, and I'll point out the point that you say that it was the Government's draft that you were uneasy with and not verbal communication but that has just been noted. You say ... you give a reason why you were uneasy with the statement of solvency and you said that "if market participants purchased shares in companies, once the guarantee was issued and it subsequently transpired that these companies were not as strong as contended". Why would you be concerned about these companies not being as strong as contended?
Pearse Doherty (Donegal South West, Sinn Fein)
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Did you believe it was un-factual to say that these were-----
Ciarán Lynch (Cork South Central, Labour)
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Just let him respond, Pearse, I'll bring you back in again.
Pearse Doherty (Donegal South West, Sinn Fein)
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But Mr. Sheehy ... Mr. Sheehy, when you left that meeting, and correct me if I am wrong, but from the evidence we have heard, when you left that meeting and when you asked for the insolvent ... the statement of solvency of the institutions to be deleted, that you believed that you were only referring to four institutions that were going to be guaranteed by the Government. And the question I have to ask you again is, did you have suspicions that any one of the four ... because you only believed that the four were going to be guaranteed, but you asked them not to make a statement saying that those four were solvent. Did you have any concern in relation to any of the four institutions that you thought were going to be guaranteed by the Government on that night?
Pearse Doherty (Donegal South West, Sinn Fein)
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You say in this memo again-----
Ciarán Lynch (Cork South Central, Labour)
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You are running out of time, Deputy, so I need your final, final question so I can close now.
Pearse Doherty (Donegal South West, Sinn Fein)
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I'll finish now. You say that the reason that you wanted this deleted was that, if company ... participants purchased shares in companies, once the guarantee was issued and it subsequently transpired that these companies were not as strong as contended.
Ciarán Lynch (Cork South Central, Labour)
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Final question, final response Mr. Sheehy.
Pearse Doherty (Donegal South West, Sinn Fein)
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Now we heard evidence last week-----
Ciarán Lynch (Cork South Central, Labour)
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Deputy.
Pearse Doherty (Donegal South West, Sinn Fein)
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That this was in relation to Anglo and Nationwide. But I put it to you, that you left that meeting believing that Anglo and Nationwide was not going to be guaranteed, so that statement couldn't have referred to those two institutions.
Ciarán Lynch (Cork South Central, Labour)
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Okay, thank you. Final question, final response. I need to move on.
Ciarán Lynch (Cork South Central, Labour)
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Can you just clarify ... just this single point for me. Did AIB have to be guaranteed? Forget about other banks' behaviours, other banks' balance sheets, other banks' position on the night. Did AIB require a guarantee that night?
Ciarán Lynch (Cork South Central, Labour)
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Okay, thank you. Senator Marc MacSharry.
Marc MacSharry (Fianna Fail)
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Thanks very much. During your tenure as CEO, Mr. Sheehy, how much time would the board have allocated to strategy and business model development and its monitoring, as opposed to other work?
Mr. Eugene Sheehy:
The board schedule, obviously there was a monthly schedule and a lot of the time in the monthly schedules was taken up with kind of business reviews and updates and scheduled items that would be there for some time. And then every ... every year we had a strategy session, which was normally an off-site, two-day session where we would look at what the issues were for the business going forward.
Marc MacSharry (Fianna Fail)
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And at no time was it identified, say going back to the Jim O'Leary issue mentioned earlier, to say that look we are over-focusing. You yourself earlier said that you were happy enough up to early 2008. Were there anybody around the table during the period that said "Look"?
Mr. Eugene Sheehy:
Actually one of the off-sites ... one of the strategic meetings we had, I think it was up in north County Dublin, we had Professor Ahearne and Dr. FitzGerald, and that was specifically an off-site about what's the shape of the Irish economy, how does it relate to property and values. So very specifically, some of the strategic thinking and board input would have been around the whole future of this stage.
Marc MacSharry (Fianna Fail)
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And following that then, was there any specific actions taken to cool the AIB pursuit of more enthusiastic lenders, let's say?
Mr. Eugene Sheehy:
We definitely ... we definitely were quite cool on the mortgage market in terms of the amount ... the amount of people who could borrow ... that could borrow from us and the way we used our debt service calculator. So that remained cool, we were cool on intermediary-driven business. On the other ... on the other side, the commercial and residential property development, we were applying the stress tests and the Basel model, which we thought mitigated the risk.
Marc MacSharry (Fianna Fail)
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But didn't, as we know. Can I ask ... you mentioned that you were a branch manager for a period of years in your career. Can I ask, would you have had targets for lending when you were a branch manager?
Marc MacSharry (Fianna Fail)
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I get the picture, so there was targets?
Marc MacSharry (Fianna Fail)
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Would your remuneration be reflected by your performance versus those targets?
Marc MacSharry (Fianna Fail)
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Okay, so as CEO, would branch managers have lending targets?
Marc MacSharry (Fianna Fail)
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No, it's okay, I just need yeses and nos. It is a very specific line of questioning.
Mr. Eugene Sheehy:
The answer is "No". They had targets on three levels and it was called the people performance index. They had to have a profit outcome, they had to have a people index outcome which was a stat survey, and they had to have a customer service outcome, which was a customer service initial shopping survey. I introduced that process in late 2001 in conjunction with HR to actually deal with the issue of a more holistic approach to management in branches.
Marc MacSharry (Fianna Fail)
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In reality, and I appreciate that there was this approach, were there targets given to branch managers which manifested themselves in volumes of money lent?
Marc MacSharry (Fianna Fail)
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I didn't say they did and the question is not in relation to underwriting. The question is relating to ... are there volume targets?.
Marc MacSharry (Fianna Fail)
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No, are there volume targets specific to lending for branch managers?
Marc MacSharry (Fianna Fail)
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So how do you measure the performance of a branch?
Marc MacSharry (Fianna Fail)
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You mentioned the model there that you had ... What I'm trying to say-----
Marc MacSharry (Fianna Fail)
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So let's say you lent nothing and you took on no investment in increased deposits, how could you reach your target? Was it possible to reach your target by lending less and accepting less deposits? So, say, I'm the branch manager and my branch had a run and I lent nothing. Could I reach my target?
Marc MacSharry (Fianna Fail)
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Okay, so is it reasonable or not to assume that in order for me as a branch manager to reach my targets that, I along with other issues, would have to increase deposits and increase lending? Yes or no?
Ciarán Lynch (Cork South Central, Labour)
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He can answer any way he wants.
Marc MacSharry (Fianna Fail)
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I have asked my question and I have asked that it be answered in a certain way. And no doubt he'll respond without your help.
Mr. Eugene Sheehy:
If I'm a branch manager, and as I can't sanction loans, that is a factor that is beyond my control so I have to grow the business through a whole myriad of revenue lines. Lending is one of them and the only function I play in lending is bringing that proposition to the decision makers elsewhere.
Marc MacSharry (Fianna Fail)
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Would branch managers be expected to cross sell the products of the branch ... of the bank?
Marc MacSharry (Fianna Fail)
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And would they be volume-related or would it be -----
Marc MacSharry (Fianna Fail)
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Would you accept or not that in order for branch staff to reach their targets that they would focus on increasing the volumes of sales of bank products, including loans?
Marc MacSharry (Fianna Fail)
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Including increased lending.
Marc MacSharry (Fianna Fail)
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No, they had no control over underwriting, but in terms of numbers of applications-----
Marc MacSharry (Fianna Fail)
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Okay, so would it be possible, therefore, that an unintended consequence of the targeting approach of the bank may have led to a volume of applications of a lesser quality? Would it be or not?
Marc MacSharry (Fianna Fail)
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Okay, I have to move on as I have 2.4 minutes left, not including the leniency that you gave Mr. Doherty there ... so whatever I get for that.
In terms of the interaction with the regulator and the loan-to-values, Mr. Buckley you mentioned earlier on, and I'm quoting, "applicants who are in a special place" ... for example ,you said they may have got help from family and so on, so were there any developers or commercial customers that were ever in a special place, to use your own word?
Marc MacSharry (Fianna Fail)
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And Mr. Sheehy in your time? Were there any applicants of a commercial nature that were in a special place to use your predecessor's -----
Marc MacSharry (Fianna Fail)
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No. So when Mr. Gleeson last week mentioned that on one occasion the board increased lending, say, and these were his figures, by €200 million from a €700 million position, would that person have been at a special place?
Ciarán Lynch (Cork South Central, Labour)
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Can you just refer to the transcript there if you are using that, Senator MacSharry?
Marc MacSharry (Fianna Fail)
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I don't have the exact page but it's there.
Mr. Eugene Sheehy:
The case you're referring to was a board decision with a 64 page mark-up accompanied by professional evaluations and net worth statement of €3 billion net of debt. The special place, the name of the individual was irrelevant. It was a financial transaction that was examined forensically as to whether it was a good risk or reward proposition for the bank.
Marc MacSharry (Fianna Fail)
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And there was an established process that one would follow in those instances, would there be?
Ciarán Lynch (Cork South Central, Labour)
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I will give the Senator a bit of time because Mr. Buckley is indicating -----
Mr. Michael Buckley:
Just on a point of clarification because I may not have been 100% clear ... the phrase you used about ,"in a special place", could be misinterpreted maybe.. What I was referring to is that in response to a general request from the regulator to all banks to review their lending policies in relation to mortgages, one of the things that came up before the AIB board, and which was reported back to the regulator, was that we have a particular approach which we applied to the generality of people looking for mortgages, and that includes certain formulae to do with loan-to-value ratio and repayment capacity. What we do then is that in certain cases where we believe, and we're talking about categories rather than individuals, in certain cases where we believe that people's repayment capacity will grow quite rapidly in the future or where they have family support, we are prepared to go to a higher LTV then we generally would, that's what I said. So it wasn't about special cases; it was about categories.
Marc MacSharry (Fianna Fail)
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I get the point, thanks very much. Right, just three very quick questions, Chairman. First of all, last week Mr. Gleeson again referred to a private conversation with Mr. Lenihan in which he was given the clear understanding, he said, that Mr. Lenihan was of the view that Irish Nationwide and Anglo should be nationalised. Did you ever have - and this is to Mr. Sheehy - any personal conversations or telephone calls with either Mr. Lenihan or Mr. Cowen?
Marc MacSharry (Fianna Fail)
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And was that view expressed?
Marc MacSharry (Fianna Fail)
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And was there agreement or no response?
Marc MacSharry (Fianna Fail)
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Okay, before you were dismissed were you given a clear impression or anything like that?
Marc MacSharry (Fianna Fail)
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But you were shocked the next day? Yes or no?
Ciarán Lynch (Cork South Central, Labour)
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Next question, Senator-----
Marc MacSharry (Fianna Fail)
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I'm nearly there ... Also last week, Mr. Gleeson made reference to article 14.3 in his opening statement of the ECB statute which says that they can intervene with central banks effectively and direct them how to act, and he seemed to think that interest rates should have been using the Taylor rule between 6% and 12% during the boom years. Have you a view on whether the ECB should have intervened? What should they have done if you do have that view? And, very finally, tomorrow we have the opportunity to speak with Mr. Trichet, the then head of the ECB, and I'd be very interested to know any recommendations you might have about what we might ask him?
Mr. Eugene Sheehy:
The Taylor rule is a rule that often comes up when people are looking back and saying, "Oh, it would have been good if we had the Taylor rule". Ireland at that time was trying to promote itself, including the Irish Financial Services Centre, as a place to do business that was mainstream European and compliant with all the international standards of Basel, IFRS and everything else. I think it would have been difficult, very difficult for the Irish authorities to carve out a special case while wanting to drive in a general direction of being really pro-central European. I don't know what you would ask Mr. Trichet.
Marc MacSharry (Fianna Fail)
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ECB. It is not that the Irish authorities-----
Ciarán Lynch (Cork South Central, Labour)
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Do you have a question?
Marc MacSharry (Fianna Fail)
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We know what we did, and could have done, and did not do. What I am asking is, your then chairman had a very specific view, which he articulated last week, that the ECB had authority to direct the Central Bank to act in particular ways to, as he put it, mitigate against the unsustainable nature of low interest rates. I think I am quoting precisely so I am interested in your view on that.
Ciarán Lynch (Cork South Central, Labour)
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Okay Senator, can we get the answer because I need to move on? Mr. Sheehy, if you do have an answer that is.
Ciarán Lynch (Cork South Central, Labour)
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Thank you very much. Deputy McGrath please.
Michael McGrath (Cork South Central, Fianna Fail)
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Thank you very much Chair. I would like to welcome Mr. Sheehy and Mr. Buckley. Mr. Sheehy, you passed a comment earlier on that the guarantee did not cost anything. That would be quite different to the commonly-held view about the guarantee so can you just elaborate on what you mean by that?
Mr. Eugene Sheehy:
The question was in relation to AIB. The guarantee of the depositors and the bondholders in AIB did not have a direct cost. The cost to the State from AIB was when the assets were transferred. They were less than the value that we thought they were. But the funding of the bank during the tenure of the guarantee was paid for out of the charge that was ordained by the ECB.
Michael McGrath (Cork South Central, Fianna Fail)
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Had you any bonds that matured during the two years in question?
Michael McGrath (Cork South Central, Fianna Fail)
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Did AIB have senior debt?
Mr. Eugene Sheehy:
We had nothing maturing. Senior debt is perpetual so it never matured unless you decided to call upon it. Obviously you would not call upon it during the tenure of the guarantee. There was substantial equity created obviously when the bank put those debt instruments back to investors in offer for other ones, I think over €3 billion of equity created in the AIB book and €15.9 billion in the State overall, in burning the bondholders if you want to use that phrase.
Michael McGrath (Cork South Central, Fianna Fail)
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You said in response to the Chairman that AIB did need a guarantee at the end of September 2008, so by extension would the bank not have survived if there had not been a guarantee intervention?
Michael McGrath (Cork South Central, Fianna Fail)
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How quickly would it have become fatal for AIB if there had not been a guarantee?
Mr. Eugene Sheehy:
Well, we were still in reasonable position five or six weeks out and we had not used any of the other mitigants. For instance, we could have got all our mortgages and turned them into self-funding assets. We could have sold down our corporate loans, probably taken a loss on it. It is speculative to say how long. I would say months and months and maybe over a year. But I do not know, it would depend, it is pure conjecture.
Michael McGrath (Cork South Central, Fianna Fail)
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I suppose what I am asking is, if the Government had sent you home that night and said, "Look, we are not getting involved, sort out your own problems", what would the future have been for AIB and how quickly would matters have developed in your opinion?
Michael McGrath (Cork South Central, Fianna Fail)
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You have opened up a question mark there, so just to put the question again, would AIB have survived without a bank guarantee, in your view?
Michael McGrath (Cork South Central, Fianna Fail)
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And the guarantee provided that liquidity.
Michael McGrath (Cork South Central, Fianna Fail)
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Can I just ask about the issue of a four-bank guarantee, because your testimony and that of Mr. Gleeson is quite consistent on that issue? You had the clear impression that a four-bank guarantee was being considered, not a six-bank guarantee. On what basis did you have that impression? The only direct reference in the notes you took on the night is to Mr. Hurley, for example, saying it was impossible to bring down a bank of that size in the middle of the week and could lead to a fumble etc., which is the same word Mr. Gleeson used. So can you be specific? How did you have that clear impression that it was going to be four banks and not six?
Michael McGrath (Cork South Central, Fianna Fail)
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That was to get it to the weekend. That was your understanding.
Michael McGrath (Cork South Central, Fianna Fail)
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You say, again in the notes you took on that night, that you felt ... the view that AIB took in relation to Anglo and presumably INBS was of being closed down, nationalised or put into some sort of run-off position and ring-fenced from the rest of the institutions. They are all very different things in some respects. What were you saying should have happened to Anglo and INBS in your view at that time?
Mr. Eugene Sheehy:
Technically, it was totally beyond our experience and competence to even have an idea of what to do, to be quite honest. There was no statutory mechanism. Liquidating a bank is an entirely different process to liquidating other going concerns, because it is a public event. Quite honestly, we did not know what the best thing to do was. We just knew that if they could not fund their obligations the following morning, there was no way forward.
Michael McGrath (Cork South Central, Fianna Fail)
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Even with the guarantee of your liabilities, could AIB have survived a disorderly wind up of Anglo? If Anglo had been allowed to collapse the following day and you had a Government guarantee for the four banks, how do you think that would have played out?
Michael McGrath (Cork South Central, Fianna Fail)
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But Anglo was allowed to fold.
Mr. Eugene Sheehy:
There would have been ... I have some notions of what might have happened. There would have been a credit downgrade of all Irish institutions. There would be a systemic mark on Ireland which would have made funding much more difficult immediately, even with a guarantee. There is no doubt about that in my view. But the market would, I think, then have said there is a problem in Ireland and they are addressing the core of it, there would have been a distinction made in due course. It may have taken a number of weeks for that distinction to be accepted by the market.
Michael McGrath (Cork South Central, Fianna Fail)
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So the outcome in your view is unclear or not in that scenario?
Michael McGrath (Cork South Central, Fianna Fail)
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Okay. Mr. Buckley, can I ask you what was your view on the earnings and EPS growth targets set by the board of AIB, given the maturity of the market? I refer to AIB B1, Vol. 1, pages 43-55, which is a board paper from a seminar. If you wish to comment on that issue - the earnings and the EPS growth targets that were set.
Michael McGrath (Cork South Central, Fianna Fail)
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Of your tenure, yes.
Mr. Michael Buckley:
-----2005. I felt that - just to give an overall comment - I felt that achieving double digit growth was a realistic target, that it was stretching to some extent, but that it was realistic and if I may take that in the context of the Republic of Ireland division, I suppose to summarise the reason why I would have thought that there was good growth available in the Irish division. Twofold: one, the demographics that I referred to before. Second of all, a point I mentioned in my opening statement, that, while we had a big share of the current accounts of households and individuals and of the working accounts of companies and the strong position with the SMEs that, on a product-by-product basis, we actually had a much lower market share. So let's say in mortgages, while we had 30% of all the current accounts in the country, we had 16% market share in mortgages. So, there was inherent growth potential and when we made an assessment of what would be the net result of doing better on that front, but also reorganising ourselves, for instance by centralising the way in which we dealt with producing mortgages and producing a better proposition, that we would get there. Double digit growth in the sense of 10% or 11% or 12% per annum, in the context of the economy we had, was not a wild or strange target to have would be my view, even still looking back at it now.
Michael McGrath (Cork South Central, Fianna Fail)
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Mr. Sheehy, you made reference a few minutes ago to taking a voluntary reduction in your pension. Do you wish to reveal to the committee what your annual pension from AIB is?
Michael McGrath (Cork South Central, Fianna Fail)
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Okay. Do you wish to confirm the figure?
