B of I have job to convince investors of merger's worth

The initial stockmarket reaction to the proposed merger between Bank of Ireland and the Alliance & Leicester (A&L) was to send the shares of the two banks shooting upwards. But now that the market has had time to absorb what details are available, some analysts are beginning to wonder whether it is the right deal for the Republic's second biggest bank.

When details of the merger filtered into the public domain last weekend, the market was stunned by the scale of the deal, which appears to be in the final stages of completion.

Together, Bank of Ireland and A&L plan to merge into a £13.5 billion company (€17.6 billion) with more than 500 branches. Some 68 per cent of the group's assets will be held in the UK market with just 30 per cent in the Republic. The rationale for the merger from Bank of Ireland's perspective is partly defensive - taking a long-term view, if it is not part of a larger grouping then it risks being swallowed up itself. The bank will argue that it is also a crucial step to building long-term growth and value for its shareholders. The pace of consolidation which is sweeping across the global banking sector is constantly gathering speed. So far most big mergers have been within national boundaries, but it appears only a matter of time before the major institutions emerging across Europe will seek to expand beyond their own territories, possibly spawning the emergence over the next decade of a small number of really major players.

Irish financial institutions are aware that against this background they will eventually be forced to consider new alliances and a shift in their ownership structure, if they are to remain competitive.

The Bank of Ireland/A&L merger will, both hope, offer a greater degree of control over their destiny. In this scenario, they get to choose who they get into bed with rather than being forced to entertain an unwelcome advance from a larger predator at some stage. Crucially, their joint resources will allow them to consider further expansion - a £13 billion bank is still only middle ranked in UK terms - with the British market the most likely initial target.

But whatever the long-term strategic motivations, market sentiment towards the deal has turned somewhat negative over the past couple of days. In particular, market analysts have cast doubts over the benefits of the deal to Bank of Ireland. Many feel the bank is settling for a lot less than it should in terms of management control and they are also cautious about the prospects for the very competitive UK mortgage market.

These concerns are based on the details that are in the public domain at the moment. One of the difficulties for both banks is that stockmarket rules and the need for regulators on both sides of the Irish Sea to work out how they will oversee the new institution, mean that they are precluded from giving further details. In the resulting vacuum, some negative comments have hit the Bank of Ireland share price, in particular.

One of the features of the deal drawing market comment is that despite Bank of Ireland's dominant position - holding 55 per cent of the total shares in the combined entity - the new group will be managed by A&L chief executive, Mr Peter White.

The plan is that Bank of Ireland group chief executive Maurice Keane will relinquish his management role to become a non-executive director, becoming nonexecutive chairman next year while the bank's deputy chief executive, Mr Pat McDowell, will become deputy to Mr White. Bank of Ireland will appoint the first chairman - Howard Kilroy - and he will be succeeded in a year by Maurice Keane. Board positions will be divided 50:50.

Bank of Ireland's management team is well respected within the investment community. The bank has staged a remarkable recovery over the past decade and shareholders have done very well on the back of this success. It is not surprising that concerns are being voiced about the changeover in command.

Mr White's lack of experience in running an institution as diverse as the Bank of Ireland seems to be the main bone of contention. His reputation for cost cutting is considered a strength by the markets, but in the absence of full details on a proposed headquarters and management structure, the markets remain confused over how the new institution will be run.

The merger is being structured as a merger of equals. To achieve this, the new entity must contain an equal number of management from both companies. So when the final details are announced the make-up of the new management team may allay many of these fears.

Bank of Ireland may also argue that it is looking to the long term. Mr White is 57 and may serve in the top job for just three years. Some observers would suggest that as the merger is primarily of strategic importance, concerns over who will hold the top job in the short term are overdone. After all, in any merger of two institutions, someone has to be appointed as chief executive.

Bank of Ireland has been under pressure to diversify its earnings beyond its core market in the Republic. When it reported a 24 per cent rise in pre-tax profits to £831 million (€1.1 billion) earlier this month, its shares traded lower on the stock market. To some extent the share price was depressed by the huge amount of surplus cash the bank was continuing to sit on, but it also reflected concerns, particularly from investors in London about its heavy reliance on the Irish economy for future profit growth. Official forecasts are predicting a slowdown in the rate of growth of the Irish economy over the next few years which, if proved correct, would make it harder for the bank to sustain substantially higher profits.

The merger is the bank's response to such concerns. Alliance & Leicester is one of the most diversified of the UK former building societies. In 1998, 41 per cent of its profits came from activities outside of its core mortgage and savings business. These include Girobank, the market leading cash handling business in the UK, Sovereign Finance, an asset finance operations - which is similar but smaller than Woodchester and a personal banking business which offers personal unsecured lending, credit card and current account products. It also operates a centralised treasury operation.

Together the group will become the UK's fifth-biggest mortgage bank with enormous cash resources to aggressively expand its share of the market. It would also be well placed - in the longer term - to consider alliances with some of the larger Continental European banks.

As in all agreements, the devil is in the detail and until it is finally signed off there remains a chance that the deal will unravel. In particular, regulatory approval may take some time. If the deal were to fall apart, A&L would seem to be the more vulnerable to a takeover by one of its UK competitors. But equally, Bank of Ireland has shown its cards and could receive an approach from one of the UK or major European players.

Even if the two companies finalise the merger, they will have to convince their shareholders to vote in favour of the merger. Shareholders may be sweetened by a share buy-back or the payment of a special dividend if the deal is approved - after all both have large unspent cash piles. But it remains to be seen whether this will be a sufficient inducement to win the day.

At the moment, Bank of Ireland in particular seems to have a job to do to convince investors that the merger is worth doing. Then again, market sentiment has been known to be fickle - just look at the Bank of Ireland share price this week. Most will reserve judgement until the full details of the merger, and the strategic thinking behind, are fully explained by both sides.