Financial shares have long been a favourite outlet for private investors.
A combination of relatively high dividend yields and a broad exposure to economic developments, key characteristics of financial stocks, has proved to be historically attractive to investors. Analysis of the share price performance of the three largest quoted Irish financial companies shows that investors' enthusiasm for these shares has not been misplaced.
The five-year annualised absolute returns for Bank of Ireland (B of I), AIB, and Irish Life & Permanent (IL&P) has been 23.2 per cent, 17.5 per cent and 12.4 per cent respectively. The past 12 months has been difficult, with only B of I managing to produce a positive absolute return. Nevertheless, the share price performance of these three financial shares has been good when compared with the overall market.
The share prices of the two weaker companies, AIB and IL&P, declined by less than the overall ISEQ index and, therefore, their performance relative to the ISEQ was positive over the past 12 months.
Over the five-year period, AIB and B of I significantly outperformed the overall ISEQ index, whilst IL&P underperformed by a tiny margin. The booming Irish economy of recent years has clearly been a key factor in enabling these companies to grow their revenues and profits.
Of course, differing corporate strategies have had a substantial influence in differentiating relative share price performance.
AIB has pursued a broad international diversification strategy. In contrast, IL&P is almost exclusively focused on the Irish market, with B of I somewhere in the middle.
The recent evidence showing deteriorating global economic conditions has led investment analysts to sharply reduce their profit forecasts for financial stocks.
In the US market, recent quarterly results from US Bancorp, a mid-west based US regional bank, could be a harbinger of things to come. It took a $655 million (€714 million) charge in loan losses with respect to loans to the manufacturing and transport sectors. As a result, its quarterly earnings per share fell to $0.11 from previous quarterly earnings of $0.44.
Of the three larger Irish financials, AIB is the only one with a large exposure to the US through its Allfirst subsidiary in Maryland.
Irish banking analysts have already reacted to these deteriorating economic conditions and have cut profit forecasts for the domestic banking and insurance companies. This has been a key factor in the recent share price weakness of these stocks.
However, there are several reasons to believe that further downward pressure could re-emerge. The continued sharp decline in the rate of growth in tax revenues suggests that the Irish economy is slowing down at a very worrying pace.
If the economy suffers a hard economic landing over the next 12 months, loan growth will slow down quite sharply. Despite low interest rates, concerns about asset quality could emerge, leading to the need for banks to increase their loan loss provisions.
A further downward twist to the bank's ability to generate revenues is coming from weaker stock markets. Fee income from asset management activities is very closely correlated with conditions in stock markets. IL&P looks particularly vulnerable in this regard, but AIB and B of I are not immune, given the large asset management businesses that they have built up in recent years.
Many of these negative trends have probably been built into already weak share prices. However, an important factor that would create further downward pressure would be negative international sentiment towards the Irish economy. As yet there is little evidence that this is occurring.
The recent upgrade to the Republic's credit rating by Standard & Poor's is a positive sign in this regard. However, as evidence mounts that the Irish boom is over, international investors could become more cautious about investing in the Irish market.
