We believe that BoI felt obliged to update the market with the detailed preliminary results of its Balance Sheet Assessment (BSA) yesterday (in contrast to the brief statements from AIB and ptsb) given the bank’s pressing desire to refinance the Government Preference Shares over the near-term, in order to avoid the looming principal step-up trigger in Q1 2014. In terms of next steps, we expect BoI to continue deliberations with the Central Bank of Ireland (CBI) and its auditors before ultimately bringing the provisioning and RWA issues to its Board of Directors. This process may run a few months, culminating in the approval of its 2013 full-year accounts (expected to be released in late February/early March 2014). While the bank may continue to view the CBI’s BSA outcomes as being overly conservative for its (prudent) risk profile, these assumptions are likely to be used as the basis for the ECB’s Comprehensive Assessment (CA) next year, giving the bank limited scope to recognise provisions and RWA models on its own terms. <p>
Regarding the CBI’s perceived mortgage portfolio provision shortfall of c. €360m, BoI state that this charge was driven by an industry wide grid modelling, which it disputes and doesn’t believe reflect its relatively better performing book. In addition we understand that the BSA took no account of the improved Irish macro back-drop, basing its analysis on the June 2013 point in time snapshot (fails to capture pick-up in recent economic data). The bank currently assumes conservative peak-to-trough Irish house price falls of 55%, compared to actual national declines of 47% as at October end according to the latest CSO residential property price index. BoI has previously indicated that provisioning would increase by €75-80m for every incremental 2% decline in property prices beyond the 55% level. Assuming the opposite also holds, we estimate that BoI could release up to €320m of mortgage provisions from updating models to actual house price levels, however this would leave the bank with very little headroom to cope with any potential future required changes in provisioning variables (e.g. new accountancy rules moving from incurred provision model to an expected loss approach).<p>
In terms of scenarios, assuming our current 2013 impairment charge rises by an additional €0.7bn to €2.1bn and RWAs increase by €3.4bn to €54.5bn (c. 50% of CBI observed shortfalls), the group’s CT1 ratio would decline by c. 230bps to 11.4% on a Basel III phase-in basis. Extrapolating this out and factoring in expected pension gains (€400m) and an equity placing (€600m) to refinance the Government Preference Shares, we estimate the group’s fully-loaded Basel III ratio would decline to c. 5.5%. These assumed provision and RWA increases would also reduce the bank’s capital buffer to c €1.9bn (above 8% CT1 ratio) ahead the ECB’s stress test next year. <p>
On valuation, the latter scenario and hit to equity would imply that the stock is currently trading on 1.7x its trough 2013 tangible net asset value (16.7c), representing a significant premium to peers. Nevertheless many investors in the equity markets are still focused on future “normalised earnings” that BoI can generate over the medium term (we forecast post cycle attributable profits of €670m in 2016 which implies the bank is trading on 12.5x undiscounted 2016 earnings). Given the existing benign market backdrop and strong investor interest in BoI, we still believe that the group can move ahead and refinance the Government Preference Share over coming weeks, though the prospect of the State disposing of the instruments at a significant premium has diminished somewhat in our view.
<p><h5>Ciaran Callaghan</h5>
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