Michael McGrath (Cork South Central, Fianna Fail)
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€250,000. And the amount of the voluntary reduction that you took? If you wish to reveal it.
Michael McGrath (Cork South Central, Fianna Fail)
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Okay. And you took a reduction from the level that ... that you would've been contractually entitled to, is that the case?
Michael McGrath (Cork South Central, Fianna Fail)
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Okay.
Michael McGrath (Cork South Central, Fianna Fail)
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Sure.
Michael McGrath (Cork South Central, Fianna Fail)
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Sure. Mr. Buckley, do you wish to reveal your annual pension from AIB?
Michael McGrath (Cork South Central, Fianna Fail)
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Okay.
Michael McGrath (Cork South Central, Fianna Fail)
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And the non-disclosure requirement provides that you can't disclose the amount of the reduction, is it? Or that you can't disclose your-----
Michael McGrath (Cork South Central, Fianna Fail)
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-----pension?
Michael McGrath (Cork South Central, Fianna Fail)
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Thank you.
Ciarán Lynch (Cork South Central, Labour)
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Thank you very much Deputy. I just want to tidy up a few matters, I'll bring in the two leads to conclude and then we'll conclude. Just very specific to yourself, Mr. Sheehy, just your own description, as to how you would briefly characterise AIB's relationship under your stewardship with the Financial Regulator in the period of 2003 and 2008?
Ciarán Lynch (Cork South Central, Labour)
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Yes. 2003 to 2008.
Ciarán Lynch (Cork South Central, Labour)
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Oh sorry.
Ciarán Lynch (Cork South Central, Labour)
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Okay.
Ciarán Lynch (Cork South Central, Labour)
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All right, and just a ... on to round off some stuff on the guarantee, a ... you ... AIB brought a formula of words of some description on that night, as Mr. Gleeson said last week. And it ... this may have been covered already, but should sub-bondholders ... should sub-bondholders have been asked to bail in, by your view?
Ciarán Lynch (Cork South Central, Labour)
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And correct me if I am wrong here, by your own testimony today, you seem to have had the impression when you went home that evening, very late into the early hours of the morning, that the guarantee was going to be of one construction to be surprised the following morning to have been shaped in a different way. Do you have a current view as to the appropriateness of the guarantee and how it was put in place?
Ciarán Lynch (Cork South Central, Labour)
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A final issue. Earlier this morning, I think it was on the questioning engaged with myself, you said that AIB was, sort of, monitoring itself against Bank of Ireland than maybe Anglo Irish Bank or other monitors. That was the model space you saw yourself in, yes?
Ciarán Lynch (Cork South Central, Labour)
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Traditionally, okay. So, with reference to those earlier comments, can you maybe explain why AIB needed four times more taxpayers' money than Bank of Ireland?
Ciarán Lynch (Cork South Central, Labour)
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All right. I'm kind of moving into the conclusion here and I'll conclude the final speakers if I can maybe get this covered. You mentioned Sarbanes-Oxley Act this morning, Mr. Buckley, that you were involved in that. Could you just explain to the committee what that actually is? That's an American piece of legislation, that's not an Irish-----
Mr. Michael Buckley:
No, but it applied ... it applied generally around the world and it is ... was really about introducing the sort of huge piece of legislation of, I don't know, 800 pages or something like that. But essentially, it introduced a whole lot of extremely detailed sign-off processes at all levels in a, for instance, a banking organisation, to get to the point where the board of directors would sign off the accounts to make as sure as possible that the accounts were representative of the state of the business. So it was a whole new panoply, if you like, of sign offs and cross sign offs, and all that sort of thing.
Ciarán Lynch (Cork South Central, Labour)
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Okay, as I understand it, and you ... my interpret ... because this came up in our engagement with Professor Black as well, is that the Sarbanes-Oxley Act, very much what it does, is it ties senior banking officials into signing off on the true and fair record-----
Ciarán Lynch (Cork South Central, Labour)
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-----of the bank. Are there criminal sanctions, then, that arise out of that if ... in that act, that are related to it?
Ciarán Lynch (Cork South Central, Labour)
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Yes, sure.
Ciarán Lynch (Cork South Central, Labour)
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Yes.
Mr. Eugene Sheehy:
It related entirely in substance, to malfeasance and misrepresentation at a very senior level in organisations about the state of the companies involved. The sign-offs were to link the leadership of a company to all the public information in that company. And, if there is a disconnect there or a misrepresentation or fraud, that is a legal ... that's a legal problem.
Ciarán Lynch (Cork South Central, Labour)
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Do you have a view in, sort of, robust legislation which kind of ties people tighter into the process that would have very, very strong sanctions being applied? Do you see a shortfall in the current situation there and in where something like this could be done?
Mr. Michael Buckley:
I feel that that tie-in is very important, Chairman, and in fact, I think I'm right in saying that relatively recently, it has become much more explicit in the UK for financial services companies at least. But the answer to your question is, I do believe that the tighter it is, the better it is. Because the more review there will be at each level-----
Ciarán Lynch (Cork South Central, Labour)
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But specifically to Sarbanes-Oxley, that the senior banking officials would be tightened in more to the accounts that they are signing off on and that would require ... that ... resulting in, if it wasn't done appropriately, would actually have very significant sanctions, would be your view.
Ciarán Lynch (Cork South Central, Labour)
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Can we wrap up, Deputy O'Donnell? Five minutes.
Kieran O'Donnell (Limerick City, Fine Gael)
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Thanks, Chairman. Just a very quick question, Mr. Buckley. The fact that your colleague, Mr. Sheehy, has disclosed what his pension is, would you be ... feel that you might disclose what your pension is at the moment?
Ciarán Lynch (Cork South Central, Labour)
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It has been answered. Five minutes, Deputy.
Kieran O'Donnell (Limerick City, Fine Gael)
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Can I go back to Project Omega to Mr. Sheehy, about ... Can you just explain the circumstances of Minister Lenihan's approach to the bank, was there a meeting? Were you surprised with the approach in terms of asking that AIB would take over Anglo?
Kieran O'Donnell (Limerick City, Fine Gael)
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Were you surprised?
Kieran O'Donnell (Limerick City, Fine Gael)
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Why?
Kieran O'Donnell (Limerick City, Fine Gael)
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So were you in survival mode yourselves?
Mr. Eugene Sheehy:
We were ... we were not in survival mode. We were managing our assets as best we could and we were reviewing everything. The PwC report was in process at the time. But, like, it wasn't even conceivable that we could take on another risk, for starters. We wouldn't have had the people or the resources to do due diligence on a bank like that, would take, I don't know-----
Kieran O'Donnell (Limerick City, Fine Gael)
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And two quick questions. What was the reason that Minister Lenihan gave that he wished for you take over Anglo and what was his response when you said you were not willing to take it over?
Kieran O'Donnell (Limerick City, Fine Gael)
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Can I go back to AIB, sorry, C3b, Vol. 2, pages 37 and 38, and I suppose the question, a very quick question I want to ask is, was there a draft provided on the night of the guarantee by the Government to the banks?
Kieran O'Donnell (Limerick City, Fine Gael)
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Well, you've stated in your proposals, the Government submitted a form of guarantee which was inspiration. So the question, I suppose, I want to ask is, what did you get in the guarantee that in the original draft provided by Government was not there?
Kieran O'Donnell (Limerick City, Fine Gael)
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What did you request?
Kieran O'Donnell (Limerick City, Fine Gael)
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Okay.
Kieran O'Donnell (Limerick City, Fine Gael)
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So, in essence, the final agreement outside of the fact that it included Anglo and Irish Nationwide and that it included lower tier 2 subordinated debt, in substance was it the guarantee that AIB and Bank of Ireland requested?
Kieran O'Donnell (Limerick City, Fine Gael)
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But in substance was it-----
Kieran O'Donnell (Limerick City, Fine Gael)
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: Okay-----
Kieran O'Donnell (Limerick City, Fine Gael)
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Are you required as a bank ... were you required to file in any shape or form that the bank was solvent at any time in terms of Stock Exchange reporting or other requirements?
Kieran O'Donnell (Limerick City, Fine Gael)
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So therefore why were you unwilling to allow ... sorry ... Well then, what was your objection to the element being put into the statement that the system was solvent and that all banks were solvent? If a guarantee was being put in place and you were filing on various occasions that the bank was solvent and you claim, and you make a statement here, that AIB was solvent on the night, why, by definition then, did you not agree? I would have thought it should have been a welcome development-----
Ciarán Lynch (Cork South Central, Labour)
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We'll get your thoughts later, Deputy.
Mr. Eugene Sheehy:
Yes, I've explained a few times. It was a liquidity guarantee we were looking for. Deposits is what we were guaranteeing. I referred to the fact that clarity was so important to the markets. It didn't work in the US because of muddled communication. We wanted a guarantee of the deposits of the bank. That's all. Anything else that was added to it wasn't on the agenda, never came up that night until towards the end of it. It was our view that is wasn't adding anything-----
Kieran O'Donnell (Limerick City, Fine Gael)
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And finally, when you were leaving, the last meeting you had, what time was it at? And at that time, were you given the impression by Government ... or who were you given an impression by that it would involve four banks with the outline of the type of guarantee that was put in place?
Kieran O'Donnell (Limerick City, Fine Gael)
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What time was that?
Kieran O'Donnell (Limerick City, Fine Gael)
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What time did you go home at?
Ciarán Lynch (Cork South Central, Labour)
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Okay, all right. Senator, Barrett.
Sean Barrett (Independent)
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Thank you, Chairman and again welcome to our visitors. Was it ever discussed that you might go the ECB or consult Mr. Trichet in relation to these difficulties?
Ciarán Lynch (Cork South Central, Labour)
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Were you in attendance at that meeting, Mr. Sheehy?
Ciarán Lynch (Cork South Central, Labour)
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Senator.
Sean Barrett (Independent)
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And the crisis hadn't developed at that stage?
Sean Barrett (Independent)
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But having broken the ice, so to speak, it didn't arise that you would, in the critical week, involve him?
Mr. Eugene Sheehy:
Well, we would only have a relationship with our own regulator. It wasn't open to us to go past our own regulator or it wouldn't be appropriate to go past our own regulator. There were mechanisms, ELA for instance, which was a mechanism that was available to the regulator to give loans to banks, secured loans to banks, for funding purposes but we didn't ... The regulator didn't want that to happen because when a state regulator facilitated banks with ELA, it was published in the European communiqué from the European central banks, and that then, by extension, became a sovereign issue for that country, so I think the regulator wanted to avoid that, if it could.
Sean Barrett (Independent)
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Okay, thank you. On B3, Vol. 1, page 6, there's material from Mr. Treble who was looking at the loan-to-deposit ratio going up to 157% at the end of 2006, which would brought you second only to HBOS, and that is a more risky form of banking than relying on deposits and, in the same volume he said that targets were set not to go to 157% but to be less than 134% at the end of 2006. And the same document you see that coming into 2007, it was already at 162%. Was that not a risky way to respond to Mr. Treble's concerns about that issue?
Mr. Eugene Sheehy:
Mr. Treble wrote a report in the spring of '09 as a look back at what went wrong. He also had ... he was a treasurer, you know, for part of his time, so he would have a view on this and a responsibility .... The loan-to-deposit ratio that we had was targeted to be in the middle of our peer group and if you look at Regling & Watson, page 34, table 12, you'll find that AIB was 143%, Bank of Ireland 173%, Anglo 127% and others up to 250% - that's Irish Life and that's ... I just use data points to show you how unreliable a measure a loan-to-deposit ratio is, because the far more important one is the adjusted loan-to-deposit ratio which imposes constraints. You could fund ... you could have huge amounts of deposits that were very volatile and very short.
Sean Barrett (Independent)
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Okay, thank you on that. Now, there was .... for Mr. Buckley ... this is the last one, thanks very much, Chairman. The organisation ... On page 4 of your speech, Mr. Buckley: "The organisational reshaping involved centralising as much as positive routine transactional and processing services out of branches, it involved creating a centralised mortgage processing and decision-making centre". Now, if I could direct to B2 on page 8, the internal auditor says: "There were only three staff members in place in the Galway office who had the skills to manage cases on a daily basis, which includes an assistant manager with responsibility for the unit. This could lead to the bank missing significant events or accounts and the subsequent financial loss," which NAMA had said to us, but it is a theory that a solvent bank with a long history like yours went wrong the day it reduced the power of local managers. Mr. Sheehy did refer to the bank being nearer the customer and centralised everything and Galway, in particular, is mentioned, by the internal auditor as having experienced that difficult. And we did find an emphasis on extending new mortgages rather than servicing the old ones.
Sean Barrett (Independent)
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B2, Vol. 1, page 8, if it comes up on your screen.
Sean Barrett (Independent)
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Maybe I got the lucky one .... yes, B2, Vol. 1, page 8-----
Mr. Michael Buckley:
Sorry, Senator, I think I'm right in what I'm saying subject to correction. The first thing you mentioned was about centralising our mortgage decision-making processing out of the branches and that was done. And I think that was a good decision and it meant that there was consistency in decision-making and in dealing with any exceptional situation. The second thing ... the audit report from my recollection over the last two months of reading thousands of pages is an audit report which is talking about our work-out teams managing loans ... commercial loans that had gone bad.
So the two things are actually not connected, if I may say so, in the way that you're connecting them.
Sean Barrett (Independent)
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Well he does say: '"This could lead to the bank missing-----
Ciarán Lynch (Cork South Central, Labour)
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I need a reference, can you just show me, Senator, just put up the booklet a second so I can ... can you just show me the cover?
Sean Barrett (Independent)
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It's B2, Vol. 1.
Susan O'Keeffe (Labour)
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It's B2, Vol. 1, page 21, 31 March.
Ciarán Lynch (Cork South Central, Labour)
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Page 21. Thank you.
Mr. Michael Buckley:
Yes, it is ... I think I'm right, Senator. The first point you made was about mortgages and how we were organised to make decisions on mortgages. This, I think, is the ... we had, from recollection, three work-out teams on commercial lending in different ... you know, Dublin, I think Cork and Galway is what I recollect, and he is making the point here that there was a resourcing issue in Galway, and it's a factual point, and there's an agreed management action against it. "I agree with the point raised", which is what whoever the manager was said, "and agree to sit down by the 30th of June to develop and agree a staffing action plan." It's signed by the senior executive in lending in commercial banking, so there was a resourcing issue. It could have ... if it was left to continue it could have had those consequences, but the manager concerned or the executive concerned committed to dealing with it and to be honest, I don't know what happened after that but it sounds to me like quite a straightforward situation.
Sean Barrett (Independent)
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Except that NAMA also found it a problem much later. Thank you very much. Thanks Chairman.
Ciarán Lynch (Cork South Central, Labour)
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Okay I'm going to bring matters ... just I'm ... not a question, only just a just clarification, yes?
Michael D'Arcy (Fine Gael)
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On the matter of the question that I put to Mr. Donal Forde, on page 125 of the transcript -----
Ciarán Lynch (Cork South Central, Labour)
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Of which transcript now?
Michael D'Arcy (Fine Gael)
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Last week's, Thursday. We had a meeting at 9.30 a.m. I questioned Mr. Forde, "The expansion of the loan book of AIB for property and construction averaged 29% per annum, and that was in the sector that you were in charge of. Would you have considered your growth in that sector reckless?" His response is, "No. I didn't then." I questioned, "Do you now?" Mr. Forde says, "Yes, in hindsight ... reckless is a strong word." Thank you very much.
Ciarán Lynch (Cork South Central, Labour)
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Okay thank you very much. Right, I'm going to bring matters to a close. If Mr. Sheehy or Mr. Buckley would like to add anything further I'll just give you a moment now.
Ciarán Lynch (Cork South Central, Labour)
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Nothing. Okay thank you. Okay so with that said I would like to thank Mr. Buckley and Mr. Sheehy for their participation here today and for their engagement with the inquiry. The witnesses are now excused and I propose that we will break until 2.45 p.m. if that's agreeable to members. Okay? Thank you.
Ciarán Lynch (Cork South Central, Labour)
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As we have a quorum, can I propose that we go back into public session? Is that agreed? And we'll now commence with session 2 of today's public hearings with Mr. Duffy, chief executive officer, Allied Irish Banks. The committee of inquiry into the banking crisis is now resuming in public session and can I ask members and those in the public gallery to ensure that all mobile phone devices are switched off?
We will now hear from Mr. David Duffy, chief executive officer at Allied Irish Banks. David Duffy joined AIB Group in December 2010 as chief executive officer, chairman of the leadership team and board member. From 2006 to 2011, he served at Standard Bank where he was head of strategic projects. Prior to this, he served at ING Group and at Goldman Sachs International. Mr. Duffy, you're very welcome before the inquiry this afternoon.
Before I begin proceedings, I just wish to advise the witness, Mr. Duffy, that by virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of their evidence to this committee. If you're directed by the Chairman to cease giving evidence in relation to a particular matter and you continue to do so, you're entitled thereafter only to a qualified privilege in respect of your evidence. You are directed that only evidence connected with the subject matter of these proceedings is to be given. I would also like to remind members and those present that there are currently criminal proceedings ongoing and further criminal proceedings are scheduled during the lifetime of the inquiry which overlap with the subject matter of the inquiry, so I've been advised that the utmost caution should be taken not to prejudice those proceedings.
Members of the public are reminded that photography is prohibited in the committee room. To assist the smooth running of the inquiry, we will display certain documents on the screen here in the committee room. For those sitting in the gallery, those documents will be displayed on the screen to your left. Members of the public and journalists are reminded that these documents are confidential and they should not publish any of the documents so displayed.
The witness has been directed to attend the meeting of the Joint Committee of Inquiry into the Banking Crisis and you have been furnished with booklets of core documents. These are before the committee, which will be relied upon in questioning and form part of the evidence of the inquiry.
So, if I can now ask the clerk to administer the oath.
Ciarán Lynch (Cork South Central, Labour)
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Okay.
Ciarán Lynch (Cork South Central, Labour)
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Sure.
Ciarán Lynch (Cork South Central, Labour)
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Yes.
Ciarán Lynch (Cork South Central, Labour)
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Okay.
Ciarán Lynch (Cork South Central, Labour)
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Sorry, I'll just go through it. You joined in December 2011?
Ciarán Lynch (Cork South Central, Labour)
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Yes, okay. My apologies if I misread that. Okay, so with that said, Mr. Duffy, if I could invite you to make your opening remarks to the committee, please.
Ciarán Lynch (Cork South Central, Labour)
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That would be very assisting, Mr. Duffy, and just that you know as well that the full document itself will be published by the committee-----
Ciarán Lynch (Cork South Central, Labour)
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-----over the course of the afternoon. Thank you.
