For the remaining Irish banks, 2023 was about as good as it gets.
Having seen off overseas-owned Ulster Bank and KBC Bank Ireland and reclaimed much of the mortgage market share ceded in recent years to nonbank upstarts like ICS Mortgages and Finance Ireland, the three surviving banks got down to making money as interest rates soared with central banks seeking to rein in inflation. And plenty of it.
AIB, Bank of Ireland and PTSB, which rebranded itself from Permanent TSB in October, are on track to see their combined net interest income soar by 60 per cent in 2023 to more than €8 billion, according to company forecasts and analysts estimates, driven by European Central Bank (ECB) interest rate increases and the three lenders carving up and sharing most of the loan books of Ulster Bank and KBC Ireland.
Irish banks lagged most European peers in raising mortgage costs — and deposit rates — as the ECB hiked its main lending rate from zero to 4.5 per cent since July 2020 in its fight against inflation. However, they are making massive returns on surplus deposits stored with the Irish central bank.
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AIB and Bank of Ireland alone have more than €60 billion of excess customer deposits parked in the Central Bank of Ireland, almost all of which — outside of minimum reserves commercial banks must place with the authority — are generating interest. The two are earning an annualised €2.3 billion in interest, based off the ECB’s 4 per cent deposit rate.
This contrasts with the period between 2014 and mid-2022, when euro zone central banks were charging lenders negative rates on surplus deposits.
While Irish banks have increased rates on certain savings products to as much as 3 per cent during the year, following the series of ECB rate hikes, about 95 per cent of household savings remain in on-demand — or overnight — accounts that are earning little or nothing.
AIB chief financial officer Donal Galvin said in November that the shift by borrowers into higher-rate savings products had been “a little slower than we would have imagined”.
But with economists and financial markets now pricing in a series of ECB rate cuts next year — after euro zone inflation cooled sharply in 2023 — analysts are beginning to take red pens to their 2024 forecasts for Irish banks, which are among the most dependent in Europe on interest income for total earnings.
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Bank of America analyst Alastair Ryan moved this month to cut his profit forecasts for AIB and Bank of Ireland and now sees their combined net profits declining by 15 per cent over the next two years to €3.1 billion — even as both expand their loan books in a growing mortgage market.
“Irish mortgage applications are recovering quickly and home prices have resumed their rise,” said Mr Ryan. “We see the potential for [loan] volumes to reaccelerate in 2024, particularly with Irish economic growth [in prospect].”
The domestic Irish economy — measured by modified domestic demand, which strips out some of the ways multinationals can distort activity — is forecast by the Economic and Social Research Institute to expand by 2 per cent next year, following 0.6 per cent growth in 2023.
The hit to earnings from lower rates will be cushioned by the fact that both banks have in recent times entered into financial contracts to mitigate the effects of market rate volatility.
Analysts see profits being underpinned by the fact that executives across the board have not reported any notable increase in loan arrears as a result of rising inflation and interest rates. Businesses have been more affected by hikes in interest rates on their loans than property owners to date.
Investor returns
Non-performing loans make up an average of about 3.5 per cent of Irish bank loans — down sharply from a peak, according to the central bank, of 31.8 per cent exactly 10 years ago. The hope among the two main banks is that as they approach the EU average of about 3 per cent, it will encourage the central bank to give them the green light to start making large returns of excess capital to shareholders by way of increased dividends and share buybacks from next year.
“Looking into 2024, dividends — which have not been big features of the investment cases for Irish banks in recent years — will now begin to come to the fore,” said Diarmaid Sheridan, an analyst with Davy. “Irish banks are overcapitalised and profitability has improved materially which supports higher levels of dividends and buybacks in the coming years.”
AIB chief executive Colin Hunt has promised that his bank will “answer comprehensively” in March, as it publishes annual results, how much capital it plans to return to investors over the coming years.
“Our preference will be to grow a cash dividend sustainably and transact with the Government on a directed basis where we possibly can,” Hunt told analysts on a call. “That makes good sense for us as we reduce a large shareholding overhang from the Government.”
Sheridan reckons AIB will pay out almost €4.3 billion to investors over the next three years — the equivalent of almost 45 per cent of its current market cap. Some €2.4 billion of this will be by way of ordinary dividends, with the remaining €1.8 billion odd likely to be spent buying back more State shares.
Irish taxpayers’ stake in AIB stands at just under 41 per cent, with the Government having reduced the position from 71 per cent since the start of 2022 by way of share sales and participating in share buybacks.
Bank of America’s Ryan estimates Bank of Ireland will be in a position to distribute about €3.5 billion to its investors over the next three years.
PTSB, which has not paid a dividend since before the financial crisis, managed to secure approval from the central bank just before Christmas to start paying dividends again. However, it is not yet clear if the board of the bank plans a dividend payout next year on 2023 earnings.
