Economics 11/8/10: Bank of Ireland H1 results

Bof I results for the H1 2010 did represent a significantly different picture from those reported by AIB, with one notable exception – both AIB and BofI are yet to catch up with reality curve on expected future impairments.

BofI profit before provisions was €553mln against €811mln in H1 2009. This, however, doesn’t mean much, as a score of one-off measures were included in H1 2010 figure:

• Losses on sales of loans to NAMA’s were factored in at €466mln
• Debt exchange added a positive of €699mln
• Pension deal brought in a positive contribution of €676mln.
• Net positive of the one-off measures was, therefore around €909mln implying that BofI really was running a loss €356mln before provisions and after one-offs are factored in.
  

Underlying loss before tax, net of charges, was €1.246bn or almost double the €668mln loss last year. The impairment charges amounted to €1.8bn in H1 2010, inclusive of €893mln non NAMA provisions. The impairment charge therefore almost doubled on €926mln in H1 2009.

Big ‘news’ today was that BofI continues to guide for €4.7bn in impairments charges for March 2009-2011. Given that the bank has taken €3.9bn of these provisions to date, it will have to deliver an €1.2bn gain on H1 2010 (roughly 1% of its loan book value) before March 2011 to stick with the impairments estimate. How much can BofI squeeze out of its customers remains uncertain, but to get to its target figures, the bank needs either a helping hand of Nama (on valuations for Tranche 3) or a dramatic reduction in cost of funding (unlikely) or a 30%+ increase in what it charges on loans (without any subsequent deterioration in their quality).

These are unlikely for the following reasons.

Impaired loans are up by a significant €2.1bn reaching 7.1% of the total loan book (these were 5.5% at the end-December 2009). Risk weighted assets stood at €93bn down on €98bn in December. And asset quality is still declining: impaired loans were €15.8bn of which €8.86bn were on non-NAMA book. This compares to €13.35bn in December of which €6.79bn related to non-NAMA book. Provisions were €6.64bn in June of which €3.725bn non-NAMA, implying 42% cover, down from 43% in December when provisions amounted to €5.8bn in total, with €3.0bn non-NAMA.

BofI maintains that bad debts peaked in H2 2009, showing a charge of 1.4% on gross loans in H1, compared with a charge of 2.9% in Q4 of last year.

This looks optimistic. BofI business side continues to suffer from income declines and costs overruns. Total income was down 8% yoy at €1.76bn. Cost cutting this year will have to come at a premium as BofI prepares to shed some 750 more jobs. Total staff numbers are down by 805 or 5% yoy so far in 2010.

BofI H1 2010 net interest margin was 130 bps down 40bps relative to H1 last year. Causes: higher deposit and funding costs, lower capital earnings and Government guarantee. Assets repricing helped by adding 19bps to the margin. Cost to income ratio increased to 61% relative to 54% a year ago, despite costs falling by 3% to €916mln. This means income is seriously under pressure. Impaired loans on residential lending book have increased by 58.5%.

One improved side – capital ratios came in at Core Equity Tier 1 of 8.2% up on 5.3% in December and ahead of 7% regulatory target, but still low relative to European and US peers. Tier 1 ratio was 9.9% virtually unchanged on 9.8% in December.


BofI might be right in some of its rosy projections. You see, Nama has been rolling over for the bank so far. BofI originally guided Nama discount of €4.8bn on €12.2bn it planned to transfer to Nama, or 39% haircut. Nama obliged so far by shaving off 36% on the €1.9bn of loans transferred in Tranche 1 in April and then 35% on Tranche 2 transfer of €1.5bn in July. This was done despite the fact that impaired loans proportion continues to rise in the sub-portfolio of BofI loans destined for Nama.

And this rise is a serious one. At the end of June, 69% of the loans remaining in the Nama-bound portfolio were impaired, up on 54% in the overall Nama portfolio set aside in December 2009. So Tranche 1 transfer picked out better loans or the loans have deteriorated dramatically since Tranche 1 transfer or both. Either way, lower discount on Tranche 2 loans suggests a blatant subsidy from Nama.


Funding side remains under threat, though BofI put a brave face in stating that it raised €4.6bn in term funding so far (mostly in the beginning of the year before the proverbial sovereign debt sh***t hit the fan). The bank still has to raise €9.5bn more before the end of the year 2010. The balancesheet numbers as well as market conditions suggest that this might be tight.

