|Shares Out. (in M):||0||P/E|
|Market Cap (in M):||15,000||P/FCF|
|Net Debt (in M):||0||EBIT||0||0|
Bank of Ireland (ADR: IRE) is one of the two dominant full service banks in Ireland and trades at a compelling valuation of only 9.4 times current year EPS (fiscal year ends in March) despite recently reporting 22% annual operating EPS growth (all organic) along with a bullish outlook statement. This valuation makes even less sense when considering that the country of
Why does Bank of Ireland trade at such a discount?
Three words: housing, housing, housing. The focus on mildly softening prices (from €310K in December 2006 to €301K in April 2007) and new completions has become a point of obsession and idiocy to the neglect of many positives. As a result of
#1 Look what some of the U.S. housing/mortgage stocks did after the big sell-off in late February and March. They rebounded with a vengeance: WaMu up from $39 to $44; CFC from $33 to almost $42; MTB from $105 to $113.
#3 Less than 10% of IRE’s earnings come from its Irish mortgage operations. At a recent Merrill Lynch conference IRE presented on its property and construction business. It is worth flipping through: http://www.bankofireland.ie/html/gws/includes/investor/pdfs/lynch.pdf. While there is no denying that the strength of Ireland’s real estate market has probably supported many aspects of IRE’s overall business, IRE is clearly a diversified, full service commercial bank with several earnings drivers beyond Irish housing prices and mortgages. And rather amazingly, because of
#6 The Irish government runs a fiscal surplus and will likely cut taxes (specifically the stamp tax, which is a sales tax on the purchase of housing), further boosting the ability of Irish homeowners to spend and make their mortgage payments. In addition to this, in 2001, the Irish government introduced Special Savings Investments Account (SSIAs), for which every Irish citizen was eligible. Basically, it is a five-year savings/investment plan that the government tops up by 25% through a tax credit. So, if you put €100 in, you will get €125 in 5 years. These plans proved to be extremely popular (particularly in the 2001-2004 era of low interest rates) with a total of 1.1M accounts opened and €16B invested (for an average of almost €15K per account or almost €4K for every person in the country). While much of these savings will likely be re-invested, they provide yet another cushion of support to Irish consumers and homeowners that require it.
#10 At least part of the softness in housing prices this spring was due to the national elections. (Bertie Ahern won his third election on May 24th.) Both candidates and parties were talking of cutting or reducing the stamp tax, which is a sales tax on the purchase of housing that can be as high as 9% of the purchase price. While the effect is difficult to calculate, would you really want to buy a house if the politicians were clamoring about cutting the sales tax? Of course you would defer your purchase. This likely reduced demand temporarily. A preliminary version of the bill was released on June 20 effectively eliminates the stamp tax for all first time buyers and will be retroactively applied to any purchased made since March 31. (The tax is currently 3% of homes prices from €317K -€381K, 6% from €381-€635K, and 9% on anything over €635K.) A key advantage of
#11 On June 17th, the Department of the Environment (government agency that keeps statistics) published its results on housing completions for May and also provided a very interesting adjustment to its 2006 numbers. It turns out that because of the extraordinary amount of building activity that was going on in late 2005, about 5,000 of the completions were more or less booked in the first half of 2006 when they were actually built in 2005. Adjusting for this, housing completions are actually up 2.6% through the first 5 months of 2007. This is remarkable, particularly considering all of the election rhetoric regarding the stamp tax.
#12 On June 21, competitor Irish Life and Permanent (see below) released a business “trading update” and raised 2007 EPS guidance from mid-teens growth to high teens. The strong performance was driven by their life/pension business, but their banking operations did just fine.
Almost all of what I write about IRE, applies to the other market leader, Allied Irish Banks (ADR is AIB) which we also own. AIB is slightly more complicated, however. Through historical circumstance, they have a $3B stake in New-York based M&T Bank (MTB), which at 17 times Q1/07 annualized EPS is a good stand-alone short, but works out as a decent partial hedge to being long AIB. AIB also gets about 10% of its earnings from its majority ownership in a Polish bank, which happens to be publicly traded. AIB (and many others) is very bullish on the potential in Poland, which still has a very low penetration of mortgage and financial products and a population that is about 10 times the size of Ireland’s (39M vs. 4M). It presents a rather ideal scenario as AIB can seamlessly invest the excess capital generated from the Irish operations into its rapidly growing Polish operations. If you deduct AIB’s stakes in MTB and the Polish bank (both are publicly quoted), you get the rest of AIB’s core operations for about 9-10 times 2007 EPS.
Anglo-Irish Bank is the third large Irish bank and they are probably also a decent buy at current prices, but they are a specialized commercial property lender. They are also something of a cult stock, trading near 13 times earnings, much higher than its Irish peers. They also have fairly extensive operations in the
Irish Life & Permanent is the smallest, with a €5.2B market cap. Half the company is devoted to life insurance, asset management, retirement planning (“asset accumulation”), which is a very good business, comparable to what Principal Financial Group here in the
A basket investment of these four names makes sense. If I had $10 to invest, I would put $3 in IRE, $3 in AIB, $2 in ANGL.L, and $2 in IPM.L.
