ANALYSIS:Remedial action has startled the market but it may prove effective in reducing exposure to risk
BANK OF Ireland had the unenviable task of issuing a trading update days after US investment bank Lehman Brothers collapsed, another, Merrill Lynch, was saved in a $50 billion takeover and the US government rescued one of the world's largest insurers, AIG.
Ireland's second largest bank doesn't have anything like the problems that have caused the tremors on Wall Street this week; it is not directly exposed to the toxic US assets that brought Lehman down. But the bank is unwinding financial customer positions with Lehman, though the cost involved is "not material".
Like all Irish banks, Bank of Ireland faces tough times due to falling property values, weaker economic conditions and the higher funding costs arising from the unprecedented financial turmoil.
The bank expects bad debts to rise from €232 million at the end of March to as high as €1.3 billion at the end of March 2010, if the financial market and economic conditions remain poor. This, combined with higher funding costs, will reduce the bank's earnings.
The jump in the forecast for the bank's bad debt charge raised eyebrows as AIB, which has a greater exposure to struggling property developers, estimated that bad debts would top a slightly lower percentage of its loans next year.
The declining property market has raised the risks facing Bank of Ireland. The bank expects 45 per cent of the bad debt charge in 2010 to arise on its property investment and development loans.
Loan-to-value (LTV) ratios on the bank's €24 billion property investment loans have risen from 62 per cent when provided to the high 70s, as values have fallen up to 25 per cent. The ratios on development loans, totalling €8 million,have risen from the low 60s in percentage terms to the high 70s.
Values on land banks, which account for €5 billion worth of loans, have dropped 30-40 per cent, though the LTV ratios on these loans were in the high 50s.
The bank startled the market by back-tracking on its dividend policy and halving its payouts in a bid to give the bank a more sturdy capital footing amid the downturn.
"It's a pretty stark move," said analyst Sebastian Orsi at stockbrokers Merrion Capital.
Bank of Ireland is also minimising further risks by slowing the growth of its loan book sharply.
Chief financial officer John O'Donovan explained that these were two of four "levers" available to the bank to build up capital.
The bank is reluctant to pull the other two levers - selling assets and tapping shareholders for cash.
The bank would prefer not to sell any assets "unless you absolutely had to", said Mr O'Donovan.
On dividends, Bank of Ireland's rivals have reacted differently. AIB raised its half-year dividend by 10 per cent in July, while Irish Life & Permanent left its half-year payout unchanged last month.
NCB Stockbrokers said that even after the cut, the bank has a dividend yield - a key measure followed by investors - of more than 7 per cent, though investors appeared to have priced a large dividend cut, judging from the share price, as the yield reached almost 12 per cent earlier this year.
The investors were right.