Total loans held grew by €3bn in H1 2010 to €125bn driven by sterling appreciation. Meanwhile, deposits were down €1bn to €84bn, so bank’s loan-to-deposit ratio, ex-NAMA, rose to 143% from 141% in December 2009. Deposits decline was driven by ratings downgrade for S&P in January 2010 which shaved €3bn worth of value from the ratings-sensitive deposits.

This doesn't make BofI any more attractive to the lenders.

But the bank has done coupple of things right. BofI is gradually improving its funding outlook by extending funding maturity – up to 41% of wholesale funding being in excess of 12 months in H1 compared to 32% back in December 2009. And BofI has been reducing its reliance on wholesale funding – down €3bn in H1 to €58bn total. BofI still holds €41bn worth of contingent liquidity collateral, theoretically eligible for ECB borrowings.

The bank also has €8bn exposure to ECB – same as at the end of 2009. You can either read this as the brokers do, meaning that BofI still has massive reserve it can tap if it needs to go to ECB. Alternatively you can say that in the last 6 months, the bank did nothing to work itself off the reliance on ECB funding.

Finally, virtually all analysis (with exception of one brokerage – if I recall correctly it was NCB) overlooked the data released on the deposits breakdown. Per note, “deposits with a balance greater than €100,000 amounted to €50bn at end-June. …As it stands, the ELG guarantee will no longer cover corporate deposits greater than €100,000 with a maturity of less than three months — presumably a significant proportion of these balances — after September, with the ELG set to go completely at year-end. It seems certain to us that the ELG will have to be extended to shore up confidence and facilitate the as yet unfinished wholesale terming effort.”

Economics 17/05/2010: BofI rights offer - back of an envelope

Update: Tasc have published a very interesting piece of research (here) mapping the real Golden Circle of Ireland's interconnected political and economic elites. Fair play to Tasc for covering semi-state bodies and companies. Well done to the authors! (hat tip to RDelevan)



Back of an envelope calculations for the BofI rights offer - self explanatory stuff:
But what about taxpayers' buy-in into BofI under this deal? Well, if the value of this offer is negative at the buy-in price of 55 cents per share, think what the value is for the taxpayers, who bought at €1.80 per share! Ok, let's do the maths: we have post-rights price of BofI at 81.9 cents, for which we paid 180 cents - the net return is the loss of 98.1 cents per share bought by the Irish Exchequer... Amazingly, there is no reason for this loss whatsoever - as an existent shareholder in the bank, Irish Exchequer is entitled to participate in the same deal offered to all current shareholders. we, therefore, could have limited our losses to 24.75 cents per share from 81.9 cents per share and still done the same deal!


Note: the above estimates are based on straight forward linear model of equity-price relationship. These are, therefore approximations. Based on expected balance sheet model, the returns can be estimated different - with upside growth scenario over the next few years potentially yielding a positive return, while downside growth scenario can yield an even deeper loss. You be the judge, but my figures should be treated as being closer to risk-adjusted (static model) averages.

Disclaimer - I do not hold any shares or any other financial instruments (equity or debt) in any of the Irish banks.

Economics 19/02/2010: Bank of Ireland deal

And so it comes to pass - the saga of missing dividend from Bank of Ireland, and the taxpayers are left holding the bag... The background to the story is here. Karl Whelan's post here gives the relevant links to the documents. And my analysis is as following:

Following the conversion of dividend due (€250 million) from the Bank of Ireland preference shares owned by the state to ordinary shares on 22 of February, the state will emerge as an almost 16% owner of the bank equity.

The relevant ISE document stipulates that:
"As a consequence of this and, in accordance with Bye Law 6(I)(4), the Directors of the Bank of Ireland announce that on 22 February 2010 it will issue and allot to the NPRFC 184,394,378 units of Ordinary Stock being the number of units equal to the aggregate cash amount of the 2010 dividend of €250.4m divided by 100% of the average price per unit of ordinary stock in the 30 trading days prior to and including today's date. Application will be made in due course for the listing of these units of stock. This increases the units of Ordinary Stock of Bank of Ireland in issue to 1,188,611,367. As a result the NPRFC will own 15.73 per cent of the issued Ordinary Stock (excluding the NPRFC Warrant Instrument)"

Which means a massive shareholder dilution and a significant set back to the BofI ability to raise equity. Recall that the BofI was planning for a €1 billion rights issue which would have meant roughly a 38.6% dilution of existent shareholder rights. Now, with a preemptive 16% dilution by the state, a rights issue planned will mean a 44% dilution post-rights should the price of the shares remain constant at Monday. And this is before we factor in 25% option on ordinary shares that is held within the preference shares we already have.

