Illustration: David Manion
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PART TWO |
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For the Reykjavik-based lawyer, Johannes Karl Sveinsson, the story of Iceland’s spectacular collapse began on Saturday October 4, 2008. He had spent the evening at the National Theatre with his wife and family, watching a lively musical set in Reykjavik in the 1980s, entitled ‘Love is disco, life is punk’.
While he does not recall much about the production itself, Sveinsson vividly remembers the profusion of missed call notifications that pinged on his mobile after the curtain had fallen. Most of those calls had been from Jonas Jonsson, head of Iceland’s horribly under-resourced financial industry regulator, the FME, which Sveinsson had counselled in the past. That weekend Jonsson was in desperate need of help.
Perhaps it is unsurprising that Sveinsson does not recall any details of the show. After all, late that Saturday night he had other things to worry about, foremost among them was the possibility – fast becoming a probability – of the imminent and catastrophic collapse of his country’s economy.
That is no exaggeration, says Sveinsson, when he looks back at the events of October 2008 a decade later. During the first, chaotic weekend of that month, desperate officials at the Central Bank of Iceland (CBI) had been reduced to rummaging around in the basement of the bank’s headquarters in search of old banknotes. Withdrawals from the banks had reached 20 times their normal level on Friday October 3 and ATMs urgently needed replenishing. If that meant using notes that had long since been taken out of circulation, so be it.
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Johannes Karl |
Icelanders who were overseas that weekend found their credit cards rejected, signalling that their country was facing the very real possibility of the wholesale paralysis of its payment system. As Sveinsson points out, for a country dependent on imported food and essential medicines, the endgame of a breakdown would have been unthinkable. There is only so much fish you can eat.
Traumatic though they were, the events of the first week of October 2008 were not unexpected. That much is self-evident from several of the accounts of Iceland’s meltdown published over the last decade. The most excoriating of these was the report written by the Special Investigation Committee (SIC), which was appointed by the Icelandic parliament in December 2008 to pick apart the events leading up to the collapse of 97% of the Icelandic banking system.
The document delivered by the SIC in April 2010 may be the most uncompromising, no-holds-barred manual ever written on how not to manage an economy or a banking system. It is certainly one of the longest, running to nine volumes and 2,400 pages. The insane hubris of the bankers that turned their industry into what the report calls a “leprosy patient” is well covered. But a striking feature of the report is that it spares virtually none of the institutions and precious few of the individuals it identifies as the leading figures in the run up to the crisis.
The government, it says, lacked the “capacity and courage” to address the excesses building up in a system that at its peak was 10 times the size of the Icelandic economy. The CBI, the FME and auditors are all criticized for their poorly coordinated supervision of a banking sector apparently permeated to the core by incompetence and mistakes “committed with full knowledge of the possible effects”.
Small wonder that the report was greeted with disbelief and disgust by the individuals it names. Jonsson, as the former FME chief and who was the subject of some especially harsh criticism, is not alone when he calls the report “grossly hurtful and grossly unfair”.
He has a point, given the very limited resources that were made available to supervise an industry growing at suicidal speed, twinned with the feeble attempts that had been made by the agency to keep pace with this expansion in the years before his appointment in July 2005.
“Between 2003 and 2005, when the banks were at their most acquisitive, the FME’s staff increased from 32 to 35,” he says. “In the three years to 2008, I tripled the FME’s funding and increased the headcount from 35 to over 60, but it is clear that we were still very under-resourced.”
Neither Heritable Bank nor Singer & Friedlander were bankrupt, so to this day I have no idea what chancellor Darling was talking about – Johannes Karl Sveinsson
Perhaps the most notable and regrettable sub-theme of the SIC report is that the inevitability of the crash it describes was foretold by so many observers at home and overseas.
Looking back at the crisis 10 years on, Steingrimur Sigfusson, the finance minister who would guide Iceland through the initial restructuring of its devastated banking industry, says the crisis came as no surprise to him.
“As leader of the opposition, I was worried about what was happening in Iceland as early as 2005 and 2006,” he recalls.
So was ratings agency Fitch, which shocked the market in February 2006 when it changed its outlook on Iceland from stable to negative. The global response surprised one of the report’s authors, Brian Coulton, who at the time was head of EMEA sovereign ratings at the agency.
“We published the report in the morning, and by the time we had returned to our desks every global risk market was risk-off,” he says. “I don’t think we had ever seen such a striking global market reaction from an outlook change on such a small economy.”
Not that it did much good; warnings continued to fall on deaf ears. Some of the admonitions that came from observers overseas, such as those from Danske Bank, were sneered at as the product of petty Nordic rivalry. Others were often ignored or ridiculed by Iceland’s blinkered authorities.
One of the more comical entries in the SIC report is an anecdote about the minister for culture and education suggesting in a televised interview that comments by a Merrill Lynch banker about the Icelandic economy demonstrated that he was in need of “re-education”.
Perhaps the individual concerned was Richard Thomas, Merrill’s bank analyst, who strongly suspected that the expansion of the banking industry could only have been underpinned by fraud. Thomas recalls that he could not say so, but that his clients would have been perfectly capable of reading between the lines when he expressed his reservations about “related parties”.
That is not to say that his research, which the Icelandic banks had assumed would be positive, pulled many punches.
