Stories
Bank of Ireland shares fell 15 per cent yesterday after a miserable first quarter trading update.
It announced it was setting aside €250 million to cover a wave of defaults and bankruptcies from Covid-19. It also announced new lending was 37% lower, net interest margins had fallen from 2.10 to 2.07 per cent.
Why did the shares drop 15 per cent on the day, and why have they fallen so much more than the benchmark Eurostoxx Europe Banks Index since January?
Bank of Ireland’s Covid-19 impairments are not to blame for its underperformance against the European banks, or for its 15 per cent drop yesterday. That’s because Bank of Ireland’s €250 million provision was as expected, and is proportional to the rest of the banking industry. Bank of Ireland’s €250 million amounts to 0.2 per cent of its assets, which is almost exactly the average amount set aside in the first quarter by the world’s biggest banks, below.
There’s another possible explanation for Bank of Ireland’s drop yesterday. It’s to do with the category headed “other income”. Yesterday the bank announced its other income category is expected to fall as much as 40 per cent this year, according to Chief Financial Officer Myles O’Grady. The bank wrote down €155 million against this category.
That’s a problem because other income — which is comprised of fees, trading, wealth management, and everything not to do with lending money — is not meant to be volatile. It’s meant to be stable. Whereas income from money lending rises and falls with prevailing interest rates, other income is intended to provide ballast.
As Davy’s Stephen Lyons has pointed out, Bank of Ireland’s other income was already low. European banks make, on average 49 per cent of their profits from other income. Bank of Ireland last year made just 24 per cent from it. And in the first quarter, Bank of Ireland only made 22 per cent of its pre-writedown income from the other income category.
This means Bank of Ireland has less ballast than European banks. When times are good it makes more money than the average European bank, and when times are bad it loses more.
At a normal bank, other income acts as ballast. At Bank of Ireland, it’s making earnings more unstable.
To take one example, banks’ trading desks can make a lot of money in volatile markets. That’s because banks have cash, and in a cash crunch they can charge a lot for it. The trading desk acts as a natural hedge against volatility. And this quarter, record trading income helped make up for impairment losses at Barclays and JP Morgan. But Bank of Ireland doesn’t operate a big trading desk.
Bank of Ireland (and the other Irish banks’) inability to make money outside money lending may partially explain their shocking performance versus the European banks. Where the European banks are taking their writedowns, they’re protected somewhat by their other income sources. Bank of Ireland and the other Irish banks are doubly exposed. They’re looking at writedowns and big drops in their other income sources.
What accounts for the drop in other income in the first quarter? The bulk is a €120 million charge related to assets it has under management in its wealth and insurance business. And there’s another €35 million charge relating to counterparty credit and derivative adjustments. In total there’s €155 million in charges against it.
Bank of Ireland is closely linked to the Irish economy, and the stresses on the Irish economy are clear in these results. A month ago, Irish banks reported only five per cent of mortgage holders had asked for a payments holiday. In these results, the number is up to 10 per cent. As for new loans, the bank says that between reduced demand for loans and tighter standards, new lending might fall by 40 per cent this year.
Bank of Ireland is at least getting some relief from the ECB. The minimum amount of cash-like assets it’s required to hold has been dropped from 11.45 per cent to 9.27 per cent. This gives banks some leeway to write down bad loans without having to hold extra cash-like assets against them.
The bank’s dependence on interest income is killing it at the moment, when interest rates are low and falling. If and when the recovery comes, it should recover more quickly than the European banks. But rising interest rates seem like a long way from here.
