When tough times hit an economy, bank stocks are the first to get hammered. This is exactly what happened to Bank of Ireland (NASDAQOTH: IREBY ) when the country went through a terrible financial crisis. The turmoil, which had its epicenter precisely in the real estate and banking industries, made Bank of Ireland collapse, as its stock price went from a peak of $900 to about $15 now.
The crisis took its toll on Ireland's six big native banks, and now only three are still in business. The government became the biggest shareholder of the banks that remained, and in fact it still owns a 14% stake in Bank of Ireland.
Now that you've seen this depressing chart, we can ask ourselves if there is any hope for a comeback. Here I can tell you that some recent interesting aspects about the so-called 'Irish rebound' might make this stock start to look promising once again. Let's go over them.
First and foremost you have to know that since the end of last year Ireland has formally exited its 114 billion euro ($155 billion) bailout program. The country was the first nation in the euro zone to exit the bailout, showing that the country did a couple of things right and its finances improved. Now, confidence from investors toward the country is manifesting. We can clearly see this in the drop of the country's borrowing costs. The Irish 10-year bonds interest rate is now less than 3%, quite close to the rate that the U.K. gets.
But another aspect that can even push more hope particularly for the banking industry just came from a ratings agency. Moody's Investors Service has upgraded the government-guaranteed debt ratings of four Irish banks -- including Bank of Ireland -- to Baa1 from Baa3. The agency had already upgraded the country to Baa1 from Baa3 a couple of weeks before this announcement, as it expects the recent pick-up in Ireland's growth momentum to speed up its ongoing fiscal consolidation.
Third, the recovery in the Irish property market is resulting in considerable recent reduction in government contingent liabilities. In addition, better pricing for real estate could slowly start helping to expand credit capacity in the banking industry, and Bank of Ireland is in a good position to profit from it.
How's the bank doing?
Bank of Ireland is showing some improvements. Its underlying profit improved $1.35 billion last year. In addition, despite the low interest rate environment, net interest margin is now over 2%, a substantial increase considering that it was at 1.2% in the first half of 2012.
Defaulted loan volumes, although they remain high, have started to show a decline. Since June 2013 they dropped 6% to 17.1 billion euros ($23 billion). This is thanks to the deployment of sustainable restructuring solutions. According to the banks' data, repayment arrangements are met in eight out of 10 restructured Irish mortgages, and challenged SME loans found a resolution in 90% of the cases. If the country continues to improve, we should see an increase in repayment volumes and more loans being issued.
If you are not sure about banking in the country in particular but are interested in Ireland-related assets, iShares MSCI Ireland Capped (NYSEMKT: EIRL ) is an ETF you may want to look into. Just take a look at the growth it experienced:
Since the end of 2012, this ETF has gone nowhere but up -- particularly since Ireland formally exited its bailout program. However, after such a climb, prices might stabilize. Here's why.
Although things are looking better, let's please not get ahead of ourselves. Despite the Moody's upgrade, the Irish GDP actually contracted by 0.3% in 2013 following a year of scant growth in 2012. This year, the so-called 'patent cliff' in the pharmaceutical sector -- many juicy patents that belong to companies established in the country are expiring this year -- will probably hit the Irish economy, and could impact GDP growth in the next quarters. In fact, the Irish Minister of Finance himself expressed concerns about this issue.
National debt in the country remains at over 123% of GDP; and it was at 25% before the crisis. For next year, the government expects it will need 1.2% of GDP in additional fiscal tightening to achieve its goal of a deficit under 3% of GDP. So, we will probably see more austerity measures coming ahead.
Although the fiscal tightening measures have been good for the country's financials, they are not beneficial for Bank of Ireland as they depress the domestic economy. Certainly, the bank does not want a higher stock of non-performing loans.
Ireland and its banking industry suffered a lot in the past few years. Now things are relatively calm and suggest that the Irish recovery is ongoing.
Bank of Ireland has made substantial progress over the past three years, and it expects to remain profitable and generate capital this year. The improvement in interest margins and the drop in defaulted loan volumes have been key. Nonetheless, there is still a lot to do. Just think that Bank of Ireland's total assets are around 132 billion euros ($180 billion) and defaulted loans are 17.1 billion euros ($23 billion).
Certainly, the worst has happened for Ireland, but we should not expect a strong growth in its economy in the short term. The country still holds a high public debt level, sizable fiscal deficits, and significant banking sector risks, which combined with further austerity measures should bring slow domestic growth. Further, the recovery in real estate prices has been very selective, and prices in average are still about 50% down from their peak.
In addition, it seems the growth of iShares MSCI Ireland Capped was driven by two assumptions: that the correction was too strong and that the recovery would be faster. Thus this fund could have a lot of expectations already in its price, meaning that we might not see significant growth going forward if these expectations are not met -- especially if Ireland's economy does not show major improvements.
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