“They hated it,” he chuckles mischievously, recounting the story of how many complaints Merrill received – “from the bigwigs at Exista [the holding company that owned 20% of Kaupthing], the banks and even at one point the prime minister himself.”
Regardless of what the Icelandic banks thought of it, Thomas’s research left little room for misinterpretation. Where the SIC would use several million words to tell the story of the Icelandic banking collapse, one of Thomas’s cautionary reports anticipated it in 12. With wonderful economy, he wrote in March 2008 that Iceland’s banks were: “Too fast, too young, too much, too short, too connected, too volatile.”
Too right.
Emergency law
The weekend of October 4/5, 2008, was no time to reflect on the excesses of the past. Sveinsson had an emergency law to draft and less than a full weekend to finish it before the banks were due to reopen.
That task was not quite as onerous as it sounds, given that the FME had started work on drafting the legislation earlier in the year. But that is not to belittle the importance of the emergency law, which is regarded as the first milestone in the journey of Iceland’s banking industry towards redemption.
Its main features were that it empowered Iceland’s treasury to establish new banks and gave the FME wide-ranging authority to intervene in “extreme circumstances”.
This meant giving the regulator unprecedented freedom to dispose of assets and liabilities as it saw fit, and to appoint resolution committees to implement its decisions. In short, it meant giving the regulator free rein to do more or less whatever it saw fit to ensure that the broader economy was effectively ring-fenced from the events engulfing the banking industry.
The Emergency Act also established priority status of depositors’ claims, which was an important nod not just to public opinion at home, it was also designed to reassure UK and Dutch authorities, now deeply nervous about the impact on their electorates of the impending collapse of those Icelandic banks that had mopped up billions of savers’ deposits when other funding options closed.
The bill was finalized and delivered to the ministry of trade and industry on the Monday morning, signed by the president and presented to parliament in the evening, and enacted by midnight.
The speed of its introduction was essential because it went some way towards filling a vacuum in the legal infrastructure that left Iceland so hopelessly vulnerable to the downturn that transfixed the global economy in 2008. The CBI, for example, had no more than two lawyers on its payroll when the crisis hit.
Now, I was finding those same people saying that while it was nothing personal, they couldn’t talk to me because I was a terrorist – Jon Sigurgeirsson, CBI
The inadequacy of Iceland’s legal framework had been one of the many concerns that preoccupied law firm Akin Gump’s financial restructuring partner, Barry Russell, when he arrived in the country for the first time in October 2008.
Russell, who was then a partner in the financial restructuring practice of Bingham McCutchen ((later Akin Gump), had worried about what he would encounter in Reykjavik as he prepared for the first of countless flights to the Icelandic capital that he would take over the next seven and a half years.
Glancing around the Icelandair lounge at Heathrow Airport that Tuesday lunchtime before his first trip on October 14, Russell was struck by how many familiar faces of debt restructuring practitioners were waiting for the same flight. By the end of his first day in a city that seemed to him to have mortgaged itself to its banking industry, Russell had serious doubts about whether or not the Icelandic crisis was resolvable.
“One of the issues was that there was a distinct lack of legal and financial infrastructure,” Russell recalls. “The Lehman collapse was big and complicated, but at least there was Chapter 11 to help deal with it. In Iceland there was nothing of the kind. I found it very daunting because, although I knew the banks had assets, at the time there was not even a mechanism for the government and the banks to interact with creditors.”
As well as starting to address this deficiency, Iceland’s Emergency Act would turn out to be a forerunner for regulatory change elsewhere in Europe.
“It was effectively a bridge bank solution combined with asset sales,” says Jon Thor Sturluson. He is now deputy director at the FME, but at the time of the crash, Sturluson was an adviser to the ministry of business affairs, which had the banking sector in its portfolio.
“Although there was no explicit bail-in, it was obvious that the emergency law would potentially lead to heavy losses for bondholders,” he says. “So, in many ways it foreshadowed the BRRD [Bank Recovery and Resolution Directive].”
This meant that the Emergency Act formed the basis for the restructuring framework that would be so urgently needed following the frenetic events of the week beginning October 6. These began with an unfortunate televised speech from prime minister Geir Haarde.
Geir Haarde’s speech in early October 2008 petrified rather than reassured people
It was meant to be Churchillian but ended up petrifying rather than reassuring the people who listened to it – which was most of the Icelandic population. His conclusion was “God bless Iceland”, but many had taken this to mean “God help Iceland”.
What few if any of the viewers knew was that up until the small hours of that morning, prime minister Haarde and other senior government officials were still in denial about the severity of the crisis engulfing their country.
That was in part because they had reportedly been assured by the banks as late as dinner time on Sunday October 5 that they were in better shape than most government officials privately feared.
It may also have been in part because it was what politicians and other policymakers wanted to hear. The big three banks, were, after all, Iceland’s national champions. They had been the leaders of the spirited so-called ‘outvasion’ that had put the minuscule island on the global map and allowed Iceland to play in the big league of international finance.
It was unthinkable that one, let alone all three, could be on the point of complete collapse.
