A glimmer of hope for BoI as investors return to the pillar bank

It has been a rocky road for Bank of Ireland in recent years. Is that all behind it now, asks Bill Hobbs

Bank of Ireland CEO, Richie Boucher is probably happy that the light at the end of the tunnel is not another onrushing train. Two weeks ago most people thought his bank was a dead ringer for full state nationalisation. Last week, the bank and department for finance officials succeeded in attracting €1.1bn in North American risk capital from what have been termed “long term” investors.

But the deal came at a hefty price. When done and dusted, the state will end up with a 15% shareholding costing €2bn while the canny investors will pay €1.1bn for a 34.5% shareholding. To put it another way, at current share prices, the state agreed to write off about €1.5bn playing its “get out of nationalisation” card. All told Irish taxpayers have stumped up close to €5.4bn to keep the bank’s doors open for business.

Since 2007, Bank of Ireland has eradicated two hundred and twenty five years of prudent capital husbandry during which its shares became a mainstay investment and income generator for generations of trusting retired citizens. Not only did the bank vaporise its accumulated capital, its imploding share price vaporised household balance sheets. Last Friday you could have bought twenty five of its shares for the price of a cappuccino. Four years ago it would have taken the price of seven cappuccinos to buy one share. Will ordinary people ever trust the bank again enough to buy its shares? Probably not for a long time to come.

For now, confidence is limited to a class of specialist investor willing to bet the bank will be able to extract profits using its pillar-bank market power. They are betting on the core strength of its national franchise and dominance in domestic banking. It may be the case that other investors might be attracted to buy into the bank as its debt for equity deal unravels and subordinated bond holders dump their shares on the market later this month. If in reading the tea-leaves they judge the bank a worth a punt, then Boucher will have pulled off a good deal for his bank.  But is it a good deal for the taxpayer?

The consensus is the deal is a good one as it limits the taxpayers’ downside risk. How much taxpayer’s money will ever be returned is of course an unknown.  

Was it planned like this? Last March, the Central Bank’s PCAR loan loss assessment exercise underpinned the €5.4bn recapitalisation target it told Bank of Ireland to raise.  No explanation was given at the time for what appeared to be an apparent favourable treatment of the bank’s loan book when compared to others, particularly its close commercial high street cousin AIB.

Under the Central Bank’s stress scenario, Bank of Ireland was reckoned to incur losses of 3.9% on its €27.9bn residential mortgage book. On the other hand, its close rival AIB’s numbers came out two-and-a-half times higher at 9.9% on the same-sized book.  A similar picture emerged on commercial real estate with estimated losses for Bank of Ireland of 18.8% on its €20.4bn in loans whereas AIB’s numbers were 26.2% on €19bn.

Is it the case that the bank was not as buccaneering as its rival AIB during the latter stages of the boom? Is it the case that it banked a better class of customer? Or is a case of carefully ensuring that one of the two pillar banks remained in private ownership?

Have the new investors in Bank of Ireland been sold on the possibility of extracting super-normal profits from what has become an oligopolistic banking market dominated by two banks whose liabilities are guaranteed by the state?

In the consumer “Tale of Two Pillars”, cartel-like profiteering behaviour has been flagged in the recent moves by both banks. By effectively eradicating free banking late last year, Bank of Ireland quietly squeezed up all important fee revenues. This month, AIB’s executive chairman David Hodgkinson flagged a need to increase lending margins to rebuild profitability.

Reflecting protectionist thinking, which is never far from the surface, he had the apparent temerity to suggest that while his bank should be free to price for credit risk – increase its lending margins - it should not have to pay the going risk rate for ordinary people’s deposits. Should banks enjoy a legal cap on deposit interest rates while rebuilding their shattered businesses?

Without enough retail deposits to fund their deleveraging balance sheets, they are forced to pay up to hold onto the deposits they have. The problem is the pillar banks remain hugely dependent on their ECB lifelines. Weaning off these will take a wee bit more than €1.1bn in fresh investment in Bank of Ireland or trying to manipulate margins by capping deposit rates. The light at the end of the tunnel is a glimmer of hope that maybe one day soon banks will begin to work again.

A version of this article appeared in the Irish Examiner, Business Section, Monday 1st August 2011.