The following is speculation, but I think it makes sense. While it is currently a mess, eventually ABN Amro will get bought and I think RBS will win. It is almost a $100B deal and over 80% of it is in cash. What will the former ABN Amro investors do with their $80B cash windfall? My suspicion is that much of it will get reinvested back into European banks. The Irish banks because of the low valuations and great long-term growth profiles are a natural investment. They only need a few billion of the $80B total to spark a substantial rally in the shares.
While the CEOs of both IRE and AIB have made it clear they want to stay independent (justifiably given the outstanding results) , I think it makes sense for the Irish banks to eventually be part of a pan-European bank. Perhaps we could see deals in 3-5 years. The CEO of UK-based HBOS has been rumored to be interested in buying IRE—if it were for sale. If ABN Amro, a poorly run franchise in mediocre markets, can go for 15 times earnings, I think the Irish banks could get something near 18 times. Obviously this is fairly far off into the future, but European banking consolidation will continue.
Irish housing market collapses.
Competition is pretty intense (as it is pretty much everywhere in the world), but
Recent Results and Valuation
IRE recently reported operating EPS of €1.45 per share, up 22% YOY, based on robust 13% revenue growth and 6% op/ex growth. The growth was broad-based across their four divisions: their core retail Irish operations (41% of profits) were up 27%; capital markets profits (34% of total) were up 21%;
It should also be noted that reported EPS was actually €1.77, well ahead of operating EPS, primarily because of some property sales. While these sales aren’t core earnings (they had gains the previous year as well), we shouldn’t completely ignore the fact that IRE likely owns a lot of property that is substantially understated. And the gains do add to book value. IRE trades at only 2.4 times stated tangible book value (€6.71 per share) despite earning a 28% ROE on average equity over the past year. IRE’s capital ratios also improved over the year (the Tier 1 ratio improved from 7.3% to 8.2% and the equity/assets ratio improved from 4.8% to 5.2%), leaving room for a potential share buyback. While Europeans don’t approach share buybacks with the same philosophy as Americans, we think a share buyback is one of the smartest things management can do right now—we and others are encouraging them to look at this option given the sharp decline in the stock.
While the past year’s results are particularly impressive, Bank of Ireland has been a solid long-term grower, with operating earnings up nearly 60% from 5 years ago and up over 400% from 10 years ago. The shares are currently only about 20% higher from 5 years ago despite this track record and
The stock is still trading 20% below its recent February peak despite reporting excellent results, a generally bullish stock market, and continued European banking consolidation. My suspicion is that IRE will be well above its previous peak before the year is out.
The stock also carries a healthy 4%+ dividend yield, so you get paid while you wait.
And please forgive me, but I am going to opine a bit on the large valuation gap between fixed income investments and equities. Short term interest rates in
In conclusion, how can Warren Buffett buy/own Wells Fargo (PE of 12.8, 9% EPS growth), US Bancorp (PE of 12.5, 3% EPS growth) and M&T Bancorp (PE of 14.8 and EPS growth of -1%) and not consider the Irish banks, which have both better valuations and growth profiles, solid managements, and are large and liquid? I’m serious-- someone please give him or Charlie a call.
|Entry||06/25/2007 10:13 PM|
|Top o' the evenin' Skyhawk,|
Interesting idea. Have some questions:
1. Currency - Since the ADR is in US$ and earnings are in euros, do you have any views about the current exchange climate? Would you hedge out the currency? Is there any benefit to buying the local shares over the ADRs?
2. What is the conversion ratio of the local shares to ADR's?
3. How would you split the growth between pure organic growth of the bank and the-rising-tide-lifts-all-boats GDP growth? Worst case, if GDP slows to a nominal 2%, how does that impact IRE?
4. Competition - Other than the three Irish banks that you mentioned, are there any foreign banks with significant market share? Given the strength of the Irish economy, I am just surprised what is keeping the UK-based banks at bay.
5. ABN Amro - Why do you think their investors will re-invest in Europe once they are bought out? They could buy BAC for 9.3X 2008 earnings and collect a 4.50% yield, and get an option on a stronger dollar.
|Entry||06/26/2007 02:52 PM|
|David, I can always count on you for some good questions and witty comments even though my write-ups tend not to have the spectacular short-term return potential(maybe even over-night!) that many other VIC ideas seem to have.|
1- I have no currency opinion, although I am naturally patriotic and believe that a lot of investors foolishly criticize the U.S. i.e. many economists and pundits such as Stephen Roach of Morgan Stanley constantly refer to our negative savings rate, whose calculation only a government bureaucrat could come up with. But why don't I ever hear him talk about the vacation/work-ethic of America vs. Europe? The WSJ had a fascinating article on this a week or so ago. We take far less vacation and work far more. Yet somehow we are labeled as spendthrifts up to our eyeballs in debt just stupidly using our houses as ATMS. Please.
