Joe Brennan: NatWest and Irish taxpayers will be joined at the hip in PTSB

Permanent TSB (PTSB) chief executive Eamonn Crowley expects to be able to complete his planned purchase of €6.8 billion of Ulster Bank's loan book without resorting to the State and other shareholders for fresh capital.

It largely hangs, however, on the bank's auditors in PwC and the Central Bank confirming that the deal – which would increase PTSB's loan book by almost 50 per cent – qualifies for a certain accounting manoeuvre.

Analysts estimate that PTSB needs about €400 million of fresh capital to give it sufficient regulatory reserves to support the deal.

However, PTSB confirmed on Friday, as it unveiled a binding agreement with Ulster Bank's UK parent NatWest, that part of the consideration for the loans will be paid by way of shares in the Dublin-listed bank.

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Almost 90.9 million of them, in fact – which will equate to a 16.7 per cent stake, worth about €140 million, based on the current price at which PTSB’s shares are changing hands.

PTSB has also beefed up its reserves this year by continuing a trend of offloading loans that require heavy levels of capital. Last month, it agreed to sell a portfolio of mainly non-performing mortgages with a gross value of €390 million to Wall Street banking giant Morgan Stanley, which plans to refinance the loan book on international bond markets in 2022.

But central to Crowley’s plan to avoid going cap-in-hand to the State, which currently owns 75 per cent of PTSB, and other shareholders for additional capital is getting clearance from auditors and regulators that the Ulster Bank loan purchase qualifies for so-called business combination accounting.

Negative goodwill

PTSB is taking over the Ulster Bank assets at a discount to their fair value. It will able to book the difference as “badwill”, or what’s sometimes referred to as negative goodwill, if the deal qualifies as a business combination.

Contrary to the way it sounds, badwill is actually a positive thing for an acquirer. Crowley told reporters on a call on Friday that this could unlock a capital gain in the order of “hundreds of millions” of euro.

“In the unlikely event that [business combination accounting] was not applicable at completion, then the bank would engage with NatWest and all other relevant stakeholders to seek to restructure the transaction to the extent possible and necessary to enable the bank to proceed to completion,” PTSB said.

The European Central Bank (ECB) said earlier this year that it would recognise verified accounting badwill from a capital point of view when assessing deals, as it pushes for banking consolidation at a time when banking asset valuations are under pressure.

That’s as long as the gains are not used for the payment of shareholder dividends. There’s little prospect for PTSB being in a position to do that for the foreseeable future.

PTSB has essentially been kept on life support for the past decade amid a vague hope that one day it would be mopped up by way of some form of merger to create a “third force” in Irish banking. The takeover of much of the loans of Ulster Bank, after NatWest decided earlier this year it had had enough of a difficult market, gives it a strong shot at carving out a viable future.

Mortgage boost

The transaction will boost its mortgage book by 40 per cent. The purchase of Ulster Bank’s performing micro-SME loans and its Lombard Asset Finance unit, with combined portfolios amounting to €630 million as of June, will triple PTSB’s fledgling business lending unit from a very low base.

And, having delivered a pitifully low profit return on equity of 2-3 per cent in the years leading up to the Covid-19 pandemic – compared to the 8-10 per cent range that analysts see as a sign of a healthy bank – Crowley now reckons that PTSB can reach a ratio of 9 per cent over the medium term.

With shares in PTSB having jumped 70 per cent since it emerged in February that it had an eye on a large chunk of Ulster Bank, the market seems to be beginning to believe, too. But only so much. The stock is still trading at only 40 per cent of the estimated value of its assets, compared to a rate of about 60 per cent for the wider euro zone banking sector.

The new shares being issued to NatWest will dilute the State’s stake in PTSB from 75 per cent to 62.5 per cent. Meanwhile, Crowley insists that the fact NatWest is taking a 16.7 per cent stake indicates “they see upside in the value of that shareholder over time” and “could be a long-term holder”.

Sale prediction

However, John Cronin, an analyst with Goodbody Stockbrokers, said that NatWest will be sure to file the PTSB shares in its "non-core" basket and seek to sell them over time. He's far from alone in that view.

The UK bank plans to enter a shareholder co-operation agreement with Minister for Finance Paschal Donohoe to ensure orderly PTSB stock sales by both sides in the future as they seek to ultimately lower their holdings.

And with good reason. The market overhang of 79 per cent of PTSB’s shares in the hands of two unnatural holders is bad enough without either having to worry about the other bailing out unceremoniously.

Irish taxpayers and NatWest CEO Alison Rose are likely to be joined at the hip on this one for some years to come.