What does a banker think, who awards himself or big clients of his bank loans with interest rates comparable to a state, lower interest rates than the bank gets in its own finance, continuously rolls over bullet loans for himself and major clients and on the whole constructs the loan covenants in such a way that the bank gets all the downside and the client/he himself gets all the upside? Does he think that this bank has a great future? Or only a limited future so he better hurry up to profit as he can while there is something to profit from?
After the fall of banks I was of the opinion that the banks had been badly governed by people who had, in most cases, never seen anything but an Icelandic bank – that the combination of a lack of experience of international banking, hubris and arrogance had brought them down. Now, I’m less sure. Already in his short and concise report in April last year, Kaarlo Jannari pointed out that most probably the three Icelandic banks would have folded, crisis or not, since their business model was unsustainable. At the time, the possibilities of an extensive fraud were only starting to come to light. With the report of Althingi’s Investigative Commission we know much more – and I don’t think the lack of experience explains the whole demise.
Loan contracts aren’t generally available – breech of bank secrecy. Luckily, the Glitnir resolution committee was forced to make a few contracts public earlier this year in a lawsuit. The contracts offer a fascinating insight into the world of unsustainable banking. The contracts are between Glitnir and Fons, a holding company owned by Palmi Haraldsson. In close association with Jon Asgeir Johannesson and his Baugur empire, Fons became a major shareholder in Glitnir in the summer of 2007 – and the loans shot up like a rocket.
Not only were Glitnir’s coffers wide open to Fons but the rates and covenants were wholly unsustainable. The rates were absurdly low, marginally higher than the rates for the Icelandic states and even lower than the rates available to Glitnir financing itself. The rates reflected no risk.
Was that because the collaterals were so fabuolous? A bank’s criteria for collaterals is that they can be easily sold – not exactly the case with the Fons collaterals that were illiquid shares in Baugur and Fons companies, much less so at the evaluation Glitnir adorned them with.
A well-structured loan comes with covenants that secure the bank the possibility to make a margin call and/or has a personal guarantee. None of this was carefully spelled out in the Fons loans. In addition, Fons could choose which currency the loans were in – at a time, late 2007 and during 2008 when Glitnir itself couldn’t find any finance abroad.
These are the general characteristics of the four loans that Fons got from December 2007 until summer 2008. Let’s look closer at the loan contract for the biggest loan, a ISK10bn bullet loan, from December 2007. The context for the loan is to be found in the Althingi Investigative Report, published earlier this year. According to the minutes of Glitnir’s risk committee Fons was buying shares in FL Group from two of Fons’ and Baugur’s steady business partners, Magnus Armann and Hannes Smarason, now both living in the UK. The two had bought FL Group’s shares with loans from Glitnir and no longer met the covenants. To save everyone, except the bank, Fons borrowed the 10bn to buy the FL shares.
Fons had this minor problem that it didn’t have the necessary collaterals. That problem was resolutely resolved: Glitnir secured Fons it would buy one of its subsidiary that owned Skeljungur, an oil company, in a year’s time and valued Skeljungur at 8,7bn. The sale and the loan seem to be part of the concerted efforts of Glitnir and major shareholders in FL Group to hide that the company was in fact bankrupt. The movements here indicate serious market minipulation. In August Glitnir sold 51% of Skeljungur for 1,5bn – even considering the diminishing share value in many listed companies this price indicates that 8,7bn was a wild over-valuations. Glitnir’s write off is unclear. Even though the collateral was now apparently nowhere near the loan it doesn’t seem that Glitnir did anything to secure its position.
In a newspaper interview earlier this year, before the very revealing report was published, the owner of Fons Palmi Haraldsson said that he was Glitnir’s victim. Emails published in the report tell another story: the loans were made under huge pressure on Glitnir’s management from Haraldsson but most noticeably from Jon Asgeir Johannesson in spite of the frequent smileys. It’s difficult to picture Fons as the victim here but easier to see how seriously the minor shareholders and other clients suffered at the hand of managers who squandered the bank’ money on loans to major shareholders with the covenants so biased against the bank and in favour of these borrowers that the loans didn’t make any business sense.
Scrutinising this loan shows that the covenants went completely against the interest of the bank and minor shareholders. They are in no way comparable to loan covenants in foreign banks that the Icelandic banks liked to compare themselves with.
Another indication of lax or doubtful covenants came forward in a case at the Reykjavik County Court a few days ago where the Landsbanki resolution committee tried to secure a company that the ResCom thought Fons had pledged to Landsbanki. It turned out that although the company in question was on the bank’s book as a collateral it was neither correctly filed with the bank nor was it legal to use it as a collateral – another example of the favours granted to Fons, this time not with Glitnir but with Landsbanki. Other loans in Landsbanki seem to have been used to pay out record dividends from the supermarket chain Iceland – a textbook example of corporate raiders leaving a company struggling to service staggering loans to pay dividends.
In 1993 George Akerlof, who won the Nobel prize in economy in 2001, wrote an article, ‘Looting: The Economic Underworld of Bankruptcy for Profit.’ In many aspects it seems to describe what happened in Iceland. One day, the bankruptcy of the Icelandic banks might be shown to be an extensive case of bankruptcy for profit.
There’s no reason to believe that Glitnir’s loan to Fons were in any way unique. Rather they seem to be the usual kind of loans that the banks gave its biggest clients who in all cases were also among their major shareholders. The loans couldn’t give the necessary returns for the banks to run a viable operation. It means that the banks could only operate if there was a flow of money into them. An operation where new loans are funded by incoming money, not by loans being repaid or other normal financing for banks, looks more like a Ponzi scheme and less like a bank.
I wonder where the accountants were in all this. And what did the bankers when they makes out loans with lower interest rates than the bank got for its own funding or at interests rates comparable to the state? Didn’t the bankers know that the banks were a machinery of favours, not a proper bank? In an email printed in the Investigative Report that a Glitnir employee sent to the bank’s CEO the employee writes that he doesn’t really understand why the bank has to go to all this length of setting up complicated loan structure; surely it would be a lot simpler just to send the money to Haraldsson’s Cayman accounts.
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