AIB and Bank of Ireland’s ‘outsized upside’ to rising interest rates highlighted

Bank of America Global Research note reiterates ‘buy’ ratings for the two Irish banks

Bank of America Global Research has reiterated its "buy" ratings on Bank of Ireland and AIB in a note on Irish banks titled "well, it took a while – but we made it".

The note by research analyst Alastair Ryan anticipates that the big two banks will increase their lending volumes amid strong economic, employment and wage growth.

The departure of Ulster Bank and KBC Bank Ireland from the Republic has enabled a "re-gearing" of market survivors AIB and Bank of Ireland, which now have "outsized upside" to higher interest rates, the note said.

Bank of America raised its earnings targets for AIB and Bank of Ireland for the second time in a month, citing the expectations that interest rates will increase.

While the margin on the tracker mortgage portfolio AIB is set to acquire from Ulster Bank is low, its contribution will grow "directly and proportionately" as the European Central Bank (ECB) lifts rates.

“Therefore, the portfolio acquisition is set to be immediately earnings accretive, without reducing the right sensitivity to future hikes.”

Bank of America’s price target for AIB has been raised from €3.20 to €3.30 and for Bank of Ireland it has been increased from €7.30 to €7.50.

Deposit interest

While the two banks have tripled their current accounts in the past decade to more than €100 billion, which has been costing them money since 2014 when the ECB deposit rate turned negative, the expected hikes in this rate in the months and years ahead will reward them for doing so.

The rate rises, which are likely to begin as soon as July, are “potentially highly significant” for AIB and Bank of Ireland.

“Market shares and pricing should also help loan revenues,” the research note continued.

“And with the deposit surplus residing in the listed banks, we believe that they will be the direct beneficiaries of higher rates, while wholesale funded competitors may find the bond market less accommodating.”

With the Irish economy set to grow faster than elsewhere in Europe and collateral values on the rise, Mr Ryan said Bank of America Global Research was "confident in a benign impairment outlook" for the two banks.

“With the two major banks having re-geared through acquisition and with balance sheets set to grow organically, excess capital return is a smaller part of our investment case. Growth and dividends are a larger part,” he wrote.

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