The Government and UK banking giant NatWest surprised banking observers in June by selling a combined 10 per cent stake in PTSB. NatWest, which received a 16.7 per cent stake in PTSB last year as part-payment for loans acquired from the UK group’s Ulster Bank, saw its holding decline to 11.7 per cent. The State’s interest dropped to 57.4 per cent.
Remuneration
The thorny issue of executive remuneration remained in focus in 2023, following the Government’s decision late last year to lift a crisis-era basic pay cap at Bank of Ireland (after it sold its remaining bailout shares in the bank) and allow the wider sector to pay bonuses of up to €20,000. Anything above that level remains subject to a prohibitively high 89 per cent supertax rate.
Bank of Ireland said in March that it plans to grant its chief executive, Myles O’Grady, and his chief financial officer, Mark Spain, shares equivalent to 25 per cent of their base salary next year, rising to a maximum 50 per cent payout from 2025.
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Because the so-called fixed share awards were not subject to any performance conditions, they fall outside the scope of a continuing effective ban on performance-related bonuses. Bank of Ireland widened the stock awards plan to other top executives in December.
There had been a view that Minister for Finance Michael McGrath would lift an ongoing €500,000 a year executive pay limit at AIB when he reduced the State’s stake in the bank below the key 50 per cent level in June. Department of Finance officials had suggested in early drafts of a banking review report in 2022 that this would be the natural threshold at which the cap would be removed.
However, the restriction remains in place and is unlikely to be touched next year, according to observers, as the Government eyes a general election, which must take place by March 2025.
Election nerves
Investors in Irish banks may also become more wary about the political landscape as the election approaches, according to analysts.
Sinn Féin, which opinion polls put as the most popular political party in the Republic even if its lead has slipped recently, said, for example, in its alternative budget for 2024 that it would more than quadruple the bank levy to €400 million.
As it turned out, McGrath decided in October to more than double the sector charge to €200 million next year.
Sinn Féin has also signalled that it would target high earners and what it calls “gold-plated pensions” if it enters government, even though much of its economic policy has drifted towards the centre ground in recent years.
If the party secures power and follows through on its promises, it may affect the pensions and wealth management businesses of the banks, which had grown in recent years with AIB buying Goodbody Stockbrokers and setting up a life and pensions joint venture with Great-West Lifeco, and Bank of Ireland acquiring Davy.
Non-banks
Non-bank lenders ICS and Finance Ireland pulled back from the Irish mortgage market in late 2022 as interest costs on wholesale and capital markets — where they raise their funding — spiralled.
However, the other main non-bank lender, Avant Money, grew its mortgage book by 33 per cent to €1.9 billion in the year to the end of September — helped by the fact that its Spanish banking parent, Bankinter, is largely funded by a relatively cheap deposit base.
Austrian bank Bawag has also dipped its toe into Irish home loans with a “soft launch” offering at MoCo, the mortgage start-up it acquired earlier in the year. Another company, called Nua Mortgages, which is backed by Wexford businessmen Bert and Lance Allen, former owners of beef processor Slaney Foods, is also eyeing a market entry.
With market interest rates having come back rapidly from their highs in October amid mounting speculation on when — and how fast – the ECB will cut rates next year, non-banks are likely to re-emerge as a competitive force in the market.
“As we appear to have reached the peak of ECB interest rates increases, we can expect to see rate cuts in 2024 that should facilitate more appropriate funding options for Finance Ireland and ICS which should enable them to re-enter the market,” said Trevor Grant, chairman of the Association of Irish Mortgage Advisors.
“This is all very good news for existing and new mortgage holders as increased competition brings innovation.”
Central bank
For the central bank, its era of super profits dating back to 2008 is set to come to an end in 2024.
The authority has generated more than €23.5 billion of net income in the past 14 years. This was driven initially by interest on emergency loans to banks during the financial crisis, followed by gains on the sale of Government bonds used in 2013 to refinance the bailout of Anglo Irish Bank, interest on bonds acquired under ECB quantitative easing (QE) programmes and money made by charging banks negative rates on excess deposits until July 2022.
Almost €19 billion of the profits were passed on to the exchequer over the period. That came in handy in helping to plug budget deficits over much of the period, even if the central bank’s role is to ensure financial stability, not to make a surplus.
The emergency loans and Anglo-linked bonds are no longer on the central bank’s balance sheet, bond portfolios built up under the era of QE are gradually being unwound, and the authority is now paying banks billions of euro in interest for their deposits.
Central bank governor Gabriel Makhlouf said in a blog in late October that he now expects his organisation “to report losses in the years ahead”. Still, the bank has built up €9.2 billion of provisions, capital and reserves which could be used to absorb potential future losses.
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