Shares in Allied Irish Bank were down 17 per cent on Wednesday morning after the bank warned on profits for the second time this year. Shareholders can now expect earnings of just €1.20 in 2008 versus the €1.85-1.90 figure the bank suggested back in July (cut from €2.06 in 2007). Analysts had expected EPS to fall no further than €1.75 a share.
After solidly defending the quality of its loan book the past few quarters, the bank is finally admitting bad debts are significantly on the rise, be it, mainly in the Irish residential development book:
At the operating level, before bad debt charges, all our businesses continue to perform well and the overall group rate of income growth is expected to exceed that of cost growth in 2008 by c. 2% The credit environment though continues to deteriorate and is doing so at an accelerated pace in recent months, heavily influenced by an acute scarcity of liquidity and highly elevated funding costs. There has been some negative effect on asset quality generally across our loan portfolios, though the effect is most material in our Irish residential development book. Deterioration in that book is the principal driver of a revised group bad debt charge expectation of c. 75 basis points (bps) of average loans in 2008. The expected charge comprises c. 45 bps of specific provisions and c. 30 bps of IBNR provisions, the latter figure reflecting our forward looking view in a credit environment which will continue to be challenging. This revision, together with the costs of higher funding and an estimate of the cost of the Irish Government guarantee scheme, lead us to reduce our earnings per share target for this year to around euro 120c.
Luckily, that extremely well-timed Irish government move to guarantee 100 per cent of Irish-bank held deposits has helped AIB in the funding of those impairments (for the time being). Being the first to do so in Europe, Irish banks clearly benefited from a rush of deposits into their accounts. The bank states:
Customer deposits, sourced from across the range of our domestic and international franchises, continue to be our largest source of funding and will increase as a proportion of total funding this year. We are targeting customer deposits to grow by a low teens percentage in 2008. Customer loans are forecast to increase by around 9% causing the loan to deposit ratio to fall from 157% at the end of 2007 to c. 150% at the end of 2008. We are targeting further reductions in this ratio in subsequent periods.
The bank had referred to its European businesses providing some relief to its p&l in previous statements. While AIB says its 70.5 per cent share in Poland’s Bank Zachodni/WBK is still performing well with asset quality remaining good – it now admits the country is not so immune to the global credit crisis and that it will be vigilant over performance:
The very low level of bad debt charge in 2007 will not be repeated this year due to a lower level of recoveries and we expect the 2008 charge to be a low / mid 30 bps of average loans.
On the domestic front, the bank’s outlook for its residential loan book is even bleaker. It now says the market can expect no meaningful recovery until the first half of 2011 (previously 2010), anticipating an average peak to trough fall in values of undeveloped land (c. €7bn of portfolio) and completed houses (c. €3.7bn of portfolio) of c. 40 per cent and 30 per cent respectively.
However, AIB says its commercial real-estate book is “solidly” supported by regular, recurring income streams and low vacancy rates. While it acknowledges decreasing rents could place some stress, overall quality remains good.
JP Morgan might beg to differ though. In its latest report on the European commercial real estate market the bank highlighted AIB as exposed:
In this note we focus specifically in the risks (especially to earnings) embedded in the commercial real estate market, which we see as the next area to deteriorate after the well flagged crisis in the residential real estate market, and indeed we see CRE as the first part of the banks’ corporate loan book to encounter asset quality problems.
Our universe of banks has €1trn of on-balance sheet exposure to the CRE market equivalent to 12% of their loan book or 1.76x their equity base; this is not immaterial. They also have €43bln exposure through CMBS. The most exposed banks are Aareal and Anglo with 97% and 82% respectively; they are followed by AIB, HRX, Handels, BOI, Natixis, all of whom have CRE loans of between 20% and 35%.
If troubles persist – the key question is would the bank consider the government-equity route? According to the Irish Times, AIB chief executive Eugene Sheehy told a gathering of private investors last week the bank would “rather die than raise equity” and that it had “options for self help” other than raising fresh equity. Presumably selling-off its US or Polish divisions?
Related Links:
The commercial real-estate risk list – FT Alphaville