Thursday 22 August 2019

Investors pick through banking's uncertain outlook

There are some doubts that the banks will be able to provide the funding needed for construction
There are some doubts that the banks will be able to provide the funding needed for construction
Richard Curran

Richard Curran

It seems nothing is as it should be in the world of stock markets and economics these days. Donald Trump wins the US presidential election and stock markets dive. Within 48 hours the market digests what it means and the stock market soars.

It was similar this week with Italian bank shares. Italian prime minister Matteo Renzi loses the referendum on political reform, and after a brief fall in Italian bank shares, they go up again. Even the bank in the biggest trouble, Monte dei Paschi, saw its stock climb by 9pc in the wake of reports it would seek a bailout, most likely through the ECB.

There were even some parallels in the Irish banking sector, although the issues are entirely different when it comes to understanding what lies ahead for the sector.

Irish banks have done well in dealing with legacy debts, tackling costs and seeking to maximise the leverage they hold from the apparent lack of competition in the market. Yet Bank of Ireland's share price is not exactly going through the roof, despite the fact the economy is growing.

Ratings agency Fitch reduced its outlook for the Irish banks from positive to stable during the week, as it digested the likely implications of Brexit for the Irish economy and the bank's exposure to the UK in particular.

Bank of Ireland's market presence in the UK is much bigger than that of AIB, with around 40pc of its loan book across the Irish Sea.

AIB has sharply reduced its bad debts which have fallen by €18.4bn since the peak in June 2013 - a reduction of 63pc over the three years. Fitch said Britain's departure from the European Union could slow improvements in the asset quality and capitalisation of both banks.

It added that its "assessment of asset quality also factors in a high proportion of forborne loans at both banks (Bank of Ireland and AIB), still large exposures to low-yielding loans (including tracker mortgages) and defaulted but not impaired loans, all of which add up to a high proportion of the banks' balance sheets".

This is a case of lots done but more to do for these banks, despite the fact that they have made significant progress to date.

Sentiment towards the wider banking sector, particularly across Europe, is poor. Yet Irish banks should have a strong investment story to tell. There is relatively little competition, the economy is expected to grow and we are seeing government policy towards the housing crisis which should lead to more vibrant lending for mortgages and construction.

But the ESRI's Kieran McQuinn burst that bubble during the week writing in the Irish Independent. Using a new model, the ESRI estimated that in terms of mortgage credit, domestic banks would be expected to provide close to €50bn in additional lending up to the end of 2024 when the mortgage stock is projected to reach €140bn.

Expected growth in construction and real estate credit would require another €45bn over the same period.

So happy days for Bank of Ireland and AIB? Not quite. McQuinn believes the banks will have a funding gap when it comes to having enough money to lend for all of that activity. Additional funding will have to come from somewhere else. The best place would be from new competitors arriving in the Irish banking market. It would increase competition and benefit consumers and business borrowers.

But with uncertainty in Europe and the UK, and a certain level of investor apathy shown towards banking especially in Europe, I wouldn't hold my breath.

US investors or banks could well provide an injection of investment through an AIB IPO or other forms of capital injection into the sector here.

After all, Donald Trump's new commerce secretary, billionaire Wilbur Ross, will sing Ireland's praises after tripling his money on Bank of Ireland in just three years.

Rise in stamp price buys some time for An Post

Speaking of banking, this was something An Post tried back in the noughties in order to provide fresh competition and a strategy to keep post offices open. Could it be tried again? We will have to wait and see what new chief executive David McRedmond can come up with. In the meantime, the Government has bought the company some time with a fresh price increase. McRedmond is off to a good start.

The State-owned postal group may have introduced cost savings of €100m in recent years, but declining volumes in its mail business continue to cause problems.

An Post is forecast to lose up to €15 million this year. Without further cost cuts or a price increase, the losses would be closer to €40m.

The price increase which will see the price of a basic 72c stamp go up to around 90c, will stem losses but it ultimately depends on how much volume drops.

Committed letter writers might grumble but continue to pay the higher price. Businesses, which can avail of discounts, are still more likely to re-examine whether an email would suffice on different occasions.

In fairness to An Post, the price rise brings it more in line with European peers, but it still isn't a fix for the thorny issue of post office outlets.

A Government-backed strategy commissioned during the crash made several recommendations including banking services. Postbank was a joint venture with BNP Paribas that went into liquidation in 2010.

Some of its troubles were caused by the financial crisis, but equally questions had to be asked about whether it could compete with big banks.

Threaten to close a post office and everybody says it will wreck the community. But in truth not enough people will use them while they are there, whether it is for banking or stamps.

Postbank II would require a new joint venture partner. But the losses at Postbank I make for grim reading. In the 18 months to June 2010, it made a trading loss of €26m having previously lost €44m. The wage bill alone was nearly €20m per year.

It is time to try something new, if only somebody could figure out what it should be.

Bus Eireann issue will need to be tackled

When it comes to State companies kicking the can down the road, none is better at it than Bus Eireann.

The warnings from transport minister Shane Ross about future insolvency at the bus company sound all too familiar. He was slagged off about not travelling on rural buses too often himself which seemed a little unfair. Mind you I can't picture him sitting down the back of a bus from Athenry to Galway.

However, this time round, the Bus Eireann can looks like it may have been kicked as far as it can go.

Even the trade unions are talking about sitting down with stakeholders to come up with a new model for doing business. This is a different approach to the usual analysis that its only problem is a lack of public investment.

Bus Eireann already outsources some routes to the private sector and it is simply failing to compete on profitable routes. The company may be on the way towards becoming a virtual State bus operator - still trading, still in public ownership, but not providing that many direct services itself in the future.

I remember when Mary O'Rourke announced the break-up of CIE more than 20 years ago. Bus Eireann crises have come and gone, and they keep on coming.

The unions are wrong in their bid for a 21pc pay rise but they are right about the need to figure out a whole new structure for the bus market and provision of subsidised services.

Sunday Indo Business

Also in Business