ANALYSIS:With Nama looking an unlikely panacea, banks may take unpopular moves to turn a profit, writes SIMON CARSWELL.
THE EXPECTATION that the removal of toxic property development loans from the banks will solve their problems has been shot down by Bank of Ireland, which pointed out last Friday that tightening net interest margins would squeeze operating profits. The bank was signalling to the market that the models on which brokers set their forecasts for operating profits were out of kilter.
This shows that the National Asset Management Agency (Nama), the State’s “bad bank”, will not be a panacea for the ills infecting the Irish lenders.
Bank of Ireland said lending margins were under pressure due to low interest rates, greater competition for deposits and higher funding costs. This will weaken the bank’s ability to maintain profits to absorb bad loans. The difficulty for the bank, and indeed all State-guaranteed Irish institutions, is that the demand for lending is very low and the lenders cannot make up the shortfall on margin through new loans.
All this points to one potential outcome – Irish financial institutions may be forced to raise interest rates on their variable rate loans to increase profitability.
This would anger politicians and particularly taxpayers who have so far provided €10 billion to Bank of Ireland, Allied Irish Banks and the nationalised Anglo Irish Bank, and are paying higher State borrowing costs due to the guarantee.
While all the Irish lenders have come under intense political pressure to pass on interest rate cuts from the European Central Bank (ECB) for their standard variable rate customers, their British counterparts have not followed suit. The average standard variable rate (SVR) in the Irish market is 3.2 per cent and the average margin over the ECB base rate is 2.2 percentage points, according to an analysis of borrowing rates. This compares with an average of 3.7 per cent for foreign banks operating in the Irish market and an average margin of 2.7 percentage points over the ECB rate.
In the UK market, the average SVR among the top 10 banks is 4.08 per cent with an average margin of 3.58 percentage points over the Bank of England rate.
Bank of Ireland, AIB, EBS and Permanent TSB offer SVRs ranging from 2.25 per cent to 2.7 per cent. The SVRs offered by the foreign-owned banks range from 3.85 per cent at Ulster Bank to 4.29 per cent at KBC Bank.
Analyst Scott Rankin at Davy stockbrokers recently noted that foreign-owned banks are “under less political pressure to look keen” given that they are outside the guarantee, while capital and funding pressures at home mean their Irish units are “probably hamstrung at the moment”.
Irish retail mortgages have traditionally been priced lower over recent years to increase market share. Retail and corporate deposits have in turn been higher in the Irish market, partly distorted by the higher rates offered by Anglo Irish, though AIB and Bank of Ireland are known to match rates to retain some large deposits.
Following Bank of Ireland’s statement last week, analysts have cut forecasts for the bank’s operating profits before bad loans. Merrion Capital reduced the bank’s pre-provision operating profit for the year to March 2010 by €342 million to €1.4 billion and to March 2011 by €328 million. Goodbody and NCB also reduced their targets, while Davy in turn reduced its profit forecast for AIB.
To restore profitability to the banks cutting staff or bank pay must be considered, Davy said yesterday, pointing to the 30 per cent decline in staff and branches in the Nordic banking system between 1995 and 1999.
