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Global reach will help AIB weather storm

AIB is the biggest lender to the property and construction sector out of all the Irish banks. As more and more properties remain unsold, should we worry about mounting bad debts at AIB? Let's take a closer look at what shape this institution is in.

I have always been surprised that customers of banks are not really familiar with all that banks do. People think they know what AIB does in the Republic, but they are not familiar with the details.

For example, did you know that AIB's banking in Ireland clocked up a profit of €574m in the six months before June 30 last? That was from gross revenue here of €1.1bn. In other words, the bank's overheads absorbed only 47 per cent of its income.

This is a good overhead percentage for a bank which provides full services to their customers. Some banks, such as Anglo Irish Bank, concentrate on niche services such as lending to commercial clients. By contrast, AIB provides the full array of banking services to the mass market, which means higher overheads.

In these credit crunch times, AIB's CEO Eugene Sheehy has taken a number of steps to reduce operating costs to safeguard the bank's profits, including increasing the number of financial controllers working in the bank by 150. Financial controllers are the guys who have the unenviable task on reporting back to management on ways to save the bank money.

It is an especially difficult time for staff as opportunities have almost completely dried up in the bank, and only last week AIB announced that it had reduced staff numbers by 600 this year.

But the sacrifices made by staff in the past year have not been in vain. AIB's operating costs fell by two per cent and AIB's efficiency is now ranked as the highest among Irish banks. These results have encouraged AIB bosses to look confidently to the future; so much so, in fact, that they recently increased the dividend payout by 10 per cent.

But is this confidence in the future justified?

Bad debts have almost doubled over the last year, and AIB believes that this figure may double again in the next year, which would put it at around €300m. We also know that AIB has lent the most of all the Irish banks to the property and construction sector.

This figure is almost €30bn, and only time will tell if it was lent wisely. Signs are that AIB is bracing itself for even more bad debts from the property sector. It has already employed an extra 200 credit professionals to work closely with front line staff -- and customers who have problems repaying loans.

As a last resort, banks can repossess properties to pay off loans. But CEO Eugene Sheehy is on record saying that there is no gain to be made by the bank taking over property and attempting to sell it on the market, as there are relatively few buyers.

AIB repossessed only two homes in the past year. One was a holiday home and the other an investment property. They have not repossessed any family homes. Mortgage holders should therefore not be afraid to approach the bank if they have difficulty making their repayments.

Even with credit professionals in place, the property slump will still hit the bank hard. Thankfully, AIB senior management are due real credit for the wide scope of their efforts. For many years now, AIB has implemented the key strategy of diversification into other areas of business as a protection against a significant downturn in Ireland. The bank's activities in the Republic of Ireland contributed only 45 per cent of their entire profits in the latest reporting period, so substantial profits have been generated by other areas of the bank.

The contribution of UK operations to group profit is about 20 per cent, but, of course, the UK economy is also facing uncertain times. AIB also has the biggest individual stake in a US bank called M&T. This bank is experiencing the problems facing all US banks, but, in its latest results, was the third best performer amongst the top 21 US banks

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More recently, AIB has looked towards emerging economies such as Poland, where it is in the process of building a large bank. They already have 10,000 employees and plan an extra 100 branches by the end of 2008. Poland's population is almost 10 times the size of Ireland's and their GDP growth this year will be over five per cent.

AIB Capital Markets is another division of the bank which is performing strongly. This is made up of AIB's corporate banking, global treasury and investment banking operations, and contributed almost 25 per cent of AIB's profits in the six months to June last.

Corporate banking is the part of a bank that looks after the big customers, the "captains of industry". AIB's corporate team competes with the best international bankers all over the world.

Global treasury provides services to businesses who wish to buy and sell currencies forward in order to reduce their exposure to changes in the money markets. The activities of the global treasury division also ensure that the bank has enough cash to meet customers' demands. Global treasury operatives predict movements in interest rates, currencies and commodities, from which they turn a profit for the bank.

Given the uncertain times we live in, their recent contribution to profits was immense. In the latest figures, they experienced a 31 per cent increase in revenue.

Therefore, it is down to a bit of foresight, and a lot of strong decision making, that, despite having lent the most amount of money in Ireland to builders, AIB is not solely dependent on the Irish property market for its revenue. It will surely take a hit as the property slump continues, but it is in a better position than most to take it on the chin.

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