Thirty days that could change the face of Irish banking

The next month is crucial for Irish Life & Permanent as results pour in amidst its bid to take over EBS. Jon Ihle reports

Fergus Murphy, chief executive of EBS: the lender is facing a takeover bid

Gillian Bowler, chairman of Irish Life & Permanent plc and Kevin Murphy, group chief executive. IL&P is not participating in Nama and has not been recapitalised by the state

• 1
• 2

Irish Life & Permanent (IL&P), Ireland's biggest life insurer and mortgage lender, is facing a critical 30 days. On Tuesday the group reports its interim results for the first half of 2010, updating investors on profitability amid the ongoing crisis in Irish banking. September then brings verdicts from the Financial Regulator and the European Commission on the group's capital strength and the viability of its business plan. There is also the matter of IL&P's bid, submitted 20 August, to acquire EBS in what would be the most significant development for the company since it was formed by the merger of Irish Life and Irish Permanent in 1999. If successful, the group will most likely look at buying the remnants of Irish Nationwide and possibly merging with a business lender to form a 'third force' Irish bank.
Because IL&P is not participating in Nama and has not been recapitalised by the state like its other domestic peers, the bancassurer has not come under the same kind of scrutiny as the rest of the financial sector since the guarantee was put in place. The next month should change that as chief executive Kevin Murphy leads the group into the thick of the post-crisis shake-up.
Is the business truly fit to be a consolidator in the fragile Irish market?
Analysts are expecting IL&P to post an operating loss this time, due mainly to bad loans and shrinking margins in its banking arm, Permanent TSB. The problems here are familiar and have been well ventilated in the last year.
Mortgage impairments are coming close to 1% of Permanent TSB's €38bn loan book. Although management told investors in May that arrears were peaking, analysts are still pencilling in major losses through next year.
"Our forecast assumes an impairment charge of €177m at the half-year stage, but the timing in recognition of provisioning may differ over the cycle," NCB banking analyst Ciaran Callaghan wrote in a research note last week. "We still forecast aggregate writedowns of €1.1bn over the three years to 2011, above management guidance of €800m-€900m."
The margin erosion is arguably even more critical. High funding costs for Irish lenders on the wholesale markets, coupled with relatively low interest rates on loans, means the difference between what the bank pays for money and what it charges is shrinking all the time. This continues to have a negative effect on profitability. In addition, the €60m cost so far this year of the extended liabilities guarantee (ELG) is going to eat up what little pre-provision profits the banking arm is able to generate.
This is why Permanent TSB has been at the forefront of the drive by banks to raise interest rates on mortgages in the last nine months, pushing its standard variable rate (SVR) from 3.19% to 4.19% since January. Mortgage brokers expect further rises next year, with total increases topping out in the 1.5%-2% range.
Not incidentally, IL&P's primary interest in EBS is to enhance profitability. Murphy and his private equity rivals all know that EBS's €12.5bn mortgage book is mostly SVR mortgages, with just 20% on loss-making trackers. By comparison, IL&P has less than 40% on variables and much of the rest on trackers. That means even when it raises rates, it gets the benefit on less than half of its book. The addition of €10bn in margin-enhancing EBS mortgages is the main prize IL&P is after and would go some way towards enhancing margins in an environment of rising rates.
Adding EBS does nothing to solve PTSB's notoriously high loan-to-deposit ratio, which has been hovering at or above 250% since before the crisis. This means IL&P is forced to keep relying on the wholesale markets and ECB emergency liquidity to fund its book. But EBS's deposit base, though relatively stronger, will not make much of a dent.
Yet markets do remain open to IL&P. Last week the group raised €250m in funding in a private placing outside the guarantee by using residential mortgages as collateral. Pricing was not disclosed, but was reportedly less than the net cost of guaranteed funding.
Some commentators remained sceptical, however, noting the placing was not indicative of a general return in confidence in Irish financial institutions.
"The Permo fundraising was small beer," said Oliver Gilvarry, head of research at Dolmen Securities. "There is no real appetite for Irish RMBS out there. It's specialist funds only."
With the state's deteriorating credit rating outlook following S&P's downgrade last week, there is only further uncertainty surrounding the creditworthiness of IL&P and the other banks.
Some clarity should come, however, with the results of the Financial Regulator's prudential capital assessment review (PCAR) of IL&P and the European Commission's verdict on the group's viability plan, both of which are due in the coming month. IL&P has said in the past it could do with €500m-€1bn in 'comfort capital' and told shareholders it had the means to raise €900m. If the PCAR is in this range, it should present no problems.
The group is not expected to get whacked too hard by the commission, since – unlike the other five guaranteed institutions – it has not received a penny in state funds. Having been the least troubled and troublesome institution, IL&P is hoping to redeem some of its goodwill with the government.
Murphy and Permanent TSB chief executive David Guinane are betting the government, which as EBS's de facto owner will have to approve any merger, will see IL&P's bid for EBS as a consolidation play under which the Department of Finance could retain some influence and possibly recoup its investment over the long term – something commentators say is less likely if JC Flowers, Doughty Hanson or Cardinal Asset Management win out.
IL&P is understood to have proposed a joint venture with the state under which the group could bring new capital investment to plug the €775m hole EBS needs to fill to meet the regulator's capital standards.
Whether it can really raise that money is the big question. IL&P has long talked about various balance sheet management exercises to release capital from the life side – ultimately to enable the bank to be hived off to unlock shareholder value. But the share price has been stubbornly low, meaning the proposed €900m capital raise is more than twice the market capitalisation.
Getting through this stage of bidding will help IL&P's case. Positive assessments from the regulator and commission will give the group some much-needed momentum. The future starts in the next month.