Permanent TSB

Mar 20, 2023

After the declines of the last week and a half, AIB , Bank of Ireland and Permanent TSB have given up a lot of their gains for the year and are back to December levels. But that’s after a huge rally in 2022 as their profit outlook improved. For now, all signs suggest the banking system in Ireland, though not without problems around competition, is not facing any existential risks. That isn’t to say fear is totally unjustified. There are undoubtedly weak institutions out there. For now, all signs suggest the banking system in Ireland is not facing any existential risks But the regulatory changes at the European level mean their problems can be isolated and resolved quickly, as Public Expenditure Minister and Eurogroup President Paschal Donohoe was keen to point out on German broadcaster Deutsche Welle. European Central Bank president Christine Lagarde also said the bank was “ready to respond as necessary” to preserve eurozone stability – a clear call-back to Maria Draghi’s “whatever it takes” pledge in 2012. Expand Why was Switzerland able to burn bondholders so easily? One of the big changes since 2008 is clarity on how to distribute losses in the event of a bank failure. When Irish banks burned through their capital in the crash, the government of the time insisted it couldn’t burn the bondholders without losing access to funding for a generation. But the rules are different now. The forced sale of Credit Suisse to UBS over the weekend wiped out the holders of so-called additional tier one (AT1) capital. These are loss-absorption bonds – sometimes called contingent convertibles or coco bonds – meant to stand between shareholders and taxpayers. So far, so good. But the Swiss financial authorities allowed €3bn in equity to be preserved, which represented about a 50pc haircut on the stock price. This was based on a permanent writedown clause in the contracts Yet the action essentially upended the expected order of resolution, causing outrage among bondholders who lost close to $16bn and are reportedly considering lawsuits. The action essentially upended the expected order of resolution, causing outrage among bondholders Unsurprisingly, Bank AT1 bonds, including those issued by Irish banks, fell significantly this morning as a result, with AIB’s dropping 15 percentage points. The European Banking Authority (EBA) moved to calm fears of disorderly bail-ins by reaffirming the order of resolution if a bank in an EU country were to fail. “In particular, common equity instruments are the first ones to absorb losses, and only after their full use would Additional Tier One be required to be written down,” the EBA said in a statement. However, that reassurance will have to contend with a view forming in the markets that loss absorption buffers in the banks may not always work as labelled. "We believe this AT1 writedown by a systemically important bank will have negative implications for the wider European banks’ AT1 market as well as overall funding profile and cost of equity for the banks," JPMorgan strategists Kian Abouhossein and Amit Ranjan said. What happens now? There is no obvious next candidate for a bank failure, but that isn’t to say the market won’t find one. Everyone is watching share prices nervously for signs of fragility. As we’ve seen, things can unravel quickly once confidence evaporates. But Irish banks are among the best capitalised in Europe – a legacy of being among the worst last time around – and are flush with deposits. They are also not badly exposed to rate hikes, as their excess liquidity mostly gets parked with the ECB rather than in rate sensitive bonds, as was the case with SVB. The real question is what happens to the three domestic banks in the event of a downturn scenario. Markets are now indicating that last week’s half-point hike by the ECB was the last one of the cycle While economic forecasts as recently as a few weeks ago were relatively bullish on the short-term prospects of the Irish economy. Those outlooks may, in retrospect, look naively optimistic. Expand ECB President Christine Lagarde. Photo: Reuters Markets are now indicating that last week’s half-point hike by the ECB was the last one of the cycle. Higher rates and market nerves will mean stingier funding conditions overall and, therefore, slower growth. A sluggish economy usually means lower profits for banks and more bad loans. While there is nothing to indicate Irish banks will have major problems with credit quality, investors will be alert to even slight vulnerabilities in the coming weeks and months. Perhaps more pertinently for the Irish taxpayer, who still owns a sizeable chunk of the banking system through majority stakes in AIB and PTSB, the implications of the current panic for dividends, buybacks and sell downs are not good. Volatility from this crisis means it’s going to take longer to get paid back for the last one.