We just own the ADRs directly. There is no material benefit to buying the ADRs vs. the local shares. They trade very tightly with the London listed stock.
2- The conversion ratio is 4 to 1. IRE trades locally as BKIR.L where its share price is around €15.30. Then multiple by the 1.35 €/$ exchange ratio.
3- This is a tough question. In my mind, an investment in the Irish banks is an investment in the Irish economy. Because of all the macro-reasons I listed, I do not think run-rate GDP growth will be anywhere near 2% for a long time. If you believe differently, however, I probably would not buy IRE. I also do not mean to imply that Ireland is recession proof. There could certainly be a year within the next 10 where GDP growth is zero or even negative, but the long-term average will probably be 4%+.
4- IRE and AIB are well run and managements have used their brand-names and market-share to their continued advantage. I forget what bank it was (I think it was Danske of Denmark), but a year or so ago, they tried to come into the Irish mortgage market with some cut-throat pricing. AIB and IRE immediately cut their own pricing, basically sending a big "FlipYou" type of message. AIB and IRE know that they have substantial cost/funding advantages operating in Ireland. They are prepared to cut their profit margins temporarily to send a sharp message and increase the operating loss/pain of any new entrants. The strategy has basically worked, but there is no reason why a competitor couldn't decide in the future to increase its pain threshold. But at some point, it would just be better for the competitor to buy IRE or AIB rather than fight them. Classic business school stuff.
5- The ABN Amro speculation is just a guess. But I know many analysts and PM's that are sector specific, especially for financials since it is such a large and somewhat specialized sector. I only do financials. If one of our companies got bought for cash, we would reinvest it in another financial. I also think investors tend to be parochial. I just talked to a PM who wasn’t interested in IRE because he said he invests only in the U.S. No reason he has to. He just does.
Yes, they could buy BAC at 10.0 times 2007 earnings with a 4.5% yield. But why not buy IRE which has a comparable dividend yield, a lower PE, and far better growth prospects (BAC has 3% this year and a too-optimistic 9% next year—and that is assuming they don't do some large dilutive acquisition, which is always a possibility.
|Entry||06/26/2007 04:25 PM|
Thanks for the responses. Your view that investing in Irish banks is investing in the Irish economy was what I was trying to drill into with my GDP question.
I have been thinking about the tax differential. If one compared banks by looking at EBIT, the Irish discount disappears. Of course, if the tax scheme in Ireland has no immediate threat of increasing, then all that matters is the after tax return. But, the Irish tax rate effectively serves as a deterrent to foreign takeovers. It would be very hard for a bank in a 35% tax rate country to buy an Irish bank, and make the deal accretive without a lot of cutting. So, how much of the valuation difference is due to a lack of a buyout premium?
Flip side, would it make sense for IRE to be an acquirer of banks outside of Ireland?
|Entry||06/26/2007 04:50 PM|
We are talking to IRE again later this week. I'll try to get some insider viewpoints on the tax issues. But my understanding/assumption is that many banks that operate across different countries have separate legal subsidiaries for each country and pay taxes and follow regulations according to each country. I am not sure what happens once the retained earnings are transferred to the parent holding company, but my suspicion is that the Euro currency countries do not tax the earnings twice. That would be a huge deterent to the growth/integration that the common currency was intended to build. But I know that is not the case in the U.S., which is why many U.S. companies refused to repatriate the earnings until Congress passed that misnamed "American Jobs Creation Act" of 2004.
Both AIB and IRE have expanded internationally. The tax advantage doesn't really directly help them by other than allowing them to achieve very high profitability at home which gives them retained earnings they wouldn't otherwise have. They can do anything they want with these "excess" earnings--pay them to shareholders, expand in Ireland, or expand abroad.
The Irish politicians (even those on the left) are very committed to low taxes. It is crystal clear to everyone that low taxes are what have caused the economic miracle of the last 20 years. Taxes will stay low and conceivably could even be cut further given that the government runs a fiscal surplus. Ireland should be a required case study for all business school students, future politicians, readers of the New York Times, and misguided economists like Paul Krugman.
|Entry||06/27/2007 10:36 AM|
|IRE is trading off (along with many other European banks) because of an announcement by Northern Rock, the #5 UK mortgage lender. They just released a "trading update" and lowered EPS guidance as a result of their interest rate positioning. As the Bank of England has raised rates and given signs that it will continue to do so, it has changed the yield curve (SWAP/LIBOR curve) a decent bit over the last 6 months. This has hurt Northern. In general, however, much of the rest of Northern Rock's commentary was pretty upbeat. They describe the current mortgage market as "robust." |
By the way, their hallmark product (which they introduced around 5 years ago)is a 125% LTV mortgage, which combines a 100% mortgages with an unsecured personal loan (almost like credit card debt) of up to 25% of the mortgage. While the credit losses have actually been quite good so far, we think this product will eventually lead to a blow-up if their is the slightest recession or a decent housing correction. I can't believe the regulators allow it.
