The further decline in the share prices of Irish financial stocks so far this year, coming on top of their very poor performance during 1999, means that many are now trading 40 per cent below their prices of just on a year ago (see table). While global financial stocks have been taking a battering in recent months, few international bank shares have fallen as far as their Irish counterparts.
One can identify four key factors that the experts have put forward to explain the sharp turnaround in the fortunes of Irish financial stocks. Firstly, global interest rates and bond yields have now been rising for more than a year.
Some investors take the view that rising bond yields are bad for financial shares given that many banks and insurance companies hold large bond portfolios that are declining in value. While there may be some merit in this argument, many banks in the US have recently announced record profits. This highlights that most banks now have a diversified mix of businesses, many of which have continued to perform well despite the weakness of the bond markets.
The second factor relates to the introduction of the euro and the subsequent desire by the Irish investment institutions to reduce their exposure to the Irish equity market. Undoubtedly this has been a potent factor particularly given that financials account for such a large proportion of the Irish equity market. Compounding this negative pressure on share prices has been the growing unease among international investors concerning the durability of the Irish economic boom.
Many overseas investors now believe that the Irish economy is in serious danger of overheating and therefore have been reluctant to invest in the Irish market. This has meant that selling by Irish institutions has not found ready buyers among international investors leading to inevitable weakness in share prices.
Many Irish economic commentators dismiss the risks of overheating and argue that the economy can achieve a soft landing. Unfortunately, history is not on the side of this argument and international experience has been that long-running booms rarely end in a smooth fashion.
The rampant housing market, tight labour market and high public sector spending all suggest that the risk of a hard landing sometime in the next two to three years is increasing. As the evidence of serious bottlenecks and of an asset price bubble in the housing market mounts, international investors are likely to continue to take a jaundiced view of the Irish financial sector.
The final factor that has damaged Irish bank share prices is the arrival of new competition in the shape of Bank of Scotland and Northern Rock. Consumers have rightly cheered their arrival as the profit margins on mortgage business halved virtually overnight.
For the mortgage specialists, such as First Active, the impact on their profitability has been severe. In contrast the immediate impact on the larger banks is not as serious given their broad range of products and services. Nevertheless, increased competition from overseas companies is likely to be an ongoing feature of the Irish financial scene.
The positive side of the equation is that, with the exception of the mortgage banks, profits are continuing to grow rapidly. In particular, sales of investment related products remain buoyant and the long-term prospects for life and pensions business are very favourable. Net dividend yields are now more than 3.5 per cent and bank shares are trading on price-earnings ratios in single digits. Much of the bad news would seem to be reflected in current share prices, and if the Irish economy achieves a gradual slowdown to a sustainable growth rate, current financial share prices will produce excellent returns over time.
