Irish lenders offer value

 

A Canadian approach for a minority stake in Allied Irish Banks is the clearest signal yet that Ireland's beleaguered banking sector could be shaking off its international pariah status.

Institutional investors and private equity will continue to give AIB and larger rival Bank of Ireland the cold shoulder until the government signals next month what sort of capital writedown the lenders will have to take to participate in its "bad bank" plan.

But if the writedown indicates Dublin will not end up with a majority stake in each via additional capital infusions, then AIB and Bank of Ireland's cheap shares and dominant franchises will likely encourage investors to take the plunge.

"They look attractive" said Emer Lang, analyst with Davy Stockbrokers in Dublin, said of Ireland's two main listed banks. "They are popping up on radar screens definitely among investors."

"And, of course, if they are coming up on investors' value based screens, they are coming up on banks' screens as well which has precipitated the interest (for Allied)" she said.

AIB said earlier this month it had received an approach from a third party for a minority stake and two sources familiar with the matter said the interest had come from Canada, a financial market famed for its cautious approach to risk.

Six months ago, investors were deserting AIB and Bank of Ireland in droves as a spectacular property crash fuelled fears of nationalisation and an Icelandic-style sovereign collapse.

The Armageddon scenario has since receded and shares in Bank of Ireland and AIB have risen from record lows of 12 cents and 27 cents respectively to over two euros each. 

But looking beyond the creation of the "bad bank" or National Asset Management Agency (NAMA) and Ireland's current economic malaise to 2012, tagged by some analysts as the first possible "normal" trading year for the Irish banks, and the lenders still look very cheap.

LOCAL DOMINANCE

In the post-NAMA world, it is expected that AIB and Bank of Ireland will consolidate their local dominance and enjoy improving margins as foreign banks, which controlled 34 percent of the Irish mortgage market prior to the property crash, retrench and competition for deposits eases.

AIB, traditionally the third largest player in mortgages, said in May that its share of new mortgage lending had gone from 17 percent to over twice that as rivals curtail lending.

Before it took account of some 2.4 billion euros (2.1 billion pounds) of bad debts in the first half, AIB generated a 14 percent increase in operating income to 2.8 billion euros.

Margins will initially be hit by the transfer of some performing, interest-earning loans to NAMA, but by 2012, NCB stockbrokers expect AIB to have a net interest margin of 2.15 percent, back to 2008 levels.

AIB is however the cheapest stock in Europe, with a price to book valuation of 0.4 for 2010 and Bank of Ireland is the third cheapest at 0.6 according to analysts at KBW. This compares with an average of 1.0 for European banks.

The question of whether or not this discount is too harsh depends entirely on the sort of writedown NAMA demands and AIB admitted last week that talks with its suitor would not progress until there was more clarity on the "bad bank".

CUSHIONING THE DEATH SPIRAL

Analysts at Dublin-based brokerages on average expect the government to demand a discount of around 17 percent and 20 percent respectively for the development loan books of Bank of Ireland and AIB.

Whether or not that triggers a demand for state funds depends on a number of factors including the minimum capital cushion required, existing provisioning and the banks' own ability to raise funds.

AIB, which has a larger block of risky development loans, is seen as the most likely candidate for additional state capital but not necessarily a majority stake.

The infusion of some state funds or a government-underwritten rights issue may also attract institutional funds, private equity houses and indeed, Canadian buyers such as Canadian Imperial Bank of Commerce and Toronto Dominion Bank, say analysts.

"If you get one investor who is willing to step in with a large enough slug of capital you effectively erase the problem of how much capital is written off" said Reg Watson, investment director at Standard Life Investments.

"If you provide everybody with a cushion you deal with a large part of the downward death spiral because investors feel comfortable coming in behind you."

"What NAMA does is it does create that cushion."

The full impact of NAMA will not be known for many months as loans, valued on a "case by case" basis, are transferred over between the autumn and mid-2010 and many investors, Watson included, believe it is still too risky to buy.

"Saying I am not going to invest in them until after NAMA means you get a large part of the uncertainty out of the way but it may mean you miss out on a money-making opportunity" he said.