While IRE does have some operations in the UK, it is relatively small and diversified and they don't do 125% LTV mortgages. This is a buying opportunity.
|Subject||Question about reserve levels|
|Entry||07/02/2007 07:50 PM|
|Are you at all worried that IRE may be under-reserved? Allowance for loan losses is 34 bps of average loans. The allowance is only 44% of nonperforming loans. (I believe comparable numbers for Citigroup are approximately 130 bps and more than 100%.)|
These seem especially low given the mortgage risk you talk about in your writeup. Any thoughts on this?
|Entry||07/02/2007 10:05 PM|
|I'd be curious to hear the reserve levels of Allied Irish Banks in your response to the previous question.|
I bought last week after the price drop so I apprecaite your idea.
|Entry||07/09/2007 10:44 AM|
|In regards to AIB, you mentioned, "they have a $3B stake in New-York based M&T Bank (MTB), which at 17 times Q1/07 annualized EPS is a good stand-alone short."|
This is a little off-topic, but why do you think MTB is a short? Just based on valuation, or something else?
I have been comparing IRE and AIB for a while and am currently favoring AIB, partly because of their involvement in MTB.
Thanks by the way for a good idea and write-up.
|Entry||07/09/2007 06:15 PM|
|My apologies for the delayed reply--I was in Japan visiting some banks. Interesting stuff goining on over there!|
The most important point regarding loan loss reserve and provision accounting whether it is Irish, U.S., or European banks, is that they are non-cash and often subject to manipulation by management, and therefore mostly fiction. I think all banks should dispense with the practice of provisioning for loan losses and just let losses on loans flow through the P&L as they are incurred.
Loan loss reserves are really just another form of equity. i.e. let's take two banks that have 100% of their assets in loans. They are identical except that one has 8.0% equity-to-assets and 0.0% loan loss reserve while the other has 7.0% equity-to-assets and a 1.0% loan loss reserve ratio. From a true economic profile, the banks' capital positions are exactly the same.
Sorry for the tutorial, but with it firmly established that the accounting for loan loss reserves and provisions is arbitrary, what is consistent is that a given bank is consistent in applying it. If you look at Citigroup and many other U.S. banks, you will note that they have "bled" their loan loss reserve ratios from nearly 1.5% five years ago to 1.1% currently. This reduction has boosted GAAP earnings (i.e. non-cash) over time--I estimate around 2% per year or so.
So the important thing is relative consistency/trends to a given bank's own previous ratios.
Anyway, European banks approach loan loss reserves slightly differently than Americans. They try to reserve for what the actual loss content in their loans will be. Even if a loan goes bad, it is important to remember that often times, because of collateral, the level of loss is not 100% of the loan. It might only be 10% or 20% of the total non-performing loan amount.
So lets look at IRE's #s. As of 3/31/07, they have 44% reserves-to-NPLs (non-peroming loans), which is down slightly from 45%. On a reserves to total loans basis, the ratio is currently 0.37% vs. 0.39% a year ago. So, you can definitely argue that IRE has "cheated" a little, but it is a small amount. There are many banks in the U.S. that have dropped the reserve-to-loans ratio by more than 10 basis points over the last year.
However, IRE's "cheating" is somewhat offset by the substantial improvement in capital ratios. On a risk-weighted basis, Tier 1 capital improved from 7.5% to 8.2% in the past year while Equity Tier 1 capital improved from 4.8% to 5.2%. Total capital improved from 11.4% to 11.8%.
In all honesty, I am less worried about IRE's mortgage book than some potentially risky bets made within its corporate/capital markets division--not that I have heard anything specific--it's just that any corporate bank across the world could have had a trader/gun-slinger foolishly buying U.S. subprime CDOs for instance.
|Entry||07/09/2007 06:37 PM|
|I forgot to mention the most important statistic--bad loans. NPLs increased 22% from €796M to €968M. This is a sizeable increase and is definitely something to watch, but we cannot ignore the fact IRE had tremendous growth over the year and that loan balances increased by 25% from €93B to €116B. The NPL/total-asset ratio dropped from 0.86% to 0.83%.|
|Subject||AIB saw bad loans rise from 86|
|Entry||07/09/2007 07:04 PM|
|AIB saw bad loans rise from 868M a year ago to 933M, an increase of only 8%, pretty decent considering that total assets rose by 25% to €107B. NPLs fell from 1.02% of total loans to only 0.87%.|
Loan loss reserves, however, rose by only 5% to €707M, which led to a fairly serious drop in the reserve-to-loans ratio from 0.79% to 0.66%. This should be monitored. Sometimes, I adjust earnings by seeing how much higher loan loss provisions would have to be in order to keep the reserve ratio constant. In AIB’s case, EPS would have been about 6% lower. However, some leeway should be given because of the sharp drop in the NPL ratio.
