BANK of Ireland has made a bold move to strengthen its operations in the British market with its £600 million purchase of Bristol & West. The move should prove good for the bank's shareholders.
There are three main reasons for the bank's largest ever acquisition.
. It needed to achieve scale and focus in the difficult and rapidly changing British market.
. It needed to find a way to diversify its earnings stream because about 77 per cent of its profits are generated in the Irish market.
. And, in a low interest environment, it needed to find a good acquisition to make its strong cash balances generate a good return for shareholders.
A further £145 million will be added to cash resources next week when the merger of its First New Hampshire operation in the US with the Royal Bank of Scotland subsidiary, Citizens Financial Group, is completed.
After its chastening experience in the US, Bank of Ireland is well aware of the importance of making the right acquisition.
In B & W, it is acquiring a building society which has had problems. But a new management team put in place in 1991 seems to have brought a new focus to the operations. It has sold its estate agency and is concentrating on core mortgage and savings products. This management team headed by Mr John Burke will continue to manage B & W plc.
While B & W's total income fell last year (because fee income was lower), core operations were stronger. Lending increased but loan loss provisions were lower, falling from 1.1 per cent of total loans to 0.9 per cent.
Arrears fell from 1.05 per cent of total loans to 0.68 per cent. Pre tax profits on continuing operations increased from £71.1 million to £77.1 million. The net interest margin was stable at 1.7 per cent.
The society's finances are moving in the right direction, with improving asset quality and lower arrears in a fragile housing market, which appears to be coming out of the depths of depression.
B & W has about 1 per cent of the British mortgage market, but a more significant 7 per cent of the market in the south west region. It has 3 per cent of the total UK deposit market but 14 per cent of the market in its region.
B & W has a relatively high cost base with 2,100 employees and a cost income ratio of 45 per cent, and addressing this is one way for Bank of Ireland to generate a higher return. Bank of Ireland chief executive Mr Pat Molloy said the building society is intent on reducing the cost income ratio.
Bank of Ireland management believes that B & W could generate considerably more revenue from its existing cost base. There would be cost savings through the merger of Bank of Ireland's mortgage operations in Britain (BIM) with the building society. Further cost savings would come from the reduction in staff numbers through non replacement of staff who leave.
The acquisition will also give BIM access to cheaper funds through B&W's deposit base. BIM currently borrows on the more expensive wholesale market.
There is no overlap between B & W's network of 159 branches in the south of England and the BIM operation based in Reading. Bank of Ireland's 27 branches in Britain will remain separate but may feed mortgage business to the building society.
At £600 million sterling (£583 million), the price is 11.6 times Bristol & West's 1995 post tax profits of £19.9 million after the write off of £31 million for losses on the sale of Hamptons.
By the time the deal is completed - in mid 1997 - the addition of another year's profits will mean that the multiple will be lower. On completion the price of 1.67 times book value will be lower too, for the same reason. The price is in line with similar recent acquisitions in the UK market.
Spending £600 million will reduce Bank of Ireland's strong capital ratios. But the ratio will remain well above the statutory minimum of 4.5 per cent - probably 6 to 6.5 per cent.
The acquisition meets a strategic need for Bank of Ireland. Acquiring a relatively low risk, well managed business with good potential for growth and costs savings should lead to a good return for Bank of Ireland shareholders.