Of course it won't. A rational valuation model of shareprice will require that the price declines roughly 15% on Friday close post State dilution. Which means that market cap of the BofI will fall, at current average to €1,353 million, implying the post-right dilution of 48%.

In a way, Government taking the stake in BofI prior to rights issue at current valuation means the taxpayer is buying an asset that is likely to drop in value almost 50% within months after the State takes its stake. With one sweep of the pen, Minister Lenihan just signed off on an investment - using our cash - that will be worth 1/2 of its current value once BofI goes into equity raising.

Of, course, a much grimmer reality beckons should the State move tonight spell the end to the BofI equity issue prospects. In this case, today's announcement forces the Government to fully recapitalise the bank out of taxpayers funds, leading to a 90% plus State ownership and a massive liability to the taxpayers.

Irony of all ironies - the Government will end up transferring bad assets from its own bank to its own holding entity - Nama. What can possibly go wrong?


PS: In their September 3, 2009 note titled "Irish Banking - Crossing the Rubicon", Bloxham Stockbrokers said: "There is already a €825 million benefit to taxpayers from recovery in the market value of Allied Irish Bank and Bank of Ireland: Holding options worth a 25% stake in both AIB and Bank of Ireland, the taxpayer has benefited by €825 million as a result of the shareholding. This is apart from the benefit of the annual 8% yield from the €7 billion injection into the two main banks, which adds a further €560 million to the return per annum."

Run this by us, please, Bloxham - €825 million? Again? Crossing the Rubicon it was.

Wanna see some more fantasy estimates from the brokers? Davy:
"19 June 2009 17:26 Bank of Ireland could raise €1.5 billion in September and pay off some of the €3.5 billion in Government preference shares, according to stockbrokers Davy. ...In a report on Bank of Ireland today, Davy Research says the effect of a rights issue, in which the bank would issue more shares, could be used to pay funds back to the State and potentially leave the Government with a stake of 7%. "

7%? Run this by us, please, Davy Research - 7% state ownership? Right.

Economics 15/02/2010: Bank of Ireland ethical dilemma

So here we are folks, the state has run into a bit of a trouble.

Remember those dividends that our (taxpayer-bought) preference shares in the BofI and AIB were supposed to generate? Ok, there is a problem here.

On February 22, BofI is supposed to pay out some €240 million to us (the taxpayers, in case if you wondering) in dividends on these shares. Alas, if you recall, the EU has imposed severe restrictions on the banks dividends. This means that we are now in a no-man's land when it comes to getting paid on that €3.5 billion we put into BofI. The Government has an option to circumvent the EU rules and ask for shares to be paid in instead of cash, but this surely will open claims from the bondholders who are not being paid their coupons. And, of course, if shares are issued in the way of payment, there will be dilution. At current price, €240 million worht of BofI shares will be, ahem, 24% of the expected €1,000 million rights issue or 19.1% of the market capi of the bank. Some serious dilution, unless the EU grants an exemption to the State.

But an exemption for the Government is an ethically dubious move for several reasons:

• In all other bank support schemes, the EU did not lift restrictions on dividends/interest/coupon payments for sovereigns. Should it do so for Ireland, what's next?
• Payments to other bondholders who have identical rights to the state (on paper) will not be made, opening up the entire process to legal challenges.
  

And we (the taxpayers) were told by the Government and its stockbrokers that we've made a sound investment in the BofI preference shares... Ouch...

Economics 07/01/2010: NTMA's end of year results

Here is an interesting one: NTMA published their End Year review. Per statement (page 3 top): “The National Pensions Reserve Fund Discretionary Investment Portfolio (the Fund excluding the preference shares in Bank of Ireland and Allied Irish Banks held on the direction of the Minister for Finance) earned a return of 20.9 per cent in 2009. Since the Fund’s inception in 2001, the Investment Portfolio has delivered an annualised return of 2.6 per cent per annum. Including the bank preference shares and related warrants, which are held at cost and zero respectively, the Fund recorded a return of 11.6 per cent in 2009. At 31 December 2009 the total Fund’s value stood at €22.3 billion.”

If the state were to invest €7 billion it gave AIB and BofI for their preference shares in the Discretionary Fund, the returns on these investments would have been roughly €1.463 billion in 2009. Instead, we got zilch in risk-adjusted returns.