Reserves to NPLs dropped slightly from 78% to 76%.
AIB’s Tier 1 capital improved from 7.2% to 8.2% while total capital improved from 10.7% to 11.1%.
All in all, the numbers are generally encouraging, but should continued to be monitored.
|Entry||07/09/2007 07:18 PM|
|MTB trades at a substantially higher valuation than its peers (i.e. 14.8 PE vs. 12.2 for KEY and 12.9 for PNC) because Warren Buffett owns part of it. While MTB has done far better over the last 10 years than most would have thought of a bank based in Buffalo,NY--a region of the country which seems to be in something of chronic slow-growth recessionary environment--it has recently disappointed fairly significantly on a combination of Alt-A mortgage exposure and substantial competitive pressure on its net interest margin.|
I am fairly bearish on large regional banks. Competition for loans and deposits is intense everywhere (one CEO told me over 100 new banks had been started in Texas alone over the psat year) and credit quality is worsening, particularly in slower growing areas like the Midwest. Huntington Bank (HBAN), based in Ohio, just pre-announced bad results on credit quality deterioration.
M&T is projected to have -2% EPS growth in 2007 and 9% in 2008, which is likely too optimistic.
Warren Buffett is good, but he isn't perfect. He also bought MTB a long time ago and hasn't added recently.
|Subject||National Development Plan|
|Entry||07/09/2007 07:30 PM|
|I failed to mention another critical bull point in my original write-up--the National Development Plan (NDP), a seven year plan (2007-2013) designed by Ireland's government to improve the country's infrastructure. They are planning on spending €184B, or about €26B per year, amounting to a hefty 12% of GDP per year. The is a substantial increase from the first plan (2000 to 2006), which spent €57B over 7 years, or about €8B per year. To put it in perspective, there were around 90,000 homes built in Ireland last year (which was an absolutely amazing peak year). The consensus for this year is around 65,000, implying a relatively large drop. If we assume an average cost of €300K per house, that is €27B of housing that was built last year vs. a projected €19.5B in housing that will be built in 2007. The negative delta is €7.5B. This is a fraction of the €18B annual increase coming from the NDP. Obviously government infrastructure spending and residential housing are not perfect offsets (i.e. banks directly extend loans for mortgages and residential construction), but it should be pretty clear that the second NDP is going to drive a substantial amount of economic activity over the next 7 years. On top of that, if we think about the strength in commercial construction activity and foreign direct investment, not to mention all of the demographic and tax advantages, it seems likely that Ireland's economy is going to continue surging for the next several years. The banks will get their share.|
Yet some investors would still choose to invest in fixed income securities yielding 4-5% pre-tax instead of blue-chip equities like IRE with 4-5% dividend yields, 10%+ after tax earnings yields, strong balance sheets, and double digit annual EPS growth prospects for the next 10 years.
|Entry||07/09/2007 09:54 PM|
|I have attached the links for the current 2007-2013 National Development Plan and a summary of the first NDP. Pretty interesting and clearly intended for the general public. The current plan definitely has a good degree of what I'd call a social welfare element. I wonder if the government wouldn't be better off simply by cutting taxes and using moral suasion to get private citizens into volunteer/"social inclusion" work instead? However, another competitive advantage of Ireland is its relatively cohesive and small community, making boon doggles more difficult to pull off for a potentially irresponsible government|
|Entry||07/10/2007 09:24 AM|
I would not be so harsh on the reserving practice in the US because it is the result of backlash from the accounting scandals earlier in the decade. The collapse of Arthur Andersen put a chill in the auditors. I saw it first hand in my former job, where we had to be very specific in our reserving practice and provide detailed paper trails supporting the reserves. Why? Because the auditors said so and would not sign off otherwise.
I have heard some bank CFO's complain about it because the auditors have been rearview looking. These bankers know that the past three years have been abnormally low for loan losses and want to reserve more, but the auditors point to recent experience as not justifying higher reserves. Of course, some bankers have embraced the new approach, as lower reserves translate into higher bonuses.
