Bank of Ireland (BOI) is one of the largest banks in Ireland and hence bears huge importance for the country's financial system. It is no secret that financial systems of many developed nations across the world took a serious hit as a result of the US subprime mortgage meltdown and the global recession that followed, but for Ireland the impact is compounded by seriously deteriorated financial stability of the whole country. Our valuation suggests that BOI is currently overvalued.
Capitalisation
On 31 March 2011, the Central Bank announced the results of the 2011 Prudential Capital Assessment Review (PCAR), requiring BOI to generate incremental equity capital of €4.2 billion. According to BOI, the capital requirement would cover:
- the higher target capital ratios set by the Central Bank of a minimum Core tier 1 ratio of 10.5% on an ongoing basis and a Core tier 1 ratio of 6% under the adverse stress scenario;
- a regulatory buffer of €0.5 billion;
- the adverse stress scenario loan loss estimates.
In addition, contingent capital worth €1.0 billion was also required through the issue of a debt instrument which "under certain circumstances" would convert to equity capital.
In July, BOI carried out actions to meet the regulatory requirements. The most controversial was the "Liability Management Exercise" (LME), whereby BOI passed on a large amount of losses onto subordinated debt holders, by exchanging about €2.6 billion (nominal value) of outstanding notes for equity or cash at heavy discounts (reaching as much as 80-90%). Total equity capital contribution from this transaction was estimated at about €1.96 billion.
The second part of the capital raising activities including a rights issue of €1.91 billion (gross), fully underwritten by NPRFC. The remaining part of the €4.2 billion requirement should come from additional measures. The €1 billion contingent capital was placed with the government in the form of a 5-year Tier 2 subordinated instrument with 10% coupon, with conversion price at the higher of 30-day average price at date of conversion or €0.05 (conversion is mandatory if the Core tier 1 capital of the Group's falls below 8.25%).
BOI reports that as of 30 June 2011 (before the capital increase), its Core Tier 1, Tier 1 and Total Capital ratios were 9.5%, 9.6% and 11.0%, respectively, almost unchanged from 31 December 2010, when the ratios stood at 9.7%, 9.7% and 11.0% respectively. BOI reports that the capital increase would produce a pro forma Core tier 1 ratio of 15.4% as at 30 June 2011. Moreover, on July 15, BOI announced that it passed the 2011 European Banking Authority ("EBA") Stress Test. The test allowed for the assumption of BOI's balance sheet downsizing (normally a constant balance sheet would be considered) as an exemption and was based on full implementation of the €4.2 billion capital increase. The test assessed that in the worst case scenario, BOI's Core Tier 1 ratio would be 7.1% at 31 December 2012, 2.1 percentage points above the 5% threshold (although a new Europe-wide stress test could consider a 7% threshold).
As a result of the capital raising activities, government's stake in BOI rose significantly. However, an agreement was reached with a group of shareholders to sell to them part of government's stake, so that its total holding would be reduced to 15%. At the same time, these shareholders would hold approximately 35% of BOI's capital (subject to certain approvals).
Deleveraging
The 2011 PCAR incorporates a deleveraging plan (PLAR) which envisages a loan to deposit ratio of less than 122.5% by 31 December 2013 and below 120% by the end of 2014. This ratio would be significantly lower than 175% registered at the end of 2010, and is planned to be achieved by winding down or disposing of a portion of the company's loan portfolio over the next three years. ‘Downsizing' is probably a better term to describe the planned action. Portfolio reductions envisage mainly getting rid of approximately €30 billion of BOI's non-core loan portfolios (such as UK Intermediary sourced mortgages; selected international niche businesses; certain international commercial investment property portfolios; etc.).
Impairments
In H1-2011, BOI registered lower impairments on loans and advances to customers than in H1-2010: €842 million versus €1,082 million, reflecting "Lower impairment charges on the Non–property SME and corporate, Property and construction and Consumer portfolios [...] partly offset by higher impairment charges on Residential mortgages in Ireland", although the impairment rate (as percentage of average loans during the period) remained the same as in the previous six months. BOI maintains its expectations that the impairment charges on the loans and advances to customers (excluding assets sold or held for sale to NAMA) will continue declining, and has a goal to reach impairments of 55bps – 65bps in 2014 (as percentage of average annual loan book balance).
Credit ratings downgrades
Since the end of 2010, BOI has had its credit ratings downgraded further.