Dreaded R-word hampers Donohoe’s hopes of AIB block sale

Colin Hunt, AIB’s normally quick-on-his-feet chief executive, stalled for a moment when asked on Thursday about the outlook for customer interest rates, during a rapid-fire round of questions from reporters after the bank’s first in-person annual general meeting (agm) in three years.

“Well... we... we will consider mortgage market pricing in the context of official interest rates,” he said, after an uneasy pause.

“Once we see official interest rate announcements happening, we will consider the appropriateness of our pricing right the way across our product range.”

Having been given the nod last week from the Competition and Consumer Protection Commission (CCPC) to proceed with the purchase of €3.7 billion of Ulster Bank corporate and commercial loans, as the UK-owned lender retreats from the market, the last thing Hunt wanted was to land on the watchdog’s radar for signalling rate plans for customers.

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Still, AIB this week finally publicly recognised how it stands to benefit from expected central bank rate hikes over the remainder of the year.

In a trading update issued hours before the agm, AIB said it now expected its net interest income to rise by “a high single-digit percentage” this year, when factoring in expected rate increases from the European Central Bank (ECB) and Bank of England to combat soaring inflation, as well as the purchase of the Ulster Bank corporate and commercial book.

AIB now feels comfortable with financial market assumptions that the ECB will increase its deposit rate from minus 0.5 per cent to zero by the end of the year, followed by rises in its main refinancing rate, which automatically moves tracker-mortgage rates and serves as a key reference rate for other lending rates. The Bank of England’s base rate, the subject of a 0.25 percentage point increase on Thursday to 1 per cent, is expected to be at 2 per cent by close of 2022.

Excess customer deposits

The big issue with AIB’s balance sheet is the amount of excess customer deposits it is holding, following years of muted loan demand and growing household savings – accelerated by the Covid-19 crisis.

At the end of December, AIB had a staggering €35 billion of excess cash on deposit with the ECB, attracting negative rates. While AIB has been progressively passing the penalty on to customers – with about €18 billion of deposits by customers with more than €1 million in their accounts currently subject to a 0.75 per cent charge – the remaining banks in the market will have to absorb billions of euros of deposits as Ulster Bank exits the market. AIB clearly stands to benefit from a move in official rates back to zero.

AIB’s share price jumped over 4 per cent in early trading on Thursday as investors bought into the fresh interest income forecast – and the fact that the bank had launched a €91 million share buyback programme.

The Government, with an almost 70 per cent stake in the bank following its crisis-era bailout, is poised to be the main seller into this. Minister for Finance Paschal Donohoe has also been drip-feeding AIB shares into the open market since January.

But Donohoe has been eager for some time to open a third front – given that taxpayers have so far recovered only about half of AIB’s €20.8 billion rescue bill. He deliberately inserted a line in a statement on AIB before Christmas that he was open to selling large blocks of shares to institutional investors through so-called accelerated bookbuilds. It was an important signal.

However, European banking stocks, measured by the Euro Stoxx Banks Index, have plunged almost 28 per cent since mid-February, amid rising concerns about Europe succumbing to recession amid economic shocks from the war in Ukraine, soaring energy and food prices that have been further stoked by the conflict, and worsening global supply chain problems as a result of China’s zero-Covid policy.

The surge by AIB’s shares on Thursday morning proved short lived. The stock ended up being dragged into the red along with broader equity markets during the session as the Bank of England accompanied its widely anticipated rate increase with the bombshell that it now expects the UK economy to contract by 0.25 per cent next year, compared with a previous forecast of 1.25 per cent growth.

Inflation

Even after three rate hikes since December, the Bank of England expects UK inflation to hit 10 per cent this year. Of course, much of the UK’s consumer price woes have been fuelled by Brexit trade and immigration restrictions.

But the Bank of England is the first major central bank to mention the dreaded R-word. And it’s unlikely to be the last. JP Morgan chief executive Jamie Dimon, the longest-serving chief executive on Wall Street, told The Irish Times earlier this week that he gave the US Federal Reserve, which began raising rates last month, only a 30 per cent chance of pulling off a soft landing.

The International Monetary Fund (IMF) signalled on Thursday evening that the Irish economic growth was set to remain an outlier, despite “substantial uncertainty” due to the indirect impacts of the Ukraine war. It sees Irish gross domestic product (GDP) expanding by 6 per cent this year, followed by 5 per cent growth in 2023.

“The Irish economy is well placed relative to other parts of Europe to deal with the challenges posed by both the war in Ukraine and inflation, due to the defensive nature of the multinational sector in Ireland and domestic businesses and consumers have deleveraged significantly in the past decade,” said Diarmaid Sheridan, an analyst with Davy.

“Irish banks will also be material beneficiaries of rate increases due to the nature of balance sheets with the majority of assets now deposit funded.”

Try convincing the market. AIB’s shares are currently trading at less than 50 per cent of the level at which the bank’s assets are valued – or what is known as book value – in a skittish market where European banks are trading at depressed ratio of 63 per cent, compared with 0.84 per cent before the Ukraine war.

Selling small amounts of AIB shares into the market and a buyback programme may be just about defensible at the moment, as the valuation discount is partly down to the fact that the State remains an almost 70 per cent shareholder. But any hope of a block sale must surely be on hold for now.