Mr. David Duffy:
Thank you very much, Chairman. As CEO of AIB since December 2011, I welcome this opportunity to outline to the Joint Committee of Inquiry into the Banking Crisis my own experience of joining a bank that was in a significantly challenged state and leading its return to stabilisation and recovery over a three-year period. I've worked in banking for almost 30 years, specialising in managing and restructuring banks through challenging times. Though I grew up and was educated in Ireland, I spent most of my career working abroad. From 1987 to 1997, I worked with Goldman Sachs International in various senior positions, including head of human resources Europe head of general services Europe and business manager for information technology. From 1998 to 2006, I held various positions at ING Group, including the position of head of global wholesale banking network. This role included the management of a team of CEOs covering all of the bank's regions globally.
Prior to that, I was president and chief executive officer of the ING franchises in the US and Latin America. From 2006 to 2011, I worked with Standard Bank PLC-Standard Bank International, including holding the position of CEO. In 2007, I took responsibility for the full international franchise. I relocated to Asia in the summer of 2010 and in October assumed the role of head of strategic projects. Leaving Standard Bank in 2011, I established Celtic Advisory International, providing capital raising and development advisory services to corporate and emerging companies.
I was asked to return to Ireland at the end of 2011 to become CEO at a troubled AIB that had been rescued by the Irish taxpayer following investments of €21 billion. Together with the then chairman, David Hodgkinson, who joined in late 2010, we set about a daunting task that involved a radical restructuring of the bank and its balance sheet, the implementation of a €350 million cost-cutting programme, an overhaul of the bank’s funding and pricing models, governance enhancements, and creating the ability to effectively deal with our challenged loan book.
Today AIB is a profitable organisation with key performance metrics in 2014 trending positive. In particular: our lending levels are increasing; our impaired loans and arrears levels are decreasing; the bank's capital and funding levels have stabilised and are improving; the bank’s organisational structure and risk framework have been restructured; the bank has received approval for its restructuring plan and passed the ECB-EBA comprehensive assessment; the bank has placed significant emphasis on meeting the expanded and enhanced regulatory environment across Europe. Having returned the bank to profit and stability, it is my expectation that AIB will be in a position to return capital to the Irish State over time, subject to economic conditions and the wishes of our majority shareholder.
In conclusion, as mentioned, I have covered the six topics here. I think the effectiveness of the bank's board governance is fairly well documented here, so I won't spend much time on that and we'll just deal with that in questions. Our bank credit risk strategies and risk management strategies are significantly updated here. I'd draw your attention to cash flow, credit lending, which is the most significant difference. There are many other complementary and important adjustments that have been made in the bank, but that area is one of particular emphasis, versus what has been a practice in the past.
With regard to remuneration arrangements and bank's risk assessment, I'd just draw your attention to the fact that we are under the bank's placing agreement and restricted in that matter, but I have documented our philosophy with regards to that for the purposes of discussion, although it has been in practice not applied due to the restrictions that we have.
On the clarity and effectiveness of the nexus of institutional roles and relationships, I think one area of emphasis that I will discuss is the fact that we are supervised in reality by the SSM, and so all decisions on capital funding, appointment of senior persons up to and including my replacement as a CEO, are at the behest of the European supervisors. I think those were the four that I particularly wanted to mention out of the six.
I would say that the liquidity and capital will be an extensive discussion, so I won't try and select components of that. And with regards to item 5, on the appropriateness and effectiveness of domestic policy responses, and in particular NAMA, I don't have much experience of the history prior to my arrival, but I'll endeavour to answer questions as best I can.
In summary, I wish to thank the committee of inquiry for considering my account as documented. I fully appreciate the difficulties you face in dealing with such a weight of information from so many witnesses. The banking and economic crisis in Ireland has indeed been staggering, the impact of which I could not fully understand until I returned to Ireland and witnessed the consequences first hand. I hope that my statement to you has assisted the committee in appreciating how, in spite of the depths to which it plunged, the bank has been stabilised and restructured and should go on to support the Irish economy and the Irish people, as it should rightly do. Chairman, that concludes my comments. Thank you.
Ciarán Lynch (Cork South Central, Labour)
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Thank you very much, Mr. Duffy. And to commence proceedings if I can invite Senator Michael D'Arcy, and please, Senator, you've 25 minutes.
Michael D'Arcy (Fine Gael)
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Mr. Duffy, you're welcome, thank you for coming. I'm going to start where you have finished, Mr. Duffy. "The banking and economic crisis in Ireland has indeed been staggering, the impact of which I could not fully understand until I returned to Ireland." It's a term not that often used by bankers, who tend to be more conservative with their language, the term "staggering". Could you explain why you chose that term?
Mr. David Duffy:
Well I think the thoughts leading to that kind of phraseology would not intentionally have tried to be inflammatory or excitable. They refer to the significant scale of the financial numbers involved in the rescue of AIB. The original €21 billion which was invested in AIB as capital was only part of the equation. In the first year of my taking on the role we had an additional obligation to deleverage a further €20 billion of assets under the direction of the troika regime. So that was another €20 billion, an almost coincidental number. Prior to that we had to deliver a very significant portfolio of assets to NAMA at a very significant discount with another capital impact. In addition, assets had to be sold in various other jurisdictions, notably, most significantly, Poland, but also the US. So if you look at the cumulative effect of all of those numbers it was a shockingly large number, and in addition it wasn't just about those sales, those disposals, and those injections of capital. The requirement to reduce the staff by pretty much a further 4,000 since I took over on a gross basis, and a further cut of €350 million of costs, plus an overhaul of the entire structure, governance, culture, and leadership and executive levels, I would put all of those into the rare situation of having to do all at once in one bank as being exceptional and perhaps, therefore, staggering in terms of the scale.
Michael D'Arcy (Fine Gael)
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Thank you. In your page 3 of your statement that you furnished us with, "I am satisfied that from a governance perspective we now have an executive leadership team comprising strong and diverse management capability." Can you expand upon "now"?
Michael D'Arcy (Fine Gael)
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And yes, and if you could reflect backwards on those who went before you. I'm not allowed lead a question, Mr. Duffy, so I think you could see what I have in mind, please?
Mr. David Duffy:
Thank you for the clarification. When I refer to the team, as I have referred to them, I refer to the mix of skills, very importantly, as the first element; secondly to the experience base; and thirdly to the international experience base of the team. I think it's very important, particularly sometimes when you're in a smaller universe, that you have best practice experience and benchmarks from within the universe, but also externally, and those who have the experience of crises perhaps before, perhaps not on this scale. The recruitment effort that we had sought to find the best in class for each position, and in each position we looked to see if there was a capability that had experience of how to manage significant change management programmes which was, as I mentioned earlier, fairly massive in its scale, and also had the competence to deliver on a model which we were designing which was, in our minds, being structured to prevent a recurrence of any similar catastrophe in the future. That skill base and that intellect and that experience, domestically and international, was something we took two years to put together, it was challenging, but we succeeded, and I'm very confident in that team today.
I think the comparisons to the past are not directly linked, because what we are faced with is a challenge as a change management universe and a restructuring universe is very different than a business-as-usual management universe, so regardless of whether somebody was competent or not in the past, the skills required to do what we had to do, where every single action was almost simultaneous and in a very short window of three years, were different skills than existed in the team at the time.
Michael D'Arcy (Fine Gael)
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You quoted the figures in terms of the reorganisation of AIB. You didn't quote the figure for the shareholder value loss. Do you have a final figure on that?
Michael D'Arcy (Fine Gael)
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Okay, thank you. Also in your opening statement you state, "Clearly upon my arrival at the bank there were concerns about the bank's culture and governance." How far did those concerns that you identified go back within the bank?
Mr. David Duffy:
Senator, I don't think there was a particular timeframe of reference. What I am implying by that comment is that on my arrival, when I met with the regulators, there was some dissatisfaction with our process, our control, the quality of our relationship, our communications. The bank had, during the period prior to my arrival, seen a number of CEOs and new heads, so there was a bit of disarray. There were impending material programmes, such as severance, which were outstanding 16 months at the time of arrival. That level of uncertainty and changing leadership meant that the organisation was not in a sufficiently effective place from a regulatory interaction perspective as regards the regulator's opinion.
Similarly, our shareholder in the Department of Finance in the shareholder management unit did not yet have the confidence on what the strategy would be to recover the bank as we had not obviously had time to explain that so there were concerns about how we would approach that and how effective we could be in delivery. So it was that level of interaction that led to my comment where there was a concern. Did we have the right skills, as I mentioned earlier? Did we have the right leadership? Did we have a strategy that would be agreeable to, and comply with, the requirements of both the regulator and the troika? All of those elements were uncertain at the time. I myself did not know the full extent of the problems until I had spent a bit more time there but those were very clear issues that were relayed to me by the individual stakeholders at the time.
Michael D'Arcy (Fine Gael)
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And if you were to do a one, two, three of what were your three greatest concerns starting with your greatest one, two, three?
Mr. David Duffy:
I think my greatest concern relates to what is necessary to run a bank well and that starts with culture. I think there was an organisation that had been through too much change in leadership, had been through a shocking crisis in terms of shock to the system of internal as well as external. There was a huge amount of uncertainty. There was a fear about the individual roles. It was so much of a distraction that we needed to be able to be very clear up front that the bank is not there for itself, it's not there to worry about itself; it is there to serve customers and delivering a customer culture. In other words, every thing that gets done in the bank, every process it serves, the customer had to be prioritised. How could we do that? That meant customers not just in the normal course of banking, but it meant the significant population who were in distress and arrears at the time for which we had no capability ... so creating that culture which recognised that the priority was not necessarily an internal focus, the priority was an external focus and that meant shifting the culture of the bank to an external lens and then applying all the lessons that we needed to recover the bank to that lens. So that would be the first issue.
The second issue was, I think, operational risk. You had a bank that had been through so much recent turmoil, it was not yet certain of the outcome. We had very many staff leaving, senior people leaving, and an awful lot of the organisation was in stasis. It was unable to move, it wasn't sure which direction to go, it wasn't sure of its future. So that uncertainty and operational risk that it generates ... Are people doing their job? Are they managing the processes? Are they implementing the controls that we should have?
The third area would have been the functioning of the bank in its purpose, which primarily is to lend to customers, that risk aversion was very material at the time. People weren't sure of what the capital structure was, whether our funding was stable and, therefore, were very, very adverse to taking decisions on lending. So there was a very significant adversity to taking risk in the bank and that aversion meant that I couldn't be sure where the revenue profile and the cost profile was going to end up in the first six to 12 months. So I think if ... you know, I'd want to reflect in time if I whether there was any change in that priority but I think culture is overarching. It's overwhelming in terms of success or failure and then the other two follow from that.
Michael D'Arcy (Fine Gael)
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And are you satisfied with where AIB are currently in relation to -----
Mr. David Duffy:
I am, Senator. I don't believe that by any manner of definition that you would apply that it is complete and finished work. I believe that we have stabilised return to stability, applied all of the appropriate governance that we would wish to have to prevent reoccurrences of this magnitude, but I still think we are on a journey in terms of deeply embedding a culture which is about delivering for our customer rather than the lifestyle or livelihood that you have by being in a bank.
Michael D'Arcy (Fine Gael)
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And is there any further change that is required to put in place the ultimate culture or ultimate structure that AIB should have that you haven't currently put in place?
Mr. David Duffy:
I don't think so, Senator. I think what is required is experiential learning. It is embedding everything that we have put in place. The governance model covering every aspect of the bank from credit risk to our operational risk to lending and trading risk needs to be practised at all levels of the organisation. The ultimate test of this will be time and tone at the top is where we have focused such that will be fed through the organisation through all aspects of the organisation. So it was ... I don't think there are material new developments to be implemented. I do think there is a significant amount of practice of best in practice governance that needs to be applied and learned from before we can be comfortable that it is a fully completed exercise.
Michael D'Arcy (Fine Gael)
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''Since 2011, the approach to risk management within the organisation has fundamentally changed''. That's a quotation from your opening statement. Credit assessment now focuses mainly on cash flows as a primary source of repayment with collateral considered as the secondary source. Could you explain why in your opinion this had not been the case before 2011?
Mr. David Duffy:
It's difficult to answer that not having been in the bank and also not having been in the country so I would be observing from a very far distance. I think my observation would be more limited to what was happening internationally. I think there was a crisis that was sown a long time before it happened. When you originally had Glass-Steagall allow retail and investment banking come together, that created a potential significant leverage and, ultimately, greater risk in the system. When you add to that the techniques of distribution around the globe and securitisation of asset classes where the well known subprime category and many others were combined in tranches of debt which were sold around the world, you spread that risk. which was already highly leveraged. Then on top of that, the light regulation or principles-based regulation, as it was mentioned, in numerous forums existed and the covenants and documents for loans became less restrictive and lighter and more forms of collateral were acceptable in any circumstance. And that principally allowed collateral on real estate to be offered up as part of the credit process. If you look at all of those taken together I think it was common practice across the globe to use real estate as collateral hence the subprime crisis that occurred globally. And that then was something of a cultural herd mentality that existed around the world in many countries and was no different here in Ireland.
Michael D'Arcy (Fine Gael)
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If risk appraisal had focused more on the cash flow analysis, would the impact of the crisis have been so severe on AIB?
Michael D'Arcy (Fine Gael)
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In your opinion, in relation to the statement you made about the credit assessment being focusing mainly on cash flows as a primary source of repayment, if the appraisal, the risk appraisal, had focused more on cash flow ... analysis, would the impact and the crisis have been as severe on AIB?
Mr. David Duffy:
It's judgmental, but my own opinion on it would be that the principle of cash flow-based lending is around affordability. You can't borrow unless you can afford to repay it and, therefore, I think the level of borrowing perhaps would not have been as extreme or as large and significant individual cases as the cash flow would have to be demonstrated. With collateral you tend to have value rather than cash flow so it's not provable that you can repay the loan; it's implied that you can pay the loan based on future values. Those future values are subject to, as we've seen, asset class corrections. So I think, judgmentally, I would say if you are lending on the basis of cash flow, that evidence is an ability to pay, you won't be absolutely able to avoid any crisis but you would certainly be able to be in a stronger position for repayment on your loans.
Michael D'Arcy (Fine Gael)
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Mr. Duffy, you hadn't taken up your position within AIB very long when you publicly stated that AIB would consider writing down loans, debt forbearance. In terms of debt forbearance, and a moral hazard between mortgage write-down and-or SME corporate write-down, could you just outline your view why you so quickly moved to that position?
Mr. David Duffy:
I think the philosophy we adopted at AIB in respect of any compromise on debt was again around the simple principle of affordability. We started out with two principles. If we wanted to keep people in homes wherever possible and if we wanted to protect SME jobs, what would the best approach be? We didn't necessarily take the view that someone would have to stay in their home. It may be a suitable home. We took the view that SMEs should be protected only when the business was viable and then when we applied those principles and looked at the financial aspects of each of the cases, we took the view that if it was clear that the debt was simply unaffordable, there are many extremes. You can have an SME that had a property investment strategy on multiple buy-to-lets in concert with two other businesses or individuals in a small town where the income ratio would imply that to recover the debt might take something in the order of 50 to 100 years, depending on your assumptions.
If there were extreme cases where you could not see any circumstance of repayment, we thought that on balance it was better to be realistic about that debt structure and to put ourselves in a position where the SME could return to supporting its business and its employment that it had originally started out with, and that would be constructive and positive for the economy. Secondly we would be, in the case of an individual and the home and looking at exactly the same situation, there are many examples of cases where it was more attractive for the individual and for the bank, for the individual to remain in the home. If I may give you an example. If an individual had purchased a house, as was in one case for €400,000, and if you were to evict the individual in the house - on sale in the market at the time was valued at €100,000 - and at the same time you could agree with the individual on €200,000 or €250,000 as an affordable long-term debt repayment, then you would maybe compromise on the residual debt but at the same time the individual remains in their home. They are functioning in the economy and they are repaying far more for the shareholder than would have been obtained by a simple repossession and eviction. It was that thinking that we constructed around all of those. They were very exceptional and treated all individually, very consistently.
Michael D'Arcy (Fine Gael)
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Mr. Duffy, you are about to leave AIB. You are about to move to another jurisdiction, you are probably in a better position than most now to offer a view in relation to the establishment of NAMA. I am not sure if you have seen the transcripts from NAMA's evidence to the inquiry to date. Could I ask your view ... was the establishment of NAMA helpful or unhelpful towards the banking crisis?
Michael D'Arcy (Fine Gael)
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You are about to leave.
Mr. David Duffy:
I am not being released just yet, despite my relaxed demeanour. I am in a position though, however, to say that from my involvement with NAMA, which was necessarily close both in terms of asset transfers that had happened and the ongoing servicing of the residual assets for which the staff of AIB were still retained, I think the experience I had was that it was extremely helpful to us in our ability ... the scale of what we had to do ... when you look back, it was extraordinary - the volume, complexity and concurrent nature of it and I think it was of immense assistance to AIB that we had that circumstance where we were able to execute all of our other initiatives with the support of our involvement in NAMA. Also, the NAMA exercise for us gave us a better understanding on crystallisation of losses, of what the capital deficit was and what necessary actions needed to be taken. So from the narrow view of our execution relationship with NAMA, I would have to say that on balance it was beneficial.
Michael D'Arcy (Fine Gael)
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Since nationalisation of AIB, prior to you becoming CEO ... AIB, have they used external consultants for advice, outside of your own banking knowledge and expertise?
Michael D'Arcy (Fine Gael)
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Have they ever used external consultants?
Mr. David Duffy:
Prior to me there were a number of external consultants used and I think the one comment I would make there is that consultancy may often be, whether in crisis or in business as usual, a requirement of a bank if you are looking for expertise that you don't have internally. So I don't necessarily see consultants as always a bad answer.
Michael D'Arcy (Fine Gael)
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Do you have any ... do you have the knowledge of how much was spent on external consultants by AIB since nationalisation?
Mr. David Duffy:
It is hard to quantify. I would just say that the usage of consultants since I have arrived is materially reduced. Once you can bring the expertise into the bank, the corollary of that is that you can significantly reduce your dependence on external consultancy. And I think at the same time you will have external bodies continually operating if you have outsourced within a bank, so that's another aspect of this. So I ... it's too complex to come up with an exact number but I would say that on balance, if the question is are there material amounts of expenditure and consultants contributing to AIB today, the answer is "No".
Michael D'Arcy (Fine Gael)
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Can I ask what is a safe level of growth for a balance sheet, year on year, for a bank? Mr. Bill Black, when he gave evidence, said ... his term that he used was "grow like crazy" is 30%. AIB's figures from balance sheet growth from 2001 to 2008 was 29% year-on-year. What, in your view, is a safe level of growth?
Mr. David Duffy:
I am not sure that I can say that there's any safe level of growth because I don't think growth targets are the criteria by which you would manage a bank. I think you have a simple ... when you wake up in the morning running a bank you worry about liquidity, No. 1. Secondly you worry about capital and they are the two priorities.