The irony is that the auditors' efforts to eliminate "cookie jar" reserves may result in inadequate loan loss reserves. Accounting isn't perfect but accrual accounting gives a truer picture of financial condition than using paid-basis.
|Entry||07/10/2007 10:40 AM|
I still think the whole accounting concept of loan loss provisions and reserves is flawed. It is not real. It obfuscates. Just give investors the facts (i.e. NPLs, NCO) and let us make bets about the future--that is after all what we are paid to do.
|Subject||Zombie companies. I am argu|
|Entry||07/10/2007 04:08 PM|
I am arguing for full disclosure on any problem loans. Denial is terrible. I think even more disclosure on the status of problem loans or potential problem loans would be better. I am just arguing against the accounting for loan loss provisions. Basically, I am arguing that we should keep everything the same except instead of having loan loss provisions flow through the income statement, you have actual net charge-offs (NCOs) flow through. Through the information on the NPLs, let investors decide what the future NCOs will be and set the price of the stock accordingly.
|Entry||07/27/2007 12:29 PM|
|on carryover meltdown in US to Ireland? |
Any early signs of real estate weakness?
|Entry||07/27/2007 01:59 PM|
|The sell-off in financials is remarkable and very global. The Irish banks aren't unique. The only thing I can think of that would actually hurt IRE is if their capital markets group purchased some sort of U.S. subprime CDOs. Many European banks have announced losses on such investments.|
On another more positive note, Denis Donovan, Executive Director, Chief Executive-Capital Markets bought 10,000 shares at €14.298, to hold 110,507 shares. This follows on from a purchase by the deputy governor of 68K shares earlier in the week. The fact that Donovan is the capital markets CEO gives me comfort that they aren't about to announce any sort of loss on U.S. CDOs.
Real estate probably will be weak. As I said in my initial write-up, it will be healthy if prices pull back a bit, as they were getting too high. Let me also remind you that the Irish mortgage market has virtually no subprime and no low-doc elements. This is where the substantial majority of the U.S. problems are occuring. The Irish also have lots of levers to pull-the NDP, the SSIAs, lower stamp taxes. And let us not forget that they have a very young population and employment is booming--these are people who buy houses. And eventually the ABN investors will get their cash and likely reinvest.
I won't deny that this has been painful for us as well. The stock now trades at 8.5 times current estimate of €1.61 and 2.0 times trailing tangible book value of €6.71. I will also remind everyone that March '07 reported EPS was €1.72, well ahead of the operating €1.45. IRE likely has other real estate assets that it may sell. Book value could easily be €7.80 by March 2008, putting the stock at 1.75 times future book. And it will likely raise the dividend, putting the yield near 5%.
For perspective, National City (NCC) is trading at 12 times current earnings, despite declining earnings and rising NPLs, and 2.5 times tangible book. It is making acquisitions (i.e. it is not a take-out target itself) and has exposure to slow-growing midwest, which has auto, manufacturing, and emerging credit issues. It has also recently acquired banks in Florida, which also has problems. The stock has tanked which makes it tough to short if you haven't already been there, but it might be worth shorting as a hedge if there is a relief rally in bank stocks in the near future.
Another name, JPM, the blackest of boxes, trades at 10 times curent earnings. It is an investment bank (peers such as MER trade at 9 times earnings despite large investments in Bloomberg and Blackrock) and a large crappy regional midwest and NYC regional bank with negative EPS growth and rising NPLs (this can't be worth more than 8 times earnings). It also wants to acquire poorly run Washington Mutual, which will almost certainly end up being a poor deal. They are probably a good short too. JPM should probably trade at 8-9 times earnings.
The Brazilian banks such as Itau and UBB are up 50% or so over the last year and 25% YTD and trade at 12-14 times earnings. They might be good shorts too.
IRE is well run, has high quality earnings, and trades at a substantial discount to global banking peers despite very bright long-term prospects in its home market. We continue to advise the company to buy back stock at these levels and would encourage other shareholders to as well. With 4% pre-tax cost of debt/cash, healthy capital ratios, high profitability, understated real estate investments they can sell for cash, and a slowing housing market (which should slow asset growth thus reducing the need to retain capital), it is a no-brainer--they can borrow at 4% to buy an investment yielding near 14% pre-tax.
|Subject||AIB good results|
|Entry||08/01/2007 07:39 PM|
|Allied Irish Banks released encouraging half year results and raised EPS guidance from low double digit to mid-teens growth.|
The CEO bought 150K shares recently.
Additionally, the Irish mortgage numbers came in better than expected.
|Entry||08/02/2007 07:47 PM|
|Just some anecdotal info:|
Much is made of the fact the average home prices increased 4-fold from €76K in 1996 to €300K in 2006. Ireland's nominal GDP has more than tripled from about $60B in 1996 to $200B+ today while per capita GDP has increased from $16K in 1996 to over $40K today, just under a three fold increase. Pretty reassuring.
Ireland also had 13% unemployment in 1996. While it had already been dropping from near 20% earlier in the decade, it was still pretty high 10 years ago, which likely created slack in home prices.
We also had the creation of euro currency in 1999, Ireland's joining, and the benefit of falling interest rates and infrastructure aid. This was a big deal.
