Irish Life & Permanent (IPM.I) – Known Unknowns
(This is the fourth installment in my series of case studies on the shares that make up my portfolio. To see the other three articles, on Datalex, Trinity Mirror and Datong, click on the company names)
Within my portfolio I have a tiny legacy position in Irish Life & Permanent – which is currently valued at slightly more than €10! As a result, from my personal perspective, the main ‘value’ that it contributes to me is that it carries some useful tax losses that I will use to offset gains elsewhere in the portfolio over time. However, based on some of the queries I’ve received from blog readers, I appreciate that some people are looking at it from the perspective of exploring if there is some genuine value in the stock at current levels. So, the purpose of this blog is to examine if that is the case.
To understand where IPM is at now one has to start by looking at the results of the 2011 PCAR / PLAR. This revealed that IPM had a capital requirement of €4.0bn. To meet this requirement, the group targeted raising proceeds of €1.1bn from the sale of Irish Life Assurance and Irish Life Investment Managers (ILIM), along with an LME in relation to the Tier 2 debt in its banking unit. Of the balance of €2.9bn, €0.2bn of this related to the 2010 PCAR requrement, which is being met from group resources, while the Irish government contributed €2.7bn (equity of €2.3bn and €0.4bn of contingent capital notes). Following the government capital injection, the Irish State owns just over 99% of Irish Life & Permanent plc.
In terms of disposals, the group was forced to suspend the sale process around Irish Life in late November. This means that the Irish State may have to inject another €1bn into IL&P. In recent times it was interesting to read reports that AIB is to appoint Irish Life as its new life and pensions jv partner, which should enhance the attractiveness of Irish Life to potential suitors should the sale process be reactivated.
Apart from Irish Life and ILIM, the other major ‘moving parts’ of IL&P are its banking unit (permanent TSB) and its general assurance partnership (which IL&P owns circa 30% of) with Allianz.
The bank is the main problem area for IL&P. The challenges facing it are substantial, including: (i) domestic economic weakness, with high unemployment and falling disposable incomes; (ii) an over-reliance on wholesale funding – permanent tsb’s loan-to-deposit ratio was an unsustainable 227% at the end of H1 2011; (iii) intense competition for deposits in the Irish market; (iv) a high exposure (roughly 66% of loans and receivables in 2010) to trackers, which limits the scope for repricing; (v) elevated impairment losses (IL&P booked impairment provisions of €1bn between 2008 and 2010, and a further €333m in H111); and (vi) the challenge of finding suitors for parts of its loanbook at levels that would not result in further material hits to capital.
As part of the 2011 PCAR/PLAR IL&P has to cut its LDR to 122%. As noted above, its current LDR is significantly higher than that (at the end of H1 2011 customer accounts and deposits totalled €15.5bn, or 37% of total funding) and given the highly competitive market for deposits at this time, it looks to me like selling off chunks of the loanbook is going to be the primary driver of solving the LDR issue. This brings me to the first ‘known unknown’ – the haircut that this will ultimately entail. The PLAR requires the sale of the bank’s UK mortgage book and its commercial mortgage book. The PLAR assumes that this will be done at haircuts of 25% and 50% respectively.
The second ‘known unknown’ is the level of impairments that the loanbook will incur over the coming years. At the end of June, permanent tsb’s loanbook was €36.2bn, against which the group had made provisions of €1.2bn (3.3%). At the same time some 11% of the loanbook was classified as non-performing. While some of the NPLs will no doubt be recovered, I don’t see an end in impairment charges anytime soon. On this point, it is interesting to note that the PCAR/PLAR requirement will leave the group with a 33% capital ratio in 2013 and excess capital of €1.5bn.
Given the above uncertainties, the third ‘known unknown’ for me is the valuation. At present IL&P has a market cap of €840m. Is this reasonable? Given the structure of the group, I propose to look at it on a sum-of-the-parts basis. For me there are three key components to IL&P – the bank, the life business and the associate (Allianz jv).
If you assume that, aided by the AIB reports, that Irish Life and ILIM can be sold for €1.1bn (as noted above), and value the Allianz jv at its end-2010 book value (€124m), this gives an ex-bank valuation of €1.224bn. Stripping out the current market cap means that the bank is valued at minus €382m (I am ignoring the rest of the group for the purposes of this analysis).
Is permanent tsb really worth -€382m? Ultimately, it depends on the ‘known unknowns’ above and macro developments that are outside of the group’s control. The €1.5bn of excess capital under the PLAR could offer some encouragement, but given that this is equivalent to only around 5% of the loanbook, depending on your views on the outlook for loan losses, funding costs, haircuts and the Irish economy you may come up with another view on where the capital position of the group will be in 2013. Also, disposal proceeds for the non-banking operations could ultimately prove to be materially different to what I sketch above, which would have a significant effect on the implied valuation for the banking unit. Where to even begin to resolve this?
Overall, the word that comes to mind is ‘uncertainty’. To a large extent IL&P’s prospects rely on factors over which it has limited (at best) control, which is discouraging. Depending on how it gets on with resolving its funding mix, asset disposals and managing the loanbook there could be some value at these levels, but you could just as easily assume that there is significant downside risk from current levels. My instinct – and I can offer no more than that given the uncertainty – is that the risks are simply too high to invest more in it at this time.