‘Mind the gap’: BofI boss hopes London trip will close stock discount

Keen followers of Prem Watsa, Canada's answer to investing legend Warren Buffett, may have spotted in the latest annual report, his Fairfax Financial Holdings sold its remaining shares in Bank of Ireland last year.

The quiet disposal crystallised the last slug of over €1 billion of gains made by Watsa and his friend Wilbur Ross, after the duo led a group of investors that took a 34.9 per cent stake in Bank of Ireland at the height of the financial crisis in 2011 – saving it from nationalisation.

Both started selling down their respective original 9.3 per cent stakes in early 2014, months after Ireland exited an international bailout and Bank of Ireland returned to profits after the financial crisis. (Ross, now US commerce secretary, flogged his remaining stake in mid-2014.)

The North American investors' bet was simple: that Bank of Ireland's then chief executive, Richie Boucher, could keep the lender from collapsing. They were rewarded handsomely.

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Next week is the turn of Boucher's successor, former HSBC executive Francesca McDonagh, to outline her grand plan as she hosts a capital markets day (CMD) in London on Wednesday for analysts and investors.

While the British banker got a crash course on Irish politics within weeks of arriving last October, when Irish banking bosses were hauled before the Minister for Finance for a dressing-down on the tracker mortgage scandal (she ended up setting aside a further €170 million to deal with the issue), major shareholders have given her more time to get her feet under the table. Until now.

Operating costs

The new boss has already been busy putting her stamp on the place. She’s overhauled her executive team (which has seen some high-profile departures being signalled). Having hinted in February that the company must cut its operating costs bill, from €1.8 billion last year, the new boss is seeking to take out about 15 per cent of middle management positions, and has presided over a decision in recent months to close 27 back-office service centres, affecting 420 employees.

Crucially, she moved within months of arriving to hire her own man, former National Australia Bank executive Steve Collier, to lead the €900 million information technology (IT) programme she inherited from Boucher.

Although Goodbody Stockbrokers analysts now reckon the IT overhaul will cost up to €1.1 billion, investors have been given few targets from the four-year programme, which started in late 2016, other than it is supposed to help push group costs below 50 per cent of income over the medium term. (The ratio stood at 62 per cent last year.)

McDonagh knows the stock will be punished next week if she doesn’t give more clarity on how the programme has progressed so far and what kind of savings the company can achieve from it.

In the absence of targets to date, analysts have been running their own numbers, with Goodbody estimating that €240 million of annual savings could be delivered by 2021. Sources have previously told The Irish Times that Boucher's team had been working off estimates that the project would lead to more than 1,000 job cuts. Following an almost 32 per cent drop in the bank's workforce since 2008, will the new chief executive be brave enough to talk on Wednesday about the next wave of redundancies?

Then, of course, there’s the income side of the cost/income ratio. While Bank of Ireland’s interest-generating loan book has shrunk by 45 per cent in the past decade, it has begun to show tentative signs of returning to growth. Advances increased by €100 million to €76.2 billion in the first quarter, as new lending – driven by UK and Irish mortgages – outpaced loan repayments for the first time in years. Rival AIB’s loan book also seems to be at an inflection point.

Home loans

While UK home loans have been the most active lending category in recent years, the new chief executive is expected to face a number of questions next week on the bank’s franchise in an already very competitive market on the other side of the Irish Sea – particularly in the wake of Brexit.

The UK is an important source of diversification for the bank, where it has strong relationships with the Post Office, AA and mortgage intermediaries. Indeed, McDonagh knows this market like no other chief of an Irish bank. But while Bank of Ireland’s UK retail operations currently make up about 36 per cent of the group balance sheet, it only makes up 20 per cent of income.

While the bank is currently generating better lending margins on new loans than existing facilities in Ireland, the reverse is the case in the UK.

"Concerns in relation to the UK business stem from two main issues: firstly, how the bank views the business in the context of Brexit and the economic risks that come with it," said Owen Callan, an analyst with Investec in Dublin, in a report sent to clients this week. "And, secondly, how management tend to position and develop the business, given its significant portion of balance sheet exposure, but somewhat lower proportion of income."

Boucher saw off the threat of the Bank of Ireland falling into the hands of the State like the rest of the banking system during the crisis and returned more than €6 billion to taxpayers following the company’s €4.8 billion bailout. And he prepared the ground for a return to dividends earlier this year for the first time in a decade.

But with Bank of Ireland stock trading at a 20 per cent discount to the value at which the company values its assets on its books, the Government can’t justify selling its remaining 14 per cent stake in the lender. (AIB’s shares are trading at bang in line with their “book value”.)

Investors – including Irish taxpayers – who have stuck around longer than Watsa and Ross will be hoping that McDonagh’s vision will help bridge the valuation gap.