Thursday 25 April 2019

Exchequer in line for €3bn when AIB floats but investors must still be wary of problem loans

Seven years after it was nationalised AIB is in far better shape and preparing for a stock exchange return, but it is not without issues

AIB boss Bernard Byrne
AIB boss Bernard Byrne

Dan White

The Government fired the starting gun on the sale of 25pc of AIB, from which it hopes to raise up to €3bn, last week. While it is in much better shape than when it was nationalised in 2010, with lending showing the first signs of post-crash growth, AIB's stock of problem loans remains very high.

Having dwelt in the stock exchange's equivalent of the twilight zone for the past seven years, with less than 0.2pc of its equity being privately owned, AIB announced its plans for an initial public offering (IPO) of shares to investors on Tuesday evening. Following the IPO, AIB's shares will be traded in Dublin and London.

Today's AIB bears very little resemblance to the bank that helped bring the country to its knees in 2008.

Its loan book has more than halved to just €65bn and it is now focused exclusively on the island of Ireland market.

The sprawling, highly-leveraged AIB of yore has given way to a much more conservative institution with 95pc of loans being funded by customer deposits and a common equity tier (CET) (the ratio measure of a bank's financial strength from a regulatory point of view) of 15.3pc.

Even more importantly, after years of losses AIB is now profitable once again with pre-tax profits of almost €1.7bn in 2016.

This has allowed AIB to resume dividend payments, with shareholders - effectively the State - receiving €250m earlier this year. The resumption of dividends was a crucial step in readying AIB for a return to the stock market.

A successful IPO would go some way towards repaying the €20.8bn which the Exchequer has been forced to pump into AIB since 2008. AIB calculates that it had already repaid almost a third, €6.6bn, of the taxpayers' cash.

As this figure also includes fees, dividends and interest payments, the actual repayment has been considerably less. Even with this proviso, it is clear that AIB is on track to repay a far greater proportion of the Exchequer's investment than would have been thought possible back in the dog days of 2010 and 2011.

While chief executive Bernard Byrne and his predecessor David Duffy have worked wonders in restoring AIB to financial health, problems still remain.

The most obvious problem at AIB is its continuing very high level of problem loans.

At the end of 2016 it had €9.1bn of impaired loans on its balance sheet - this had been reduced by a further €500m to €8.6bn at the end of March.

Although this was less than a third of the peak figure of almost €29bn at the end of 2013 it was still the equivalent of 14pc of its total loan book.

The fact that, nearly a decade on from the bust and after four years of strong economic growth, almost a seventh of AIB's loan book is still iffy must be cause for concern.

At the IPO announcement AIB promised to further reduce the volume of problem loans to a more "normal" levels in line with its European peers over the next few years.

The improvement in the quality of the AIB loan book over the past three years has been little short of remarkable.

But, and unfortunately it's potentially a large "but", there is considerable scope for recidivism.

Mortgages make up by far the largest proportion of AIB's loan book, €35bn or 53pc. The vast bulk of these mortgages, over €33bn, are to customers in the Republic of Ireland.

Not surprisingly by far the largest category of problem loans at AIB, just over half of the total, is mortgages with €4.6bn of home loans falling into the impaired category at the end of 2016. Impaired mortgages have almost halved from €9bn at the end of 2013.

So far so good. However, would-be investors in AIB would be well advised to examine this reduction closely.

The major contributor to the reduction in mortgage arrears at all of the banks has been mortgage restructuring, with the latest Central Bank figures showing that €23bn of mortgages, almost a fifth of the total, had been restructured by the end of 2016.

However, it would appear that there was less to many of these restructurings than meets the eye with almost four-fifths consisting of arrears capitalisations, interest rate reductions, term extensions and other essentially temporary measures rather than more sustainable solutions such as split mortgages or principal write-downs.

More a case of kicking the can down the road than dealing with the underlying problem.

Most of AIB's mortgage restructurings have if anything an even more temporary flavour to them with at least 81pc of its €5.9bn "stock of forbearance" consisting of such short-term expedients.

Throw in the fact that there are still more than €33bn of tracker mortgages, where the interest rate is tied to the official ECB rate, lurking in the balance sheets of the Irish banks and one wonders how many of these restructured mortgages would unravel if interest rates increased?

"AIB appears confident that it can get rid of most of its remaining problem loans within three years. The question must be: if they can get rid of them within three years, why haven't they done so already?" says Professor Brian Lucey of Trinity.

"These remaining loans are almost certainly the worst of the worst and have probably already been deeply written down".

Implicit in AIB's promise to "normalise" its level of problem loans is a much tougher approach to dealing with delinquent borrowers, something that was politically impossible while it was virtually 100pc State-owned.

Will a post-IPO AIB ramp up the pace of repossessions or, far more likely, flog off its problem loan portfolios to vulture funds who will be far less squeamish in doing whatever needs doing to maximise loan recovery levels?

At the same time as AIB is still dealing with these legacy loans from the Celtic Tiger era, it is finding it very difficult to find customers for new loans.

Despite Ireland having the fastest-growing economy in Europe, bank loans to Irish households fell by a further 2.1pc in the year to April 2017 while loans to non-financial companies were down by 3.8pc over the same period.

Irish households are now net funders of the banking system with household deposits of €99.1bn exceeding loans of €89bn by over €10bn.

If the Irish banks, including AIB, are to return to growth then they will have to find ways of persuading households and companies to start borrowing once again.

What are the chances of this happening? After years of contraction, the first signs of an increase in bank lending are finally emerging.

Consumer lending, basically cars, has now risen for six consecutive months. Lending to non-financial companies rose in both March and April, the first time two consecutive months of growth have been recorded since November 2014, according to the latest Central Bank figures.

Will 2017 be the year that AIB's loan book starts growing once again?

In last week's IPO announcement AIB stated that it hoped to increase new Irish mortgage lending from €5.7bn in 2016 to €10bn this year and new Irish business lending from €5.3bn to €8bn. The Central Bank data would seem to indicate that AIB is starting to deliver on this promise.

After several false starts and last month's non-binding Dail vote calling on the Government to postpone the sale, the IPO looks like it is finally going ahead this time.

With European equity markets buoyant following Emmanuel Macron's convincing victory in the French presidential election, the timing certainly looks right.

Also favouring an early IPO will be Finance Minister Michael Noonan's determination to begin the process of returning AIB to private ownership before he steps down and retires to the backbenches.

"AIB shares are a punt on the Irish and European macroeconomies. If the shares are priced with a decent dividend yield they won't have much difficulty in getting it out the door", says Professor Tom Conlon of UCD's Smurfit Business School.

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