If you are going to lend, you have to have a threshold minimum of capital, which is not just the minimum regulatory capital but is probably that plus a buffer, where you would look to have a very conservative view on a stressed environment as to what that capital could become. And that is your starting point. You can then determine what your lending can be, providing that it doesn't breach those hurdles. Secondly, your lending composition has to be understood in terms of your funding. The history of lending had no regard necessarily to the composition of funding and you have two choices: retail longer term sticky funding as it is referred to, and wholesale funding. If it is a short term, as wholesale often is and can be subject to flight in a very quick fashion as happened in Ireland, then long-term lending without short-term funding is going to put you significantly at risk.
So I think you start off with two very careful principles - what is the minimum threshold of capital - which when in a stressed environment based on rapid asset deterioration, what is that level you should maintain - and is your funding correlated to that profile? If you have confidence in those two then you can set a target of growth which doesn't breach either of those two objectives. So I would never start with a number, I would start with the capital and the funding and then allow myself grow according to those definitions.
Michael D'Arcy (Fine Gael)
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And Mr. Duffy, during the period from 2001 to 2008 which were the highest level of balance sheet growth by AIB, based upon the liquidity within AIB ... at the time I know it is before your time but I'm sure you must have done some analysis in relation to that period, what was your opinion upon the operation of the bank at that stage, outside of your opening statement?
Mr. David Duffy:
Senator, not to be difficult but I don't really have an opinion because I haven't, contrary to popular views, spent a lot of time studying in the past. Not through any lack of enthusiasm or effort but when we arrived we were already on 18 hour days trying to define the future so I didn't spend a lot of time on the past, and what I looked at was what I just described to you in my previous answer - what are those thresholds that we need to safely run the bank for the long term. So I don't really have a considered opinion on the efficiency of the management prior to my arrival.
Michael D'Arcy (Fine Gael)
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In terms of the bank guarantee, do you have an opinion on the bank guarantee? Again, I know it was before your time, but you are exiting I keep telling you - you are going soon. You may be able to offer an opinion. I think it is important that you are probably best placed to offer an opinion. You are CEO of what was the largest bank in the country and I do think it is important Mr. Duffy that you put your opinion on the record. I know you haven't gone just yet.
Mr. David Duffy:
Thank you, Senator. I would be thoughtful about how my opinion ... I think when I look at the bank guarantee I look at the international world which I was more relevantly a participant in at that time. I think in Ireland's situation you were suffering the consequences of what was happening globally, which was then exaggerated by the composition of the assets which each bank had here at the time. Many of those situations involved banks being allowed to go under and many of those situations involved banks being rescued. There were different logics applied in each of the circumstances. I think in Ireland's case, were one or two banks allowed to go under, that probably would have created quite a risk for this country but maybe it would have been a position where there was finality a lot sooner ... but is impossible to predict.
There was no question in my mind that a guarantee of sorts had to be applied. Banks don't make anything, they offer a service which is providing funding for commercial activities. If there is a failure or a lack of confidence in a bank then there is no control that you have over that and your deposits will run out of the bank. So if there wasn't a guarantee of some kind - I can't form an opinion as to whether it was the right guarantee or not - but if there was not a guarantee of some kind, the confidence in the banking system here didn't exist and it could have led to a more dramatic and severe outcome.
Michael D'Arcy (Fine Gael)
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Do banks not make profits?
Michael D'Arcy (Fine Gael)
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Just to finish, Chairman, the drive to keep up with a market share, to protect the franchise, there are terms ... a number of terms that have been used, can I ask your opinion in relation to the attempt to keep up with, potentially, another institution?
Ciarán Lynch (Cork South Central, Labour)
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In what timeframe, Senator?
Michael D'Arcy (Fine Gael)
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From our terms of reference, going back to '91 to 2013.
Ciarán Lynch (Cork South Central, Labour)
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All right, final question. I'll bring you back in if you need further clarification on that at the end.
Mr. David Duffy:
Yes, well, as a teenager at the time, I'm not so sure. I can say though that, very explicitly, you don't chase market share and you don't chase competition. What you do is you manage your bank to the limits of what your capital and funding is. I think, if there's any lesson that can be learnt, it is that your priority as an executive, or a chief executive even, is mainly risk management. You manage risk of the bank and everything you do in the bank. And that starts with capital and liquidity and then you allow yourself any indulgence you would like sufficient to maintaining those thresholds. So if somebody said to me, "You must double your market share," the very first question is: there's a lot of commercial discretion around that target, do you understand why? But the very first question is: do we have the capital and the funding to do so whilst maintaining a conservative position in the event of stress?
Ciarán Lynch (Cork South Central, Labour)
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Thank you very much, Mr. Duffy. Thank you, Senator. Deputy Pearse Doherty, 25 minutes.
Pearse Doherty (Donegal South West, Sinn Fein)
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Go raibh maith agat, a Chathaoirligh, and welcome, fáilte, Mr. Duffy, chuig an coiste. Mr. Duffy, we've been privileged to have a number of bankers before the committee in the last number of days and each of them have apologised to the Irish people for the mistakes that were made in your bank. As the previous speaker had indicated, you're probably best positioned, as somebody who came after the bailout, after the transfer to NAMA, but has an overview of what was going on within the bank. In your view, what was the key areas that led to the bank costing the Irish taxpayer over €20 billion?
Mr. David Duffy:
I think it was relatively straightforward. If you have an over-concentration in a particular asset class, and in this case property, and you have a funding profile that has too much short-term funding in it and you are suffering what would be then a global liquidity crisis, then you are not well positioned to respond to that because you are going to see a very correlated reduction in the asset values which are going to burn through your capital very quickly and that uncertainty that that creates, without appropriate diversification, leads to an exit of deposits which turns a global liquidity or a domestic liquidity crisis into a solvency crisis. So a concentration risk and a funding structure that was subject to too much short-term departure of your funding.
Pearse Doherty (Donegal South West, Sinn Fein)
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Can I ask you in relation to the global liquidity - because this has come up in evidence - and the crisis at that time; if there wasn't a global liquidity crisis at that time, would AIB still have lost ... well, we know it's well in excess of €20 billion, but would it still have cost the taxpayer €20 billion?
Mr. David Duffy:
Deputy, it's hard to quantify an exact number. I would say that my opinion would be there would have been still significant pain. I think the issues remain. You had a short ... too high a content in terms of short-term funding and you had too large a concentration in single asset class, and either of those could have caused you pain.
Pearse Doherty (Donegal South West, Sinn Fein)
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Okay, and I'll come to some of those points. But it's been suggested again before the inquiry, and the suggestion goes something like this, that the global liquidity crisis actually could have saved this State money in the long term because there was no indication that the banks were going to stop their concentration into the property and development and commercial property sectors. Do you subscribe to that notion or do you reject that notion?
Pearse Doherty (Donegal South West, Sinn Fein)
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Basically, the suggestion is, is that there was no ... there didn't seem to be a let-up from the banks of investing into concentrated areas such as commercial property, development property, and that what the global financial crisis brought on was basically a realisation that assets were overvalued and would eventually have to be written down.
Mr. David Duffy:
Well, I believe that the answer is "Yes," that the global liquidity crisis helped accentuate that reality and helped quantify it in many cases, in many countries, and I think Ireland ... when I was in previous banks there was a view across some of those banks that the asset class of real estate, particularly even private homes ... there were many others, but private homes were reaching unsustainable levels across a number of European countries, and that was observed a couple of years before the crisis hit. It was very different than sub-prime, which was part of the global liquidity crisis in the US, but when you have an income, and if your income is rising 5% or 10% a year and the cost of a home is rising 30%-40% a year there's an elasticity problem. At some point that breaks. And so I think there are ... definitely the liquidity crisis put people at risk where there was over-concentration.
Pearse Doherty (Donegal South West, Sinn Fein)
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As a banker, Mr Duffy ... we know that AIB were beginning to breach the standards of concentration limits in 2006. We've also been told that this was being worked out with the regulator and that this process may change in the future, but, as a banker, with the interest of your shareholders and that concern as one of your core priorities, is it prudent to go above the limits that were in place at that point in time or was it imprudent?
Mr. David Duffy:
I'm not entirely familiar with the detail of those limits. It depends on whether ... I'll make it very black and white, Deputy: if there are limits that are around the sustainable nature of the bank's existence, those are limits that you have to define as a banker, not somebody else. Limits in the past I have seen, have been either indicative, guidelines, or tacitly accepted as too low, many different practices in different countries. But, again, I regard that as interesting but not the criteria that you manage a bank by. You yourself have to look to the sustainability of the bank under your fiduciary responsibility and in so doing you have to set the minimum capital and other thresholds that you have, and included in those are concentration risks. The model which we have in the governance of AIB now is very explicit. You are going to set limits, with the board's full involvement, to understand in all areas what your limits are at a maximum, whether by sector or individual. Any breaches of those have to be escalated to the board risk committee, which is chaired by a non-executive, not the executive. They are raised by the chief risk officer who, in our climate now, does not report to me but reports independently to the chair of the risk committee, who is a board member. So I think you have to say: is the right answer whether you can or can't breach? No. The right answer is: what is the right concentration? And you should not breach that if you think it's the right concentration. You set those limits based on your minimum capital and funding thresholds. That's the way I would work.
Pearse Doherty (Donegal South West, Sinn Fein)
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In your opinion, what was the main weakness in the bank's risk appetite process prior to 2011?
Mr. David Duffy:
I think it was a combination of a couple of things. I think the fact that it was so heavily geared towards collateral and so concentrated in one asset class. So I think the reality there is what you're doing is you're implying that there's a value in the future. You're relying on third-party valuations for that value that you might obtain in the future and if it is such a large portion of your assets then any hit has a highly correlated negative. If you don't have a large portion of that lending in that category or sector or individual based on cash flow, you have no real certainty. You have an asset valuation model, not an income model to repay your debt. So I think that's part of the problem. There was a whole load of small issues you could consider, but in reality-----
Pearse Doherty (Donegal South West, Sinn Fein)
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The liquidity issues.
Pearse Doherty (Donegal South West, Sinn Fein)
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And, in your opinion, Mr. Duffy, why weren't those issues addressed by the incumbent management?
Pearse Doherty (Donegal South West, Sinn Fein)
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Is it obvious to you that those issues were serious issues, if you were in that position? Would it be obvious to a banker that they were serious position ... serious issues?
Mr. David Duffy:
I think a herd instinct is a lot to do with this. When I was looking at this, before I got to AIB, this was happening in many jurisdictions in many countries, and the faith in asset prices rising and the encouragement by almost every professional in the industry to chase after the best market share in that area, those were the prevailing cultures at the time and those were the prevailing thoughts at the time.
It should probably have occurred to people that, like anything else, it can't ... asset prices, any prices, can't move in one direction forever.
Pearse Doherty (Donegal South West, Sinn Fein)
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What is your view in relation to the challenge presented by the risk function to lending strategies? Were they sufficiently strong in the period leading up to the crisis in 2011?
Mr. David Duffy:
It's hard to observe on an individual case level. I would tend to look at it as allowing such concentration in an asset class would suggest a weakness. I don't know the individuals or the process, but I think there are many issues which I would look at today as being best practice which perhaps the industry didn't have at the time, not just AIB, but having a chief risk officer who is independent and having risk managers who are independent of the business, not allowing the business to originate and approve its lending, having all exceptions to any limit automatically escalated and supervised by the board directly. Those are the things which probably didn't all exist at the time and certainly, for best practice, should exist.
Pearse Doherty (Donegal South West, Sinn Fein)
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Okay, in the revised 2002 EU restructuring plan and it's on AIB B1, Vol. 2, pages 39-40, I won't read the whole paragraph but, it says: "AIB acknowledges that its decision to expand into property was misguided and that's its risk management and internal government systems were not as effective as they should have been in controlling that risk." Do you believe, Mr. Duffy, that is a fair assessment of AIB's position leading up to the crisis?
Pearse Doherty (Donegal South West, Sinn Fein)
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And can you further... you are of the view that AIB now has the appropriate structures and controls in place to ensure that we are not seeing a repeat of that type of scenario.
Mr. David Duffy:
I do believe we have. I mean it is important to define what I mean by that, Deputy, the important differentiation, for me, is the chief executive or the executive cannot be the arbiter of your risk accumulation. They can contribute, and the board contributes to a strategy, but when you are operating the bank, the people who originate must be separately accounted for in terms of those who approve. So independence of the risk function is fundamental. On top of that, the chief risk officer should not be reporting to the chief executive. If you were, as in some banks in the world today, or as accepted, you were the chief executive and you have a chief risk officer and you are paying his bonus or variable compensation, then you cannot say with absolute confidence that there would not be a conflict of interest at some point. So I think, one of the first things we did was, for both audit and risk, made sure the independence of reporting directly to a board member, non-executive, who chairs the risk committee is a fundamental principle of how you should operate. So that, and then our ... all of our policies, all of our guidelines which I have tried to document in my statement, with limits, with exception reporting explicitly mandated and required to be reviewed at the board, with all of those elements I believe we have the appropriate governance to prevent a re-occurrence.
Pearse Doherty (Donegal South West, Sinn Fein)
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In relation to your opening statement on page 3, paragraph 7, you say that the large exposures and approval authorities policy "replaced the previous Group Large Exposure Policy." Can you tell the committee why you replaced the group large exposure policy?
Mr. David Duffy:
Well, what we did, Deputy, was we felt that best practice governance would tell you that you need to have a strategy which is informed by a risk appetite and therefore you need a risk framework. So if you'll forgive me just taking you through the latter, so in your strategy there is no commercial strategy unless you have understood your risk appetite and the framework for that and then that derives your capital funding. In that risk appetite, we replaced everything, not just large exposures. And we sat down and said, for a bank whose purpose is principally to serve Ireland, and that's is its sovereign obligation, if that is its sovereign obligation, what is the risk appetite? And every policy should be resized and reformulated to align with that intent. So that is what we did. So every single sector and for single names and every asset class, we reformulated and put the policy in place that aligned to our sovereign strategy and at the same time, massively reduced the levels of limit in each of those categories so that the escalation was required at a much higher... a much earlier level in origination than would have been the case before.
Pearse Doherty (Donegal South West, Sinn Fein)
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Thanks Mr. Duffy, we know from... again evidence that has been provided to the committee in relation to the transfers from AIB and other institutions to NAMA, that the vast majority of the sum total of that money came from a small number of borrowers. And AIB is no different in this regard, did you see any issue with the group large exposure policy as contributing to the loss that AIB experienced?
Mr. David Duffy:
I think the whole asset class contributed in many different ways, but certainly it was additionally exacerbated by large concentrations with individuals were effectively in a risk scenario like that, bankruptcies and even personal guarantees weren't going to be viable and so you were liable to lose a more material amount of the individual loan that was lent to a person in a large exposure category. So I think it can have, certainly an exacerbating influence.
Pearse Doherty (Donegal South West, Sinn Fein)
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Okay, the ... again in your opening statement, you talk about the need for continuous oversight saying that: "The recent history of the banking sector has required that this process is predominantly evidence based for both potential and conduct of business regulations - banks must not only comply with what the regulations require, they must also continuously evidence that compliance." How does this process compare and contrast with what you first saw when you arrived at AIB?
Mr. David Duffy:
I think, Deputy, the previous era was a regulatory one where lighter supervision and principles-based regulation were the fashion. And much was made of it, I remember during my time in the UK, much was made of a leading financial centre because it operated a principles-based regulation. Those were far less forensic and far less, you know, controlling. I think, when I arrived, we could see that we were going to have to move to a world where we were absolutely clear in our mind as to what our risk framework and appetitive would be by sector and individual. And we were going to, internally first, be very explicit in our evidence into the board and to the executive supervisory committees that we were compliant with those. It then followed that obviously, and logically, the regulators moved to a point of wanting also to see the evidence of that. If you fast forward to today, AIB is as I said, jointly supervised but by the SSM in Frankfurt. And that is entirely an evidence-based system, so I think both internally and externally, evidence had to be your philosophy.
Pearse Doherty (Donegal South West, Sinn Fein)
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Okay. I am not sure if you have followed the proceedings so far, we have had contributors from NAMA in, which talked about, and there has been quite a bit of discussion at the committee in relation to loan-to-value ratios and what were the real loan-to-value rations that were being offered. The suggestion has been made in many cases that the loan to value were 100%. I want to put to you the evidence to the committee of Donal Forde and he said in relation to security and loan approval, it is on page 137 of his evidence and he... the quote is:
the difficulty arose because the security that we held, which in many cases was equity, also began to devalue very quickly. So I think it's true to say that in the way things ultimately developed, we were left frequently where it wasn't cash that we had recourse to, but they were assets that were of much less value.
NAMA has made the point, Mr. McDonagh and Mr. Daly who has been before, is that the loan to values in many cases and what they have seen transferred into NAMA were close to... were 100% in many cases. Do you subscribe or dissent from either of those views presented by Mr. Forde or by the witnesses from NAMA?
Mr. David Duffy:
I don't have a detailed knowledge of all of them, but I am not surprised by that. I think there were circumstances that I saw of that nature. I think the problem that I could see there is that, a bank should never be the first loss in any lending and putting equity into a transaction puts you in the position of being a first loss there in many circumstances. Secondly, loan-to-values have to be very carefully considered; they should not be at 100% in any asset class even with guarantees. I have seen in the crisis, in my previous bank, a loan-to-value of 40% become 100% in a matter of five weeks. So they are an element but they are a spurious element, they cannot be the defining criteria of your lending. And as I go back to the point, if you are relying again totally on asset valuations, and loan-to-values against an asset valuation and you have equity in the deal and no cash flow comfort, then you have a much higher risk. So... hence our model today is cash flow lending, minor collateral but mainly cash flow lending.
Pearse Doherty (Donegal South West, Sinn Fein)
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Okay, in relation to NAMA and I know you mentioned NAMA bonds on page 7 of your statement in paragraph 3, and I am also aware that you weren't at AIB at the time of the transfer of the loans to NAMA, but you were there while AIB held the NAMA bonds. Can you tell the committee for what purpose did AIB use the NAMA bonds? How did they work? What were the steps involved?
Pearse Doherty (Donegal South West, Sinn Fein)
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How important for your bank was it that the NAMA bonds became available to AIB to access that liquidity?
Mr. David Duffy:
I think, for the residual value of the transfer, we had to have an asset that was something in terms of the value that we were retained, you know, for the transfer that was applicable as a liquidity driven funder, so it was very important because, at the time, we had, I think, close to €30 billion of funding from the ECB and we had to repay all of that through the asset deleveraging and the wind-down of the NAMA bonds themselves so I think they were an important part of the construct of our funding at that time.