No, it wasn’t, said a delegation from JPMorgan made up of Michael Ridley, John Bergendahl and Gary Weiss. According to one observer, they had been flown to Iceland on a plane privately chartered by the CBI when they missed their flight at Heathrow. When the JPMorgan trio was eventually called to Cabinet House at 2am on the morning of October 6, it did not take them long to disabuse their hosts about what lay in front of them.
Ridley, Bergendahl and Weiss may well have been “incredibly nice blokes and good to talk to”, as one of the ministers at the meeting later recalled, but the message conveyed by these “well-turned-out and articulate upper class Brits” was blunt and uncompromising: for the big three banks, the game was up. The banks had failed, said the JPMorgan team, and it was time to put the Emergency Act into action.
By that same evening, Landsbanki had thrown in the towel and Glitnir went the same way the following day. Sveinsson says that there was some hope that Kaupthing’s more resilient financial profile would protect it from a similar enforced capitulation – in the short term at least. But when the UK Treasury issued its Landsbanki freezing order on Wednesday October 8 under its anti-terrorism act of 2001, putting the UK subsidiaries of Landsbanki and Kaupthing into administration at the same time, it was also game over for the third of Iceland’s big three.
Extraordinary hostility
It is hard to overstate the bitterness that was felt in Reykjavik at the UK authorities’ announcement that Iceland deserved an entry alongside Al-Qaeda, the Taliban and North Korea as a result of a measure taken to protect Landsbanki’s 300,000 or so British depositors. All the more so because this act of extraordinary hostility towards a fellow Nato member and long-standing ally appeared to be grounded more in political expedience by prime minister Gordon Brown and his chancellor, Alastair Darling, than in legal or financial fair play.
“It turned out that neither [subsidiaries] Heritable Bank nor Singer & Friedlander were bankrupt, so to this day I have no idea what chancellor Darling was talking about,” says Sveinsson.
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Jon Sigurgeirsson, Central Bank of Iceland |
The UK’s freezing order was especially upsetting to Jon Sigurgeirsson, now director of general secretariat and international relations at the CBI and who has been at the bank since 1987.
“Because I had run the bank’s FX reserves and international debt management, I had built up good long-term relationships with international bankers,” he says. “Now, I was finding those same people saying that while it was nothing personal, they couldn’t talk to me because I was a terrorist.”
The authorities could wring their hands all they liked about the Brown-Darling order, which in any event only had a walk-on role in the drama of the Icelandic collapse. The brutal fact of the matter was that in the space of three days, 88% of the country’s banking system measured by assets had gone to the wall.
A second wave of bankruptcies among smaller banks would bring this figure up to 97% in March 2009.
Relative to GDP, it was comfortably the biggest bank failure the world had ever seen. By some measures, even in absolute terms it was the third largest in history, behind Lehman Brothers and Washington Mutual. No wonder creditors were jumpy.
While some, at this stage, were opportunist hedge funds, most of the creditor base was made up of the UK and Dutch governments, together with European banks generally regarded as highly conservative.
Numbers published in December 2008 by CreditSights put the exposure of German banks at $21 billion, with UK and French banks some way behind, at $4 billion and $2.9 billion respectively. In total, 21 German banks and four from Austria would make up what came to be known as the ‘German’ creditor group.
Sigurgeirsson at the CBI says that many of those bank buyers had probably been blinded by the spreads Icelandic banks were paying relative to their ratings.
“After Iceland’s mini-crisis of 2006, bank issuers started paying considerably wider spreads than they had previously paid,” he says. “European banks and US funds couldn’t believe their luck and seized the opportunity of paying triple-B prices for double-A risk.
“A lot of Icelandic bank bonds were also printed into CDOs [collateralized debt obligations],” Sigurgeirsson adds. “Anecdotal information indicates that up to half of the CDOs issued in the last leg of that market held some Icelandic bank debt.”
When Moody’s gave all the Icelandic banks a triple-A rating in February 2007 on the basis of its joint default analysis, I remember angrily calling them up and asking what the hell they were thinking of – Jon Sigurgeirsson, CBI
This is why Icelandic banks were able to print bonds like there was no tomorrow in 2006 and 2007. Equally, it is why when the music stopped in late 2007 and early 2008, many of the investors who were slaves to ratings became forced sellers. At the same time, rising demand for protection as CDOs unravelled also began to transform the character of Iceland’s creditor base.
The agencies, says Sigurgeirsson, should acknowledge the role they played in stoking this unsustainable fire.
“When Moody’s gave all the Icelandic banks a triple-A rating in February 2007 on the basis of its joint default analysis (JDA), I remember angrily calling them up and asking what the hell they were thinking of,” he says.
The upgrades were soon partially reversed in response to market reaction, although the Icelandic banks retained double-A ratings.
But as Sigurgeirsson says, it was the confusion created by the JDA that was in part behind the firm reminder published in the central bank’s stability report in the spring of 2007 that neither the Treasury nor the CBI had issued any of the banks with any formal guarantees.
Proposals
Before JPMorgan’s devastating advice in the small hours of October 6, a number of proposals had been suggested as ways for Iceland to dig its way out of its crisis, most of them non-starters because of the sheer size and international reach of the banks’ balance sheets.
The idea of throwing all the island’s foreign exchange reserves at the crisis was soon rejected, with good reason. On the eve of the crisis, those reserves amounted to IKr410 billion, or €3.7 billion. By contrast, the banks’ combined balance sheets were IKr16,000 billion, or €145 billion.
