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Under the terms of the Irish bailout, several banks in the Irish banking system will have to reduce the size of their asset base by shrinking their loan portfolio.

There are two ways to shrink a loan portfolio. First, there is the strategy of letting the portfolio wind down as the loans are repaid. Second, there is the strategy of selling portions of the loan portfolio.

European financial officials are pushing for Ireland to adopt the second strategy and have their banks sell portions of their loan portfolios.

There are two ways for the banks to pursue these loan portfolio sales.

First, there is the approach recommended by the investment bankers which is designed to loot and pillage the Irish banking system.

The investment bankers' basic approach is to share loan-level detail with a limited group of prospective buyers. After the prospective buyers have had a chance to do their due diligence on the loan portfolios, the investment bankers then conduct an "auction" of the loan portfolios complete with competitive bidding to realize the 'best' price.

The aspect that gives rise to looting and pillaging is the absence of an independent "fair" value determined by the credit markets. Without this value,

  • How do the sellers, which is ultimately the Irish government, know if the highest price from the investment banker's "auction" is below, equal to or above fair value?
  • How do the sellers, which is ultimately the Irish government, know if they got a good deal or were ripped off?

Second, there is the alternative method for pursuing the sale of these loans portfolios which involves first disclosing current information on the underlying loans to the market.

Let the credit market analysts value these loans and independently determine what their fair value is. Then, and only then, let the investment bankers sell the loans to their prospective buyers.

Armed with the fair value of the loans, the Irish government and its banking system can see how well the investment bankers performed in maximizing the value of the loans. Were the investment bankers able to justify their fees by auctioning off the loans for more than the credit market analysts believed was fair value?

It is hard to imagine that the EU would push the Irish government to go through a process that would minimize the proceeds to the Irish banking system from the loan sale. Disclosing the loan-level information to the markets first still results in shrinking the banking system. Disclosing the loan-level information to the market first just maximizes the value of the loan portfolios and minimizes the time it takes Ireland to repay the bailout funds.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Will the EU Require That the Irish Banking System Be Looted?