Ok, one would say that ‘investing’ in AIB and BofI is a sensible undertaking as the banks are market-determining entities for ISE. Nope, wrong. Page 4 of release states: “As a result, the Investment Portfolio had an elevated level of quoted equity investment of 80 per cent following completion of the recapitalisation in May compared with 57 per cent before the preference share investments were made. The Fund took advantage of the strong equity market rally to reduce its absolute risk and exposure to the equity markets through phased equity sales of €2.7 billion through the remainder of the year. The Investment Portfolio’s exposure to the quoted equity markets had been reduced to 63 per cent by year end.”

So as the result of AIB & BofI ‘investments’, NPRF is now more heavily geared toward equities as a class. Full stop. Now, give this a thought. We have a Pension fund with 63% exposure to equities that has been forced to sell equity on the basis of the need to re-gear toward banks shares in the economy where banks are the weakest point… Aggressive high risk investment strategy. What’s next? A highly geared derivative undertaking with taxpayers money? Ooops – we already got one, called NAMA SPV.

Back to page 3 stuff: “During 2009 the Minister for Finance directed the Fund to invest €7 billion in preference shares issued by Bank of Ireland and Allied Irish Banks for the purposes of recapitalising these institutions. The terms of the deal, which was negotiated by the NTMA, include a non-cumulative fixed dividend of 8 per cent on the preference shares and warrants which give an option to purchase up to 25 per cent of the enlarged ordinary share capital of each bank following exercise of the warrants. The dividends payable on the preference shares are not recognised or accrued by the Fund until declaration by the bank concerned. These investments were funded by €4 billion from the Fund’s own resources and by €3 billion from a frontloading of the Exchequer contributions to the Fund for 2009 and 2010.”

Two points here:

1. 2009 thus saw a direct transfer of €3 billion to NPRF from the economy that has contracted by 10.5% (GNP). Since NPRF is a de facto piggy bank for public sector pensions only, this type of fiscal management, of course, has no precedent. It is equivalent to taking from the strained middle classes (taxpayers) to award future pay for public employees.
2. This reminds us as to just how outrageously overpriced the preference shares we bought were. AIB and BofI preference shares yielding 8%? Remember – these two banks have balancesheets weaker than those of the main UK banks. Yet, at the same time we were signing off on 8% return, the UK banks bonds were yielding 12-15%. What’s the opportunity cost of such a sweetheart deal for the banks from taxpayers’ perspective? 7% yield foregone, or in 2009 terms - €490 million.
   

Add the two bolded numbers: €1.953 billion is the opportunity cost to the taxpayers of the AIB and BofI capital injection in foregone earnings. This is more than double the amount of savings generated by the Exchequer through public sector wage ‘cuts’ in 2010 Budget.


Another interesting thingy – page 4: “NAMA will acquire loans with a nominal value of approximately €80 billion”. Hold on, folks – was it €77 billion or €80 billion? Or should we take it from the NTMA that +/-€3 billion in taxpayers funds exposure is simply pittance that can be rounded off? What’s next? February 2010 numbers rising to €85 billion, then to €90 billion by March? Why not just state ‘we’ll buy anything they throw at us’ and close off this Cossack Dance with the numbers?


Pages 5 (end) and 6 provide a small, but interesting insight into operational efficiencies of the State Claims Agency: “There has been a substantial decline in employer and public liability claim volumes associated with incidents that have occurred since the SCA was established. Since 2002 the number of employer liability claims has fallen by 71 per cent and the number of public liability claims has fallen by 19 per cent. The total number of active employer and public liability claims has fallen by 35 per cent in 2009 compared with 2008.”

Sounds like good news? All claims are down since 2002 and in particular between 2008 and 2009. Happy times? Not really: “During 2009 the SCA paid out a total of €64 million against all classes of claims. This compares with a total of €53 million in 2008.” So let me run this by you – cases numbers are down 35%, but payouts are up 20.8%! I guess the gravity of injuries in the public sector rose dramatically during the year.


Lastly, Appendix 1 lists bond issues for 2009. This is a nice summary of the fine work being done by the NTMA in placing our debt (although most of it has gone to the banks to be rolled into ECB). But the worrying thing is the time profile of these bonds. €14.53 billion of the bonds issued this year will mature (and will be rolled over) during or before 2014 - the deadline for our compliance with the Stability & Growth Pact ceilings on deficit and debt. Such a large amount, coming already on top of the billions in short/medium-term debt issued in 2008 doesn't do much to support markets confidence in Ireland actually delivering on 2014 commitment...