Adding Iceland’s pension fund assets to the pot would barely have moved the needle, even though they were worth more than 2008 GDP of IKr1,476 billion at the time.
One or two optimistic souls threw in some other ideas.
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Thorsteinn Thorsteinsson |
“There was a discussion about a good bank/bad bank split, which had been successfully applied in Sweden,” says Thorsteinn Thorsteinsson, the retired banker who would lead the government’s negotiations with the creditors in 2009. “That was impossible in Iceland because most of the good assets were foreign assets and Icelandic banks’ access to overseas funding was closed. So the idea of a good bank/bad bank was doomed from day one. The FME briefly experimented with having the new banks take over the derivatives book of the old banks. But that was abandoned after one day.”
Today, a number of Reykjavik-based professionals will tell you that by 2008 the banks were simply too big, their cross-shareholdings too labyrinthine and their bosses too toxic to be saved. That meant the only option available to the authorities for resolving the mess they found themselves in was the formula that was adopted, which was based on cleaving each of the banks into old and new entities.
In simple terms, the three old banks (known as the estates), which went into administration, were left to run their foreign assets and liabilities. Under the emergency legislation, at the same time three new banks were formed to absorb all the domestic operations, funded by the domestic deposits that had been guaranteed by the government.
“Iceland never had the same sort of zombie banking system that many other European countries had, precisely because the banks went under and were then rebooted,” says Andrew Speirs. At the time he headed the restructuring advisory business at the London-based Hawkpoint Partners, which advised the Icelandic government on the restructuring and capitalization of its banks.
Speirs adds that although the IMF would go on to play a key role in supporting Iceland through its crisis, a notable element of the new bank/old bank restructuring agenda was that the Fund was not directly involved in any of the negotiations.
“The IMF sometimes claims ownership of the restructuring, but it was not until early November that the memorandum of understanding was signed,” says Sveinsson. “By then, more or less everything had been decided with respect to the splitting of the banks.”
Those decisions did not go down well with creditors. They were deeply suspicious of the text of the emergency law, which some believed would leave them vulnerable to mass appropriations.
“I soon lost count of the number of messages we had threatening law suits,” says Jonsson, former head of the FME. He adds that the banks’ resolution committees that were set up immediately after the weekend encountered even more hostility.
It was not just the implicit threat of bail-in and the explicit commitment to asset sales that unnerved the Icelandic banks’ creditors as negotiations over the restructuring process began. Creditors were frustrated and edgy for several reasons. For one thing, the process was slow and hesitant, with the first formal meetings between them and the banks not taking place until November. By then, the resolution committees had each appointed an international adviser to support them in their dialogue with creditors – Morgan Stanley advising Kaupthing, Barclays Capital, Landsbanki and UBS, Glitnir.
I asked her if we could borrow a central bank director for a few months and within a couple of days Svein Harald had arrived in Reykjavik – Steingrimur Sigfusson
Some of the early disagreements around the negotiating table were a function of the sheer variety of creditor agendas, with some creditors considerably more vocal than others.
“It was often tricky to align the interests of the priority creditors and the bondholders,” says the head of one resolution committee. “The UK and Dutch priority creditors seemed to be more interested in getting the money in quickly. But the bondholders were more concerned with getting all the money, because getting it quickly meant lower values.”
Those that were involved in the multi-year, multi-agenda negotiations that followed say that much of the credit for banging heads together among the creditors should go to the team from Bingham McCutchen.
“I thought it was most admirable that somehow Barry Russell managed to keep together all of the creditors in three different estates together,” says one lawyer closely involved throughout the process.
One of the creditors’ greatest early misgivings was over the composition of the resolution committees of the old banks, which had been appointed in double-quick time by the FME. This rang alarm bells among creditors on two counts.
The first was that as they had been chosen and appointed by a public-sector agency, they were perceived by at least some of the creditors as stooges of the Icelandic government. The second was that they had been appointed by an agency known to have been poorly resourced and under-funded, and suspected of having been asleep at the wheel during much of the run-up to the crash. That may have given creditors insufficient reassurance about the integrity and competence of those on the committees.
These fears were probably unwarranted. Jonsson and his over-stretched team at the FME were certainly exhausted. He says that in October 2008 the FME resembled a crisis centre, offering its staff the services of masseuses to revivify tired shoulders and even the opportunity of seeing a counsellor “because of stress and anxiety”.
Against that backdrop, it is little wonder that the selection procedure for the resolution committees, as well as for the management of the new banks, had been rushed and possibly less scientific than it would otherwise have been. It also presented the FME with the highly unusual challenge of identifying senior individuals with demonstrable banking experience that were entirely untainted by the excesses that caused the crisis.
In a country with a population smaller than Bologna’s or Bilbao’s, that was easier said than done.
As Sveinsson says, it is worth remembering that at the time Iceland had “a million practical things to take care of” and was unable to call upon bankers – many of whom had become damaged beyond saving in the view of the public – to help. In other words, battling to reconstruct the system from scratch was like sending out half a football team to play a competitive match.
The result was one or two own goals.