Pearse Doherty (Donegal South West, Sinn Fein)
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Okay. Mr. Duffy, you weren't obviously at AIB; indeed ,you weren't in the country at the time of the bank guarantee. You mention in your opening statement you were born and educated here, you worked as CEO for Standard Bank International. I'm aware that that was a Standard Bank plc who we might recall in 2009 suggested that Ireland and Greece would end up going into a bailout by the end of the following year, or out of the European Union. Unfortunately, one of them proved true. Did you keep an eye on developments in Ireland from your role back in Standard Bank International? Did you keep an interest in what was happening during that period?
Mr. David Duffy:
I had a peripheral interest because whilst I was not here, I spent my weekends in west Cork, and as those of you will know, you are not short of an opinion in west Cork, so I was given plenty of updates as to what was going on. But on a serious note, I also in operating the role I had, would look at funding allocations around the world for our surplus liquidity and where it would be housed and ,in that analysis, our risk team would come up with, as I referred to earlier, countries that they felt were suffering asset bubbles and asset risk.
Pearse Doherty (Donegal South West, Sinn Fein)
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That's an important point that you make there in terms of asset bubbles. Did any alarm bells go off with you in that period of 2005 up to 2008 that the banks were often lending into a concentrated sector, that we were in the middle of a property bubble or any of those observations or others?
Mr. David Duffy:
I think to be honest, Deputy, my level of knowledge was sort of publicly informed confusion a little bit. There were lots of tables out there which were accessible to anybody in the public, indexes of property versus income, pricing movements across a high to low of Europe and, in all of those, Ireland and Spain were right at the very top and consistently so. There was much commentary in the two years prior to the crash in the Financial Times, in other magazines, in The Economist, people making humour of it; that the difference between Ireland and Iceland was six months and a spelling mistake. I mean, so there was a lot of commentary before the event.
Pearse Doherty (Donegal South West, Sinn Fein)
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I am aware of the commentary but I'm interested in your own views in relation to this here. In terms of an asset bubble, did you believe prior to 2008, prior to the guarantee, that there was an asset bubble in Ireland?
Mr. David Duffy:
I wasn't certain of it. I was concerned with how long the elasticity between the growth of income and the growth of property go. I was again, being anecdotally informed. Very many of my colleagues, friends, college, otherwise spoke about what they were paying for houses and how much they made in a year on a house, not unlike the '80's in the UK.
Pearse Doherty (Donegal South West, Sinn Fein)
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Finally, on the last issue I want to just raise with you, we had earlier on, one of your former colleagues, Mr. Sheehy, before the committee. We've talked to him about his memo that he dictated on the 2 October 2008 in relation to the night of the guarantee. In that there's a reference to a draft Government guarantee, which he says, "copy attached". He informed the committee that that memo went to AIB. In your time in AIB, did you see the memo that he dictated or the copy of the draft guarantee that seems can't be located?
Mr. David Duffy:
No, I've no idea where that was stored or kept. We have sourced over 50,000 documents through every crevice of AIB in support of the committee's inquiry, and there is no evidence of any such document that I have seen to date. It may well exist. It may have been given to somebody else. I don't know but I have never seen such a note.
Pearse Doherty (Donegal South West, Sinn Fein)
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Did the bank ... during your time did the bank carry out any review in relation to the issues that led up to the bank nearly becoming nationalised with the State taking a majority shareholder, 99%? Did the board or did yourself commission any study in relation to this?
Mr. David Duffy:
Directly no. I mean it's hard to articulate the environment at the time but, on arrival, the train was already travelling at 200 miles in a negative direction so the future was all you had. It almost didn't matter what happened in the past or why it happened. You didn't ask why did it happen, what lessons you learned; you asked what's the best in class in the world for those that survived this crisis and how do we put it in place as quickly as possible, so that was my disposition. So I didn't get involved in historical reviews.
Ciarán Lynch (Cork South Central, Labour)
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Okay, thank you. Just on that matter, just to clarify that Mr. Duffy and we'll wrap up and take a break then ... So you're saying AIB itself did not carry out any report as to what went wrong in the bank?
Mr. David Duffy:
It may have done. I know there were previous studies done before, I'm not exactly sure of the content, there were Pricewaterhouse reports things like that ... but I think, and the Deputy's question if I understood it correctly, did I engage in any such activity. The board may have before my time but I didn't engage in it nor was I accessing such documents to define our strategy going forward.
Ciarán Lynch (Cork South Central, Labour)
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However there were reports done, and maybe you could establish your relationship with them ... that under the EC treaty state aid rules. the bank was obliged to submit a restructuring plan to the EU Commission. There was one finalised in April 2010, it was updated again in July 2011 and was further revised in 2012, which would have been during your period.
Ciarán Lynch (Cork South Central, Labour)
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And if I can maybe just quote some of that to you ... If I can the witness document that's up there on the screen. It's page 39 and 40 of Vol. 2, AIB Bank 1. In the document - this is a report that was carried out - it says, in the summary and conclusions of the EU report in the ... it's paragraph 3.9 of it, it says: "Prior to the current financial crisis, AIB was a profitable bank with good growth prospects and the characteristics of a fundamentally sound bank". This report you would have had sight of this I assume yourself. It says:
A key element of AIB's pre-crisis market positioning was its involvement in the Irish property sector which was the fastest growing segment of the Irish economy and this strategy was regarded as reasonable at the time. AIB's enterprise bank, risk management and governance systems did not act as a sufficient constraint on this growing level of exposure to the Irish property sector. This shortcoming resulted from weaknesses in the assessment of portfolio risk under stressed conditions, the inconsistent implementation of risk limits and poor credit management processes within the Republic of Ireland division. AIB acknowledges that its decision to expand into property was misguided and that its risk management and internal governance systems were not as effective as they should have been in controlling this risk.
This is in internal documentation produced by AIB. Would you care to comment upon those value judgments that were made with regard to AIB's business model and model of governance?
Mr. David Duffy:
I think that those ... that restructuring plan was to receive approval for the going forward plan and, as part of that, the team had to contribute the views from risk, etc., as to what they thought had changed versus the past in terms of reasons why we might have failed. So I wouldn't disagree with any of the comment in there. I was quite happy with that report to be submitted or that proposal to be submitted to the European Commission.
Ciarán Lynch (Cork South Central, Labour)
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This question was put to Mr. Forde last week and again put to Mr. Sheehy this morning. It was put to them in the context of the - and Deputy Doherty has referred to this earlier - witness statement given by Mr. Daly and his opening comment when he says that:
While internal bank lending documentation may indicate that loan-to-value ratios were typically less than 100%, when the loan was drawn, the reality in many cases was that a developer's equity contribution was in form a rolling up of unrealised paper profit from other developments. This was presented as an equity position, rarely if ever was it in the form of cash.
And Mr. Daly then goes on to say
In effect, therefore, the banks were providing all of the real cash funding for both acquisitions and development. It is safe to say that quite often the borrower's paper equity position never paid for an acre of land or concrete or scaffolding or a worker's wage at the end of the week. The safety zone of a borrower's equity usually existed only on paper. The result is that the borrower was typically not the first to lose in the event of a crash. The bank stood to take 100% of the losses and that's what's happened.
Are those two documents more or less saying the same thing, or not?
Mr. David Duffy:
I think there is a correlation between them, for certain. I think the documentation kept by the bank in terms of its process was inadequate in many respects. I think the composition of some of the loans were rolling up, loans which were classified as equity, it was poor practice if you look at a commercial norm. I think when you look at a bank, it has lending and trading risk, it has operational risk and it has funding and capital risk. The operational risk is something that will damage a bank materially. If you do not have good process in a bank then all the other things in the world can go horribly wrong. I experienced, as did the team on asset transfers, very poor documentation in lots of cases and we had a huge initiative within the bank to restitute that inadequacy. Solicitors' undertakings would be a classic example.
Ciarán Lynch (Cork South Central, Labour)
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By recall, could you maybe give the inquiry some examples of what you mean by poor documentation?
Ciarán Lynch (Cork South Central, Labour)
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I am not asking for a specific portfolio. Maybe an example that would typify in general terms what a bad example was.
Mr. David Duffy:
Solicitors' undertakings is a very specific example. A lot of loans were issued on the back of solicitors' undertakings and then we are still struggling with the final access to all of those documents, so there was a laxity in the obtaining of and clarification that there were appropriate documents and storing of those documents. That is a failure of the bank.
Ciarán Lynch (Cork South Central, Labour)
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Okay. Can I now propose that we would take a break for 20 minutes, returning at 4.20 p.m.? In the meantime, can I just remind the witness that once he begins giving his evidence, he should not confer with any person other than his legal team in relation to his evidence or matters that are being discussed before the committee this afternoon? With that in mind, I now suspend the meeting until 4.20 p.m. and remind the witness that he is still under oath until we resume.
Ciarán Lynch (Cork South Central, Labour)
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All right. So, I now propose that we go back into ... and resume the public hearing with Mr. Duffy, is that agreed? And in doing so, the next member for question time is Deputy John Paul Phelan. Deputy, you have ten minutes.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Thank you, Chair. Mr. Duffy, welcome. Following on from the discussion before we broke with the Chairman, I want to raise the issue of solicitors undertakings. It was raised with Mr. Gleeson and Mr. Forde last week. I want to, I suppose, try and get a handle on how many of these outstanding matters in relation to loans that were entered into prior to your time in AIB, still remain on the books. Has there been significant losses incurred because of difficulties surrounding loans involving these undertakings and in your 30 years' experience - almost - banking, is it or is it not unusual that seven years after the banking difficulties first emerged that such cases would still be outstanding at this juncture?
Mr. David Duffy:
Okay, maybe, Deputy, if I could deal with those in reverse order. In 30 years, it only gives me four periods ... seven years, but I have been through a few crises and I can tell you that a crisis usually generates chaos in an institution and the ability to access and find documents and other parts of history usually get very confused. So there is always a chaos around documentation, the degrees vary significantly, obviously depending on the institution. That being said, it was a material concern for us in terms of the absolute level and back when I joined the bank, there were in the ... probably thousands, quite a few thousand, that were, you know, were really just not in our possession or at the level of satisfaction that we would like to have in our possession. And, it has taken at least three years, to the first part of your question, to materially resolve that issue. We still have some outstanding issues but we have an agreement in process to try and resolve those and that's going well. But, nonetheless, a very unsatisfactory issue for an extended period of time. A little bit ... the cause of it tended to be a disaggregated model where everybody was originating locally and storing their documents locally and it was in a file or in a drawer ... somebody said, "I'll get that to you next week", and it was never followed up. Typical of a one-way traffic, high-volume type environment, without discipline and process.
Now with regard to losses, I couldn't tell you what the accumulative number is - I haven't looked at that - but it has not been a major issue for the bank. It has been an issue case by case, but cumulatively not, I don't think, a material one.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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And in relation to your own experience, would it be ... would it have happened before that six or seven years later this issue would still be not fully resolved, at least?
Mr. David Duffy:
There are occasions where I have seen that. Typically, when you have something this dramatic ... there are historical references to, you know, the Japanese crisis. There was ... I've been through an experience of a Mexico collapse, a Russian collapse, an Argentina collapse and it usually ... maybe the best case is three or four years to resolve everything but it can be longer-----
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Are you satisfied that a system is in place now or are you not satisfied - I can't ask the leading question - that this cannot recur again in Allied Irish Banks?
Mr. David Duffy:
My view on our ability to engage in a process of lending where we will have adequate documentation and appropriate documentation, not just adequate, for enforcing the terms of the loan, I'm confident that the process we put in place will allow us be, you know, able to deal with all of those issues, going forward, without concern.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Can I ask in relation to a question asked by Senator D'Arcy in relation to the growth targets for AIB in the years prior to you coming into your position, you said and I quote: "I'm not sure that growth targets are the way to manage a bank, rather capital levels and liquidity". I'm asking you really for your opinion as to the previous holders of your position, do you believe that they held a similar view to yourself with regard to growth targets versus capital levels and the question of liquidity?
Mr. David Duffy:
Deputy, I'm not really qualified to give an opinion because I don't know their position. I haven't spent any time with the individuals discussing a position nor would I refer to documents which might outline their position. I think that, you know, all markets, all commentators, all regulators, all others, felt that all banks were capitalised adequately and funded well in the run-up to this crisis and that is not an Irish-specific comment, that is all countries that were involved in the crisis.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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As a matter of interest, since you've become chief executive of AIB, have you had any discussions with either of the two previous witnesses today, Mr. Buckley and Mr. Sheehy?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Okay. I can ask you then again in relation to your previous experience ... this morning and last week and I refer to core document AIB B1, Vol. 1, page 87 ...sorry, I should say AIB B1, Vol. 1, page 16, in 2004 Jim O'Leary, who is an economist who was board member of AIB at the time, raised the issue of credit concentration in the construction and development sector. This morning under questioning, Mr. Buckley, who was then the chief executive, stated that while the issue was raised in January, it was dealt with by the board in October. In your previous experience, did you ... you know, does it tend to take nine or ten months for a commercial board of a bank to act on an issue being raised at board level and being minuted as a decision, ultimately, of the board to look into it?
Mr. David Duffy:
Just reviewing the document, Deputy, there, it was agreed that the policy in respect of lending in that sector should be reviewed by the board in the near future, as far as I can read it, so that was a suggestion that sometime in the future it should be looked at it, so there may be reason that I don't understand why it took a while. If it there is an area of concern in a well-practised, well-governed bank, you will tend to respond very quickly, as quickly as required. I don't know the circumstances of that delay but typically you would look at urgent matters on an urgent basis.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Okay, I want to refer to AIB B2, Vol. 1, page 6 ... previous speakers have referred to it.
It's a reference to the then standards that existed, the Central Bank's licensing and supervision requirements and standards for credit institutions. And, this was particular focus on the 200% threshold for lending into one particular sector of the economy and 250% for two related sectors. The answer that has been given by most of the previous witnesses is that there was a process of change going on in relation to Basel II and Mr. Gleeson, last week, stated, and I want to put it to you, a direct quote, that "... this was not a regulatory standard. It wasn't a statutory instrument or a rule; it was a guide to assist us in supervision of the banks." First of all, I want to ask you did you see Mr. Gleeson's evidence last week?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Can I ... can I ask you, in terms of an indication given by a financial regulator that standards had been breached, again this is ... I suppose is a reference to your previous experience ... would it be common practice that the chairman and the board would not act to ensure that the breach would be addressed, or would it have been common practice that, you know, such rules would be seen as merely guidelines?
Mr. David Duffy:
It's a very difficult one to answer Deputy, but to do my best, in that environment, if they are ... a regulator is saying to you, as an institution, "It's a guideline", then you may probably behave in a way that could treat it as a guideline. I refer back to my statements previously which is that it is not for the regulator to set a guideline and for you then to just slavishly follow it, you must take into account that ... and if it's a rule you don't breach it, and report it if you do ... if it's a guideline, it's an input into your own risk management of the institution. So I would take a view that, at that time, if it's being implied that it was a guideline, not a rule, and there was some suggestion that it was viewed as out of date, people may have taken a position in the bank, but I'm not qualified to comment on their rationale at the time.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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A final, brief, last question. As somebody who has vast experience before you came to AIB, and having looked back at, I'm sure a number of the loans that were made, maybe the larger ones in the period 2003 to 2008, by the bank, do you believe that any of the lending practices engaged by AIB in that period were reckless?
Ciarán Lynch (Cork South Central, Labour)
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Mr. Duffy, if we could ask you to give your own value judgment on whether the interpretation of the loan is ... and to use your own language really in that response. Yes, and I'd ... maybe defer from using the word "reckless" within ... in terms ... what is your view?
Mr. David Duffy:
No, as I was saying, I think determining to be clear, I was saying that although the term "reckless" was used, it is not a term I could apply or comment on. So to be very specific on that, I am saying I couldn't comment on the terminology. I would talk about the asset concentration being the challenge that the bank faced, rather than any individual loan being reckless, or whatever the word would be used. So I don't have an opinion on the word "reckless".
Ciarán Lynch (Cork South Central, Labour)
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Thank you for that clarification. Sometimes in reviewing evidence a word can be inserted by a witness in response and then it gets applied-----
Ciarán Lynch (Cork South Central, Labour)
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Okay. Deputy Joe Higgins, ten minutes.
Joe Higgins (Dublin West, Socialist Party)
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Yes. Mr. Duffy, you say that you worked for ten years at Goldman Sachs International. Can I ask you was that a good or appropriate training ground, do you think, for being subsequently in the most senior position of a bank that crashed following a property bubble? And, perhaps by way of context, you'll be aware that Goldman Sachs was very heavily criticised in the wake of the crisis in the United States for allegedly speculating heavily on the subprime mortgage situation and crisis and famously or infamously, depending on one's point of view, was described in Rolling Stoneas a "vampire squid ... [with] its blood funnel [jammed] into anything that smells like money".
Joe Higgins (Dublin West, Socialist Party)
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Rolling Stonemagazine. Are you not aware of that article?
Joe Higgins (Dublin West, Socialist Party)
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Yes. The question was-----
Mr. David Duffy:
So, in your specific question, I won't comment on Goldman Sachs's, or any firm's involvement in a crisis or not a crisis, I would answer the question in specific terms around "Was my time at Goldman Sachs beneficial to my banking experience when applied in the future?" At the time it was a private partnership and it was ... in any circumstance if it had a loss, it was a loss of its own account, and the culture was obsessive about the customer and obsessive about the quality of your execution and I learnt a lot of good things at the time. That has nothing to do with whether they did or didn't do anything subsequently in markets when they were no longer a private partnership. But, my experience there was quite formative and instructive and quite helpful in future days.
Joe Higgins (Dublin West, Socialist Party)
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Mr. Duffy, you say on page 1 of your introduction, that Allied Irish Banks made €1.1 billion profit in 2014. Can I ask you to reflect a little bit on that, in the sense that the recapitalisation by taxpayers of AIB was €20.7 billion. On 26 February, the day before the general election in 2011, a further €1.5 billion ... it is not commonly known by taxpayers, in my view, was transferred to AIB in NAMA bonds and deposits from Anglo, and Mr. McDonagh, the chief executive officer of NAMA, estimated that all the covered banks got effective state aid to the tune of €10 billion by virtue of being overpaid €10 billion from what the market might pay for the loans, and if we ascribe a proportion of that proportionately to AIB it would be €2.83 billion, so that would be about €25 billion in total in state assistance of one kind or another. So, would it be more appropriate to rephrase your profit statement that there is at the end of 2014 ... the loss to the taxpayer has been reduced from €25 billion to €24 billion? Would that be a more appropriate way to put it, perhaps?
