ANALYSIS:The task now is to steer a clear course through the mire and persuade investors that the decline is overdone, writes Arthur Beesley.
IRISH BANKS are having wretched time of it. Prime beneficiaries of the boom times, now they are under severe pressure to convince the market that they can safely weather the storms of impending recession.
If the precipitous drop in their share prices since last year means investors have already cast unforgiving judgment, the task now is to steer a clear course through the mire and persuade them that the decline is overdone.
It is an onerous one in a climate of high uncertainty, made more difficult by the heady confluence of internal and external forces at work in the rapidly declining Irish economy.
Interest rates are going up, inflation is quickening, dollar and sterling weakness are eroding business revenues from abroad, oil prices are rising steadily and consumer confidence is on the floor.
As redundancies, unemployment, liquidations and receiverships increase, pressure on the public finances makes matters only worse.
AIB, Bank of Ireland, Anglo Irish Bank and Irish Life Permanent (ILP) and other Irish lenders rode high for years on the back of the property boom they helped to create. Their success increased competition from abroad, as Royal Bank of Scotland (owner of Ulster Bank and First Active), Halifax Bank of Scotland, Danish operator Danske (of National Irish Bank), Dutch player Rabobank and others sought a piece of the action. Now the rapid unwinding of the property boom, which many observers say was inevitable, endangers their profits.
That's the core problem. It is made much, much worse by the credit crunch in international financial markets, which flows from an erosion of trust among banks, constrains the supply of money, increases its cost, and reduces the appetite for risk. Although the subprime debacle in the US left Irish financials largely unscathed, they cannot evade its consequences. Nothing happens in isolation in international markets. Bank costs in Ireland are rising as a result.
The banks have lost some €39 billion of their value since the Irish stock market reached its pinnacle in February last year.
Profits still went up in 2007, but the downward slide continued as investors questioned the sustainability of profits given the increased likelihood of bad debts as the domestic economy goes into slow motion.
Even though the weakness of shares such as Bank of Ireland and ILP means they now offer particularly attractive dividend yields, which measures the return on investment for a stock, the market is unbelieving. By implication, the market believes current dividend rates are not sustainable.
By implication, too, it seems the market is unconvinced by the Financial Regulator's efforts to step up scrutiny of lenders with weekly liquidity reports.
Reassurances from the Central Bank that Irish banks are well-capitalised and well-placed to withstand risks to financial stability appear to have been met with indifference.
Still, it must be said that the sell-off of Irish financial stocks mirrors the decline of major international institutions amid exceptional volatility in global markets.
A further and significant factor is the prevalence of short-selling, a now-common practice that enables hedge funds and other short-term investors to take big profits from the deterioration of a share price.
Yet as banks take a pounding around the world, the irony is that not a single Irish institution has slipped into a loss-making position. Neither, to gauge from their public utterances, is that on the horizon. Yet still their shares fall. Thus did Willie McAteer, executive director of Anglo Irish Bank, tell the Oireachtas Joint Committee on Finance and the Public Service yesterday that negative sentiment was "not borne out by fundamentals".
Anglo, AIB, Bank of Ireland and ILP presented a unified face before the committee, arguing defiantly that they remain open for business, prudent in their application of lending rules, careful about risk and determined to maintain their financial position.
In one telling remark, however, Dónal Forde of AIB made a point of saying the bank would not amend its lending rules because it was conscious of the need to maintain the confidence of the international system and will do nothing to "diminish the standing of the Irish banks". This illustrates neatly the extent to which international eyes are trained on Ireland at the end of a long economic expansion.
Domestic analysts, too, share the international view that banks' high exposure to development lending is their biggest weak spot. While Central Bank figures show that total lending to business in March stood at €226.85 billion, stockbroking firm Davy estimates that Irish construction and property lending amounts to some €106 billion.
Certain senior bankers say in private that the portfolios of some developers, late to the sector, are now beset by negative equity. This means the value of a property has fallen below the outstanding sum due on its mortgage. In the current market, there is little prospect offloading such a property. The result, indicated Davy in a recent report, is that banks want to "roll" with the problem instead of taking aggressive action.
This is code for saying that the banks are willing to amend lending arrangements so as to avoid the prospect of foreclosure. In practice it means that they will take as much repayments as they can get because significant writedowns could have toxic consequences for the banking system at large.
Davy saw two risks here: "The Irish economy may not recover next year as we had thought, and a foreign bank could withdraw support from a large player, creating a domino effect."
In short: no Irish institution wants to pull down the house around it, but bankers in foreign tower blocks would not have to live with the consequences in their own back yard of pulling the plug on a big Irish client.
Finding a way out of all this will not be easy. For a start, however, banks will have to deliver the profits they promised. Expectations have diminished with the fall-off in lending and the likelihood of rising bad debts, yet profit delivery to forecast is the ultimate rebuff to a share sell-off.
By the same token, some well-versed observers say the banks would be much better to fully flush out their bad debts now, while their shares are down, to avoid the danger of a share price recovery preceding the evil day of major foreclosures with disastrous consequences.
There is also the outside possibility of a low-priced bid for an Irish or British institution from a well-capitalised predator. Although that might lead even those most sceptical about the Irish financials to rethink their stance, it presupposes that the banks themselves have won back support within the international market. For the moment, at least, that seems some time away.
At home, meanwhile, business people in stable sectors of the economy complain wearily that their banks are unreasonably turning the screw, curtailing lending to projects that would have received swift backing not long ago. Although the argument goes that this is a big constraint on an already slowing economy, the banks insisted yesterday that they're still in business as usual mode.
People say banks oversell in good times, and overreact when the tide turns. Now that hard times are upon us again, Irish banks are faced with their biggest test in a generation.
Arthur Beesley is Senior Business Correspondent