S&P upbeat on pospects for Irish banks

Standard & Poor's (S&P) expects Ireland’s two largest banks, AIB and Bank of Ireland, to remain comfortably profitable through the current economic downturn.

However, the ratings agency warned that downgrades of European banks will increase over the next 18 months due to concern over capital losses and slower economic growth.

In a report on the European banking sector published today, S&P said Ireland, the UK and Spain would see the sharpest "economic adjustments" due to falling house prices, and added it was monitoring rising inflation in Denmark, the Netherlands and France.

European banking stocks have fallen by 40 per cent on average this year. AIB shares are down 44 per cent while Bank of Ireland shares are 39 per cent lower.

S&P last month cut AIB's and Bank of Ireland's ratings from "positive" to "stable".

For AIB it said this outlook reflected the bank's "solid funding and liquidity position, improved capitalization, and our expectation of increasing pressures on profitability from the property and construction loan book as losses emerge".

Bank of Ireland's "multi-niche strategy overseas offer it a bright future", according to the report, which also noted risks from performance pressures and credit costs over the next 18 months.

S&P said credit writedowns related to US subprime mortgage losses which have hit European banks' wholesale businesses have been reflected in current ratings, adding that "the slowdown in the real economy is likely to constrain earnings".

Strained capital positions for some banks and the readjustment to tighter funding conditions was likely to require structural changes, rather than piecemeal responses. S&P cites the failure of funding market conditions to return to "normal" as evidence of the need for reform.

While ratings actions over the last 12 months were driven by liquidity pressures and write-downs, this is likely to be replaced by a greater focus on the level of credit losses and differences in capital philosophy.

These conditions may "create opportunities for some banks" as difficulties raising capital may force some smaller, specialised banks to merge, the New York-based ratings agency said.

It pointed to the recently agreed offer from Banco Santander SA for midsize British mortgage bank Alliance & Leicester, as a good example of a specialist lender joining a larger, more diversified group.

With European banks set to report second quarter earnings, S&P expects the level of writedowns to be lower than in the first quarter.

However, "we expect to notice early signs of rising delinquencies, tighter underwriting, slower loan growth, and increased resources in credit units - and therefore the expectation of higher impairments", the rating agency said.

The DJ Stoxx European banking sector index fell to within 14 per cent of its 2003 cycle low earlier this month before a rally as a number of US banks reported better-than-expected results.

On Wednesday the bank index had its best one-day percentage gain in four months, and yesterday, Credit Suisse easily beat analysts' forecasts with its quarterly results, sending its shares higher.