Ireland is often cited as having one of the highest mortgage debt to GDP ratios in the world at around 63% vs. 56% for Spain, 38% for the Euro area, and around 50% for the U.S. It is interesting to note that the UK is much higher at roughly 90% of GDP. It would seem that with lower interest rates and higher per capita GDP than the UK, Ireland can easily go much higher. (Please note, this doesn't mean that the UK is necessarily due for a crash as the value of its housing stock is 3.8T pounds, or more than triple the 1.1T in mortgage debt. The value of the US housing stock is $21T, or only slightly more than double the $10T in US mortgage debt.)
And again when we take all of this in the context of Ireland's young population, low unemployment, fiscal government surplus, trade surplus, and favorable corporate tax climate, it seems as if housing and the consumer will be just fine--not that a mild correction in housing is a good thing anyway. And let's not forget that both IRE and AIB get less than 10% of their income directly from mortgages anyway.
|Subject||I can find nothing related to|
|Entry||08/17/2007 01:05 PM|
|I can find nothing related to subprime or sketchy CDO investments. And as I noted earlier, the CEO of the capital markets recently bought stock--a pretty healthy endorsement. As I recall there is a small subprime mortgage market in Ireland, amounting to about 4% of total volume, but as I understand, much of it is controlled by GE and non-bank companies.|
As far as the continued price decline, it has been rather highly correlated with the UK housing oriented financials like Northern Rock and HBOS--trading at 7.1 and 8.4 times current earnings respectively. And that probably has something to do with the shareholder base of the Irish financials--dominated by UK institutions rather than mainland European institutions. However, because cross-border M&A is increasing, I take comfort knowing that this discrepancy will likely be eventually resolved--it just may take 5 years for one of the Irish banks to sell. In the meantime, IRE trades at less than 8.0 times current earnings and possibly less than 7 times forward earnings--and it is based in an economy that will probably grow at a minimum of 4% for the next several years.
While the following article is a few weeks old and should be viewed as biased, it is interesting to note that rents are rising rapidly, up 11% over the past year-- a good sign of strong demand fundamentals supporting housing.
|Subject||Good Anglo-Irish update|
|Entry||09/06/2007 02:29 PM|
|Anglo-Irish, the #3 bank in Ireland, which is focused on the commercial property market, released its "trading update" and noted that credit quality continued to be very good and that it would likely beat the current consensus EPS forcast by 5%. |
In other news, housing starts plummeted for August, down 58% YOY, annualized at 45K units. 2007 completions will likely be near 75K units while projections are for around 55K units in 2008, which will be close to a floor. To put a macro context on it, Ireland's 4 million population is growing around 1.2% per year and its 2.1M workforce is growing around 4% per year, meaning it is adding about 50K new people a year and 80K new workers--combined with the task of replacing existing housing that is inadequate, the sustainble run rate for new homes is probably near 55K.
IRE trades at 8.2 times current year consensus (based on 11% growth) and 7.5 times forward (based on 8% growth). They just reported 22% operating growth and have a cost cutting plan they are still delivering on. Additionally, the government's national development plan will likely keep the economy growing at a healthy level. It is conceivable that growth could be closer 15%, which would put forward earnings at 6.9 times or so.
As a final reminder, it is worth noting the IRE is not a mortgage bank--it is a fully diversified commercial bank levered to a fast growing and wealthy economy--one that has a budget surplus, a trade surplus, a young population, and one of the lowest corporate tax rates in the developed world.
|Subject||Northern Rock, et al|
|Entry||09/15/2007 02:06 PM|
|For those who are following the situation at Northern Rock closely, what is their actual US subprime exposure? It seems like their problems are primarily due to lack of liquidity because of frozen secondary and short term markets, not any problems with subprime defaults, though the press is making references to subprime.|
If Northern Rock's problems are just based on lack of funding, will this spread to the Irish banks such as IRE and AIB?
|Subject||Northern Rock was/is an aggres|
|Entry||09/18/2007 02:28 PM|
|Northern Rock was/is an aggressive, highly levered pure play UK mortgage bank. Although its "Tier 1" capital was 8.5%, it is interesting to note that they had around £2B of equity and over £100B of loans, putting it at a 50 to 1 leverage or 2% equity-to-assets. |
Ultimately, I think this is the root of the problem. Thornburg, while not a bank, got into trouble, with only 25 to 1 leverage. I think banking regulators are going to have to address the favorable risk weightings that mortgages receive.
As far as the Irish banks go, IRE is certainly trading as if they are about to implode (current year PE of 6.8 for IRE). They (and AIB and Anglo) are currently presenting at a Davy Stockbrokers conference and have indicated comfort with their funding and still generally bullish prospects--admittedly with a bit of tempering.