“We probably only got it right about half the time,” says Sturluson at the FME. He adds that an extreme example of how rushed the process became was his own appointment as chairman of Glitnir. He held the post for one day, recognizing that it was inappropriate to play the dual role of chairman to a new bank and adviser to a minister.
At the FME, Jonsson explains that the resolution committees were generally each comprised of three external appointees alongside two internal figures with hands-on experience of the day-to-day running of the bank, such as Arsæll Hafsteinsson.
A lawyer whose career had begun at Bunadarbanki Islands in 1988, Hafsteinsson had worn several hats in the legal division at Landsbanki, making him an ideal candidate to lead the resolution committee when the bank fell on October 7.
Still, Hafsteinsson was astonished when he was called by Jonsson at 3am the following morning and invited to step round to the FME’s office. By 6am he had agreed to take on the role of acting head of the resolution committee. This meant ensuring that the bank could open by 9am and continue to operate normally – as it would appear to the general public – until the opening of Landsbankinn, as the new bank would be named.
I was a good choice for the job because I had international experience, which gave me a better understanding of the counterparties and allowed me to earn respect at the negotiating table – Thorsteinn Thorsteinsson
Equally surprised at the turn of events in early October 2008 was Supreme Court attorney Steinunn Gudbjartsdottir, whose summons from the FME to join the board of Glitnir’s resolution committee came soon after she had watched Haarde’s ill-advised ‘God bless Iceland’ speech.
“We came into the bank at about 8pm that evening, and at the beginning it was all about putting out fires,” she recalls. “We stayed in the office all that night, beginning the process of identifying the bank’s creditors and creating a platform for getting in touch with them.”
Pall Eiriksson, general counsel on Glitnir’s resolution board at the time, says that the principal challenge in the early weeks was protecting Glitnir from creditor litigation. It was not until late November that a three-month moratorium on creditor proceedings was issued by the district court of Reykjavik, with Gudbjartsdottir appointed as moratorium administrator. That came too late for the bank to prevent its Norwegian subsidiary, Glitnir ASA, from being swallowed up by 20 savings banks at a fire-sale price of NKr300 million ($42 million).
Early in 2009, the local press would put Glitnir ASA’s value at more than $280 million, almost seven times its sale price.
“The financial authorities in Norway made it very clear to us that if we didn’t sell the bank they would seize it,” says Eiriksson. “One of the lessons learned from the crisis is that it’s important to put protection in place from the beginning.”
Hafsteinsson, meanwhile, held his first informal discussions with Landsbanki’s creditors in October, aimed chiefly at stabilizing the relationship between the two parties and issuing reassurances that there would be no fire sales. It marked the start of a long and increasingly cordial relationship between him and the creditors, and when the resolution committee was eventually wound down, the estate of the old bank made a special point of keeping Hafsteinsson on as an adviser.
Structure
It was the fall of the emabttled Haarde government and its replacement by a minority administration in early 2009 that at last brought some structure to the negotiations between the banks and their creditors. Thorsteinsson says this had previously been characterized by a laissez-faire approach, particularly from the ministry of finance, based on the belief that the banks, the FME and their advisers were grown-ups who could sort the problem out among themselves.
Creditors had Steingrimur Sigfusson to thank for the more decisive approach that was urgently required. The founding chairman of the Left-Green political party, Sigfusson became finance minister when a coalition government led by Johanna Sigurdardottir came to power in February 2009.
Initially, creditors had been understandably suspicious of Sigfusson’s left-leaning political pedigree. But they and others were pleasantly surprised when it became clear that he had no intention of allowing politics to continue to frustrate the resolution of Iceland’s banking crisis.
“Sigfusson had always been a fierce critic of the IMF,” says Franek Rozwadowski, who became the IMF’s resident representative in Iceland in March 2009. “But to his great credit, he was always more pragmatic than ideological during his tenure as finance minister.”
One important sign of this pragmatism was a determination to ensure that the Icelandic authorities set aside the differences that had bogged down the decision-making process for years. Even as the crisis took hold, it had not been entirely obvious who was in charge of Iceland’s clattering train.
“Up until the last minute, there had been a lot of mistrust between David Oddsson, governor of the CBI, and Jonas Jonsson at the FME,” Sveinsson recalls. “At the start of the crisis, it was still unclear who would be in charge of decisions about splitting the banks and who would have policy-making powers over their restructuring.”
“Things had been incoherent and disorganized in previous years, which clearly had to change,” says Sigfusson.
If that meant breaking tradition and looking overseas for a new central bank governor to replace the mercurial Oddsson, so be it. One of the first calls Sigfusson placed was to his opposite number in Oslo, Norwegian finance minister Kristin Halvorsen.
“I asked her if we could borrow a central bank director for a few months and within a couple of days Svein Harald had arrived in Reykjavik,” Sigfusson recalls. A safe pair of hands, Harald stayed in post until July 2009, when he was succeeded by the present incumbent, Mar Gudmundsson.
Sigfusson did not just inject some much-needed joined-up thinking into the bank restructuring programme. Those who worked with him say he also threw himself into the challenge of solving the banking problem with extraordinary energy, zeal and self-sacrifice.
“It’s true that I generally arrived at the office at 7am or 7.30am, and was the last to leave at 11pm or 11.30pm, Saturdays and Sundays included,” he says. “Almost everything else was secondary to getting the job done – even my family.”
