Last week, AIB managing director Colm Doherty announced that the bank's board had signed off on a capital-generation plan to fill the estimated €4bn-plus hole in the group balance sheet. Doherty said AIB is capable of raising this money from private sources, relying first on what he called "self-help options" such as asset disposals, balance sheet management, strategic investment and, finally, a rights issue.
But with such a damaged core franchise in the Republic of Ireland part of the business – where most of the Nama bad debts are – and the certainty of the state ending up with a larger share of the bank's stock, concerns are growing that capital gains could come at the expense of long-term viability, leaving the taxpayer owning a badly weakened bank.
"We are having to screw ourselves to get the money back," said Brian Lucey, associate professor of finance at Trinity College Dublin, who argued last year that the government should nationalise AIB and Bank of Ireland. "As the banks engage in [asset disposals] we'll end up with a banking system that is less diverse and therefore inherently riskier."
At the heart of the conundrum is what AIB does with its profitable majority stake in leading Polish bank BZWBK and, to a lesser extent, its 23.3% strategic share in M&T Bank, a large US regional lender. The real money is wrapped up in these overseas assets.
Analysts estimate the bank could gain as much as €2bn by selling these shareholdings, which Doherty said it is prepared to do even before getting EU approval on its business plan.
"The most valuable asset we have is Poland, it's the jewel in the crown," said Doherty. "An inordinate number of buyers are interested in Poland."
The issue the bank then faces in selling BZWBK is that the Polish bank is not only the most valuable asset from a capital point of view, but also from an earnings point of view. BZWBK was part of a division that contributed €309m of top-line earnings and had very little in the way of impaired assets, unlike the Irish operations. Polish earnings alone grew 6% compared to a 25% decline in Republic of Ireland operating profit.
"If AIB holds onto Poland there is a very attractive investment case," said a senior analyst at one Dublin stockbroker. "It's hard to say whether it will be held or not, though."
Without the Polish bank as part of the group, however, AIB could struggle to convince existing shareholders or a strategic investor that the rest of the bank is worth a punt.
Doherty said as much himself last week: "If you sell your best assets, strategic interest reduces."
But Doherty appears more concerned with filling the bank's enormous capital hole than with preserving the earnings capability of the group. Shareholders have reportedly said they do not want to hear from the bank regarding a cash call until he has pulled every other lever available to raise equity levels to market norms. Asset disposals will get him halfway there, liability management a little further.
"We will only consider a rights issue after all other options are exhausted," said Doherty. "Our shareholders have told us to crystallise value in the group first."
If the bank can pull this off and shareholders support the strategy with fresh funds, AIB will meet its capital needs without further recourse to the state apart from the expected share transfer to cover its recapitalisation coupon payments due in May. That will leave the government with a large minority chunk of the bank, but short of effective nationalisation.
But the plan is a highly contingent one which depends on the timing and outcome of Nama and the EU's approval of the bank's business plan in time to allow disposals to take place.
"At this stage, management is unable to clarify the specifics of Nama, its likely usage of the new funding guarantee, the EU response to its restructuring plan or the level of capital deemed appropriate," said Davy analyst Emer Lang.
The danger, market sources have said, is that all the uncertainty still hanging over AIB will keep it from executing its capital generation plan, turning it into a zombie bank with no real value for all the taxpayer money which has been pumped into it.
Bank of Ireland has fewer so-called 'self-help' options than its rival AIB when it comes to raising capital, but increasing clarity around the business make it a more attractive investment proposition for investors, analysts say.
"Publication of full-year 2009 results and expected European Commission approval of its restructuring plan in the coming weeks will set the scene for the cash-call needed to rebuild its balance sheet," said NCB banking analyst Ciaran Callaghan in a report last week. "Bank of Ireland's franchise in Ireland will come through the crisis intact, if not enhanced, in our view."
The bank needs to raise €2bn-€2.5bn in fresh capital to reach 8% core equity, the new norm in European banking. It can still raise a potential €525m in equity uplift from bond buybacks or swaps, but the bank lacks valuable, income-producing overseas assets it can sell. Yet the limited options mean there is more certainty about where the bank is going.
"Bank of Ireland seems less problematic than AIB," said Brian Lucey, associate professor of finance at Trinity College, Dublin. "It's more a pure-play than AIB and management has been seen to be more upfront as the guys who recognised their problems earlier."
Ironically, Bank of Ireland is the one with the bigger government-shareholding. Even this is being seen as positive by some, however.
"By increasing the market capitalisation of the bank, the share issue will reduce underwriting risk for a potential rights issue," said Sebastian Orsi of Merrion Stockbrokers in a note on the positive unintended consequences of increased state-ownership in Bank of Ireland. "The creation of a new major common shareholder increases the alignment of the government's interest with private shareholders."
What's at stake here is the ability to fund future business: better capitalised banks can access funds more cheaply. A successful rights issue would allow Bank of Ireland to wean itself off the government guarantee and improve its net interest margins so it can return to profitability. With AIB prepared to wait until the end of 2012 to reach optimal equity of 8%, Bank of Ireland has an opportunity to take advantage.