Mr. David Duffy:
Well I think that would be a matter of opinion for the shareholder and the markets but I would look at this as very simply returning AIB to a sustainably profitable bank, to allow it to generate capital to lend and to allow it generate a shareholder return, which allows in turn a valuation to be ascribed to the bank, where it is not just profits that repay the taxpayer, it is the valuation of the bank in the sale. So, it is still my belief that we will return all those funds to the taxpayer over time. It is a matter of opinion as to how you should characterise it, but the output is that the State will get repaid all of its funds no matter how we characterise it in the interim.
Joe Higgins (Dublin West, Socialist Party)
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Is it the case, Mr. Duffy, that AIB will pay no corporation tax in 2014 on the €1.1 billion profit?
Mr. David Duffy:
It is likely to be true, but it is a very important context that one must understand as well, that is because of our deferred tax assets, which I think you are referring to, and those deferred tax assets are incorporated in the calculation of our capital, so those deferred tax assets have avoided the State having to invest capital in the bank, so I think there is a value. It is not just about the tax repayment, there is a value by capital not having to be invested.
Joe Higgins (Dublin West, Socialist Party)
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To explain to the people out there, maybe you might, if I am correct that ... until, if the present tax arrangement remains, all the losses at AIB, which is let us say, €20 billion, can be written off against the taxes, and that, therefore, going into the future AIB would have to raise, or could raise roughly €20 billion in profit before it would pay a penny in corporation tax. Would that be the way to explain it?
Mr. David Duffy:
It is a matter of technical fact, I am not quibbling with that at all. That is entirely true. The value to the State is 100% of that, as the primary owner of the bank, and it is not without regard to the fact that the deferred taxation assets are the cause and have been of significant benefit to the State in terms of the bank's capital.
Joe Higgins (Dublin West, Socialist Party)
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Yes. You referred to the opinionated people of west Cork, Mr. Duffy. Would you say that the people in west Cork or, indeed, west Dublin might think that not paying a penny tax on profits until €20 billion in profit is realised is paying twice for the same losses that the taxpayer has bailed out already? Do you think they would be ... feel somewhat aggrieved, and do you think that might be a just, or not, grievance?
Mr. David Duffy:
Well, I think for anybody in Ireland, regardless of their particular jurisdiction, notwithstanding west Cork is my home, I would say to those people that if AIB paid a few hundred million in tax to the Government, and paid the tax, is one case, if it doesn't because it has a tax allowance for a period of time, but then distributes that as a dividend to the Government, it is still coming to the Government and to the State and the taxpayer, by definition.
Joe Higgins (Dublin West, Socialist Party)
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Is it the case that if AIB is privatised that that tax credit will go on to the private owners?
Joe Higgins (Dublin West, Socialist Party)
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What's the current value of AIB would you say now?
Joe Higgins (Dublin West, Socialist Party)
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€12 billion or €13 billion. Mr. Duffy, in 2014, NAMA redeemed €6.3 billion in bonds held by AIB ... sorry, NAMA bonds that you held and you paid ... NAMA paid you €105 million ... on top of that, €105 million in interest.
Ciarán Lynch (Cork South Central, Labour)
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Just be mindful now, Deputy, that we could be stepping outside the terms of reference of the inquiry. I'm just giving a bit of leverage here, in that NAMA is inside the terms, but activities that might be going into 2014 and 2015 may be beyond it but-----
Joe Higgins (Dublin West, Socialist Party)
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Yes, I'm-----
Ciarán Lynch (Cork South Central, Labour)
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Just, okay, would you proceed?
Joe Higgins (Dublin West, Socialist Party)
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Yes. Well, we are talking about the terms of reference also about the policy responses and preventive reforms.
Ciarán Lynch (Cork South Central, Labour)
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And legacy issues and all, yes.
Joe Higgins (Dublin West, Socialist Party)
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And if the witness is happy to-----
Ciarán Lynch (Cork South Central, Labour)
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Sure, sure.
Joe Higgins (Dublin West, Socialist Party)
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-----comment briefly. And there were various other interests, interest payments that were paid to AIB, perhaps a total of €6.5 billion. What did AIB do with the €6.5 billion that it received from NAMA?
Joe Higgins (Dublin West, Socialist Party)
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Okay. So, again, Mr. Duffy, to ask you, the taxpayer has bailed out AIB to the tune of €20 billion-plus. There are ... there is no corporation tax for 20 years perhaps and the billions that come in from NAMA's activities go into AIB, go straight to the ECB loans. Again, could I could ask you would the taxpayer out there be justified or not in feeling deeply aggrieved at this, considering the pressure on their public services, health, education etc., and yet everybody is ahead of them in the queue, it seems to them?
Ciarán Lynch (Cork South Central, Labour)
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One minute, Deputy; last question.
Joe Higgins (Dublin West, Socialist Party)
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Yes, Mr. Duffy, final question then: you were brought in from foreign fields where ... because you had no hand, act or part, personally, in what was going on here in the course of the bubble, the crash etc. Was your role or is your role, which is now coming to a conclusion, fattening up Allied Irish Banks for privatisation?
Mr. David Duffy:
The role ... the short answer is "No". My role was to stabilise the bank and prevent it from collapsing; to make sure that we could lend and support the Irish economy, without which the Irish economy couldn't grow, given the number of banks in the country; and, lastly, to address the issue of arrears and people in distress and try to recover as much of the livelihoods of people in homes and in businesses. Those were the primary roles. All of my actions are prioritised around those, as are the objectives of the board.
Ciarán Lynch (Cork South Central, Labour)
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Okay, thank you. Deputy Kieran O'Donnell, ten minutes.
Kieran O'Donnell (Limerick City, Fine Gael)
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Thank you, Chairman. Mr. Duffy, can I just ... what have AIB learned from the crisis in terms of the banking model and in terms of their behaviour with customers?
Mr. David Duffy:
I think the primary learning is around the issue of culture. If you run a bank, truly run a bank with a customer lens, it changes every behaviour and every process in the bank. If you are running the bank in service of a customer, it changes the disposition of the staff and I think, if you are looking outside and you see that you are in a bank entitled to nothing other than the service of a customer, and if you do well you're entitled to an existence, if you get that culture into the bank, then many of the mistakes we made will be avoided and that's the single biggest lesson. We need a culture in the bank that respects the fact that our job is the service of a customer.
Kieran O'Donnell (Limerick City, Fine Gael)
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And how do you reconcile that with the view amongst many of the general public that banks will revert to being banks and that, effectively, that people got into large mortgage arrears, with mortgages in some cases they feel they should probably have not been extended by the bank? How do you get to that point where people will have faith in the way banks operate, when banks are now beginning to recover, into the future?
Ciarán Lynch (Cork South Central, Labour)
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Mr. Duffy's view on that?
Kieran O'Donnell (Limerick City, Fine Gael)
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Yes, your view on that?
Mr. David Duffy:
My view on that is that banking as an industry has been irreparably damaged in many ways. It is going to take a considerable amount of time to rebuild trust as, referencing your example, I think that in rebuilding that trust you have to address the conduct issues, which are a regulatory, topical subject at the moment. Conduct risk and how you behave, how you lend to customers, what you sell or don't sell to customers, the fitness for purpose of the product you sell to a customer. That philosophy must become appropriately and deeply embedded in the culture, and if you do that you will start out well, and over time you will re-earn the trust of your customers.
Kieran O'Donnell (Limerick City, Fine Gael)
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And in terms of ... you've spoken about governance, are there any set of circumstances where the crisis that happened in terms of the Irish taxpayer picking up €64 billion for the banking system, that we could find ourselves in that position again into the future?
Mr. David Duffy:
As a matter of just macroeconomics and war, you can never be absolute, but if you look at the more normalised expectations of all of us, everything we have done in the bank is to make sure that we are lending appropriately, that the risk associated with the lending is predominantly cash flow model driven, that the capital thresholds are the minimum regulatory plus a conservative buffer, and that our funding is long-term matched to our liabilities, not short term. So if you look at the primary influences, they are in a shape that I think will prevent a risk occurring again, and, on top of that, we stress as a board quite extremely, as does the SSM independently of our board, the asset changes in pricing. So I believe that all of those taken together will leave us in a relatively secure position, notwithstanding another crisis.
Kieran O'Donnell (Limerick City, Fine Gael)
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And going back, we'll say, over the years where you had this rapid growth in loans with property loans with AIB in construction, between '04 and, we'll say, '08, where it went from being, as a percentage of the loan book overall, from being 25% in '04 up to 37% in '08, what do you regard as a sustainable level of a property and construction being as a percentage of the overall loan book? I know you've spoken earlier about growth not being the only parameter, but in terms of a percentage of loan book, what do you regard as sustainable?
Kieran O'Donnell (Limerick City, Fine Gael)
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I'll put it this way to you. I suppose the point is, do you view that the level of the percentage of the loan book being property and construction being at 25%, '04, rising to 37% in '08, was too big of a risk factor?
Kieran O'Donnell (Limerick City, Fine Gael)
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But you're a professional banker-----
Ciarán Lynch (Cork South Central, Labour)
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Leave him time to respond.
Mr. David Duffy:
And so my point is, there are very different asset classes in property. Someone in a home is very different than development land that's undeveloped. One has an income paying a debt, and the other has none. It has an asset value. So it is too generic a description. That being said, any single asset class or correlated asset class, like in property in general, being too high an overall percentage of your portfolio is risky.
Kieran O'Donnell (Limerick City, Fine Gael)
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Have ye put ... in terms of looking at your business model into the future or currently, you must have put a benchmark level at which the percentage of the entire loan book that property and construction can take.
Mr. David Duffy:
We don't disclose in an open market, for perspective, what exact percentages we have in each component, but I can tell you that for every single property component, and for every single borrower who may have property plus other assets, we have set very conservative limits and very early thresholds for escalation to the board.
Kieran O'Donnell (Limerick City, Fine Gael)
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And what ... are we talking single digit figures, are we talking-----
Kieran O'Donnell (Limerick City, Fine Gael)
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Can I talk about, because ultimately we are here, in terms with AIB, the fact that there's over €20 billion of taxpayers' money has gone into AIB to save that bank; where do you see the ... into the future, the date deadlines in terms of the taxpayer getting back, or the Irish citizen getting back, the €20 billion plus they've put into AIB? Over what timeframe do you see that?
Mr. David Duffy:
The starting point is at the Minister's discretion. Our objective in the bank was at the end of this three year cycle, or three and a bit year cycle, to create a bank that investors would find attractive, and that begins the process. The exact duration is a function I can't predict. How much is sold and how much is retained and then what the dividend will be can vary it quite significantly but I do believe over time, however long it takes, in whatever construct the Minister wants to sell, the money will be returned.
Kieran O'Donnell (Limerick City, Fine Gael)
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Is the bank in ... in terms of the financial well-being of the bank at the moment. What's generated the perceptions of the markets in terms of ... the type time of timescale that would ... is AIB in the position at the moment financially that ... you could do a large flotation on the market?
Ciarán Lynch (Cork South Central, Labour)
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Okay we are drifting into kind of what ... commercial issues for a start -----
Kieran O'Donnell (Limerick City, Fine Gael)
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Yes. Given the parameters-----
Ciarán Lynch (Cork South Central, Labour)
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I ------
Kieran O'Donnell (Limerick City, Fine Gael)
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... getting the taxpayers' money back...
Ciarán Lynch (Cork South Central, Labour)
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Yes, there is indeed, and there are legacy issues, there are share concerns and all the rest of it here. In terms of a legacy issue, I'll take it that we are not going into what is day-to-day current banking inside AIB, Mr. Duffy.
Kieran O'Donnell (Limerick City, Fine Gael)
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And in terms of your ... I suppose international experience ... do you believe in terms of the structure of the guarantee ... I suppose two very quick questions. Do you believe that AIB would have survived without the guarantee? And do you believe that if burden-sharing had been a feature in terms of the construct of the guarantee, what impact would that have had on AIB?
Mr. David Duffy:
My opinion would be that in a circumstance where there was no guarantee with the lack of confidence in the system there was a significant risk as deposits would leave and there was a preponderance of short-term deposits. I don't know what the final outcome would be because I can't predict that. But certainly there would have been a high risk. With regard to the second element of burden sharing, obviously if there was burden-sharing there would have lessened the burden for us and that would have helped the position but I don't know what the rationale for the decisions were as I wasn't here so I can't comment further.
Ciarán Lynch (Cork South Central, Labour)
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Okay. Thank you. Thank you very much. Next questioner is Deputy McGrath.
Michael McGrath (Cork South Central, Fianna Fail)
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Thank you very much Chair. You are very welcome Mr. Duffy and thank you for your engagement. Just if I can pick you up on a question asked earlier on about I think by Deputy Doherty and the Chair as well. When you joined the bank in late 2011 you said you didn't initiate any review or any internal inquiry as to what happened in AIB and how it came to the fate that it met. Can you say why ... why would the board not have considered doing its own inquiry as to why a once traditionally conservative bank ended up having to be bailed out by the State with a bill of €20 billion?
Michael McGrath (Cork South Central, Fianna Fail)
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Yes -----
Mr. David Duffy:
... in the past which may have satisfied those obligations. If I can put it into context, Deputy, in terms of what we were faced with. In my first month I was sitting with a Troika and sitting with a shareholder and trying to understand the amount of time we had to come up with a solution and what we had as obligations to deliver. To be honest every hour we spent looking backwards trying to understand the problem would be an hour wasted when we had to understand what the best model would be going forward. And that's what we were spending all our time on. So it's not that we were being careless it's just that we were being very considered around the future.
Michael McGrath (Cork South Central, Fianna Fail)
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Nobody is suggesting carelessness on anyone's part but the board could have requested somebody else to do the review. I don't think anyone is suggesting that you would have come in and prioritised doing a backward looking review, but the board should that had taken over governance who had a lot of new members ... do you know if they considered conducting any internal inquiry or review as to how the bank ended up with a very large bailout?
Michael McGrath (Cork South Central, Fianna Fail)
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Okay. Thank you. Can I ask Mr. Duffy in your experience how rare or how exceptional were the confluence of events and factors both domestic and international which lead to the banking crisis in Ireland and indeed elsewhere in September 2008? How rare or exceptional an event was it or was it entirely predictable?
Mr. David Duffy:
I think there was an element of exceptionality around it. It's a once in a generation circumstance where the availability of a huge amount of liquidity including retail bank liquidity which wasn't available before in the sense that it was made available as well as geopolitical events where China in order to grow was very much a supporter of a cheap cost of capital through its purchasing of US debt despite the overall levels of debt.
That meant that the US consumer became very heavily indebted and that was a contributor to the property boom. So there were many macro or geopolitical events that were fuelling cheap funding and property escalation of pricing. With that there was also a light regulatory universe which ... of all of the asset classes in property many of which were sub-prime, they were packaged and securitised, distributed around the world with a mix of good and bad assets in those packages. And rating agencies on top of that were rating the majority of these triple A. So, bad risk was distributed globally with a high rating. I don't think in history there has ever been a confluence of events around the scale of cheap money and the distribution of risk and the unknown element of risk contained in the securitisations. That cheap money was allowing every market to chase property and when it collapsed in the sub-prime and then was further influenced by allowing banks to go bankrupt in the US, there were many more banks were very close to going bankrupt. So the extraordinary measures of the US Government at the time, both negative and positive, if you put all of those together, it is an exceptional period of time. Ireland's problem was that we were very badly positioned to react to that given our concentration.
Michael McGrath (Cork South Central, Fianna Fail)
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And relative to our size as a country, was Ireland's banking crisis the worst of 2008 and the subsequent years?
Michael McGrath (Cork South Central, Fianna Fail)
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In terms of the changes to the regulatory regime and the legislation that has been introduced in recent years, do you think that we have struck the right balance in terms of those changes and do you believe that we now have a strong and robust regulatory system?
Mr. David Duffy:
I think we do because I think it's not only the regulatory process itself but it is the disposition of what the regulator sees as the purpose of a bank. I think the original mistake that started all this that was made, was that Glass-Steagall was unwound and that prevented retail deposits being given to investment banks. Now once you put the two of them together you had a whole lot more money, a whole lot more leverage and a whole lot more risk. A retail bank ... its purpose is, I think Lord Turner many years referred to it as "socially useful". But it is serving the economy you reside in, for the purpose of growth of the economy that you reside in. Doing so in a way that you're selling products that are suitable to those customers and frankly you should be a boring utility. That's what banking should be. It lost the run of itself, it got into all kinds of leverage and chaos that it should not have been in. So, if you ask the question "Are some of the regulations better today?" - yes. "Is the process better?" - some of it's a pendulum swing and maybe it's going too far in terms of the bureaucracy sometimes, but the spirit of what the intent is, I fully support.
Michael McGrath (Cork South Central, Fianna Fail)
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Can I ask you about the appropriateness of the transfer in August 2012 of €1.1 billion from the company's balance sheet into your pension fund. The pension fund at the time had a deficit of almost €1.5 billion.
Mr. David Duffy:
The assets at the time were part of a €20 billion deleveraging requirement mandated under the troika restructuring programme. The disposal of those assets was going to happen regardless and was done at arm's length market pricing. The pension trustees purchased those, as would anybody else within the market and that allowed them create a reduction of the deficit, so this was extremely open, fully public and at arm's length.
Michael McGrath (Cork South Central, Fianna Fail)
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So in return for transferring the assets from the company to the pension fund, what did the company receive in return? Are you saying it received a commercial -----
Michael McGrath (Cork South Central, Fianna Fail)
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The commercial value?
Michael McGrath (Cork South Central, Fianna Fail)
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So it was fully arm's length, a market transaction -----
Michael McGrath (Cork South Central, Fianna Fail)
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What was the gain so, from the point of view of the pension fund, if it paid market value -----
Michael McGrath (Cork South Central, Fianna Fail)
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Sure. Okay. And you don't know how much was paid for the face value of €1.1 billion of loan assets?
Michael McGrath (Cork South Central, Fianna Fail)
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Okay. So it would have been open to the fund to purchase any other assets outside the bank?
Michael McGrath (Cork South Central, Fianna Fail)
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Finally, can I ask you about the issue of former executives? And I know that again back in 2012, and I think subsequently, you wrote to about 30 or in excess of 30 former executives suggesting that they consider making a voluntary reduction in their own pension. Would you like to elaborate on the outcome of that? I know you won't give any details about individuals, nor am I asking you to, but in aggregate terms can you give us any information as to the nature of the response you received?
Mr. David Duffy:
Deputy, the only limitation I have is that there are confidentiality agreements, but I could say that there was a positive response and a reasonable number of people responded positively over the period of time and have agreed to reductions in pensions, etc. So there was a positive response.
Michael McGrath (Cork South Central, Fianna Fail)
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Are you prepared to elaborate on what that means? Is that 50% of people agreeing to a reduction, is it?
