Irish banks rebound as interest-rates boost eclipses cost-of-living-crisis loan losses

Irish banking stocks, all too often laggards on the Irish market and European banking sector over the seven years, stood out as rare bright spots on the market in 2022. And analysts reckon they aren’t done yet.

The Iseq finance index, dominated by the three banks — AIB, Bank of Ireland and Permanent TSB (PTSB) — followed up a 40 per cent surge in 2021 in buoyant global markets with a more than 70 per cent advance this year, even as equities globally generally took a hammering.

Deutsche Bank analyst Robert Noble’s price targets for AIB and Bank of Ireland point to a further 15 per cent and 35 per cent upside, respectively, as he predicts 2023 is set to be “a third year on the trot” that Irish bank stocks outperform European rivals.

Borrowing levels in the Irish economy have “declined substantially since the 2009 financial crisis after a painful adjustment. The economic outlook is one of the most favourable in Europe with positive GDP [gross domestic product] growth, contained unemployment, and a Government in surplus”, said Noble in a recent report on Irish banks.

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Following years of ultra-low interest rates internationally, shrinking loan books and demands from regulators to hold ever-increasing amounts of expensive capital, news in 2021 that Ulster Bank and KBC Bank Ireland were quitting the market prompted investors to look afresh at the remaining lenders, as they prepared to divide up the exiting banks’ loan books.

Rate hikes

However, a series of European Central Bank (ECB) interest rate hikes since July has transformed the prospects of Irish banks, who are more reliant on interest income for earnings than their average European peer. The main earnings boost has come from banks no longer being charged negative rates by the ECB on their tens of billions of euros of excess deposits.

Still, lenders have also passed on increases in official lending rates to tracker mortgage borrowers and marginally increased the cost of new fixed rates — with more moves expected to follow early next year.

The consensus view in the market is that the combined net profits of the three Irish banks will soar by more than 50 per cent next year to €2.22 billion, according to figures compiled by Bloomberg.

Bank of Ireland delivered an early Christmas present to shareholders on December 16th when it raised its net interest income growth forecast for the second time in less than six weeks.

The lender, where Myles O’Grady was installed as chief executive in November, now sees its net interest income growing by about 10 per cent in 2022. That points to a full-year figure of €2.44 billion. Net interest income accounted for three-quarters of Bank of Ireland’s total operating income last year.

AIB and PTSB have also guided up analysts’ net interest income estimates in recent months.

“The outlook for profitability in the Irish banking system has not been so positive for quite some time,” said Diarmaid Sheridan, an analyst with Davy, which was taken over by Bank of Ireland in June. “Arguably, sustainability at this point is a more important way to assess the banking system. Capital, leverage and funding levels are very strong, and the last number of years has been characterised by de-risking of loan books and muted new lending.”

John Cronin, an analyst with AIB’s Goodbody Stockbrokers unit, also sees Irish banks delivering further share price gains next year.

“The key contributory factors are higher official rates driving much-improved interest revenues, evidence of continued strong credit quality despite a more challenging macro backdrop, [and] improved dividend yields,” he said.

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Cronin added that investor focus is now turning to the two main banks returning excess capital to shareholders and the State continuing to sell down its crisis-era investments in the sector.

AIB signalled to analysts on a call earlier this month that while it plans to stick to its current policy of paying out 40 per cent to 60 per cent of profits to shareholders on this year’s earnings by way of dividends and share buybacks, it plans to temporarily increase the payout level to as high as 100 per cent between 2023 and 2025. AIB’s net profit is seen approaching €1 billion in 2023 and comfortably beating that level in the following two years, according to analysts.

Problem loans

There is, of course, one clear threat to earnings: problem loans stemming from the mounting cost-of-living crisis.

While Irish banking industry executives say they have yet to see an uptick in non-performing loans, it is only a matter of time. Deutsche sees loan loss provisions across the three Irish banks rising from a combined net figure of about €100 million this year to €560 million in 2023.

Davy’s Sheridan said: “From an asset quality perspective, we have seen a huge change in cost of living and borrowers’ headroom to service debts has contracted. But a key area to consider is employment — and at an overall level, it remains robust. We expect impairment charges to increase, from very low levels in 2021 but will remain manageable given the underlying increase in pre-provision profitability.”

Share sale

In September, the Government sold its remaining shares in Bank of Ireland, making it the first Irish lender to return fully to private ownership following the State’s crisis-era €64 billion rescue of the financial system. All told, taxpayers recovered almost €6.7 billion from the bank, compared to €4.7 billion pumped into the lender following the crash.

Paschal Donohoe, as minister for finance before swapping jobs with Cabinet colleague Michael McGrath a few weeks ago, reduced the State’s holding in AIB from 71 per cent to 57 per cent over the course of the year by selling down shares. This raised about €1 billion.

While the Government has recovered about €11.5 billion of AIB’s €20.7 billion bailout and its remaining stake is worth about €4.86 billion, taxpayers remain underwater to the tune of about €4.34 billion on what they committed to the bank to keep it afloat during the crisis.

