Davy downgrades BoI but talks up long-term prospects

Davy Stockbroker analyst Emer Lang has downgraded Bank of Ireland from “outperform” to “neutral” on the back of near-term challenges to its net interest margin, rising impairment losses, and limited growth opportunities.

However, the bank is an attractive medium- to long-term play on the Irish economy.

She said: “The bank will enjoy a market leading position in a recapitalised, consolidated, and right-sized banking system. Its fate is therefore linked to the medium- to long-term fortunes of the Irish economy. The Irish economy is stabilising and is expected to deliver attractive growth in the medium- to long-term.”

The report notes that the recovery hinges on a resolution to the eurozone debt crisis and Ireland’s continued efforts to bring the fiscal deficit under 3% within the agreed timeframe.

“Trading at a discount to our end-2014 [total net asset value] forecast of 19.6c, the shares are an attractive long-term play on the Irish economic recovery. However, weak trading conditions pose a near-term challenge.”

Ms Lang notes that achieving Bank of Ireland’s net interest margin of 2% over the medium-term “looks an increasing challenge following the sharp contraction in the margin in the first half [of 2012]”.

“Weak revenues also create uncertainty over the timescale to get the cost/income ratio down below 50% — costs were flat in the first half of 2012.”

The bank faces margin pressure from higher costs of deposits; lower interest rate environment; increased cost of wholesale funding; and a change in the asset/liability mix.

Bank of Ireland has exceeded the impairment losses set out in the Central Bank’s Prudential Capital Assessment Review base case scenario in non-property SME and corporate lending and for Irish mortgages, but it remains below the base case scenario for investment property and personal loans.

“Our revised through- the-cycle losses of €8.2bn include a €2.15bn Irish mortgage charge, driven by our new mortgage arrears model.”

Ms Lang notes that Bank of Ireland continues to make good progress meeting its deleveraging targets — its loan-to-deposit ratio is 136%, which is down from 144%, and the bank remains on course to reach its loan-to-deposit target of 122% by the end of 2013.

“Our revised estimates see more modest profits in 2013 [€271m versus €367m] and remain contingent on margin rebuild, extrication from the eligible liabilities guarantee, and a more normal impairment charge, all of which carry further downside risks.”