Investor - An insider's guide to the market: The spotlight in the financial sector has been firmly on Bank of Ireland this week as it updated the market on current trading and its proposed cost initiatives over the next four years.
On the basis of media headlines, one could be forgiven for thinking that the bank was about to engage on a major redundancy programme.
The headlines emphasised the group's planned reduction of 2,100 in its staff numbers. While this is undoubtedly significant in the context of a total group head count of 17,000, reductions will be implemented over the next four years.
These rationalisation measures are expected to eventually yield annual cost savings of €120 million.
However, the savings will build up gradually over the four-year period, with cost savings of just €30 million expected to accrue in the current 2005/06 financial year, increasing to €75 million in 2006/07, and eventually reaching an ongoing annual reduction in costs of €120 million by 2008/09.
The cost reduction programme will focus on the retail business in Ireland, streamlining support services and consolidating some processing activities.
Rationalisation and implementation costs to achieve these savings are expected to amount to €210 million and technology capital expenditure of €40 million is also planned.
Along with other Irish financials, Bank of Ireland has enjoyed rapid growth in loans and deposits over the past five years. A substantial decline in net interest margins has meant that the resultant profits growth has been more muted.
Nevertheless, as measured by its share price performance, the bank has delivered reasonable returns to shareholders over the past five years. Over the past year, the share price has risen by just under 20 per cent, while the five-year annualised return is approximately 14 per cent.
This one-year performance is in line with the Iseq Overall index, but the five-year performance is substantially ahead of the Iseq. If dividends are taken into account, it is clear that B of I has delivered very respectable returns to its shareholders over the past five years. By focusing on its cost base, the group seems to be recognising that the pace of growth in its loan book is likely to slow considerably in the coming years.
Even if the Irish residential property market stays strong, the percentage annual rate of growth in the demand for mortgages is bound to slow in coming years.
Furthermore, competitive pressures seem set to intensify and therefore profit margins, as measured by the net interest margin, are likely to keep contracting in the coming years.
As well as aiming to make the Irish business more efficient, B of I also stated it had received some approaches for Bristol & West, its UK building society. If a deal is eventually agreed, only B&W's branch network and deposit base will be sold.
B of I will retain the mortgage book and will continue to run this within its overall UK operation. Following the recent sale of Chase de Vere, and assuming that the Bristol & West branch network is sold, B of I will have gone a long way in streamlining its UK business.
In terms of its update on current trading, the statement contained few surprises. The group's net interest margin is expected to decline by 20 basis points, so that loan growth of 16 per cent will translate into growth in net interest income of 9 per cent. Non-interest income is expected to rise by just 2 per cent, reflecting lower fee income from asset management due to fund outflows of €10 billion from BIAM.
The short-term market reaction to the bank's plans was muted and the share price in fact declined in the aftermath. Most investors in B of I will, however, have a long-term perspective and the key issue is whether the bank is embarking on a strategy that will continue to enhance future shareholder returns.
Most long-term investors will probably look favourably on the bank's strategy. At its current price, B of I is trading on a price-earnings ratio of 10.1 and an historic dividend yield of 3.4 per cent.
These are not particularly demanding ratings, although there are in line with UK and Irish banks (see table).
Investor believes that banks in general will find it difficult to achieve high rates of growth in earnings-per-share in coming years. B of I should be capable of producing modest but consistent growth in earnings over the medium term and its focus on cost cutting should be viewed favourably by investors.
Therefore, the combination of an undemanding stock market rating and prospective steady profit growth should reward investors in B of I with solid returns over the medium-term.
:quality(70)/cloudfront-eu-central-1.images.arcpublishing.com/irishtimes/VR3765MFOBH2NMV2QNICYDF67M.png)