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Sheehy leaves AIB in a sorry state

AIB chief Eugene Sheehy last week made his final public outing. He leaves behind a troubling legacy. Part of this is that Bank of Ireland has now eclipsed AIB and may have a much brighter future, reports Emmet Oliver

Richie Boucher Bank of Ireland chief

The departing chief executive of Allied Irish Bank

"Incautious property lending has defined the Sheehy era at AIB, in the same way that the John Rusnak scandal defined the Michael Buckley era"

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Property. It's what got Allied Irish Bank into trouble and, according to departing chief executive Eugene Sheehy, it's what will lift the bank out of trouble. Despite the bank's dangerous addiction to the generous commissions available on property lending, the bank is now hoping sales of excess property will help AIB to raise €1.5bn of desperately needed capital before the end of the year.

As Sheehy bowed out last Wednesday for the final time, it was almost inevitable his parting remarks would concern property sales, house prices, commercial development and land prices. Incautious property lending has defined the Sheehy era at AIB, in the same way that the John Rusnak scandal defined the Michael Buckley era at the bank.

It could all have been so different. Sheehy, whose branch-banking background makes him almost an oddity in international banking terms, has never done an on-the-record interview. His reclusive, guarded personality was supposed to insulate him from the kind of trouble which ensnared the likes of Tom Mulcahy, Gerry Scanlon and Michael Buckley, but it didn't have the desired effect .

Sheehy's decision to remain out of the media glare, particularly during last year's banking crisis, came across as aloofness, as if the former branch manager simply did not fully appreciate the scale of the crisis facing his bank and the others in the sector. The decision to prowl the corridors of AIB Bankcentre rather than engage directly with shareholders, the media, customers and the public in an open and frank way made Sheehy look remote and out of touch.

But a failure to map out a convincing communication plan seems a trifling issue when placed alongside the chief legacy of the Sheehy era, which began in July 2005.

With €33bn of 'criticised loans' and €8.5bn of impaired loans in Ireland alone, the property lending legacy left behind by Sheehy and his executive team is clearly a troubling one. It's likely that the losses posted by Allied Irish Bank during the Sheehy era will not be exceeded by any future chief executive (see panel).

Its not a legacy Sheehy will wish to linger over for long, but there is also another legacy he leaves behind which may have longer-term implications for the entire banking sector and that is the contrasting fortunes of AIB and its long-term rival Bank of Ireland.

For years, AIB was a far larger institution than Bank of Ireland and its staff took pride when international financial publications automatically used the descriptor "AIB, Ireland's largest bank". But now, on virtually every significant measure, AIB has been utterly eclipsed by Bank of Ireland. Bank of Ireland has a larger balance sheet (its assets are worth €194bn to AIB's €182bn), its market value at €2bn is larger than AIB's €1.8bn and in terms of share-price growth, there is no contest, with Bank of Ireland up 141% this year while AIB has ticked up 21%.

Figures drawn from balance sheets and income statements only get one so far these days – instead it is all about asset quality and that is where AIB and Bank of Ireland have gone their separate ways too. AIB's liking for the purchase of speculative land has left the bank with €9bn worth of fields and empty sites in Ireland, compared with the more modest €3bn accumulation at Bank of Ireland.

Overall, the sheer size of the legacy assets at AIB is astonishing. At the end of 2008, AIB had €47bn of construction and property loans, compared to Bank of Ireland's €36bn. In terms of the haircut on these loan assets, AIB is expected to take a 25% discount, while Bank of Ireland will accept a haircut of 20% (Davy Stockbrokers, 29 April).

While Eugene Sheehy last week said this will be the peak year for loan impairments for AIB, that has more to do with the fact that Nama will be taking on impairments from now on. Bank of Ireland on the other hand is considering a rights' issue in the autumn to shore up its capital position further, although the timing of Nama may yet interfere with that plan.

Either way, it's already starting in a stronger capital position than AIB. The last set of results issued by the Richie Boucher-led bank showed it had core tier 1 capital of 9.5% at the end of its last financial year, while AIB was back in its slipstream at 5.8% at the end of its financial year.

But that is now irrelevant history. Which bank will be stronger once the Nama transfer of loans is completed? Broker figures suggest that once more AIB's crippling legacy assets will weigh it down more than Bank of Ireland.

AIB will have a core equity tier 1 ratio of 3.2% post the loans being transferred, while Bank of Ireland will be at a slightly perkier 4.5%. Clearly, both are going to need huge transfusions of government capital, but the larger capital reserve held by Boucher gives him a head start and means he can limit the government stake, unlike Sheehy's successor, who will be in a less-favourable position.

The unflattering comparisons between AIB and Bank of Ireland are all the more frustrating for AIB because it has far more market-leading positions than Bank of Ireland and its profit engine (pre provisions of course) is far stronger. Based on its last full-year results, AIB managed an operating profit margin of 6.76%, whereas Bank of Ireland was only able to squeeze an operating profit margin of 3.31%.

In terms of raw numbers AIB managed an operating profit of €2.7bn, compared to Bank of Ireland's €1.8bn. For whoever succeeds Sheehy, there is clearly the chance that Nama and the final elimination of most of the major property provisions could free up AIB to re-assume its position as Ireland's pre-eminent financial institution, but the long shadow cast by its legacy issues is likely to make that a long journey. It may yet become Ireland's largest bank, but the description this time around is likely to be Ireland's largest government-controlled bank.