Bank of Ireland: H1 Results Thoughts
(Disclaimer: I am a shareholder in Bank of Ireland plc and AIB plc) The main news, at least from an Irish plc perspective, today is Bank of Ireland’s interim results. Six months ago, when the group issued its FY2011 numbers, I wrote that: “[The] results are a bit of a mixed bag, and to tell the truth, they are a little bit worse than what I had expected“. This morning’s interim numbers have produced a similar reaction from me.
It should be noted that, particularly at this troubled time, but it’s also generally true, that banks’ results are always subject to a certain degree of volatility given the vast number of moving parts at play. This makes forecasting numbers with a high degree of accuracy a challenging task – how, to take two examples, is one supposed to adequately model for either: (i) the accounting impact of fair value movements in derivatives that economically hedge the Group’s balance sheet; or (ii) economic assumption changes for Bank of Ireland’s life assurance unit. These two items combined had a €59m positive impact on Bank of Ireland’s bottom line, and were indeed equal to circa 100% of its H1 2012 pre-provision profits!
With this in mind, when I look at the Irish banks I run through a check-list of five key items to see how they are performing against all of them. I find that a more useful method of evaluating their performance than simply focusing on headline numbers that can be heavily influenced by accounting adjustments, such as those mentioned above, that have limited read-through for the underlying performance of the group. Obviously, in the longer term the headline numbers themselves will take on more relevance, but given the present volatility their usefulness is, in my view, somewhat limited.
The five key areas of interest to me are: (i) Trends in pre-provision profits; (ii) Trends in deposits; (iii) Trends in the net interest margin; (iv) Progress on deleveraging; and (v) Trends in impairments. Below I evaluate Bank of Ireland’s performance on all five metrics.
To start with trends in pre-provision profits – here Bank of Ireland saw a 65% decline to €58m relative to H12011. This was all down to the margin. Net interest income slid by €177m (-17%), which more than offset the positive trends seen in all of the other line items between it and pre-provision profits, namely: government guarantee fees (a €25m reduction year-on-year), net other income (a €43m improvement year-on-year), operating expenses (a €1m reduction year-on-year). The conclusion from me from examining the trend in pre-provision profits is that Bank of Ireland is doing a good job on the levers it has control over.
Next we look at deposits. Earlier this month AIB said that its customer deposits rose €2.9bn (+5%) in H1 2012. I would have expected at least the same again from Bank of Ireland. However, BKIR’s Irish retail deposits have actually fallen by €1bn in the first six months of the year. This was more than offset by a €2bn rise in UK retail deposits, while other deposit headings remain stable. This relative underperformance may well be explained by Bank of Ireland having recently taken (necessary) steps to lead price reductions in deposit rates here, so there could be an element of savers ‘shopping around’ going on. With other banks having followed BKIR’s lead, hopefully it will win back some of this money over time. However, my conclusion from Bank of Ireland’s deposit trends is that, while not a major cause for concern, they will need to improve their performance here to help strengthen its funding base.
The net interest margin is a source of disappointment to me. At 1.20% it is 13bps lower than year-earlier levels and below the 1.24% reported by AIB in the first half of 2012. Action to reduce the level of deposits covered by the Irish government’s ELG scheme means that margins after taking that into account are 0.88% for Bank of Ireland and 0.90% for AIB. Given that Bank of Ireland has a arguably superior mix of loan exposures to AIB, this margin underperformance is as surprising as it is disappointing.
Deleveraging is something that will, thankfully, no longer be an area of particular attention come 2013. Bank of Ireland has already met its PCAR targets, having offloaded €10bn of loans more than a year ahead of target. The other pillar bank, AIB, in contrast, is only 70% of the way through this process. So, top marks to Bank of Ireland here.
Impairments are clearly an area of focus for the Irish banks. Given the heroic achievements of Katie Taylor in yesterday’s Olympic boxing final, you’ll forgive me for the analogy that our financial system has suffered a ‘one-two combo’ in terms of being smacked first by land and development loans (now mainly housed in NAMA) up front and then a second blow from mortgage losses as unemployment has moved upwards. Total loan impairments in H1 2012 for Bank of Ireland were €941m versus €842m in H1 2011. Mortgages were to blame here, as impairments in that area rose to €310m from €159m a year ago. Consumer and SME impairments saw an improvement, while property and construction losses were flat. Given the troubled economic backdrop, I would imagine that losses will get worse before they get better, although I note management says: “While the Irish economy remains challenging and our impairment charges remain elevated, we expect the impairment charges to reduce from this level, trending to a more normalised level as the Irish economy recovers“. The ultimate impairment bill is, to use Mr. Rumsfeld’s parlance, a key ‘known unknown‘ for Bank of Ireland.
In all, as I said in the opening the results are a bit of a mixed bag, but overall the key negatives (deposits and margin) outweigh the positives (good work on costs, no major surprises on the impairment front). I’m not surprised, therefore, to see the shares open weaker this morning. In terms of how I approach Bank of Ireland as an investment case, I think the market has already priced in a lot of the risks it faces, with the shares trading on less than half its expected end-2013 NAV per share. However, the regular occurrences of either flare-ups or grounds for optimism in the Eurozone crisis means that, for high-beta stocks like Bank of Ireland, the near-term outlook for its share price remains volatile. I remain of the view that there is longer-term upside in this name for patient investors, while for short-term traders its elevated levels of both liquidity (especially by Irish standards) and volatility makes it a great trading stock to punt around on in the intervening period. Mind you, this also means, in my opinion, that it’s not really one for widows and orphans!