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How much is a cleaned-up AIB now worth?


If AIB is to have any chance of returning to private ownership, then it is vital the preference shares and the contingent capital notes are sorted out

If AIB is to have any chance of returning to private ownership, then it is vital the preference shares and the contingent capital notes are sorted out

If AIB is to have any chance of returning to private ownership, then it is vital the preference shares and the contingent capital notes are sorted out

Last week's AIB capital restructuring cleans up its balance sheet and paves the way for its return to private ownership. However, despite the repayment of over €1.6bn to the State, it will be a long time, if ever, before the €20.8bn of taxpayers money pumped into AIB is fully recovered.

The two 'terrible twins' of the Irish banking bust were AIB and Anglo Irish. Between them these two lenders managed to gobble up over €50bn of taxpayers' cash, almost 80pc of the total cost of the bank bailout. However, while the €30bn that went into Anglo has gone forever, things are looking a lot better at AIB.

Under its current chief executive Bernard Byrne and his immediate predecessor David Duffy, AIB has been gradually nursed back to a state approaching financial health.

AIB recorded a pre-tax profit of €1.1bn in 2014, its first pre-tax profit since 2008. It has begun to seriously address its problem loans with AIB's impaired loans falling from €28.9bn at the end of 2013 to €22.2bn by the end 2014 and €18bn by mid-2015.

One of the legacies of the State bailout and the various share issues that accompanied it is that AIB now has over 523bn shares outstanding, as against just 918m at the end of 2007. This has resulted in massive dilution for the original AIB shareholders, with the State now owning 99.8pc of the bank.

In addition to purchasing hundreds of billions of new ordinary shares, the State also pumped other forms of capital into AIB as part of the bailout. These included €3.5bn of preference shares issued in 2009 and €1.6bn of contingent capital notes issued in 2011.

If AIB is to have any chance of returning to private ownership, then it is vital the preference shares and the contingent capital notes are sorted out first.

The preference shares were paying an annual dividend of 8pc, while the coupon or interest rate on the contingent capital notes is a usurious 10pc. AIB's failure to redeem the preference shares within five years meant that the price of repaying the State rose by 25pc - that is, from €3.5bn to €4.375bn.

Last week's restructuring dealt with the preference shares. The State will receive €1.7bn from AIB when it redeems 1.36bn preference shares while the remaining 2.14bn preference shares (which now have a nominal value of €1.25 each) will be converted into ordinary shares at a price of 1.72 cent per ordinary share.

This will give the State another 155bn AIB ordinary shares. Not surprisingly, as part of the process of cleaning up its balance sheet, AIB is also consolidating its shares, giving shareholders one new share for every 250 which they previously owned. This will reduce the number of AIB shares from a totally preposterous 678bn to 'only' 2.7bn.

It's hard not to see the partial conversion of the preference shares, which would have yielded the State €2.675bn if they had been redeemed, as a sort of backdoor AIB bailout.

Will the equity value of AIB rise by a similar amount as a result of the conversion? The reality almost certainly was that AIB would not have been able to raise the €4.375bn necessary to redeem the preference shares in full without seriously jeopardising its plans to make a full return to the Stock Exchange.

Unlike Bank of Ireland, which sold its €1bn of contingent capital notes to private investors in 2013, AIB has indicated that it will redeem its CCNs when they mature in July 2016. This will yield a further €1.6bn for the State.

In a statement last Thursday, Finance Minister Michael Noonan said the partial redemption of the AIB preference shares had yielded the State a net €1.64bn (the €1.7bn gross proceeds, plus accrued interest of €165m less the €225m cost of redeeming a promissory note issued to AIB subsidiary EBS). When the €3bn the State has already received from AIB in the form of guarantee fees, interest and transaction fees is added, Mr Noonan calculated that AIB has now repaid the State €4.6bn.

Throw in the €1.6bn which the State will receive from the redemption of the CCNs next year, and the implied equity value of €11.7bn and the State's AIB investment has at least a theoretical value of almost €17.9bn - back within spitting distance of the original €20.8bn figure.

But how realistic is such a calculation?

One could surely quibble with the inclusion of interest received and guarantee fees in the 'capital repayment' figure - try telling your bank manager to knock the interest you have paid off the amount you owe on your loan.

A cynic might be tempted to conclude that the timing of last week's developments at AIB were at least partially motivated by political considerations, with the Government determined to receive at least some cash from AIB before the general election.

Most close observers of AIB believe the bank is still very much a work in progress.

TCD finance professor Brian Lucey describes the bank as "only now coming out of the intensive care unit and into the recovery ward".

The €18bn of impaired loans that AIB had on its balance sheet at mid-year, while down by over a third over the previous 18 months, still represented almost 28pc of its total €65bn loan book.

Clearly, for a bank to have such a high level of problem loans in the fourth year of a recovery, leaves very little margin for error.

Davy banking analyst Emer Lang also sounds a note of caution on AIB. She believes that when valuing bank shares investors must now price-in much lower returns on capital - low-teens compared to high-teens before 2008.

Banks must be able to achieve returns on capital necessary to exceed their cost of capital, which a recent Bloomberg survey estimated at between 9pc and 10pc.

It is only by doing so that banks can generate the capital necessary to pay sustainable dividends. Ms Lang forecasts that Bank of Ireland will be in a position to declare a full-year 2016 dividend, which will be paid in early 2017 - but a return to dividends at AIB will take a bit longer.

What this means is that an AIB IPO (the sliver of AIB's equity that is now privately held is currently traded on the Irish Stock Exchange's junior ESM market) is unlikely before late 2016. Professor Lucey reckons the Government will sell no more than 25pc of AIB in the IPO and that it can expect to receive €2bn-€3bn for its shares. Full private ownership of AIB is unlikely before the end of the decade.

The future of retail banking is likely to be one of ever-tighter regulation and ever-higher capital requirements. While this will make it extremely difficult for new players to enter the market, it will also depress the returns that incumbents can expect to earn on their invested capital.

In future, bank shares, including AIB, will probably be valued on a similar basis to utility companies -such as electricity, gas, water or telecoms providers - with the regulator allowing them to earn a fixed margin over their own cost of capital.

This would be very much a case of back to the future.

As Professor Lucey points out, American retail banks were valued very much as utilities (with their activities strictly circumscribed) in the 60 years after the passage of the Glass-Steagall Act in 1933 during the Great Depression.

And on this side of the Atlantic, retail banks operated under similar restrictions up to the mid-1970s, being confined to a narrow range of activities and with their shares valued on the basis of the dividend they paid - more like a bond than a conventional share.

This is almost certainly very bad news for those who hung on to their AIB shares after the crash.

At the current 3.7 cent price, AIB shares are down almost 99.9pc from their 2007 peak. And they are almost certainly still way too dear.

At the current share price AIB has a notional market capitalisation of almost €19.4bn - a figure that will rise to €25.1bn when the new shares the State will receive after the conversion of the preference shares are added. This is quite clearly absurd, with the State valuing those shares at just 1.72 cent.

So the bad news is, while the State may eventually get most or all of its money back, AIB's pre-2008 shareholders never will.

Sunday Indo Business