Markets News Wednesday: Irish bank shares rise again in Dublin
Following the agreement of 10 of the world's largest car companies to a sweeping US government regulation mandating sharply higher fuel efficiency standards and tailpipe emissions limits, President Barack Obama announced on Tuesday at a Rose Garden ceremony, flanked by Detroit's Big Three automakers and the president of the United Auto Workers, the deal as "an historic agreement to help America break its dependence on oil, reduce harmful pollution and begin the transition to a clean energy economy."
The agreement requires automakers to meet a fleet-wide average of 35.5 miles per gallon by 2016 -- with passenger cars averaging 39 mpg and light trucks 30 mpg. The new regulations begin with the 2012 model year and call for 5% average annual increases. California Gov. Arnold Schwarzenegger told reporters outside the White House that talks had gone through the weekend. "During this last weekend, we negotiated and the negotiations got very intense and all of a sudden they all clicked and we came together," Schwarzenegger said. It helped that Detroit's Big 3 automakers had almost zero bargaining power. The sale is part of the bank's previously announced plan to sell shares as it seeks to raise up to $33.9 billion in equity to meet the US government's stress test requirements. On Tuesday it sold a block of 825 million shares at $10, which was below its Tuesday closing price of $11.25. It had sold the other 425 million shares previously. The Shanghai Composite Index has climbed 47 percent this year on optimism that a 4 trillion yuan ($586 billion) stimulus package will revive growth after exports collapsed. The world’s third-biggest economy is “struggling” and may fall short of the government’s target of an 8 percent expansion this year, Oppenheimer & Co. said this week. Newry, Northern Ireland-based First Derivatives plc which provides software and consulting services to the financial services industry and is listed on the small companies market in Dublin, today announced pre-tax profits, before currency adjustments, of £5.4m sterling for the 12 months to the end of February 2009. This is up 13% on the figure of £4.7m the previous year. "the economic climate has seen a significant currency fluctuation in Sterling. Pre-tax profit is stated after a loss on currency translation of £922,000 which has arisen from the necessity under accounting treatment to translate the group's Dollar loans at the exchange rate ruling on 28 February 2009 in comparison to the exchange rate on 1 March 2008. This treatment takes no account of the group's natural hedge to its Dollar loan when considering the Dollar assets carried at historical cost on the balance sheet." "Consumer spending dropped sharply in the 12 months to the first quarter of 2009. It was probably as much as 11% lower in volume. More than half of that decline was directly attributable to higher savings out of disposable income rather than the drop in income itself (although they are obviously inter-related). The economy will reach an important inflection point when savings reach peak as a percentage of income for the cycle. We think that may happen late this year. Future income prospects, wealth effects and age are the three obvious determinants of saving. Yet cultural factors, as well as access to consumer credit, also play a part. The likelihood of better visibility on further wage declines, the peak in unemployment and the scale of future tax increases may lead to improvement in confidence by the end of the year. Access to credit meanwhile can only loosen from here. Particular national characteristics are the final important variable. Ireland's demographic stricture is the youngest in Europe. So the life cycle theory would suggest that propensity to save in Ireland should be lower. One caveat is the relatively high level of mortgage debt that was built up among younger age groups. But the savings ratio will average at least 11% in 2009 and on a quarterly basis reach a mark in excess of that. That compares with a low of 2.7% in 2007 (the previous low was 3.1% at the peak of the first boom in 2000). We just do not think that Ireland's ratio will reach the heights of certain countries in continental Europe (15-16%) where the average age of the population is much older." "Although it continues to pay for the privilege, international bond markets continue to remain open to Irish bond issuance. Yesterday, the third Irish bond auction in as many months took place, raising another €1bn euro in the process. This brought the amount raised so far this year in the form of medium and longer dated bonds to €13.3bn. Given that the total funding requirements this year amount to c.