Irish banks can’t escape legacy issues of the crash

No matter how hard they run, AIB and Bank of Ireland can't distance themselves from the legacy issues of the crash.

They are both back in profit and generating capital but their mountain of non-performing loans and arrears continue to weigh heavily on them.

This was illustrated by the results of the European Banking Authority’s stress test results, which ranked them near the bottom of a league table of 51 European banks under an adverse scenario being applied to capital buffers for the 2018 financial year.

When the numbers were run through the machine, AIB had a fully loaded Core Equity Tier 1 (CET1) ratio of 4.31 per cent while Bank of Ireland’s was 6.15 per cent. Regulators and analysts would expect to see a figure of at least 5.5 per cent.

The only bank with a worse rating than AIB, using this methodology, was Italy’s Banca Monte dei Paschi di Siena, widely considered to be a basket case. It had a rating of -2.44 per cent.

Unlike previous examinations, the EBA tests weren’t about passing or failing. This data was to inform the markets and will feed into the annual supervisory review and evaluation process, or SREP as it is otherwise known, which is used to determine capital requirements and capital guidance for banks.

Negative coverage

Nonetheless, the headlines around Europe about the Irish banks were negative and both AIB and Bank of Ireland found themselves on the back foot in terms of their messaging around the results.

It added to the negativity in the minds of Irish taxpayers who bailed out both institutions and don’t hold financial institutions in high esteem.

It seems that neither the banks, nor the Central Bank of Ireland, nor the Government foresaw this negative reaction in the run-up to the results.

The regulator seems baffled as to why the focus fell on the fully loaded CET1 figure, which is where the Irish banks performed poorly, as opposed to the transitional numbers, under which they are currently regulated.

Both banks published their half-year results earlier in the week and, while they were careful not to comment specifically on the outcome of the EBA results, they both indicated that they were comfortable with their capital positions. The clear impression was that there was nothing to worry about.

It turns out that while the bank’s knew their own individual numbers, they were not aware of how the other banks had fared and they were blind to the fact that they would be lumped in with Monte dei Paschi and other laggards at the bottom of the rankings.

There was also confusion as to whether the fully loaded figure would feature in the EBA’s results.

There are mitigating factors for AIB and Bank of Ireland. The tests were carried out on a so-called static balance sheet basis, at end 2015. Both have since booked substantial profits in the first half of this year and generated additional capital.

Both have expensive contingent capital notes coming off their books and the full loaded figures didn’t take account of the large deferred tax assets that they should be able to utilise in the years ahead.

The adverse scenario also applied big hits to loan books that have already been substantially written down since 2008 to reflect the massive crash that occurred. This is probably a bit harsh.

Capital depletion

Yesterday, in a speech to the IIEA, the Governor of the Central Bank Philip Lane noted that relative to other member countries, the Irish banking system had experienced higher loan loss rates since 2008.

“Since projected credit losses in the adverse scenario are calculated based on past experience, the capital depletion in the adverse scenario is inevitably more pronounced for Irish institutions,” he said.

The governor added that the primary message from the EBA exercise was that AIB and Bank of Ireland were adequately capitalised but “remain vulnerable to a downturn, especially in relation to the continued workout of problem loans and the sustainability under stress of current profitability levels”.

Will this vulnerability impact on the planned IPO next year of AIB? It’s hard to say at this juncture, but the the EBA results haven’t played well with the markets, with European banking stocks being hit across the board.

Bank of Ireland's share price is about 14 per cent lower than its close last Friday, while Permanent TSB, which didn't feature in the EBA's exam, has shed 2.3 per cent. AIB's share trading is meaningless in the context of it being 99.9 per cent State owned.

Some of this decline might be due to Brexit, which ratings agency S&P yesterday signalled as a “negative” for the Irish economy.

But the EBA stress tests have reminded us that we shouldn’t take the recovery of the domestic banks for granted.

Events can conspire to dash the best laid plans and AIB’s planned IPO might not happen in 2017, just as it didn’t this year or last.

Twitter:@CiaranHancock1