In a new research paper on the Irish banking system, Deutsche Bank said Bank of Ireland is in the best position among the domestic banks to return to profitability. However, it faces three main challenges: the looming BSA and asset quality review into its loan book; what to do with the €1.8bn in preference shares; and, a potential solution to the tracker mortgage problem.
“It would take a major (and probably worse than the stress scenario of the original PCAR) discovery of poor loan classification/provisioning/risk weighting or a very high Basel 2.5 hurdle rate to cause problems for either.
“This is unlikely, given the scrutiny Irish banks have already been under. So we expect the BSA to pass the Irish banks,” said Deutsche Bank.
However, the big uncertainty hanging over the Irish banks stemming from the looming stress tests is what capital framework will be used. If the regulators opt for a Basel III framework, which has much tougher capital requirements, then the Irish banks would more than likely have to raise new capital after the tests.
But Deutsche Bank analysts, David Lock and Jason Napier, say that the Irish banks will probably be tested under a Basel 2.5 framework, which is a compromise between the older and less rigorous regime and Basel III, which has to be fully introduced by 2019.
“BKIR has a contingent convertible which triggers at 8.25%, so 9.5% might be seen as too close for comfort for the market and management, particularly heading into an AQR/Stress test next year. Each additional 50bps would require roughly €250m (0.9c per share) of equity.
BKIR can raise up to 5% of their equity base without needing an EGM (5%: €6bn is €300m). We include a capital deduction of €300m in our valuation to bring BKIR to the 10% level. But given the AQR next year, management would want to ensure that any equity raised covered all possible outcomes in 2014.”
Bank of Ireland is also faced with a €1.8bn Government-owned preference share redemption deadline of Mar 31. If the shares are not redeemed by then, they increase in value by 25% to €2.25bn.
The authors say of all the options open to Bank of Ireland, keeping the preference shares is the least preferable because they have a punitive coupon and are only eligible as core tier one capital until 2018.
Deutsche Bank doesn’t think that Bank of Ireland will have any problems raising the €1.8bn in equity needed to redeem the preference shares before the March deadline.
Moreover, the authors warned that a solution is needed for the negative carry trade arising from the tracker mortgage book. If the ‘credit enhancement’ option outlined by the troika in the last review of the economy was available then it would be a massive boost to the sector and accelerate the return to profitability.