€26bn, the NTMA has comfortably gone beyond the half-way stage in its funding programme for the year. Demand at the auction was significantly higher than in April, and the spread paid over the German equivalent was also substantially lower compared to last time out (24bps lower for the ten-year issue). The true funding position is even less concerning in the short-term, as there is already a significant cash pool built up as a contingency fund, to be used in what now looks to be the unlikely scenario of the debt markets becoming closed to further bond issuance. Although the source of demand for the latest issue is unknown, an increasing proportion of the demand in recent auctions has stemmed from the domestic banking sector. For example, although 80% of Irish Government bonds were owned by foreigners at the end of 2008, Irish institutions accounted for 55% of the demand for the Treasury Bond maturing in 2012. Given that 72% of the total take-up came from banks, this is proof that Irish domestic financial institutions are taking up an increasing proportion of Irish bond issuance. This is a useful liquidity tool for the domestic banks as these bonds can then be repoed into the ECB as they are allowable collateral. This process is not exclusive to Ireland of course, as domestic banks in the UK have been doing the same thing. In the context of rising savings in Ireland, this is the process by which these savings get recycled. It is not a medium-term solution but it has provided a useful liquidity tool for both Governments and banks in what was a very stressed period for the financial markets. With risk appetite continuing to improve, demand from international sources may indeed pick-up, given the extra yield attached with Irish bond issues relative to core Europe. Although there is still the important job of reducing the budget deficit and sorting the banking situation to be done domestically, it seems to us that funding concerns, reflected in yields still being at similar levels to Greece, about Ireland Inc look to be overdone." BOI’s FY09 results were a bit better than anticipated. In addition, the news of the buy back of some of its debt capital is helpful (we are pencilling in a gain of c€700m). Finally, RWAs were also lower than anticipated (transition of a number of portfolios to foundation IRB). Elsewhere, BOI raised its base credit charge guidance for the 3 years to FY11 from its central case in February of €4.5bn to its previous €6bn stressed figure. We are already at €7.8bn (5.9% of loans) for the same period and estimate a cumulative over the cycle charge of 8.5% (€11.1bn). Our target capital is a 4% core equity ratio at the bottom of the cycle (FY12 for BOI) as per the UK (FSA) and US (Fed) stress tests. Any shortfall, outside of additional capital measures, is made up by conversion of the requisite amount of government preference shares (the UK & US trend). Previously, we estimated BOI required to convert €2.3bn of the preference shares to meet the 4% target. Revising our models for the results and incorporating an estimated €700m gain from the bond buyback, sees this drop back to €1.1bn. This brings back the level of government dilution to a 45-65% range on a 4-6% core equity ratio sensitivity, from 60-75% previously. The likely lower State ownership is a clear positive, somewhat accentuated by the recent share price rise.BOI absorbed €2.8bn negative adjustments to its equity in the period (AFS, structural FX hedge, cash flow reserving and pension fund obligations), leaving the reported tangible common equity to total assets ratio (ex life assets) a lowly 1.9%. However, these movements don’t impact regulatory capital (unless crystallised), with the core equity ratio (ex the government preference shares) at 6.2%. Given the short (2.6yrs) average duration of its AFS portfolio, we are looking through its impact of the markdowns on the TNAV, adding back the changes in the cash flow hedge and also adjust the structural foreign currency hedge based on our in-house FX rates. Elsewhere, the bond buyback gain is helpful for the TNAV (Total Net Asset Value). So we are now forecasting a post-NAMA TNAV per share of 115 cent.On a simplistic basis, BOI is trading at 0.4x its end FY09 reported equity. More appropriately, though, it is trading at almost 1.2x our bottom of the cycle TNAV, bearing in mind we have generously added back all the FY09 TNAV adjustments bar the move in the pension deficit (will take longer to resolve). Alternatively, the market is pricing BOI at 0.6x the bottom of the cycle TNAV using the company’s own credit charge guidance. Firstly, our credit charge figures tally quite well with the recent US stress tests, bearing in mind that Irish GDP will be substantially worse than the US outcome. Note that impaired loans were 2.8x higher in March from the interim stage and “challenged” loans were up from 3% to 11.6% of the loan book over the 12 months. Secondly, we believe that the Irish banks will deliver sub-par ROEs post the cycle, particularly as they move to rebuild capital ratios to where markets are likely to deem fit (10% T1 ratio and 7.5% core equity, in our view). This could require additional capital raising, further diluting returns. So we deem a discount to TNAV appropriate (0.65x). Our fair value moves from €0.3 to €0.75."
