AIB (ALBK.I) – Punt away or stay away?
(This is the fifteenth installment in my series of case studies on the shares that make up my portfolio. To see the other fourteen articles, on RBS, Marston’s, France Telecom, Ryanair, PetroNeft, Irish Continental Group, Independent News & Media, Total Produce, Abbey, Glanbia, Irish Life & Permanent, Datalex, Trinity Mirror and Datong, click on the company names)
While it is fair to say that we’re all wise in hindsight, former Allied Irish Banks (AIB) Chief Executive Eugene Sheehy must rue the day he said: “We’d rather die than raise equity“. In the three and a half years or so since he made that remark AIB (which now has 517bn shares in issue, versus 880m in 2008), and indeed the rest of Irish banking landscape, has been transformed beyond all recognition.
Of the six Irish institutions that were ‘covered’ by the bank guarantee, two have been nationalised and are now in wind-down mode (Anglo Irish Bank and Irish Nationwide Building Society), three are now 98% or more owned by the State (AIB, EBS – which has been subsumed into AIB, and Irish Life & Permanent’s ptsb unit) with only one, Bank of Ireland, remaining in majority private sector ownership. The casualties of the Irish banking crisis were not solely limited to domestic players, with many foreign owned institutions dramatically scaling back or closing their operations in recent years.
The government’s strategy for the banking system going forward is that it be designed around two ‘pillar banks’ – AIB, incorporating the Educational Building Society (EBS), and Bank of Ireland. A much slimmed-down ptsb will act as a third force in Irish banking, but given its small scale it will likely remain a marginal player in the absence of a major recapitalisation. I will deal with Bank of Ireland in a future blog, but for today my analysis is focused on the other ‘pillar’, AIB.
To illustrate the scale of the horrors AIB has endured in recent years, it is useful to look at its position going into this crisis. The bank was the leading player in the Irish economy, which had enjoyed years of buoyant growth during the so-called Celtic Tiger period. It had a significant presence in the UK, particularly in business banking. It owned a majority stake in BZ-WBK, the third biggest bank in Poland. It owned over 20% of M&T Bank, a US financial group whose second-largest shareholder was Warren Buffett. It also had operations across the Baltic States, Bulgaria and owned other businesses including asset management and stockbroking. In other words, it was a very diversified operation with some first rate assets. In 2007 its loanbook was split as follows: Ireland 67%, UK 25%, Poland 5%, USA 2% and ROW 1%.
However, this diversification could not protect it from the fall-out from the Irish economic disaster. Over the past four years the group has booked impairment charges of €21bn, which to put into context is roughly a sixth of the loanbook at the end of 2007. It has been forced to divest its Polish (net proceeds €3.1bn) and US operations (net proceeds €1.5bn), while selling other non-core business units, but even despite the billions of euro of proceeds they have brought in, and €4.3bn in LME gains over the past three years, the Irish State has still had to inject over €20bn into the group (see slide 49). In an effort to purge its loanbook of problem loans it transferred €20.2bn of loans to NAMA at a discount of 55% in exchange for €9.0bn in NAMA bonds (see slide 43).
Funding conditions have been very challenging for the group. Its net interest margin has been pared from 2.21% in 2008 to 1.03% last year. Customer accounts provide only 45% of its funding base, with deposits by banks (including €31bn from the Central Bank) a further 27%.
In terms of where the group stands today, following the disposals of recent years it has an 81% exposure to the Irish market, 18% to the UK and a 1% exposure to the US. Within the loanbook, 46% relates to residential mortgages, while a further 25% is construction and property related. Given that mortgage losses have a long ‘tail’ it appears likely that AIB will book another significant impairment charge in 2012, although management guided in the 2011 results presentation that “provisions [are] expected to materially reduce in 2012” (2011: €7.9bn). With the group’s end-2011 loanbook of €99bn standing well above the €79bn target set for end-2013 as part of the PLAR/PCAR process, further disposals are a certainty, and the haircuts they incur remains to be seen. Should demand for these loan assets prove slow, this will presumably further limit AIB’s ability to lend into the Irish market, which has the ‘vicious circle’ effect of dampening domestic activity at a time when AIB could really use a pick-up in the economy.
On paper the group has a strong capital base, with core tier 1 capital of 18.0% at end-2011, but the future impairment charges, restructuring costs (the group has embarked on a big voluntary severance programme) and haircuts noted above will test this in the coming years. The LDR of 136% at end-2011 is a big improvement on the 165% seen in 2010, and AIB will be looking to improve this in order to meet its target of 122.5% by end-2013.
Unlike the last bank I featured in my series of case studies, RBS, in my view AIB has not yet turned the corner. The difficult domestic economic conditions, allied to wider Eurozone fears, the ‘known unknowns’ in the shape of further impairments and haircuts on disposals and tepid credit demand all paint a difficult picture. On top of that, the valuation is completely anomalous. Due to the vast numbers of shares issued to the Irish State (which owns 99.8% of AIB) in exchange for various capital injections and in lieu of cash payments on preference shares, AIB has 517 billion shares in issue, so every 1c move in the share price has a significant impact on its market cap. Based on this evening’s closing price (6.5c), AIB is capitalised at €33.3bn, which compares with the €2.7bn its similarly sized fellow ‘pillar’ Bank of Ireland is capitalised at. Indeed, AIB’s market cap today is a multiple of what it stood at during the height of the Celtic Tiger, when it also had significant operations in the US and Eastern Europe. Looking at it on conventional valuation metrics, based on its reported end-2011 NAV and the present number of shares outstanding, AIB is trading on a trailing price-to-book multiple of 2.3x. It should also be borne in mind that this NAV is flattered by government capital contributions designed in part to cover losses out to end-2013. Furthermore, using the same metrics its fellow pillar, Bank of Ireland, trades on a trailing price-to-book multiple of only 0.3x.
In terms of my investment view, my shareholding in AIB consists of what is now around €20 worth of legacy staff shares purchased under a scheme called: “Salary Foregone”. My gut feeling is that “Salary Gone” is a better way of describing that ‘investment’. To me, AIB is too expensive in both absolute and relative terms, is over 80% exposed to a very challenging Irish market and there are a great many significant ‘known unknowns’ in terms of impairments and haircuts on disposals to negotiate before a clearer picture on its prospects will emerge. For years the bank’s advertising jingle on television and radio ads has been: “Be with AIB“. Looking at it from an investor’s perspective, my answer to that is: “No thanks”.