As far as US subprime exposure, IRE has €0 in direct US subprime, €56M in CDO exposure, and a €763M back-up liquidity facility to a conduit. The $819M maximum exposure represents 10% of equity. I've got a call into management, but I'm pretty sure these aren't real risks. They are far more diversified and less levered than NRK.
|Subject||Thanks for the high rating. I'|
|Entry||11/07/2007 08:10 PM|
|Thanks for the high rating. I'm embarrassed by the performance and take minimal comfort in the fact that neither IRE nor its peers have announced any adverse developments. Despite the terrible performance, I am somewhat doubtful that the shares will have a dramatic bounce in the near-term given the incredibly negative sentiment that surrounds them and many large cap global banks in general. With the housing disaster that is unfolding in the U.S., it isn't outside the realm of possibility that there will be some deterioration in Ireland. My fear is that even just slight deterioration in asset quality will send the stocks much lower, as investors will assume the worst. |
As far as new developments in Ireland, housing planning permits are coming in lower than expected. There are rumors that they will be as low as 45K for 2008, down from 88K in 2006 and around 60K for 2007. Based on population and demographics--55K is seen as the sustainable annual number. Some are taking this to mean GDP growth will clock near 2-3% next year. I'm not sure what to make of it. Normally I'd say that 2%+ GDP growth is still good in the context of plummeting housing construction and that the run-rate growth going forward will be much higher given that housing has already been worked down. But then I look at the U.S. and look at the 3.9% GDP growth reported for Q3--it is completely dislocated from the carnage we are seeing with the U.S. banks/mortgage lenders.
The one thing that bothers me with the Irish banks is the stubbornness of the managements. Clearly, the market is flashing a huge warning signal. Rather than paying attention and reducing balance sheet exposure, as we suggest to them whenever we talk, they are locked in a stupid market share game for a low margin product that doesn't contribute much to the bottom line anyway. It would be a far better use of capital to buy back stock at current levels rather than fund new mortgages. This is where AIB and IRE have a nice advantage over someone like Anglo-Irish. They are diversified banks, and while lending on real estate is important, they have many other businesses they can focus on.
Another thing that bothers me is Basel II, which provides the new capital/regulatory guidelines for global banks. It went into effect this past January. One of its key changes (from Basel I), which has turned out to be spectacularly ill-timed, is the improved risk weighting for residential mortgages. It is causing banks to stupidly fund mortgages supported with thin capital. Northern Rock’s failure is the poster child of such a policy. Although Northern Rock’s imprudent funding strategy was the direct cause of the failure, the 50-to-1 leverage was the real cause. Despite having only 2% equity-to-assets, NRK was able to report that it was “well capitalized” with a Tier 1 ratios of 8%. The geniuses who designed Basel II need to reverse this change as soon as possible. And of course, if that happens, it will reduce credit to borrowers, which will reduce housing demand, which will cause prices to fall, which will increase losses....
Gosh, I just re-read my note—-maybe I should go short. Just kidding, but I will warn you that I’m hedged with short positions in Spain and the UK as well as in the U.S. If you’ve read any of my other posts, you’ll know that I’ve been pretty bearish on banks for a while and remain so.
|Subject||As per your last post Skyhawk.|
|Entry||11/14/2007 04:54 PM|
|Would you short it in here?|
|Subject||Call me mentally weak, but I f|
|Entry||11/14/2007 11:06 PM|
|Call me mentally weak, but I find it tough to short at these levels when something like WaMu trades at 1.4 times tangible book and 10 times earnings despite being highly levered, under-reserved, and demonstrating huge increases in bad loans, not to mention something of a pureplay on the U.S. mortgage market, which is going to be terrible for the next 1-2 years at least.|
If the stock bounces, however, I would probably look to sell shares. The sentiment and the shareholder base do matter.
|Entry||01/28/2008 10:08 AM|
|I see that IRE and AIB were downgraded by UBS. Do you know what their concerns are? I have not seen the reports.|
|Entry||01/28/2008 03:02 PM|
|The main concern of the report is commercial property prices, which they argue could fall by 30%. The big concern is that rapid price appreciation over the past 10 years has pushed commercial property yields to very low levels (3.4% for retail, 4.3% for office, and 5.1% for industrial). With financing rates at roughly 6.0% (5 yr. swap rate of 4.5% plus a spread of 150 bp.), these assets are negative yielding BEFORE any operating costs. Even assuming strong 10-15% annual growths in rents, the investors will have negative cash flow for several years--the only way they get bailed out is substantial rate cuts from the ECB, which seems unlikely as of right now--although the Fed may force its hand. |
I believe these are legitimate concerns. I do not know if it will lead to large losses for the banks, but it is certainly a serious concern.
|Entry||01/28/2008 05:07 PM|
|Thanks for the comments. Reading over your write-up again, it seems that most of these concerns were priced into the stock at the time of the write-up -- presumably the reason it was at around 9x earnings to begin with was because of real estate markets coming off of a peak. Perhaps the concern then was residential and now it is commercial. But as you pointed out, these banks are huge and have diverse operations. What is their exposure to commercial real estate? How do falling values and rising cap rates lead to losses for the banks?|
I guess the idea is that commercial real estate is a barometer for overall economic growth which surely will slow considerably, despite Ireland's long term trends...