The announcement that AIB was effectively being nationalised because it would need another €3bn to cover its property loan losses was arguably the best thing to happen to Bank of Ireland (BoI) since it successfully raised €2.7bn from shareholders in May.
Almost immediately the share prices of the two banks, which for years had gone up and down in tandem, diverged markedly. BoI rose strongly while AIB continued its long slide down. By last week AIB was hovering around 42c, more than 15% below its fixed rights-issue price of 50c, while a post-rights BoI held close to 65c – nearly a 25% rebound from recent lows.
The decoupling of BoI and AIB had been under way for some time. As early as autumn 2009, institutional investors were urging BoI to do a rights issue while its shares were trading at a relative high of more than €2. The thinking was that BoI was the stronger of the big two Irish banks and needed to lock in its advantage while the market was receptive.
Even though that fundraising window closed before chief executive Richie Boucher and chairman Pat Molloy could take advantage of it, due to delays at Nama and the European Commission, the perception remained that BoI was the best of a bad bunch of troubled Irish financial institutions.
The bank's successful capital raising in May, which involved the largest rights issue in Irish corporate history and a substantial private placing, only reinforced that perception. Crucially, Boucher and Molloy had maintained BoI's independence by keeping the state's shareholding to 36% while meeting the Financial Regulator's tough new capital standards.
But can it last? Or will BoI, like Anglo Irish Bank, Irish Nationwide, AIB and EBS before it, ultimately fall into state hands as losses outpace capital generation?
The future may be out of the bank's hands, as its franchise is essentially now an all-in bet on the state of a still-weak Irish economy.
"The recovery in BoI's share price looks to us like it has run its course for now," wrote Davy analyst Stephen Lyons in a note to clients last week. "We expect that further gains from here are contingent on a positive market reaction to 'Ireland Inc' in terms of the forthcoming budgetary announcements."
Investors have regarded BoI largely as a play on the Irish economy since at least the advent of Nama. This has been largely to the bank's advantage, especially when raising capital last spring, while AIB has suffered in comparison.
Davy's caution gives reason for pause, however, as the stockbroker has a history of looking favourably on BoI. The increase, again, in Nama haircuts has forced the bank to revise down its 2010 and 2011 profit figures by about 10% and 15% respectively. Davy also put up its 2011 impairment estimates by a massive 50%.
"Given the weaker outlook for the economy and pressures on property, as evidenced by Nama valuations, we think we are currently too optimistic on the fall-off in impairments in 2011, which we are now upping to €1.2bn [from €800m previously]," wrote Lyons.
The worsening outlook for banks on Nama haircuts, which tipped AIB over the edge into de facto nationalisation, is prompting some commentators to wonder whether BoI could ultimately end up in the same place.
"I'm not convinced that we have seen the end of the loan losses at AIB and BoI," UCD economist Karl Whelan told the Sunday Tribune. "With more write-downs to come on their non-Nama loans, BoI may also end up in majority state ownership."
Nama's decision to leave property and development loans of under €20m with the banks means that, even with a bigger Nama haircut this year, a significant amount of bad loans will stay on the books to cause losses in 2011 and beyond. According to a statement by the bank, €2.1bn of these loans will remain on the balance sheet. As of last June, €1.6bn worth of loans were impaired but only €800m were provided for, meaning more likely losses.
Notwithstanding the caution of local observers and the formidable challenges Boucher still faces in managing through the crisis, some optimism about BoI is returning to international markets.
Last week London broker Collins Stewart issued a favourable assessment of the bank as the "strongest player" in a weak market.
"If capital is scarce or an industry is engaged in more disciplined deployment of capital, voluntarily or not, then there is potentially a higher returns opportunity for the strongest player," wrote Collins Stewart analyst Gary McCarthy. "Unquestionably, BoI with its completed rights issue is best positioned to win market share and drive returns higher."
McCarthy said BoI would benefit from the retreat of foreign-owned banks as well as an EC clampdown on unsustainably high deposit rates among state-aided banks, which should help margins and profitability. He estimated BoI should be able to earn upwards of €1bn a year given an Irish GDP of more than €150bn.
"As a sanity check, a profit of less than 1% of GDP for the dominant local transaction institution might well be undercooking it," he wrote.
Again, the issue for BoI boils down to what happens in the economy. Whatever native strengths the bank possesses – stable management, dominant market position, capital security – its overall operating context is treacherous, especially given its lack of geographic diversity. As the government approaches a crucial budget in December, the economic outlook does not seem to be improving.
NCB last week downgraded its forecast as it said the growth outlook was deteriorating out to 2013. Economist Brian Devine cited surprisingly bad figures from the second quarter and cut his predictions in half for the next two years. Bloxham similarly is expecting "subdued growth" such that getting the budget deficit down to the eurozone maximum of 3% by 2014, as Ireland has committed to do, is a "tall order" we might not be capable of fulfilling.
The government will be seeking up to €4.5bn in budget cuts, or 50% more than the originally proposed €3bn adjustment, which many commentators fear could damage demand in the economy and stall what little recovery there is.
Ireland is one of only two EU countries still experiencing deflation, which means the real cost of borrowing is higher than the advertised rates. This is one reason behind depressed lending and economic activity, which brings the conversation back to funding and margins.
The reliance of Irish banks on ECB emergency money increased significantly in September as they rolled over debts incurred immediately post-guarantee. The wholesale markets are still effectively shut due to the high prices demanded of anything Irish.
BoI has pledged €13bn of its €41bn in eligible collateral to the ECB, making it the least addicted of the Irish banks. NCB analyst Ciaran Callaghan said the surge in low-cost Frankfurt funding should support margins, which have been shrinking badly the last two years, until December.
Beyond that is the end of the extended liabilities guarantee and uncharted territory for BoI.