One of the most important early examples of the decisive pragmatism that Sigfusson applied to addressing the banking crisis was his appointment of some of the figures who would play a pivotal role in rehabilitating the industry. The first of these was Thorsteinsson, who was identified in the middle of February as being the most suitable candidate to lead the government’s negotiations between the new banks and the creditors.
Like the chairmen of the resolution committees, the 60 year-old Thorsteinsson ticked every box. A highly experienced banker who had held positions at the Nordic Investment Bank between 1986 and 1996, and at Bunadarbanki in Reykjavik and Luxembourg from then until 2003, Thorsteinsson had been out of the industry for more than five years when the crisis erupted. That guaranteed that he was entirely dissociated from the mismanagement that had brought the industry to its knees.
Because they were taken seriously and invited to participate directly in the negotiations, creditors bought into the process – Andrew Speirs
There were other reasons why Thorsteinsson was the perfect candidate for the job.
“I was available, because I had decided to retire at the end of 2008,” he recalls. “But even if I say so myself, I think I was a good choice for the job because I had international experience, which gave me a better understanding of the counterparties and allowed me to earn respect at the negotiating table. It also so happened that two of the chairmen of the resolution committees, Arsæll Hafsteinsson at Landsbanki and Arni Tomasson at Glitnir, had been colleagues of mine at Bunadarbanki, which helped strengthen relations quickly.”
A second key appointment made by Sigfusson was the London-based corporate advisory firm, Hawkpoint. It was something of an 11th hour appointment and came after Mats Josefsson, who was acting as a consultant to the Icelandic government at the time, voiced reservations about references given by the previously favoured candidate, Houlihan Lokey.
Josefsson, who had spent 13 years at the IMF, knew his way around Nordic crises, having helped to rebuild the Swedish banking sector after its misadventure in the 1990s. Hawkpoint may not have been the most experienced firm available to advise the Icelandic government. It may also have been a little over-enthusiastic at first, putting a picture of Greenland rather than Iceland on the cover of its pitch. But Gudmundur Arnason, permanent secretary at the ministry of finance, has nothing but praise for what Hawkpoint’s Charles Williams and Speirs brought to the negotiations.
“They were lean, flexible and agile,” he recalls.
They needed to be.
Foremost among the sticking points between the banks and their creditors were the valuations that would form the basis of the recapitalization plan outlined by the FME in December 2008, aimed at rebuilding the banking sector and ring-fencing the Icelandic Treasury.
This stipulated that the old banks would be fairly compensated for the transfer of net assets into the new banks. This compensation, the FME originally indicated to the resolution committees, would take the form of bonds issued by the new banks for a value equal to that of the net assets transferred.
Deloitte was hired shortly before Christmas to make the necessary valuations, while Oliver Wyman was appointed to review them and reassure the creditors about their fairness and accuracy.
On paper, it all looked fair and relatively straightforward. The snag was that the debt issued by the new banks could only hope to be sustainable if the valuations of the loans and other assets transferred to them by the old banks were reasonably clear and deemed to be realistic.
The basis of those valuations, and therefore the sustainability of the debt, would need to be derived from the five-year business plans that the new banks had cobbled together in December 2008. This was against the backdrop of an economy in shock, with businesses failing by the day, property prices collapsing and the krona halving in value.
There were several reasons why it was important that the valuations were delivered quickly – well before the target date for the completion of the recapitalization, which was originally mid May. One was that with Iceland unable to access overseas markets, the IMF needed reassurance that the plan was feasible and that all creditors were being treated fairly.
Another was that by early 2009, Iceland was coming under increasingly intense political pressure to resolve the IceSave dispute that was souring relations between the government in Reykjavik and its counterparts in the UK and the Netherlands. A third, as Speirs at Hawkpoint observes, is that all parties were quick to recognize that the unpalatable alternative would have been a tiresome and corrosive litigation process likely to drag on for years.
At the same time, it was essential that the asset valuations were realistic. This was in part to forestall any legal action that might arise from inaccurate estimates. Morgan Stanley’s Karsten Hofacker, who was advising Kaupthing, adds that realistic valuations were also vital in order to protect the new banks from the catastrophic possibility of creating the need for further equity injections in their infancy.
This is why things did not appear to be especially promising when, rather later than originally planned, Deloitte presented valuations on April 22, 2009, that initially looked hopelessly inexact. Rather than provide precise calculations, Deloitte gave high and low estimates of net asset values that were very wide – varying by close to IKr100 billion in the case of Islandsbanki and Kaupthing, and by well over IKr100 billion for Landsbanki.
Inevitable
It is easy in hindsight to criticize Deloitte for the vagueness of its numbers. But as Williams, then managing director and head of financial institutions at Hawkpoint says, the explanations for the variance were plausible enough. One of these was that the global economic outlook in the aftermath of the Lehman crisis was highly uncertain, eroding the dependability of any macroeconomic forecasts on which much of the recovery value would need to be based.
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Charles Williams, Hawkpoint Partners |
Another was that the business plans that the new banks had drawn up at the end of 2008 had inevitably been rushed and needed updating as the issues facing the new management teams became clearer. Above all, splitting the banks created severe issues for their funding, which needed to cover inflation-linked mortgages. More challenging still, it also needed to cover foreign currency loans, which accounted for about three-quarters of domestic corporate borrowing in Iceland prior to the crisis.
