Wednesday 21 February 2018

Taxpayer unlikely to make profit on bank shares

Ireland can look to Spain and Sweden for answers on the rehabilitation of our banks, writes Mark Pignatelli

A nationalised banking system in Ireland (with no stock market quotes) makes it difficult for the man in the street to asses the rehabilitation process.

With this in mind we can draw some useful parallels for Ireland with the Spanish banks, where investors have daily transparency.

Both Ireland and Spain are now running current-account (trade) surpluses with the eurozone as a result of booming exports. This shows that both countries have competitive corporate sectors and the improving profit performance of these companies will feed directly into lower defaults on loans and an improving provisioning profile for banks.

The other half of Spanish and Irish bank loan books -- mortgages -- will clearly take rather longer to blossom but the perception of a permanently impaired banking system as a result of the property boom and bust is completely misplaced.

The first point to bear in mind is that the average maturity of bank loan books is around four years. This means that in four years' time, the whole book of business will have been rolled over into new loans. There may well continue to be high levels of impairments on the legacy loans but this stock of loans shrinks with each passing year.

What does this mean for Santander, Spain's and the eurozone's largest bank by market value? Last year Santander's punitive loan-loss provisioning resulted in a total provision bill of €10bn versus post-provision (pre-tax) profits of €13bn. As these problem loans drop out of Santander's loan book over the next two years, provisioning is likely to fall to around €3bn, which adds €7bn to pre-tax profits.

Governments have had to step in and take over bankrupt banking systems in the past: most notably in Norway and Sweden in the early 1990s. In both cases the banks were restructured and sold back to the market at a healthy profit within three years. Today the UK government is roughly breaking even on its investments in RBS and Lloyds.

Realistically, the Irish taxpayer is unlikely to turn a profit on their period of bank stewardship, given the fusion of sovereign and bank debt in the country. Spain, however, can give a useful gauge of what might be expected from the Irish bailout in terms of capital requirements.

Spain's economy (at €1,000bn) is 6.5 times the size of Ireland's. The country has €2,000bn of loans, supported by €160bn of bank equity. This should rise to €200bn over the next two years. Using Spain as a proxy suggests that Ireland's underlying bank capital will need to be around €30bn, so a capital top-up (as instructed by the Irish Regulator on Friday) of €24.2bn on an existing €13.3bn capital base looks comprehensive.

Finally, what about the other two drivers of bank profitability -- costs and interest margins?

Costs are set to fall consistently with respect to revenues throughout the eurozone region over the next couple of years but a more important and less well understood dynamic is the boost to interest margins that results from ECB interest-rate increases. Banks make money both by lending to customers and from their depositors.

The second dynamic is simple: if short-term interest rates are 3 per cent, banks will pay 2 per cent on savings accounts and 0 per cent on current accounts, typically making a spread of 150bps. At 0.5 per cent (rather than 3 per cent) this spread is negligible, whereas at 1.0 per cent the spread starts to breath oxygen into the system.

Swedish banks -- where interest rates have already been rising -- suggest that a 1 per cent increase in short rates will boost profits by 20 per cent. Ireland is a competitive economy -- moreover, within two years Ireland's banking system will have largely worked through the problem half of its loan book -- and, as the credit cycle turns, the outlook can improve markedly.

Mark Pignatelli is European equity lead manager with Smith & Williamson

Sunday Indo Business

Promoted Links

Business Newsletter

Read the leading stories from the world of Business.

Promoted Links

Also in Business