Investor/An insider's guide to the market:AIB's sale/merger of its Allfirst operation to M&T Bank duly closed on schedule at the end of the first quarter. Under the terms of the deal AIB is left with a stake of over 20 per cent in the new M&T Bank as well as receiving $886 million (€834 million) in cash.
At the time of the transaction AIB announced that it would utilise $450 million of this cash to buy back its own shares. It was generally expected that the buyback programme would be spread over a three- to six-month period.
However, on April 4th AIB announced that it had purchased 10 million shares (equating to 1.1 per cent of AIB shares in issue) at an average price of €12.85. This suggests that AIB is likely to complete its repurchase programme on a much shorter timescale.
Bank of Ireland has also been buying back its own shares on a phased basis for several months. During its current buyback programme B of I has repurchased approximately 13.5 million shares at an average price of €9.9.
The capacity of the Irish banks to repurchase their own shares is largely a reflection of the very high returns generated over a long period. This has resulted in the banks having excess capital on their balance sheets and in a period of slow overall growth and depressed equity markets, repurchasing their own shares represents an efficient use of this spare capital.
The Irish banks have been able to build up this excess capital by generating consistently high returns on capital over long periods. The banks were well-positioned to benefit from the booming Irish economy - and can do so again. They are also well managed when assessed against their international peers.
Furthermore, all of the Irish quoted banks, with the exception of AIB, have avoided banana skins in recent years. None of the Irish banks has had significant exposure to any of the major corporate collapses in recent years. Neither have they been exposed to such areas as junk bonds and therefore the quality of their loan books is very good.
The only exception was the Rusnak fraud perpetrated at AIB's Allfirst subsidiary. Although the loss involved was very substantial, it was one-off in nature and has been adequately dealt with by AIB.
From the perspective of investors the buyback of their own shares by AIB and B of I sends a positive signal to the marketplace. The scale of buybacks by both banks suggests that the boards and managements of these companies are taking the view that current bank share prices offer better investment value than alternative investment opportunities.
A review of the share price performance of Irish banking stocks over the first quarter suggests that the market shares this view. In absolute terms B of I's share price was static in the first quarter whilst AIB's declined by a modest 2 per cent. However, when compared with European markets the Irish banking sector performed exceptionally well, as can be seen from the accompanying table.
B of I did best, outperforming the Eurotop 300 index by 12.8 per cent, whilst AIB outperformed by 11.6 per cent. All of the other quoted financials outperformed, but by smaller margins.
A key investment attraction of Irish banking stocks is that they now offer very high dividend yields. Shares in Irish Life & Permanent now offer a yield of 5.5 per cent whilst AIB and B of I are each offering a forecast 2003 yield of 4.3 per cent. In an historical context these are high yields, but when compared with current alternatives they appear to offer exceptional value.
These dividend yields are well above even the highest deposit rates offered by banks. Of even greater significance is that AIB's and B of I's dividend yield is now approximately level with the yield on offer from long-dated Government bonds. Whilst investing in bank shares is unquestionably riskier than investing in Government bonds, the prospective growth in bank dividends now seems to more than compensate for such additional risk.
Of course, there are many European financial stocks that offer much higher dividend yields than the Irish banks. However, in most cases there is a high probability that many of these dividend payments will be cut in the future.
In contrast, the dividends paid by the Irish banks look very secure, and furthermore they seem capable of continuing to increase dividend payments on a sustained basis. Dividends must be paid out of profits and a key measure of the sustainability of dividend payments is "dividend cover", which relates earnings or profits to dividends.
For example, Bank of Ireland has a dividend cover of 2.5 - that reflects the fact that its earnings are 2.5 times its dividend. Therefore, even if B of I went through a period of modestly declining profits, it could still maintain its dividend payment.
For financial stocks, a dividend cover ratio of about two is considered to be very satisfactory and it can be seen from the table that all of the Irish financial stocks enjoy a dividend cover in excess of two.
These relatively high dividend yields - viewed in the context of active share buyback programmes on the part of AIB, Bank of Ireland, and Irish Life & Permanent - suggest that investment value remains a feature of Irish financial stocks.