As Williams explains, with no access to foreign funding and the krona in freefall, this created currency imbalances on the banks’ balance sheets well in excess of the maximum of 10% of equity prescribed by the CBI. With prevailing rates paid on krona deposits very high – interest rates had been hiked to 18% in October 2008 – it also meant that the banks were incurring large monthly net interest losses.
Against that backdrop, it is surprising that the asset values estimated by the estates themselves would turn out in some cases to have been remarkably accurate. In the case of Landsbanki, for example, the estimates made by the resolution committee turned out to be within about IKr10 billion of the final value or less than 3% out, according to Hafsteinsson.
In any case, Arnason at the ministry of finance says that paradoxically the width of those original valuation bands may have been no bad thing.
“The wide discrepancy in valuations actually put the government in a favourable negotiating position,” he says. “We made it very clear that we wouldn’t be prepared to compensate for any assets that had been overvalued. So we invited the creditors to take equity in the banks, which in two of the three cases they did.
“This also served to reduce risk for the sovereign, which was already accumulating debt at an alarming rate,” adds Arnason. “This is because the equity injected into the new banks amounted to less than a third of the initial IMF estimate of close to 25% of the country’s GDP. Given the overall circumstances, characterized by extreme uncertainty and a bleak outlook, this was important.”
The figures speak for themselves: Iceland went from having virtually no debt in 2008 to close to 115% of GDP when it peaked. Further capitalization of the new banks, says Arnason, would have added to this fast-growing debt pile.
What emerged from the discussions steered by Thorsteinsson was a consensual, risk-reward sharing agreement between the creditors and the banks. This was the product of open and relatively speedy negotiations aimed at finding fair value for the assets, twinned with upside potential in the event of any positive revaluation.
That the negotiations proceeded productively was all the more remarkable given that the interests of the ba
The creditors were particularly attracted by the equity, because of the added control and upside it gave them – Charles Williams, Hawkpoint Partners
nks were best served by advocating low valuations, while the creditors naturally pushed for the highest possible values.
“Asset valuations, and therefore bank solvency, was achieved through transparent negotiations between parties with differing objectives, rather than by so-called experts,” says Speirs. “It was critical that the valuation work was recognized as guidance for the negotiations rather than determination. I don’t think I’ve ever heard of a negotiating process in a crisis where there was such an open and transparent discussion about valuations.
“Because they were taken seriously and invited to participate directly in the negotiations, creditors bought into the process,” adds Speirs. “This meant that serious opposition to the recapitalization plan was minimized. In turn, this allowed for the process to be completed relatively fast, with strong IMF support and little subsequent legal opposition.”
Establishing trust between creditors and the resolution committees was also vital if the banks’ own business plans and long-range valuation estimates were to be regarded as credible and fire sales avoided.
Landsbanki’s Hafsteinsson says that if the bank’s assets had been monetized immediately, they may have been worth in the region of IKr300 billion, compared with claims of around IKr2 trillion. Landsbanki argued at the time that the five-year recovery value would reach at least IKr1 trillion – not quite enough to cover the IceSave claims of about IKr1.3 trillion but certainly heading in the right direction. Subsequent revaluations, as the Icelandic recovery gathered pace, meant that the IceSave claims were comfortably covered.
Looking back at their discussions with creditors, some of the banks’ advisers say they were struck by how professional they were and by the thoroughness of the homework they had done on the Icelandic banks. Eiriksson, then at the Glitnir winding-up board, says this was especially true of some of the secondary investors who joined the process later.
“What fascinated me was how secondary creditors seemed to have a better idea of the value of the assets than anybody else,” he says.
Quarrel House
None of this is to suggest that the negotiations were easy. As the process neared its conclusion, many of these were now taking place in the wonderfully named Quarrel House. This stood next door to Kaupthing’s headquarters and, ironically, a stone’s throw from Höfdi House – scene of the Gorbachev/Reagan peace summit in 1986. The Quarrel House is used by Iceland’s unions to hammer out negotiations and pay disputes, and it had occurred to Thorsteinsson that the large meeting rooms on its top floor would be ideal as discussions between the banks and the creditors went into the final stretch.
The Quarrel House talks were exhausting but productive. Typically, they would begin with a large plenary meeting bringing together five or six representatives from one of the banks, the appropriate resolution committee and its advisers, the Hawkpoint team, a handful of creditors and Thorsteinsson.
They would also involve plenty of lawyers from firms such as Lovells and Landslög (representing the government), Allen & Overy (acting for the new banks) and Slaughter & May, Morrison Forester, Bevan Brittan, Logos and Bingham McCutchen (advising the creditors). Following the preliminary meeting, smaller groups would reconvene in several of the top floor rooms for private meetings.
Between Monday and Thursday, this process would extend long into the evening, with participants sometimes spilling out of the Quarrel House well after midnight. Given that this was taking place in the middle of an Icelandic summer, it was still light even when meetings went on until the small hours, which Speirs says was helpful for keeping alert.
