Bloomberg News

Bank of Ireland Becomes a ‘Slave’ to Sovereign Debt Woe

June 15, 2011

(Updates with chairman’s comment in ninth paragraph.)

June 15 (Bloomberg) -- As Ireland goes, so goes Bank of Ireland Plc, the nation’s largest and oldest lender.

As investors meet today for the 228-year-old bank’s annual general meeting, the company’s market value has shrunk to about 694 million euros ($1 billion), less than a 25th of its peak four years ago. If the lender succeeds in raising some of 5.2 billion euros of additional capital demanded by regulators from investors, it will be the only Irish bank to raise money from money managers since the government guaranteed the industry’s debt in 2008. Failure would put the last of the country’s six top lenders under state control.

“If the bank comes up with a credible investment case, investors will see it as a proxy for Ireland,” said Frank O’Dwyer, chief executive officer of the Irish Association of Investment Managers, whose members oversee 250 billion euros. “It will be a big beneficiary from a recovery in the economy.”

The fundraising will be the first litmus test of investors’ confidence in the country’s economy since Enda Kenny became prime minister three months ago. Following last year’s 85 billion-euro bailout, Ireland doesn’t have to sell bonds until 2013. The lender’s shareholders will need to decide if the government can avoid a default or a restructuring before then.

“Bank of Ireland is now a slave to the sovereign’s fortunes,” said Cathal O’Leary, head of fixed-income sales at NCB Stockbrokers in Dublin. “Investors either want to play Ireland’s recovery or they don’t. If they do, then this bank is the best and most leveraged way to do it.”

Royal Charter

Founded in 1783 by Royal charter, the Governor & Company of the Bank of Ireland became the official banker to the Irish Free State on independence from Britain in 1922. The Dublin-based bank has about a fifth of the home-loan market, a third of business and checking accounts and a similar share of the credit-card market. The lender’s 254 branches in the country rank second only to Allied Irish Banks Plc’s 268 outlets.

Bank of Ireland’s market value and loan book have surpassed Allied Irish since the housing bubble burst in 2008. Allied Irish is now 93 percent state-owned after receiving 7.2 billion euros of bailouts over the past two years. The government owns 36 percent of Bank of Ireland after injecting 3.5 billion euros.

The lender may post a 1 billion-euro pretax loss this year, according to the median of four analysts surveyed by Bloomberg.

“My only concern is to get this ship off the rocks,” Bank of Ireland Chairman Pat Molloy said at the shareholder meeting today. Outflows of deposits have stabilized since late 2010, and there are indications the economy is stabilizing, said Molloy, who had to dodge an egg hurled during the meeting in Dublin.

‘Economic Apocalypse’

The economy may expand by 0.75 percent this year after a 15 percent contraction over the past three years, the government said in April. Growth may accelerate to 2.5 percent in 2012, according to the government.

Consumer confidence rose in May, gaining for a fourth month in five, on increasing optimism unemployment has peaked and as concern about “an economic apocalypse” fades, KBC Bank Ireland Plc and the Dublin-based Economic & Social Research Institute, an economic research group, said on June 8.

“There’s no way that we can look back on this investment and say that it was a success,” said Robert Taylor, director of international research and portfolio manager at Chicago-based Harris Associates LP, Bank of Ireland’s largest institutional shareholder, with a 5.8 percent stake. “But the one thing we got right was that this is the bank to invest in if you look at the management team and long-term value prospects.”

Fundraising Plans

Investors will today discuss Bank of Ireland’s plan to raise 5.2 billion euros to bolster capital. The lender is seeking to raise at least 2.1 billion euros by swapping subordinated bonds for as little as 10 percent of their face value for cash or stock. The bank will then raise as much as 2.2 billion euros in a separate share sale next month.

Depending on how many existing shareholders buy new stock in the share sale and on how many bonds are exchanged, the government, which is underwriting the fundraising, may own between 27 percent and 88 percent of the lender, Bank of Ireland said on June 8. The bank also said that day it was in “active discussions with other sources of private capital.”

Most junior bondholders are likely to convert their debt to equity because the terms of the swap are more generous than those of the debt-for-cash offer, according to Jim Ryan, a director at Glas Securities, a Dublin-based fixed-income firm. Holders of Bank of Ireland’s Tier 2 bonds are being offered 20 percent of par value in cash or 40 percent in stock.

“The bank will still need to encourage significant private participation in the forthcoming rights issue if it is to avoid majority state control,” he said. “This is not so easy to predict,” he said.

Bond Yields

The lender is raising money as the cost of insuring Irish government and bank bonds against the risk of default has jumped amid the European debt crisis. Credit-default swaps on Ireland surged 192 basis points over the past two months to 738 basis points today. CDSs show the probability of an Irish default within five years is 46 percent, according to CMA prices. Irish 10-year government bond yields have almost doubled over the past year and touched a euro-era record of 11.479 percent today.

“How can anyone buy a share in a bank as inextricably linked to the sovereign as Bank of Ireland without taking a view on the country re-profiling its debt -- which I think is inevitable,” said Stephen Kinsella, a lecturer in economics at the University of Limerick. At “the very least” Ireland will need to secure a deal in 2013 to repay its debts over a longer period, he said.

Greek Restructuring

If Greece restructures its debt, the odds of Ireland following would narrow significantly, according to Brian Devine, chief economist at Dublin-based NCB Stockbrokers.

Bank of Ireland had 3.8 billion euros of Irish government bonds held as assets for sale at the end of December as well as 5.1 billion euros of government-guaranteed bonds it received as payment for risky real-estate loans the state acquired last year, according to its latest annual report. The bank held more than 600 million euros of bonds issued by other governments at the end of December.

A restructuring of Ireland’s debt would force the bank to write down its holdings of sovereign bonds, eroding the capital the bank has been ordered to raise. Bank of Ireland would have to raise additional capital if its core Tier 1 capital ratio, a gauge of financial strength, fell below the Irish central bank’s 10.5 percent target. The planned fundraising would boost that capital ratio to about 15 percent, according to Bank of Ireland.

Even if Bank of Ireland falls into state control in July, the fact it has proportionately less capital to raise than other Irish banks “puts it in a relatively better position, all else being equal, to be the first to extricate itself from state involvement at some stage in the future,” said Eamonn Hughes, head of research at Dublin-based Goodbody Stockbrokers.

“At that stage, Ireland Inc. and probably the entire banking system has to be in the right shape,” he said.

--Editors: Edward Evans, Steve Bailey.

To contact the reporter on this story: Joe Brennan in Dublin at jbrennan29@bloomberg.net

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net


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