AIB bond move may net €1bn profit

AIB is leveraging the Government’s bank guarantees in a debt buyback strategy which could leave AIB with a net profit of close to €1 billion.

Bank of Ireland has already boosted its reserves by €1bn through the employment of a similar stratagem.

Originally both banks borrowed billions to fund property loans to Irish customers by issuing perpetual bonds. As the property bubble burst and the global banking crisis grew the value of these loan bonds crashed by as much as 65%.

Now the banks are buying back these loans at a massive discount, generating huge profits by eliminating billions in debt.

Bank of Ireland used cash to buy back the impaired bonds. AIB plans to maintain liquidity and issue fresh bonds, made more attractive by a combination of higher rates of interest, premium prices for the impaired bonds and 100% security on the new debt provided by the Government guarantee scheme.

Banking analysts estimate that AIB could make anything from NCB’s estimate of €540 million to Merrion Capital’s estimate of €1.2bn.

AIB needs to raise an additional €1.5bn in capital on top of a €3.5bn Government injection of funds unlike Bank of Ireland, which the Minister for Finance has indicated may not need further state capital.

If AIB manages to pull in profits at the upper end of the estimates of €1.2bn then it will not, for now, be forced to sell off any significant portion of investments, such as its M&T Bank holding in the US or its Polish bank assets at knock-down prices. These could be sold-off next year as bank asset prices improve on the back of an anticipated ending of the global recession.

Institutional investors are generally steering clear of Irish banking stocks while they wait to hear the detail of the Government’s plans for its bad bank scheme to cleanse the sector of property-related bad debts.

The write-down lenders will have to swallow before they transfer their development portfolios to the bad bank may trigger another capital call and result in the State taking further stakes.

The bulk of the notes Allied Irish wants to swap are quoted at around 35%-45% of their nominal value.

Goodbody’s Eamon Hughes said if AIB bond holders were happy to accept prices similar to that offered by Bank of Ireland, and the take-up as a percentage of the amount of the securities outstanding is the same, €2.8bn, it would realise a pre-tax profit of €910m for AIB, adding 68bps to its equity tier 1 ratio.

“This benefit will be eroded somewhat by an estimated €90m per annum due to the higher coupon that would need to be paid on the replacement lower tier 2 capital, than that being paid on the instruments being exchanged.

“We estimate that AIB’s lower tier 2 capital is currently yielding about 11%. Over the 3 years to the end of December 2012, this would reduce the benefit to equity tier 1 to 56bps.”

AIB shares rose 25 cents, or 13%, to €2.24 yesterday.