PTSB now has a fighting chance of delivering returns that will allow a Government exit

Spare a thought for Jeremy Masding, the Welsh banker who took on the job nine years ago of saving Permanent TSB (PTSB).

As chief executive, Masding developed PTSB’s mortgage arrears systems from scratch, convinced the government and the European Commission that the bank had a future after a €4 billion taxpayer bailout, and returned it to the main stock market after failing European stress tests. He also, against the odds, completed the sale of its UK loan book in 2016 after the Brexit vote, and offloaded billions more of problem home loans.

It was enough for regulators and the government to indulge Masding and allowed PTSB to trundle along, even though it had little prospect of making enough profits to justify its existence over the long run. The vague hope was that, one day, it would take part in some form of industry merger to form a “third force” in banking.

But, by the time Masding left the bank in June last year, that prospect seemed as elusive as ever.

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His successor, Eamonn Crowley, who joined the bank as finance chief four years ago, is having more luck.

On Friday, PTSB, reduced to a shadow of its former self after more than a decade of painful balance sheet shrinkage, confirmed that it plans to acquire €7.6 billion of mortgages and small business loans from Ulster Bank, as the latter retreats from the market at pace.

Ulster Bank's parent, UK-based NatWest Group, raised the white flag in February, conceding that it had given up any hope of making a decent return in the Republic amid ultra-low interest rates, high capital demands as a legacy of the extent of the crash here, and muted loan demand stemming from the triple whammy in recent years of Brexit, a dysfunctional housing market and Covid-19.

Loan book expansion

The deal will increase PTSB’s pitifully small loan book by more than 50 per cent to €22.5 billion and also involve the bank taking over 25 of Ulster Bank’s 88 branches in the Republic.

PTSB had €3.8 billion of excess deposit funding on its balance sheet at the end of December and it has a real incentive now to lure depositors over from Ulster Bank in the next nine to 12 months to give it more cash to complete the loan purchase. Debt issuance will also be an option.

But the real concern from the outset, when PTSB announced in February that it was in early talks to buy Ulster Bank loans, was the fact that it would need to raise hundreds of millions of expensive equity capital to support the expansion of its balance sheet. Much of it was expected to come from the State, which continues to own 75 per cent of the bank.

However, PTSB said on Friday that it wouldn’t need to go cap in hand to shareholders, confirming an Irish Times report from last month that NatWest was prepared to accept up to a 20 per cent stake in the bank as part-payment for the loans.

A back-of-an-envelope job by Goodbody Stockbrokers analyst Eamonn Hughes suggests this could amount to €200 million. But PTSB needs to generate about €440 million of capital, all told, to support the loan purchase.

The difference is expected to come from NatWest selling the Ulster Bank loans at enough of a discount so that it generates a capital gain for PTSB – or what accountants like to call “badwill”.

The European Central Bank (ECB) said earlier this year that it would recognise verified accounting badwill from a capital point of view when assessing deals, as it pushes for banking consolidation at a time when banking asset valuations are under pressure. That’s as long as the gains are not used for the payment of shareholder dividends.

Transformative deal

By taking a stake in PTSB, NatWest hopes to benefit from any upside the discounted loan sale will deliver for the Dublin-listed bank.

PTSB was cranking out a profit return of just 3 per cent on shareholders’ equity even before Covid-19 – about one-third of the rate investors expect to see in a healthy bank. Hughes only expected it to claw its way up to 6.5 per cent by the middle of this decade, before the Ulster Bank deal was on the table.

Only one bank in the market had a worse return on equity (RoE) than PTSB before the pandemic: Ulster Bank. Of course, this was not helped by the high level of capital it was being required to hold on its balance sheet by regulators. Hughes reckons the transformative deal could push PTSB’s RoE up to 9 per cent by 2025.

AIB boss Colin Hunt has also been making eyes at Ulster Bank as it retreats. Having agreed last month to take over €4.1 billion of corporate and business loans, Hunt is now looking to bag Ulster Bank's €6.5 billion tracker-mortgage book at a tasty discount, according to sources.

The difference between Hunt and Crowley is that AIB is awash with excess capital, thanks to the then government’s over-the-top recapitalisation of the bank during the crisis as it sought to convince financial markets the lender was not going to implode.

But in an effort to save himself from going to the Minister for Finance for money to buy Ulster Bank loans, Crowley will find himself with not one but two shareholders that have no real interest in staying on board any longer than they have to.

With 80 per cent of the stock in the hands of the Government and NatWest – itself majority-owned, for now, by UK taxpayers – this will linger like a dark cloud over PTSB’s share price.

But, with a fair wind behind it, PTSB now has a fighting chance of delivering the kind of returns that will win over stock market investors – and allow the Government – and NatWest – to exit.