Michael McGrath (Cork South Central, Fianna Fail)
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And just to clarify, aside from the numbers, the individuals that you wrote to, were they people who had a senior management role within a defined period of the bank's recent history? How did you choose 30-plus names to write to?
Michael McGrath (Cork South Central, Fianna Fail)
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Thank you. Thank you, Chair.
Ciarán Lynch (Cork South Central, Labour)
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Senator Marc MacSharry.
Marc MacSharry (Fianna Fail)
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Thanks very much, and thanks, Mr. Duffy, for coming along. Earlier we had some predecessors in the bank and we were talking to them, or I was asking them about targets, and you had mentioned here earlier that the bank ... that the company ... you must run the company through the customer lens, and that changes everything, you said. And you also said - if I can find it here - that growth targets is not the criteria by which one would run a bank, it's about liquidity. So all of us probably have friends that worked in banks and different things and ... so how does it operate in branches then? Are people given targets for sales or-----
Marc MacSharry (Fianna Fail)
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Okay. So let's say a mortgage; what way does that work?
Mr. David Duffy:
Well, mortgages go through the branches where people walk in and ask for a mortgage, they go through the online activities, and then some send in manual applications direct to the head office. So you have all three sources. And they are doing so based on the requested criteria for affordability and completing the documents in person or online accordingly. That's how it works.
Marc MacSharry (Fianna Fail)
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There'd be mortgage officers in each branch?
Marc MacSharry (Fianna Fail)
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And would they have targets?
Marc MacSharry (Fianna Fail)
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Does anybody in AIB have a target for sales?
Mr. David Duffy:
To be honest, I couldn't answer that absolutely. I think there are targets for sales within the bank, within our overall portfolio at regional levels, but I couldn't tell you exactly what level those targets go down to. I'd have to refer back to our retail managers and let you know.
Marc MacSharry (Fianna Fail)
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So how would you, as a member of the board, pursue profitability on behalf of shareholders?
Mr. David Duffy:
What we do is manage our margin. So we have ... when you look at a net interest margin, which is the criteria by which our margin is measured, we would look at the cost of running the bank, the cost of our funding, and the cost of risk, and the requirement to generate a shareholder return. We would subtract them from the aggregate revenue we receive in the bank, and the difference between those two is our margin. And that's what we call the net interest margin. That's what we look at at the board.
Marc MacSharry (Fianna Fail)
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Would it be fair to say that the more applications that are made, the more mortgage products will be purchased, or loans taken out, and, therefore, the potential to gain more profit would be more? Is that a fair statement or not?
Marc MacSharry (Fianna Fail)
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That's the case, is it?
Marc MacSharry (Fianna Fail)
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No, no, because I ... it doesn't matter what I think, because I can't lead you. It's what you think. So what I'm trying to get to the bottom of is, if nobody in AIB ... because this is consistent actually with what your predecessors are telling us earlier.
They said nobody had a target, that you run the bank, in your view, based on liquidity. And nobody had sales targets, so what I am trying to get to the bottom of, really for the people at home is... are branches set up and people put in place purely "Now you sit in there and you service the public if they come in" or are there targets given to regions or branches or individuals to say, "Now look what we want to try and do this month is sell X amount of investment products and Y amount of loan products" and so on? In essence the question is, did a targeted environment, albeit phrased in a different way ... I know that there was the... the people profit index, is that what it was referred to? Your predecessor mentioned something like that earlier on. I may be getting it wrong and the record can correct me. Did a target culture - and you have mentioned a cultural change - have an unintended...albeit unintended consequence to drive more mortgage product sales?
Mr. David Duffy:
Okay, I think I understand a little bit better. I think, from the observations of the previous market, there was a competitive universe, including many overseas competitors coming in with more attractively priced and higher LTV products and driving a market share battle which led everybody down that path. If you look at what are we doing today to be more specific, our position is controlled by our risk appetite. As you've said, I've correctly said, the liquidity in the capital are your baseline thresholds which you must maintain adequate resources for. And then, beyond that when you sell, you can't just sell any amount of anything, there has to be limits within each part of your portfolio and those are strictly monitored and then obviously that's the margin.
Marc MacSharry (Fianna Fail)
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I get that, thanks very much. It's just that my time is short and I know it has taken me a while to get... to ask my questions.
Again, we know we are talking about your tenure, but again given your international experience and while you have pointed out to other members that you focused on the future and getting things right and I'm sure you that you've done that very well, but in your international experience, was the culture of that time that, you know, target driven, sales driven? I'm not going to allow the incoming foreign bank to eat my lunch, so get out there and lend more products, lend more money. Was that happening?
Mr. David Duffy:
To be honest, Deputy, I can't be absolutely clear about that because I didn't have enough knowledge of that marketplace but I can tell you that from a distance when you have so much competition with so many banks - there was a huge number of banks all offering 100% mortgage type things at high LTV - it created a market environment where people were forced to compete. And I can say one thing that I take away from that environment, what it did was drove market share chasing and margins come down and products were inappropriately priced. And that is where you have got high volume trying to compensate for what was a declining margin over ten years. And in today's environment we have barely crawled out of it, and we are already starting to talk about how much all the margins or rates should be cut. We have to be very careful. The issue is not so much whether you are volume selling; the issue is concentration risk and the issue is having appropriate margin to have capital to protect you in the downturn. That's my observation from that period.
Marc MacSharry (Fianna Fail)
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And again, to the extent that it is possible to give a "yes" or "no". Did the culture of the era, before your tenure, lead to unnecessary amount of lending?
Marc MacSharry (Fianna Fail)
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Okay, that's fine. Former chairman of the bank, Mr. Gleeson mentioned in his testimony that interest rates during the crisis period were too low and suggested that using the Taylor rule, that they should have been between 6% and 12% or thereabouts and he further said that under the ECB's statute, article 14.3, that the ECB could and should have directed the Central Bank here to introduce measures to cool the market, let's say. That was the thrust of what he was saying. Would you have a view on that?
Mr. David Duffy:
Well, I think the Central Bank has an important part to play. I think that's been evident by their actions on setting mortgage limits, so there is a role for a regulator to play. You can't regulate a commercial market, but you can contribute to the common sense applied in that market. The mortgage limitations, the loan-to-value, etc., I think, are sensible, so there is a value to that input from a regulator.
Marc MacSharry (Fianna Fail)
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So, let's say, with 2% tracker mortgages available, and 8% growth rates in the real economy, what could the ECB have directed our Central Bank to do in your experience, internationally?
Marc MacSharry (Fianna Fail)
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Exactly but I suppose we're trying to get a picture or an explanation of what may have been possible. We don't know but you're an expert in the field.
Mr. David Duffy:
But I think what may have been possible ... it isn't down to the regulator to tell you that. What was at risk was a commercial model were you relied on volume to compensate for declining margin. And at the end of the day a 2% tracker mortgage is below your cost of funds. And that means you're loss making at tracker levels and that cannot be healthy for the bank in the long term.
Marc MacSharry (Fianna Fail)
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So ... just, so that I'm clear, we did rely on volume to compensate for the lower margins and that lead to the crisis?
Marc MacSharry (Fianna Fail)
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That's all. Thanks ... thanks very much.
Ciarán Lynch (Cork South Central, Labour)
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Thank you very much. If, maybe, I could just refer to two items just following on from Senator MacSharry's questioning. I just want to refer to document reference AIB B1, Vol. 1, page 87. And what there are here are a summary of main findings. These relate to review focused at enterprise at Republic of Ireland level. This is an AIB document and if you scroll down the page there, it's about the fourth line, it says in there, Mr. Duffy, that in short "the main trust of the Business in ROI [this is the AIB Republic of Ireland model] was to focus and volume [I presume that there's a spelling error there, that should be focus "on" volume] market share-driven loan origination. This was achieved by growing property advances and related income in an unbalanced manner." Would you care to comment upon that?
Mr. David Duffy:
I can only give an opinion, Chairman, as an observer. What I saw was a very ambitious growth market share level in all banks and every adviser that I have seen reports of or heard of spoke to the banks encouraging them to compete with each other on a more aggressive basis. So it would not surprise me to see a comment like that.
Ciarán Lynch (Cork South Central, Labour)
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So, just to summarise, in short what we're seeing there is the main trust of the business of the Republic of Ireland model was to focus on share-driven loan orientation, so there was a practice in the bank that would relate to the questioning line that Senator MacSharry took with you. There was a practice there ... or not?
Ciarán Lynch (Cork South Central, Labour)
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Okay. Just on the broader context ... and to ... just a comment that you made earlier with regard to property diversification and that these are separate, stand-alone silos and that the risk is separate in all of these and so forth. I want to challenge the ...that assumption if I may and put it to you ... is that the subdivision of property portfolios into different classes, i.e. development land, office block, housing ... are they not actually both in the lead-up to the crisis and in the post-crisis period and even now ... but in the downturn ... or in a downturn or crisis ... these subdivisions, are they not actually quite closely correlated and related to one another? And they're not actually diversified, as we would say, in that when the prices drop in one sector, they usually drop in the other sector as well.
Mr. David Duffy:
Absolutely. The perspective we have on that is that at a high level we have a portfolio management approach, which is that all of those assets are correlated. And in a small country in an open economy with the connections between those different assets and the borrowers, you have to be extremely sensitive to that fact. So I fully agree, Chairman, that is a high correlation risk that you must be very attentive to. Why we do the segmentation is to make sure we limit each of them and to make sure that we understand that you don't want to have too much development land or too much mortgage or too much retail, you want to have a balance between them, with income coming from them rather than asset valuation protection. But we absolutely accept that correlation risk has to be very conservatively managed.
Ciarán Lynch (Cork South Central, Labour)
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Okay, thank you. Senator O'Keeffe.
Susan O'Keeffe (Labour)
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Thank you. Mr. Duffy, we heard from Donal Forde - on page 129 of his evidence - that all the colleagues in the Republic of Ireland division were eligible for some kind of bonus, they may not have all got it. What is the current position now in relation to those colleagues, if you like, at that level? I'm not talking here about executive or senior.
Susan O'Keeffe (Labour)
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Okay. What sort of benefits were available to staff when you arrived? I mean, benefits above and beyond any kind of bonus, you know, like mortgages or sports club or insurance.
Mr. David Duffy:
There were mortgages at attractive pricing structures, there were pensions defined benefit which we closed for future accrual in 2012, company cars which we eliminated. In some cases there were medical benefit allowances, which we also eliminated. There was a variety, not non-traditional, but certainly a healthy variety of benefits available. We addressed all of those. There is no variable and all of the other benefits were either curtailed or eliminated. In terms of salaries and associated elements. We cut a lot of the salaries. I cut mine and senior guys, and then all through the organisation. So I think approximately €230 million is the amount of salary-related cuts we made in the organisation. Benefits and salaries were all cut and there is no variable compensation.
Susan O'Keeffe (Labour)
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Were you surprised at the level of salaries, particularly at very top level, when you arrived into the bank?
Susan O'Keeffe (Labour)
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The salary that you now earn is less than €500,000. Is that the sort of salary you believe might be appropriate into the future?
Mr. David Duffy:
Mine is in the sort of low €400,000s, after the pay cut I took. I don't have a view on what is appropriate. I think the market has to determine that. If you look at the small community of banking in Ireland, there's a bank CEO on twice my income. There is another bank on twice that income, CEO. So same jobs, same street, a bus stop away, massively different. I think it is very specific to the circumstances. The one thing I would say about compensation and I believe this passionately; it is not so much the number, it is who bears the risk with that number. My practical example, if you will forgive me for a second, Senator, is I am used to a culture where I was paid a variable amount of compensation. It was deferred for three years pending the performance of the bank. It was put in the shares of the bank, and if the shares of the bank tanked then I lost it. At the end of that, it was also subject to a malice clause which is matching the duration of risk to the duration of my bonus and could be ... and 100% could be clawed back. So philosophically, I believe that is the only way you pay variable compensation and if there was a model in the future that allowed for that, the market drove it, investors drove it, I would very much believe that that is the kind of structure you put in a bank. The shareholder does not bear the risk, 100% recovery for staff.
Susan O'Keeffe (Labour)
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Deputy McGrath raised the fact that you had written to some former members and asked them about their pensions, I believe. You also said I think you had not spoken to any of the former members of the executive or the board, so you did not ever invite them in and have tea or lunch or breakfast and say, "Guys, tell us the short cut, what happened here" ?
Mr. David Duffy:
I would have to go back and check. I had a coffee with Mr. Gleeson once for about 20 minutes just to say,"Hello". Politeness. Mr. Conway, who was not part of these hearings, for just half an hour to get his perspective. But I really, you know ... no substantiative commercial discussion with any party, as that was just not a priority for me.
Susan O'Keeffe (Labour)
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Has the bank during your tenure made any corporate write-downs?
Susan O'Keeffe (Labour)
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Can you give us any indication of the measure of the extent of those?
Susan O'Keeffe (Labour)
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We probably sort of know how it works, but in terms of its significance for the bank or loss to the bank.
Susan O'Keeffe (Labour)
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It is significant. You said that one of the reasons you did not talk to people was that you were looking to the future but you also said that you were talking to the troika. So what sort of priorities did the troika ... what were they saying to you when you were sitting with their representatives?
Mr. David Duffy:
The troika really were not trying to direct too much but they were asking you to deliver a plan which would be viable. They defined certain levels of capital as the norm in the market, now how did we think we could go about it? The engagement was exploratory. What do we think was necessary? What do we think could be achieved? Then they were judging in their opinion whether it was successful. Their purpose was to monitor and review your performance and execution on the strategy to a point where they were satisfied that the bank was sustainable. It was almost like a monitoring engagement.
Susan O'Keeffe (Labour)
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So they didn't set you strict targets that you, just to be clear, I'm sorry ... they didn't set you straight targets? They-----
Susan O'Keeffe (Labour)
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------talked with you about the targets.
Susan O'Keeffe (Labour)
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Okay. And then when the targets were agreed, have you ... did you achieve all those targets? Was there anything that didn't-----
Susan O'Keeffe (Labour)
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Okay. When Mr. McDonagh was here, in page 44 of his evidence, from NAMA, he said that: "The colleagues concluded that when the loan-to-value ratios were examined, they were probably closer to 100% rather than the average that they'd averaged out at 77%." I know you'd nothing to do with that, but, as a banker, if you look at that, how could it happen that a bank, a series of banks, could be so out of sync with what was found? How do you arrive at that position?
Mr. David Duffy:
It's a little difficult without specific knowledge of the cases, but I have seen circumstances where a loan-to-value starts out at, let's say, 50%, 60% in some environment that someone was lending to an individual and then the asset price declines and it goes to 75% or 80% but along the way, equity had been put in, but it would've been in the form of debt and suddenly it's 100%. It's not right, you have to be ... And that's where I go back to my principle, if you are not doing your loans on a cash flow lending basis, this LTV process can be very risky.
Susan O'Keeffe (Labour)
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Did you find any evidence in your tenure that AIB had invested equity in any of the property transactions for which it had also provided debt funding?
Susan O'Keeffe (Labour)
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Okay. How much then, looking at it, did the bank contribute to its own downfall?
Mr. David Duffy:
I think it contributed materially to its own downfall due to the position it arrived at with, you know, excessive concentration in an asset class that was materially reducing in terms of value and then, you know, in that environment having a huge dilution of its capital and its funding base was very volatile. So I think, you know, it was a contributor due to the concentration risk.
Susan O'Keeffe (Labour)
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And could you say that it contributed ... but roughly, look, these things are not accurate, but is it ... did it contribute 30%? Was the bank responsible, if you like, for 30% of the downfall, or 70% or what figure might you attribute? And I appreciate it's-----
Mr. David Duffy:
Senator, I think it'd be hard for me to say that because I'd be very specifically commenting on how the bank was managed in the past. I'd rather limit my observation to the fact that, I think, arriving at a portfolio of that concentration was the contributing ... I don't know, because there's so many other variables in it, what precise percentage that might reflect.
Susan O'Keeffe (Labour)
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Obviously when you arrived and you took on the job, you took it voluntarily, so you knew it was a difficult position. How much more difficult, if it was, was it, when you walked in and suddenly saw ... because of course you couldn't have been privy to everything ... was it worse than you thought it might be or was it better than you thought it might be?
Mr. David Duffy:
It was worse, I would admit, Senator, in a sense that not only were the numbers, which I was privy to material and compounding, the urgency that was required to recover was probably more than I had anticipated and certainly the uncertainty and somewhat the disarray internally with constantly changing senior leadership and uncertainty about the future ... the combination of those was a little more onerous than I might have anticipated when I went in.
Susan O'Keeffe (Labour)
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What will be AIB's profit driver in future, do you believe, given that your ... the bank is clearly going to be more cautious about how it lends to property and it was driven into that position by the need to become profitable because of the competitive environment in which it was operating? So, what is ... what can it do now if it can't have that market anymore? What's it left with?
Mr. David Duffy:
I think it will operate a traditional model of a retail bank, which is a balanced portfolio of lending in all sectors of the economy. I think it is also a requirement given our status in the economy so that will include consumer lending, it will include SMEs, and it will include corporates and some elements of property. So I think it will be all asset classes and-or borrowers of the economy will be served for the bank ... by the bank, and in that context, there should be, not excessive, but reasonably margins available.
Susan O'Keeffe (Labour)
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It'll go back, more or less, to what it perhaps was in our ... in our, sort of, memory?
Ciarán Lynch (Cork South Central, Labour)
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Deputy Eoghan Murphy.
Eoghan Murphy (Dublin South East, Fine Gael)
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Thank you, Chairman. And thank you, Mr. Duffy. I still have a few questions in relation to NAMA, if I can. When you came into the bank, NAMA had just finished ... or was in the process of finishing the transfer of loans from AIB into NAMA.
So did you review their work over that previous 12 to 20-month period?
Mr. David Duffy:
I didn't review the work but I had to spend a bit of time on the transfer, given that the ... NAMA had requested that our staff set up a separate entity, as our staff, to service and manage those loans on behalf of NAMA. Whilst they had all decisioning rights, we had provide the support and resources.
Eoghan Murphy (Dublin South East, Fine Gael)
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This is part of the service level agreement?
Eoghan Murphy (Dublin South East, Fine Gael)
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So you had to establish a relationship with NAMA.
Eoghan Murphy (Dublin South East, Fine Gael)
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In terms of with the CEO, say with ... or the chairman. Did you have to then go and formally meet them and-----
Eoghan Murphy (Dublin South East, Fine Gael)
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And would they have raised any concerns with you in those meetings about some of the loans they were encountering or the performance of those loans or the treatment of those loans?
Mr. David Duffy:
We didn't get into specifics a lot but they would indicate that in certain cases they felt that there was going to have to be either a further recovery from us if the process they were engaged in ended up in a certain way. But it was directional and just advising us that they would be engaging with the bank in due course if that became an event. So, high level only if it was material and only occasionally.
