Bank of Ireland back in black
There was some cheer at BoI's AGM last week. Dan White looks at the future of Ireland's oldest established bank - which is now back in profit
After losing almost €9bn between 2008 and 2013, Bank of Ireland (BoI) is profitable once again. Pre-tax profits at the bank increased by a third in 2015 - to €1.23bn, from €920m in 2014.
The recovery in operating profits (before loan loss provisions of €296m) was still a healthy 11pc to €1.45bn.
In the interim management statement released to coincide with the AGM, BoI told its shareholders that "the group continues to trade in line with expectations".
Back in profit, but hardly restored to full financial health. While BoI's non-performing loans fell by a further €900m in the first quarter, they still stood at €11.1bn - or almost 14pc of its total loan book of €81bn - at the end of March 2016.
The fact that almost a seventh of BoI's loan book remains impaired eight years on from the bust and four years into a strong economic recovery is deeply disappointing and leaves the bank potentially vulnerable in the event of a sudden financial shock.
There are also clear indications that this may be as good as it gets for BoI. We may have the fastest-growing economy in Europe, with the ESRI forecasting GDP growth of 4.8pc this year and 4.1pc in 2017, but bank lending is still contracting.
The latest figures from the Central Bank show that overall Irish bank lending fell by a further 11pc to €194bn in the 12 months to the end of March.
Lending fell across all of the major categories, with lending to households down by more than 5pc to €89bn, lending to non-financial companies falling by 17pc to €46bn and lending to financial companies down by almost 15pc to €58.5bn.
In its 2015 results announcement, BoI claimed that what it called its "core loan book" grew by €3.9bn last year. Probably more relevant is that new loans advanced exceeded the repayments on existing loans by €700m in the final six months of 2015.
This trend, if sustained, would mean that the bank's loan book was no longer shrinking.
Faced with such an uncertain outlook, it is hardly surprising that the BoI share price has gone nowhere over the past two years.
At the current 27 cent share price, the market is valuing BoI at €8.7bn. That's the equivalent of just seven times last year's pre-tax profits and less than its year-end book value of €9.1bn. Clearly the market feels that the best of the good news is now behind BoI - Wilbur Ross's decision to sell the first tranche of his BoI shares for 32.9c in March 2014 looks better with every day that passes.
This is certainly the picture that emerges from analysts' predictions. Consensus forecasts compiled by financial information provider Thomson Reuters indicate that operating profits will merely tread water at BoI for the next few years, with a consensus operating profit of €1.23bn in 2016, €1.26bn in 2017 and €1.28bn in 2018.
What this shows is that BoI's bottom line improvement is being driven almost exclusively by lower loan-loss provisions rather than any underlying growth.
It would be wrong to conclude from these figures that BoI is a basket case. Far from it. It has a very good domestic banking business and it came through the downturn in far better shape than any of the other domestic banks.
Unlike all of its indigenous competitors, it avoided outright State ownership, with the State shareholding now just 14pc.
It has also fully repaid the €4.8bn of public money which it received - and the State's 14pc stake is worth more than €1.2bn at the current share price.
The strongest signal yet that the BoI recovery story is for real will come early next year when it becomes to the first Irish-owned bank to resume paying dividends to its shareholders.
Analysts are predicting a payout of one cent a share for the 2016 and 2017 financial year, rising to two cent for 2018.
In addition, many of the problems facing Bank of Ireland are common, not just to all of the Irish banks, but to those operating throughout the Eurozone.
The ECB has responded to the Great Recession with a combination of ultra-low interest rates - the official ECB interest rate now stands at precisely zero - and massive purchases of Eurozone government bonds currently running at €80bn a month.
These two policies have tended to reinforce each other as the ECB bond-buying has driven up bond prices and pushed down yields.
Lower bond yields have in turn driven down long-term interest rates at the same time as cuts to the ECB's official rates have slashed short-term rates.
While lower interest rates may be good news for impecunious governments like our own as well as cash-strapped borrowers, it is a different story for the banks. In practice they can't cut their deposit rates below zero. This "lower bound" means that the margin between what banks, including BoI, receive in interest on their loans and the interest which they in turn must pay their depositors is being relentlessly squeezed.
This has serious implications for BoI. In the early recovery it was able to ruthlessly exploit the exit of overseas competitors from the market to push up its net interest margin - something which its variable rate mortgage customers learned to their cost.
However, there are clear signs that this process has gone as far it can, with BoI's net interest margin of 2.19pc in 2015 being barely changed from the 2.11pc recorded in 2014.
The interim management statement would seem to confirm this, stating: "On a constant currency basis, our net interest income has performed in line with our expectations during the first quarter. Customer loan asset spreads remain in line with H2 2015 levels".
Translated from bankerspeak, this looks suspiciously like an acknowledgement from BoI that its net interest margin has probably peaked. While the interim management statement includes a promise from BoI that it will seek to further reduce funding costs, the scope for doing so is extremely limited.
The bank that has emerged post-crash is a very different beast from its Celtic Tiger-era predecessor.
It is literally only half the bank it used to be with its customer loan book having shrunk by more than 40pc. And that's not going to change any time soon. After spending a gross €64bn bailing out the Irish-owned banks, the last thing either the Government or the Central Bank want to see is the re-emergence of an oversized banking sector.
Ireland's experience wasn't unique. Previously prosperous Iceland was also laid low by its banks - while one shudders to think what would have happened to Scotland if it had been an independent country when RBS and HBOS effectively went bust in 2008. Small countries can't afford the risk of having to stand behind large banks.
So where does BoI go from here? The experience of the past eight years means that large-scale overseas expansion will not be an option for the foreseeable future. In normal circumstances, given its dominant position in the domestic market and low share price, this would have made BoI a prime candidate to be taken over by a foreign bank.
This is what may eventually happen - just don't bet on it happening anytime soon.
The Euro Stoxx index of bank shares is down by 28pc over the past year. Suddenly the performance of the BoI share price, down by "only" 26pc over the same period, doesn't look quite so bad.
While the severity of our bust meant Irish banks had no choice but to make a realistic assessment of their likely loan losses, most mainland European banks are still in denial.
When, as happened last February, the German Finance Minister Wolfgang Schaeuble has to go on Bloomberg TV to reassure nervous investors that he had "no concerns" about the health of his country's largest bank, Deutsche Bank, it's time to get worried.
Several of the Italian banks are in even worse shape, with the country's banks having an estimated €360bn of bad loans on their balance sheets.
The Italian Central Bank has organised a fund to pump fresh capital into several of the weakest lenders including Monte Dei Paschi, the country's third-largest bank.
All of which means that 'steady as she goes' is probably the best that Bank of Ireland can hope for, with Davy banking analyst Emer Lang saying that: "Bank of Ireland has a strong franchise in two markets, Ireland and the UK. As the economy improves there will be room for improvement on non-performing loans.
"We would hope that there would be a return to growth at some stage. In the meantime Bank of Ireland will have to manage its interest margin as well as it can".
Sunday Indo Business