With the last stage of its €3.56bn capital raising officially under way following shareholder approval of its rights issue last Wednesday, Bank of Ireland not only has replenished its Nama-depleted reserves, it also exceeds tough new requirements to keep its equity levels above 7% to absorb any future hits to its balance sheet.
But, according to the bank, the point of the rights issue is not just to fill in craters caused by Nama bombshells, but to create a better quality capital structure to support the group's future profitability and growth. Those investors who take up their rights, therefore, will be looking towards future profitability and a return to dividends. The question is where those profits will come from.
According to the interim management statement Bank of Ireland released when it announced the rights issue, trading conditions in its core markets remain challenging despite some signs of stabilisation. The main problem is in net interest margin, which is still falling. Dolmen Stockbrokers expects it to decrease a further four basis points to 1.55% by the end of the year - 20 basis points off the bank's target margin of 1.75%.
The reasons for the low margins are well-known by now: low ECB rates on one side, which keep lending prices down, and high deposit rates and wholesale funding costs on the other side. Margins on new business are good, the bank said, but the volume of new business is too small still to make much of an impact on the overall margin picture.
The results of the stress could be seen in Bank of Ireland's fairly weak operating profit of €1bn for the nine months ended in December 2009.
Analysts see the bank continuing to lose money this year and only breaking even in 2011, before returning a small profit in 2012 and finally achieving "normalised" profits in 2013.
Oliver Gilvarry, head of research at Dolmen Stockbrokers, said Bank of Ireland should achieve around €1.2bn in top-line operating profit in 2013 - far below earlier peaks of around €2bn.
"Bank of Ireland had over 20% return on equity (ROE) in the past, but that's not going to come back," he said. "Irish banks will see ROE in the low teens in the medium term."
Within that universe of Irish banks, however, Bank of Ireland appears to have the best prospects, having retained both a dominant domestic franchise and its UK business after the European Commission approved its business plan. The bank will have to shed New Ireland Assurance, Bank of Ireland Asset Management and ICS Building Society by 2014, although these disposals will not have a major impact on either capital or profitability.
"Bank of Ireland has a first-mover advantage and is in a better position than its peers," said Gilvarry. "The retention of the UK business and the Post Office joint venture is a big thing in our view, since it gives the bank access to deposits and loans in an economy that is likely to grow faster than Ireland's."
Here in Ireland BoI's prospects depend on a broader economic recovery. In fact, institutions which participated in the bank's €500m share placing last month saw the investment as a play on the Irish economy rather than a bet on a single company, according fund management sources. But the downside risk is that bad debts might still get worse, even if Ireland climbs out of recession.
"The pace of economic recovery is the real driver of profits," said Kevin McConnell, head of research at Bloxham Stockbrokers. "On the other side we have to have the full run-through of the bad debt cycle, where there is a level of unpredictability."
Bank of Ireland has kept its 'through the cycle' bad debt guidance at €4.7bn, but a double-dip recession cannot be ruled out.
On the upside, however, the current crisis in the euro and the ongoing uncertainty it is causing might create certain benefits for the Irish economy, McConnell said, by helping exporters sell into the UK and the US and by keeping interest rates low for longer.
"Low interest rates are supportive of economic recovery, of banks rebuilding their margins and in terms of bad debts," said McConnell. "Plus Ireland exports a lot of services, which are extremely price-sensitive, so we get a much bigger kicker from devaluation than some other economies."
Even if profits recover earlier, though, dividends are probably some way off. The bank is barred from paying a dividend until 30 September 2012, unless the government sells, redeems or converts its remaining €1bn in preference shares before then - an unlikely prospect according to both the bank and analysts.
The investment case
● Trading conditions remain challenging
● Pressure on net interest margins
● Peak of impairments has passed
● Deposits down, but trend reversing
● Wholesale funding outlook improving
● Retaining UK businesses
● State ownership capped at 36%