Davy adds €1.1bn to SME loan loss estimate

Loan losses at Bank of Ireland and AIB through exposure to the SME sector could exceed the adverse scenario in the last Central Bank stress tests by up to €1.1bn, according to a new report by Davy Stockbrokers.

However, these losses can be absorbed by savings made through the Central Bank’s prudential liquidity assessment review, according to Davy analyst Emer Lang.

As part of the last round of stress tests conducted in March 2011, AIB and Bank of Ireland were instructed to shrink their loan-to-deposit ratios by disposing assets. There were concerns at the time that both banks would suffer huge capital hits by selling assets in distressed market conditions. But the losses incurred through disposals came well within the levels expected in the review exercise. These savings are sufficient to absorb the €1.1bn in excess SME losses, says Ms Lang.

The next round of Central Bank stress tests, conducted in July of this year, will look at potential losses in four different sectors: residential mortgages; non-mortgage retail; micro SME and SME/corporate. In a report issued last August, Davy estimated that losses in the pillar banks’ mortgage books would exceed the adverse scenario in the last round of stress tests by €1.4bn.

The next stress tests will reveal if the banks need further recapitalisation.

The Irish SME sector has core loans of €26.3bn and property-related loans of €33.5bn. SMEs are crucial to the economy. These types of businesses account for 855,000 of the 1.24m people in private sector employment in Ireland.

A Central Bank report released last July found that Irish SMEs were among the most challenged in the eurozone in terms of access to bank finance. Irish banks reacted angrily to this report and blamed the paucity of lending on lack of demand.

A number of foreign owned banks have exited this country in recent years. Bank of Scotland Ireland is in the process of winding down its loanbook while Ulster Bank has scaled back its lending operations over the past few years. But Ms Lang notes that the Government has attempted to fill the lending gap through different initiatives — most recently through the National Pension Reserve Fund.

The quality of SME loans hinges on the economic recovery and future employment levels as well as domestic demand.

Irish banks face a number of capital-related hurdles over the next few years, according to Ms Lang. These include a lack of internal capital due to weak underlying profitability and elevated impairments. The two pillar banks are scheduled to repay the Government’s preference shares by March next year. Bank of Ireland’s preference shares have a value of €1.8bn and in AIB €3.5bn. Both banks have significant pension deficits and deferred tax assets.

Moreover, the banks have to set out their plans to meet increased capital and liquidity requirements, as part of the Basle III regulations, which will be phased in between 2014 and 2019.