AIB's announcement last Thursday that it would be seeking to improve its capital strength by replacing perpetual bonds with subordinated debt is welcome news from a bank that has had little positive to report recently.The plan, which follows a similar move last month by Bank of Ireland to buy back heavily discounted undated debt of its own, would allow AIB to boost its equity by €600m-€700m, depending on the appetite of the bondholders for the deal. In return for giving up the discretionary high-coupon payments attached to the nearly €3bn in perpetual notes, the bondholders would instead receive more senior, secured debt of lesser value - with the bank writing the difference to its capital reserves. The Sunday Tribune had questioned why the Irish banks weren't using this method of booking profit months ago.
The bank's exchange offer arrived not a moment too soon. Market analysts were beginning to get anxious that, despite AIB admitting in April that it would need to raise another €1.5bn to help absorb losses on bad debts, nothing was stirring on the capital front down at bank centre. The situation was all the more perplexing given AIB's peer and main rival, Bank of Ireland, had closed its debt buyback tender early due to a better-than-expected response which yielded a full €1bn capital boost. Industry sources have even been talking up the prospect of an equity issue for BoI by the end of the year, which would virtually assure that the bank's shareholders retain control of the institution.
AIB's dilatory response to the mounting capital crisis, on the other hand, had left market observers wondering whether the fight had gone out of the bank and whether the outgoing executive team had resigned itself to majority government ownership. A week ago last Friday, Davy worried in its weekly market comment that AIB had been left behind by BoI and that the "opportunity cost" of delaying any beneficial changes to its capital structure could be as high as €250m. That figure equates roughly to the expected equity gain from selling the bank's stake in US regional M&T Bank or, as Davy put it, "the difference between majority government ownership or not".
One possible reason that AIB delayed in choosing a debt exchange over a buyback, though, was an attempt to preserve its Tier 1 ratio – a measure of its financial strength which would have been weakened to fund a bond repurchase. According to NCB, a debt buyback could have pushed AIB-s Tier 1 ratios – which were last reported at 7.4% compared to Bank of Ireland's 12% – below the minimum target set by the financial regulator. Also, as Davy pointed out, the benefit was reducing all the time, as the market had bid up the price of AIB's Tier 1 instruments in the weeks following the BoI buyback offer – another consequence of not following quickly enough.
Now that AIB is pursuing a debt strategy which could potentially satisfy half of its current capital needs, questions still remain over the mooted disposals of its stakes in M&T, the profitable mid-Atlantic regional bank, and Polish commercial bank BZWBK.
Moves to sell off the prize American and Polish assets are being met with some internal reluctance, especially among the many staff members who have worked in either M&T or Bank Zachodni and helped integrate them into the larger AIB Group. Although the sale of these stakes would help AIB's capital position, both also produce much-needed income for the group. M&T contributed €94m in 2008 while BZWBK returned a very strong €263m – more than the historically more profitable UK business. So, ironically, the healthiest parts of the bank may have to be sacrificed to keep the remainder alive.
A glimmer appeared on the horizon early last week when it emerged that PKO Bank, the second-largest bank in Poland, said it was going to raise more than €1.1bn in a share issue. Media reports speculated that this could be used to buy AIB's BZWBK stake, but no specific guidance came from the bank itself. Irish analysts gave the reports a tepid endorsement, noting that a tie-up would make a good strategic fit, but that BZWBK was no longer the attractive asset it once was. Moreover, consolidation in the Polish market was being stymied by the number of local banks controlled by foreign parents more concerned with their own domestic issues than with the strategic demands of their Polish holdings.
Apart from one unsubstantiated rumour that a €1bn buyer popped up to buy the M&T stake early in the year, nothing seems to be shaking Stateside. AIB is hamstrung somewhat here by the terms of their original agreement to acquire the M&T stake back in 2003, which states that AIB must first offer the holding to the existing owners before shopping it on the open market. This effectively means Warren Buffet's Berkshire Hathaway, another large minority owner, or M&T itself.
AIB has given itself until the end of the year to make progress on these issues, but for now, Bank of Ireland is making most of the running on capital recovery and ultimate freedom from government control. By December, there could be some serious distance between two banks which have effectively been running neck and neck for decades.
How the two banks measure up...
AIB (as of 12/08)
Share price change year to date: +29%
Core Tier 1 equity ratio: 8.4% (including government preference shares, but before debt restructuring)
Market cap: €2bn
Pre-provision profits: €2.7bn
Percentage loans written down: 1.37%
Bank of Ireland (03/09)
Share price change year to date: +160%
Core Tier 1 equity ratio: 9.5%
Market cap: €2.2bn
Pre-provision profits: €1.9bn
Percentage loans written down: 3.9%