It is widely expected that the holding will fall below 50 per cent in the first half of next year. Meanwhile, Permanent TSB’s purchase of much of Ulster Bank’s loan book has seen the UK-owned lender’s parent, NatWest, take a 16.7 per cent stake in the bank as part payment. This diluted the Government’s previous 75 per cent interest to 62.4 per cent — albeit in a much bigger and more viable company.

A Department of Finance review of the state and future of Irish retail banking, published in November, contained a number of recommendations. These included: calls for new laws to protect access to cash across the economy at a time when digital payments are accelerating; a requirement that the Central Bank carry out a cost-benefit analysis of any rules it proposes; and a fresh push by various arms of the State and the banks to resolve long-term arrears at a time when 27,000 home loans are more than a year in arrears.

The International Monetary Fund had warned in a report this year on the Irish financial system that the persistence of long-term arrears “pose a challenge to the effectiveness of the overall system for debt resolution and creditors’ rights” and creates uncertainty on how lenders can recover their collateral when a borrower defaults. The issue affects the attractiveness of the Irish mortgage market for new entrants, according to bankers and regulators.

However, the part of the department banking review that gained most attention was a recommendation — adopted by Donohoe — that salary caps be scrapped at Bank of Ireland after it returned to full private ownership, and that bonuses across the sector, banned since the financial crisis, be restored at levels up to €20,000. There is little prospect of any government bringing a proposal any time soon to the Oireachtas to remove a prohibitive 89 per cent tax enshrined in law on bonuses in excess of that threshold.

Donohoe has left it to his successor, Michael McGrath, to decide when to lift the €500,000 salary cap at AIB and PTSB.

Tracker scandal

The tracker-mortgage scandal, dating back to 2008, when banks started to deny borrowers their right to rates tracking the main ECB rate, came to a head, of sorts, in 2022 as the Central Bank concluded its enforcement investigations into the banks.

A record fine of €97 million levied against AIB and its EBS unit in June would soon be eclipsed by a €100.5 million penalty imposed on Bank of Ireland in September. It brought the total haul from monetary sanctions imposed on seven lenders subjected to tracker investigations to almost €279 million.

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Seána Cunningham, the Central Bank’s director of enforcement, has said that “individual accountability is an area of focus” for her team, and that “we will take action where we believe it is merited and appropriate”.

The regulator decided in last 2021 to set up an inquiry into former Permanent TSB (PTSB) chief executive David Guinane for alleged suspected regulatory breaches in relation to the lender’s role in the tracker scandal. The case has not progressed to date other than the holding of some case management meetings in private. Others are likely to follow.

Even now, almost a decade and a half after the tracker controversy began, we still have lenders — namely Ulster Bank and Permanent TSB — fighting through the courts decisions by the Financial Services and Pensions Ombudsman to include certain customers for redress, after being disregarded in an industry-wide examination overseen by the Central Bank.

Wind-downs

It was originally envisaged that Irish Bank Resolution Corporation (IBRC), home to the remnants of failed lenders Anglo Irish Bank and Irish Nationwide Building Society and which was put into liquidation in February 2013, would be wound down by now.

However, the liquidators decided at the height of the pandemic in 2020 to extend its lifespan by two years to the end of 2024. But there are risks that even that date may be missed, as the liquidators have pushed out to 2024 the planned sale of Ukrainian and Russian property once owned by the family of businessman Seán Quinn, as a result the Kremlin’s invasion of its western neighbour earlier this year. Even the planned sale of those properties in 2024 is dependent on a resolution of the war by then.

The Quinn family settled a bitter dispute with IBRC in 2019, having originally claimed that Anglo Irish Bank had illegally given them €2.35 billion in loans at the height of the financial crisis to prop up a stake in the bank before it failed. An execution of a judgment against the Quinns for €440 million was stayed on condition that the family helped secure the return to IBRC of valuable assets in their international property group.

The wind-down of the National Asset Management Agency, meanwhile, is not scheduled to be completed until the end of 2025.

Big switch

One of the biggest banking stories of 2022 was the so-called big switch, as Ulster Bank and KBC Ireland went about pushing customers — holders of more than one million current and deposit accounts — to find new homes for their banking.

The main focus has been on current accounts, given how they are used for the likes of direct debits and standing orders as well as inward salary and social welfare payments.

The Central Bank reported earlier this month that almost 192,000 “primary” current accounts in departing banks remain open, despite a 50 per cent fall in the number of such accounts at the two banks since July.

Ulster Bank started to freeze inactive or low-use current and deposit accounts in early November and KBC began to close similar types of accounts at the start of December month after the initial wave of customers to be given six months’ notice to find alternative homes for their banking activities passed that deadline.

Brendan Burgess, a consumer advocate and founder of Askaboutmoney.com, has little sympathy, however, for customers of the exiting banks that have yet to move accounts.

“People have been aware since early last year that these two banks were leaving. The six months’ notice that these banks have been giving is plenty,” he said.

“Customers have been receiving regular reminders. There have been major ad campaigns on radio and television. I know we all like to bash banks, but we’ve got to be realistic. Some people won’t go about moving until their accounts have actually been frozen.”