On Fridays, sessions broke up much earlier to allow participants to reach Keflavik Airport in time for the late afternoon flights to London and New York, the business class cabins of which would generally be full of people who had spent much of the week opposite one another in animated discussions.
“One week I decided not to put myself through the Friday evening rush and took the Saturday flight instead,” Speirs recalls. “You could see the nervous look on people’s faces when I said on the Friday afternoon: ‘Let’s debate this properly, I have as long as it takes.’”
By July, compensation structures had been agreed by the majority of creditors in the case of two of the three banks. For Islandsbanki, which was the new incarnation of Glitnir, creditors were offered the choice of new contingent bonds allowing them to participate in any upside arising from revaluations of the assets, or the option of taking a majority stake in the new Islandsbanki.
A similar choice was offered to Kaupthing’s creditors. However, as the value of deposits transferred exceeded those of Kaupthing’s assets, a negative compensation instrument was structured. In the case of both Islandsbanki and Arion (the new Kaupthing), the estates of the old banks later exercised their equity options, becoming majority owners, with the state initially holding 13% and 5% respectively of the new banks.
“The creditors were particularly attracted by the equity, because of the added control and upside it gave them,” says Williams. “But at the same time, they emphasized that they also wanted the government to provide support, which it did in the form of tier-2 capital.”
That ensured that the new banks met the 16% regulatory capital minimum required by the FME, with 12% in tier-1 and 4% in tier-2.
“This was important, because it meant that the new banks would never need to be recapitalized again,” adds Williams.
Negotiating an outcome for Landsbanki took rather longer, chiefly because taking a large equity stake was never an option for its principal creditors, which were the UK and Dutch governments. Nor was it wanted by the Icelandic government. Instead, it was agreed that in addition to a main bond for IKr260 billion, a conditional instrument for IKr92 billion would be issued by the new Landsbankinn in the event of a big asset revaluation.
As an incentive, there was also a provision allowing for conversion into a minority shareholding if the contingent bond was not paid out. In the event, these were repaid in full and ahead of their original maturity, with the final payment made in June 2017.
Fundamentals
It is tempting, a decade on from the crisis, to imagine that the banks’ astute creditors gazed deep into their crystal balls, saw how robust Iceland’s rebound would be and opted to hold equity in the banks as a proxy for the economy as it recovered.
After all, as Arnason says, Iceland’s meltdown was the product of a banking catastrophe, rather than an economic crisis.
Rozwadowski at the IMF agrees. He says that the fundamentals of the economy going into the crisis were sound and that, while the banking industry was left in ruins by the events of 2008, important sectors such as fisheries and hydro-electricity were left largely untouched.
As the creditor base evolved into one dominated by hedge funds, international investors were increasingly expressing a view on the outlook for Iceland’s economy and the prospects for the krona. Matt Hinds, managing partner at the independent restructuring firm, Talbot Hughes McKillop, says that this was especially true of bondholders in Glitnir, whom he advised between 2011 and 2015.
“Glitnir had a larger domestic exposure than Kaupthing,” he says. “Approximately a third of its assets were domestic, including a 95% stake in Islandsbanki, which by 2011 had evolved into a large, well-capitalized bank that was doing well and was a good proxy on the Icelandic economy. Given that its assets had originally been transferred from the old bank, investors in Glitnir believed with some justification that they had played a role in capitalizing and financing the Icelandic recovery.”
It was international funds’ views on the outlook for the Icelandic economy that to a large degree shaped the evolution of the creditor base for Glitnir and Kaupthing.
“The creditor base was broadly similar in the sense that it was made up of hedge funds, which bought and sold distressed debt for a living,” says Hinds. “The big difference was in their trading hypothesis. If you liked the prospects for the Icelandic economy, you bought Glitnir. If not, you were more likely to have bought Kaupthing.”
Given the complexity of the negotiations and the number of parties involved, perhaps the most remarkable feature of the process was the speed with which it was wrapped up, with the heads of terms for two of the banks signed on July 17, 2009.
“In light of how big the numbers were, I think it was almost a miracle that we achieved what we did within a year,” says Sigfusson.
A quick resolution was not just a nice-to-have, says Arnason. It was also a precondition for the new banks to build credible, long-term business models.
“Moving rapidly towards finality in the terms meant that we could set up definitive balance sheets for the new banks more quickly,” he says.
Thorsteinsson was also delighted with the outcome to the negotiations. If he has one tiny regret, it is that the final Landsbanki negotiations, which took place at Hawkpoint’s headquarters in London, had not been completed two or three hours earlier.
As discussions extended into their second night on October 9, Thorsteinsson glanced at his watch, hoping that the heads of terms could be signed before midnight, which would mean that exactly a year had passed between Landsbanki’s collapse and its official rebirth.
In the event, he says that a protracted discussion with Slaughter & May, which was representing the UK Treasury, meant that the final agreement was not signed until 2am on October 10. The delay did nothing to dampen Thorsteinsson’s exhilaration at what had been achieved.
“My hotel was in walking distance from Hawkpoint’s office,” he recalls. “But I walked past the hotel and on to London Bridge, where I sent a text to Indridi Thorlaksson, head of the steering committee at the ministry of finance. I don’t remember the exact wording of the text, but it was something like: ‘Deal done. Three down; none to go.’”
