AIB is post-crash bank with pre-crash cost structure
The bailed-out lender's loan losses have shrunk since the crash, but it's operating costs have risen, writes Dan White
Continuing losses at AIB and the squeezing of its net interest margin is bad news for the bank's borrowers, with further increases in interest rates and reductions in deposit rates being inevitable over the coming months.
About the best that could be said about AIB's 2012 results, released last Wednesday, was that loan losses were well down, with the bank writing off €2.5bn last year – down by more than two-thirds on 2011's catastrophic loan loss figure of €7.7bn. The bad news is that these latest write-offs bring AIB's total loan losses to a scarcely credible €24.3bn since the Irish banking crisis began almost five years ago. That's the equivalent of 18 per cent of its peak customer loan book of €135bn.
Despite this, the outlook remains uncertain for AIB. Even when the €3.27bn gain recorded by AIB in 2011 from redeeming its subordinated bonds is excluded, AIB's underlying operating (pre-interest) loss before loan write-offs doubled from €657m in 2011 to €1.31bn last year.
So why, with loan losses falling sharply, is AIB finding it so difficult?
One reason is AIB's continuing high level of operating costs. Despite shrinking the size of its loan book by 45 per cent, from €135bn at the end of 2008 to €75bn at the end of 2012, its operating costs have barely budged and increased from €1.88bn in 2008 to €1.93bn in 2012.
It's difficult not to conclude that AIB is a post-crash bank with a pre-crash cost structure. In fairness to AIB boss David Duffy, he has recognised this problem and is taking steps to address it. Last July, AIB announced plans to make 2,500 staff, a sixth of the 15,000 total on the island of Ireland, redundant; the bank estimates this will save €200m each year.
AIB has also been busy flogging off the family silver. In September 2010 it sold its 70 per cent share in Polish bank BZWBK to Santander for €2.9bn. While the cash was desperately needed at the time, it is now clear that AIB would have done much better had it been able to wait – which of course it wasn't.
Just how much better was illustrated earlier this month when KBC Bank sold its 16 per cent shareholding in BZWBK for €900m.
This deal valued the whole of BZWBK at €5.5bn as against the €4.2bn valuation implied by the September 2010 transaction. If AIB had been able to wait it would have pocketed an extra €900m.
AIB also seems to have been short-changed in the sale of its 22.5 per cent shareholding in US bank M&T. AIB's 26.7 million shares were sold to investors at $77.50 (€60.46) per share in November 2010 in a transaction that yielded AIB a gross $2.07bn.
Last week, M&T shares were trading at $103. What this means is that AIB would have pocketed an extra $681m for its M&T stake if it had sold its shares last week.
As a forced seller, AIB lost out on up to €1.58bn on the sale of its overseas businesses. The prices achieved by AIB for the sale of its American and Polish interests are now water under the bridge. The question now facing Mr Duffy is how he can deliver on his promise of returning the bank to profit by 2014.
In addition to the aforementioned €200m annual cost savings from staff layoffs, AIB will also benefit from the end of the eligible liabilities guarantee (ELG) scheme, aka the September 2008 bank guarantee, which expires today. In 2012 this cost AIB about €380m. Scrapping the ELG will save AIB about €285m this year and €380m in a full year.
However, even a full year's savings from the end of the ELG and the layoffs still amounts to just under €600m, less than half of AIB's 2012 operating losses. Quite clearly Mr Duffy is going to have to find another source of revenue if he is to fulfil his promise.
That extra revenue is almost certainly going to come from AIB's depositors and borrowers.
One of the casualties of the banking bust has been AIB's net interest margin, the difference between what it receives in interest from borrowers and what it pays depositors. Way back in 2008, AIB's net interest margin stood at 2.21 per cent. This fell to just 0.91 per cent in 2012 (1.22 per cent before ELG payments to the Government).
For AIB just to break even at the operating level it would have to increase its net interest margin to 1.8 per cent, a move which would yield the bank an extra €700m. While some of this could be achieved by cutting deposit rates, with all banks desperate to reduce their dependence on ECB funding, the scope for doing so is limited.
Which leaves AIB's borrowers, including homeowners with mortgages, as the most likely target.
With €39.5bn of Irish mortgages on its books, including those inherited from EBS, AIB is by far the largest mortgage lender in the Irish market. While a 0.6 per cent across-the-board increase in its mortgage rate would be painful but bearable for most homeowners, in practice well over half of AIB's Irish mortgage book are trackers so the increase would have to fall disproportionately on variable-rate borrowers who could find themselves facing an increase of somewhere between 1.2 and 1.5 per cent.
AIB's variable-rate mortgage customers should be afraid, very afraid.