Eoghan Murphy (Dublin South East, Fine Gael)
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NAMA in their evidence raised two issues with us in relation to what they discovered from the loans when they brought them across from the various banks, and one was as the crisis hit, the extent to which banks were attempting to collect income, it was going to debtors and not the banks, so rental income from shopping centres or office blocks in the millions, and they gave us two figures - 20% of income from investment assets was being mandated to the banks, 80% of income was being diverted away. And NAMA said that nobody seemed to be following up on it, so they followed up on it. Is it the case in AIB that no one was following up on this income?
Mr. David Duffy:
I think it's probably not nobody but I think far less than should have been or could have been but that comes down to a very simple issue, we had not yet built a 2,000-strong division whose capabilities existed in that regard. We had to build a restructuring unit which had to address all of those. And those issues of income coming through larger real estate developers or others had been diverted, manifested themselves across the entire spectrum including individual homeowners or by-to-lets in other cases. So we had not yet ... and it was one of my first priorities and, in later term, one of the top priorities of the bank to build a capability across all asset classes to address that and many other similar issues. So, it was not being effectively done at the time of the asset transfer as we didn't have the capability.
Eoghan Murphy (Dublin South East, Fine Gael)
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So it comes down to personnel issues?
Eoghan Murphy (Dublin South East, Fine Gael)
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Okay. The other issue I raised was in relation to advances to debtors by AIB, once NAMA was announced, until the loans were acquired by NAMA. The Central Bank had said that it would be acceptable if NAMA deemed those advances to have been made on a commercial basis. So, this is to the debtors that are moving into NAMA from AIB and AIB advanced €595 million in that period but only 62% of that was deemed as being eligible and, therefore, as being made on a commercial basis. Can you explain that?
Eoghan Murphy (Dublin South East, Fine Gael)
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Okay, they drew our attention to this quite particularly ... that AIB had been told that it could advance money to debtors that were transferring to NAMA as long that money was advanced on a commercial basis. And when NAMA did its review, it found that only 62% of that had been advanced on a commercial basis - 62% of €595 million, so the amount that was eligible was €367 million. I mean that's a significant amount of money.
Eoghan Murphy (Dublin South East, Fine Gael)
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And NAMA didn't bring this to your attention when you took over as CEO?
Eoghan Murphy (Dublin South East, Fine Gael)
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Okay, thank you. Thank you, Chairman.
Ciarán Lynch (Cork South Central, Labour)
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Thank you. Senator Barrett.
Sean Barrett (Independent)
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Thank you, Chairman, and you are very welcome. Just to explore with you the transition to "boring utility banking" as you call it, what loan-to-deposit ratio would you have in mind to illustrate success in that regard?
Sean Barrett (Independent)
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And on the property concentration, I think that went to 390% when combined with development and the target was 250%, so again it's a ratio where AIB was out of line before the path to boring utility banking. So, what have you got in mind for that particular one?
Mr. David Duffy:
Well, we don't publish at all, but, I mean, our total portfolio is going to be incredibly conservative versus those numbers, but more importantly, the risk governance around being able to exceed limits, which you had, which is very much part of what this number became, don't allow you to do that without prior discussion and approval at the board. So I think a conservative governance and independent risk model, and a very careful segmentation, will lead us to a much safer place in that regard.
Sean Barrett (Independent)
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Has the function of internal audit strengthened since you've come in? Because I see, in the 2006 report it says that when they examined the independent valuation they found that 13 of 25 cases tested were without valuations. One in particular, Glencairn Homes, was for €93 million. So have you tightened valuation procedures in line with what the internal auditor found?
Mr. David Duffy:
We have indeed. The internal audit function is ... Frankly any CEO who doesn't have a first class internal audit function puts themselves at personal significant risk. That person is also an independent reporting person in that they don't report directly to me; they report to the chair of the audit committee, who is our SID and is also a non-exec, and a board member. So, I have ... I can't direct audit. So what I do is agree with the board audit chairman what exactly the priorities are for the year ahead and make sure they're executed, but that independence is fundamental. All those policies behind your statement there were also revisited in light of that.
Sean Barrett (Independent)
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You mentioned the perks, I think, to Senator O'Keeffe. The core documents found at B1, pages 5 to 8, the absence, until 2011, which I think was your time, of a central register for hospitality, entertainment, marketing expenditure. Was that an innovation that you introduced or had it been taken in a matter of months before?
Mr. David Duffy:
It was being started and being addressed but we made absolutely, explicitly clear, to the board our accountability in that respect and put the centralised governance in place, because it's just unacceptable ... one of the key issues which we framed in our culture is having the integrity very visible and tested in the marketplace around everything we did. And if we were going to be engaged in that space and have no control over, and no authority and approval, over those elements, we would never be able to protect that integrity.
Sean Barrett (Independent)
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The internal auditor also found, in 2006, I think that Deputy Eoghan Murphy referred to it, not collecting money from people who owed it to the bank and, in particular, they mentioned in their internal audit that there were only three staff members in place in the Galway office who had the skills to manage cases on a daily basis and then they say, "The consequences would be ... would"-----
Ciarán Lynch (Cork South Central, Labour)
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Can you just give me a reference for that so I can get it on the screen there, please, Senator?
Sean Barrett (Independent)
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Thank you, Chairman. AIB B2, Vol. 1 and it's page 21.
Ciarán Lynch (Cork South Central, Labour)
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Page 21, thank you.
Sean Barrett (Independent)
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And ... and it had just three people in what seems a major part of the Irish economy, particularly in the Celtic tiger era, and they ... what your internal auditor said, "This could lead to the bank missing significant credit events on accounts and the subsequent financial loss".
Ciarán Lynch (Cork South Central, Labour)
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Sorry, Senator, can I just get a page number, not the reference page number that the document is coming out of, the page number in the booklet?
Sean Barrett (Independent)
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Yes, the page number in the booklet is 21, Chairman.
Ciarán Lynch (Cork South Central, Labour)
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All right, thank you.
Sean Barrett (Independent)
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And it's AIB B2, and I hope I've ... I've described that accurately, or correctly.
Sean Barrett (Independent)
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Credit Support, that's the one, Mr. Duffy, yes. Was that a problem that was encountered?
Sean Barrett (Independent)
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There seemed to be a shortage of staff in Galway, and you spoke earlier about the change in corporate culture. Well, to the outsider, it seemed that up and down the country, management was ... the bank manager, who was an important figure in towns and cities, that his powers were all transferred centrally. Have you gone back to the Galways and the Tralees, and so on?
Mr. David Duffy:
It's an important issue, Senator. There were two events that were driving the circumstance of change, the first being that the regulators required us to concentrate back into the centre and centralise many of the governance and approval and risk principles around this.
Secondly, from my perspective I wanted the risk governance to be brought into the centre and the authority to be brought into the centre, whilst we fixed it. To answer your question then in detail, we then decided that once we had control over it, and once we had confidence in our processes and our governance, we would allow certain decisions being made in certain categories of clients for specific reasons. I can give you an example. We said that we would approve an amount of money in 48 hours to an existing customer, provided we understood their credit history, and that would be at the delegated authority of the branch manager, so they could make that decision independently of the centre. So that was what we introduced, but first we brought everything to base, restructured, put in the appropriate governance and only when satisfied with that, redelegated some portion of it.
Sean Barrett (Independent)
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Some commentators and I think some of the institutions didn't much like the Central Bank rules on deposits, but I take it from your evidence you're a supporter of that rule.
Mr. David Duffy:
Yes, at the time I made a ... I think it was in - not that I am picking on it, but theCork Examinermade some comment that I supported the rules, because, in effect, our portfolio for the entire bank was better than each of the ambitious targets that they had in its total. And, secondly, I believe you go back to cash flow borrowing. Borrowing for a house, you have to be able to afford it, and I remember exactly what it was when I was looking to do the same in Ireland when I was young. It was more or less what was announced recently. So, again, it is consistent with my own philosophy on the utility nature of banking.
Sean Barrett (Independent)
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How does your present regulation, SSM, work? Do you send data to them? Do they come to see you from time to time?
Mr. David Duffy:
Yes, there is a joint supervisory team, comprising of the SSM representative, that is the single supervisory mechanism in the ECB model, and then the national competent authority, as it would be referred to, which is our current regulator. All issues are reviewed jointly and those issues involve capital decisions. They involve the approval of my replacement. The meetings, typically, are monthly. I have one next week. They are, typically, quite extensive. They have a very large on-site presence, with frequent forensic reviews of different topics which they schedule throughout the year. So it is a very very intrusive and intense engagement.
Sean Barrett (Independent)
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The last one, if I may. The pillar bank, does that present the danger to the wider Irish economy of a duopoly between the two pillars?
Mr. David Duffy:
I think that that is going to be resolved in the not-too-distant future. I think Ulster Bank has stepped back significantly into the marketplace. You have seen PTSB regain some strength in its franchise through its raising of capital and its ambitions around its own market presence. KBC has also made some further inroads and opened up some branches, so I think whilst it is not yet at a level that is truly, fully competitive, it is emerging, and I hope it will get stronger.
Sean Barrett (Independent)
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Thank you very much. Thank you, Chairman.
Ciarán Lynch (Cork South Central, Labour)
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Thank you very much. I am going to move towards the wrap-up and before I bring in Senator D'Arcy and Deputy Doherty ... west Cork has been referenced a couple of times this afternoon, Mr. Duffy, and there is the kind of colloquial saying down there if somebody was to ask for directions they will tell you, "Well, I wouldn't start from here". Maybe your career, in arriving in AIB was a bit like that as well. Maybe you could tidy up one matter for us. Deputy McGrath referenced it and Deputy Doherty referenced it and some other people referenced it as well. Was AIB on the road to collapse regardless of what was happening in the international financial markets? Was the model ultimately unsustainable, and regardless of what happened with Lehman's and other international factors, was AIB going to hit the wall at some stage or other?
Ciarán Lynch (Cork South Central, Labour)
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Okay.
Mr. David Duffy:
And why do I say that? I just say that if you are so concentrated in one asset class, and that the pricing of that asset class was disconnecting rapidly from the income evolution in the country, there was bound to be an inflection point where there was a revaluation of those assets downwards materially.
Ciarán Lynch (Cork South Central, Labour)
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Yes.
Ciarán Lynch (Cork South Central, Labour)
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And, because of the timing with Lehman's and everything else, that eventually, then ultimately became the guarantee and so forth, because of the business model that was in place in AIB at that time, if those events didn't actually happen, and maybe something else triggered the type of sequencing you're talking about, would the exposure to the Irish taxpayer have actually been higher, given the model that was being operated, if let's say the model continued for another 18 months, two years or so?
Mr. David Duffy:
Very hard to be really precise on that, Chairman. I would just say that if you continue to build the level of concentration or, more importantly, I imagine, if you look forward, the leverage, so there were larger amounts to individual add, then the quantum could have been greater in terms of exposure.
Ciarán Lynch (Cork South Central, Labour)
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Okay. So the intervention at that particular time, in or around ... or what was happening ... it was not an intervention, but the event that happened in 2008 determined the extent to which the bank was then exposed, but there was potential that, if that event didn't happen, that the event ... that the exposure could have been greater?
Ciarán Lynch (Cork South Central, Labour)
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Okay, thank you. Senator D'Arcy.
Michael D'Arcy (Fine Gael)
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Mr. Duffy, thank you again; I think we're nearly there now. At the start, you used the term "staggering": €21 billion Government guarantee; €20 billion de-leverage; €11.5 billion NAMA write-down; the sale of other assets and the shareholder loss. Was AIB badly managed prior to your takeover of the bank?
Mr. David Duffy:
I find it very difficult to answer that, Deputy, because it was a very successful bank for a long period of time. The two years before I arrived, or year-and-a-half, involved multiple CEOs changing and then the executive chairman, David Hodgkinson, who took over. I think my narrow lens on that, not having been here to observe it, would have been that the concentration that was built up was probably ill-advised and led to the exacerbation of the issues that the bank faced when the crisis hit, so from that perspective, I think that was unwise.
Michael D'Arcy (Fine Gael)
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Is that a "Yes" or a "No"?
Ciarán Lynch (Cork South Central, Labour)
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Well, the witness can answer the question how he wants. You can ask the question.
Michael D'Arcy (Fine Gael)
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Well, I've asked him "yes" or "no".
Michael D'Arcy (Fine Gael)
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Okay, but you're probably in the best position than anyone else in the country for an opinion.
Mr. David Duffy:
Well, I think ... I just think that the ... commenting on individuals that you've no knowledge or sight of, or participation in and hardly ever met in your life is a risky business. I would just say that the banking community, both foreign and domestic, in this country got into a position which was extremely unwise.
Ciarán Lynch (Cork South Central, Labour)
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Senator? Deputy Doherty?
Pearse Doherty (Donegal South West, Sinn Fein)
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Go raibh maith agat. Mr. Duffy, we were talking about asset bubbles earlier on and concentration of lending into a certain area which had an asset bubble. Do you believe that there's a property bubble under way at this point in time?
Mr. David Duffy:
My answer to that is I don't believe there's a property bubble. I think there is an imbalance in Dublin. I don't think that's representative, by any stretch of the imagination, in all other areas of the country. The imbalance is a complex one of supply and demand. I think the regulation from the Central Bank will have an impact slowing it down. I think rents are too high because of that demand issue. The requirement for the deposit size to make an entry into the housing market will have a material effect on first-time buyers. If you go down to the other major cities of this country, you will see much less of a rise and much less pressure on housing and then there are other parts along the middle spine of this country where there is no pressure on the house pricing. So, on balance, I don't see this as a property bubble.
Pearse Doherty (Donegal South West, Sinn Fein)
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Now, if we just take Dublin alone, and you mentioned the Central Bank's measures, which dampened house prices for three of the last five months, house prices have again began to increase, as we see from the CSO, at 1.1% in the last month, with a 22.8% increase over the last 12 months. If that were to be repeated in the next year, house prices in Dublin would exceed where they were in 2005. Like, when should the alarm bell, or what would the level be that an alarm bell should go off in relation to a property bubble in Dublin?
Mr. David Duffy:
I think you shouldn't be seeing, on a medium-term basis, double digit growth every year, but the balancing side to that right now is there is a supply equation being solved, so we are engaged with quite a number of builders, etc., developers, to make sure that there is a supply. I think, if you start to build between 15,000 and 20,000 and 25,000 houses, depending on the ... it'll take a while to build to that, over the next three or four years, that continuum, you might have some spikes up and down but, on balance, you will have a more normalised market. We do need that housing supply.
Pearse Doherty (Donegal South West, Sinn Fein)
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Yes, because a bubble can be caused by a number of reasons, am I correct in saying that? It can be in the past caused by credit, or in the future caused by, or in the present caused by lack of supply. And to take me onto that question you mentioned about the interaction that AIB is having with six developers. I think you've mentioned last July that you were looking to fund 5,000 houses in the Dublin market. Has that shown any traction, as you expected in 2015 that there'd be significant traction?
Mr. David Duffy:
It has. A lot of it is now either shovel ready or processes of development that has started the building. A lot of complexity in getting infrastructure approval and getting zoning licences and planning permissions recalculated for the purpose that they were now intended. But that is getting traction, and I think, like us, other banks will be engaged in the same activity, and I think you will see an escalation in the number of developments over the next six, 12 months, and that will build to a peak probably in three years' time.
Pearse Doherty (Donegal South West, Sinn Fein)
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And you talk about the confidence that the public needs to have in the institution, and your institution serves the public. I know you haven't released names of the developers and I'm not expecting you to release names of the six developers that you are, I think, talking about between €500 million and €1 billion of funding to be made available, but are you concerned that there may be a reaction from the public that AIB is back into funding major development in this way?
Mr. David Duffy:
I would be concerned if I had any doubt about the risk management of the process of our engagement with developers. I don't. We are ... they have to put in equity and we will put in debt, and it will be very much geared around their ability to repay. So I think the changed model gives me confidence that I could articulate that to the general public.
Pearse Doherty (Donegal South West, Sinn Fein)
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Okay, in your opening-----
Ciarán Lynch (Cork South Central, Labour)
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Sorry, just in terms of reference now, Deputy, just remain within the terms of reference.
Pearse Doherty (Donegal South West, Sinn Fein)
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Sorry? Yes, yes, well that was kind of looking forward for how do we prevent what's happened in the past. But in relation to your opening statement you talk about the need to deleverage to meet the newly-proposed Basel III ratios and also the demands of the Troika. How has AIB deleveraged its loan portfolio, and can you give us a sense of the type of loans that AIB deleveraged? In your view, if it wasn't for the Troika's demand would AIB have been better to hold on to them for a while longer?
Mr. David Duffy:
I think the answer to that, Deputy, is that of the €20 billion of loans there was a lot of overseas UK property, which was non-core to our activity at the end of the day. There was some miscellaneous property portfolios around this country which we probably would have sold, and there was some which, in the benefit of hindsight, if we'd seen the speed of the recovery, you might keep. So there's no explicit black and white answer, it's a combination of the above. But I think the significant portion of that portfolio would have been for sale in any case. It has allowed us, additionally, create the space in our capital structure to lend at the levels which we're seeing today, which is new lending stimulating the economy, and more valuable therefore, so a little bit of positive comes out of it in any case.
Pearse Doherty (Donegal South West, Sinn Fein)
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Thank you.
Ciarán Lynch (Cork South Central, Labour)
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Very, very last question, Mr. Duffy. In your view, having been at the helm of AIB for a number of years now, given that the bank was a publicly owned ... or privately owned bank, it is practically now in full public ownership, and has potential to return to private ownership again, do you believe that it's in the best interest that the bank would now become a private bank once more, or would be developed into a publicly owned bank on behalf of the State?
Mr. David Duffy:
Can I give a personal opinion on that, if I may? I think that running an institution like the AIB is very complex. It isn't as easy as it looks. You need smart people, you need to get the best people for the market, you need to pay them what you need to pay them to do it right. I think that in that circumstance, you know, opening up to a participation, I'm not saying sell the entire bank, but selling a material amount that allows you freely operate on commercial terms in the marketplace, with a significant participation by the State, that hybrid of the future would, I think, be the appropriate model.
Ciarán Lynch (Cork South Central, Labour)
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And that was just to bring me to a kind of space of recommendations. If there's anything further you'd like to add, or that you feel that you might like to comment upon before I close proceedings?
Ciarán Lynch (Cork South Central, Labour)
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Thank you very much, Mr. Duffy. Just for members, there's just one item in regard to tomorrow's proceedings that has to be dealt with, so we just need to go into private session just for a couple of moments for that. What I'm proposing now is to suspend just for a few moments, to excuse Mr. Duffy before I make the suspension, to thank Mr. Duffy for his participation before the inquiry today, and to formally excuse you.