Monday 22 April 2019

Why rate-capping bill will delay the AIB share sale

With politicians set to foist rate-setting powers on the Central Bank that it doesn't want, the prospect of an AIB sale recedes further

AIB Photo: Steve Humphreys
AIB Photo: Steve Humphreys

Dan White

Last Tuesday, AIB's shareholders gathered for the bank's AGM. Chairman Richard Pym told them that 2015 had been "a decisive year" and that last December's repayment of €1.7bn of capital to the State "paves the way" for the State to sell some of its AIB shareholding.

The Strategic Investment Fund, the body which holds the State's bank shareholdings, valued the State's AIB shareholding at €11.7bn at the end of March - and the newly minted Programme for Government envisages a sale of at least some of the State's shareholding in the bank during the lifetime of the curent Government.

However, the fall in the value of European bank shares, with the Stoxx index of European bank shares down by over 15pc since the beginning of the year, means that hopes of a sale of up to 25pc of AIB's shares later this year have had to be put on hold.

Speaking earlier this month, Minister for Finance Michael Noonan discounted the possibility of an AIB sale in the final quarter of this year. According to the Minister, such a sale is now more likely to occur in the first half of 2017 - if, he warned, "the market corrects" in the meantime.

While a delayed AIB sale will deprive the Government of a substantial windfall (some optimists pitching it as high as €3bn) in advance of a possible general election which could take place as early as next spring, it also avoids crystallising a loss on the €20.8bn that various governments were forced to pump into the bank since 2009 to keep it from going bust.

So how much is AIB worth? With only 0.1pc of its shares in public hands we can safely ignore the €18.7bn value implied by the current €6.90 share price - a figure which would make AIB the second most valuable Irish quoted company after CRH.

Even the Strategic Investment Fund's €11.7bn valuation strikes me as being way too optimistic.

AIB recorded a pre-tax profit of €1.91bn in 2015 - a 72pc increase on 2014. So can we take it that the patient has finally recovered and all is well with AIB once more? Maybe we should look again. On closer examination it quickly becomes apparent that there was less to AIB's 2015 profit increase than meets the eye.

The key figure boosting AIB's 2015 profits was a €932m write-back of provisions previously made against bad loans, up from €188m in 2014. When these write-backs are excluded, AIB's underlying pre-tax profits before exceptional items rose by 17pc from €1.1bn in 2014 to €1.29bn last year. It is this underlying profit figure that provides the best basis for valuing AIB.

The other yardstick is the market valuation of AIB's partner in the Irish banking duopoly, Bank of Ireland.

Unlike AIB - a semi-state in all but name - Bank of Ireland never fell into majority State ownership with the State shareholding now down to 14pc. This means that, unlike AIB, Bank of Ireland's market capitalisation (its share price multiplied by the number of shares) is a realistic indication of its actual value.

At the current 26.5c share price, Bank of Ireland has a market capitalisation of almost €8.6bn. That's the equivalent of just over seven times its underlying 2015 profit of €1.2bn. Applying a similar multiple to AIB would give it a value of about €9.2bn - which is €2.5bn less than the most recent valuation from the Strategic Investment Fund.

Barring a strong recovery in bank stocks over the next 12 months, Mr Noonan or his successor is likely to be disappointed by the amount which they receive from the sale of a chunk of AIB, probably about 25pc, in 2017.

AIB calculates that it has repaid €6.5bn to the State. (This figure includes €3bn that AIB has paid in deposit guarantees, bank levies and other charges.) But you try persuading your bank to offset previous interest payments against your outstanding credit card balance.

While the €6.5bn figure includes the €1.7bn which the State received from the partial repayment of its preference shares in AIB last December, a further €2.14bn of preference shares were converted into ordinary shares pushing the State to the back of the repayment queue for this money.

This preference share conversion was effectively a surreptitious recapitalisation of AIB.

However, even if one accepts the €6.5bn figure as being kosher, when added to the €9.2bn market value figure implied by its underlying profitability and the €1.8bn which AIB will hand over next July to repay the contingent capital notes and the interest due on them, the State will come up at least €3.3bn short on its "investment" in AIB.

So why, almost eight years after the bust, is the value of AIB still so depressed? As last week's controversy surrounding the sale of a pool of 900 distressed owner-occupier mortgages and a further 2,000 buy-to-let mortgages to a vulture fund demonstrated yet again, the balance sheets of the Irish banks are still weighed down by bad loans.

At the end of 2015 AIB had €13bn of impaired loans on its books. While this was down from €22bn at the end of 2014, it still accounted for almost 19pc of AIB's total loan book of €70bn. The good news is that impaired loans fell by a further €1bn in the first quarter of 2016 but they still remain at extremely high levels.

Not alone are AIB and the other Irish banks still stuffed to their gills with bad loans, they are doing very little new lending. The most recent figures from the Central Bank show that bank lending to Irish households and non-financial companies fell by a further 10pc to €135bn in the 12 months to the end of March.

AIB is no exception to this continuing credit contraction. While it made great play of the increase in loan approvals to €14.4bn in 2015, the value of loans actually drawn down was only €8.7bn, just 60pc of the value of loans approved. The nub of the matter is that AIB's loan book shrank by a further 7.5pc in 2015.

Apart from informing us that loan drawdowns increased by 17pc in the first quarter of 2016, the trading update issued by AIB to coincide with the AGM has little or nothing to say on the size of AIB's loan book. Given what we know from the latest Central Bank statistics, it seems reasonable to assume that it is still shrinking - as repayments on existing loans continue to exceed the drawdowns of new loans.

AIB is, not to put too fine a point on it, still little more than a zombie bank.

Further complicating matters ahead of a possible AIB share sale is the worsening political situation. Despite it being in virtual complete state ownership, both Mr Noonan and his predecessor, the late Brian Lenihan, were largely successful in shielding the bank from overt political interference.

That may no longer be possible following last February's indecisive general election result. The speed with which the Government was forced into a U-turn on Fianna Fail's bill giving the Central Bank the power to cap "excessive" loan interest rates show how much things have changed.

The fact that the Central Bank doesn't want these powers and will be extremely reluctant to use them will do little to reassure nervous investors.

Neither will the fact that, by reducing its variable mortgage interest rate to 3.4pc - Bank of Ireland's standard variable rate is 4.5pc - chief executive Bernard Byrne has probably immunised AIB from the mortgage rate controversy, do much to help.

With the markets already wary of bank shares, even the perception of political interference will make any AIB share sale even more difficult.

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