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General Category => Investment Ideas => Topic started by: ValuePadawan on December 07, 2019, 09:24:35 PM

Title: A5G.IR - AIB Group PLC
Post by: ValuePadawan on December 07, 2019, 09:24:35 PM
Hey everyone I'm trying to understand the dynamics for bank profitability specifically in Europe so I can figure out why Allied Irish Banks is valued so cheap.

I'm a complete newcomer to looking at bank stocks so if I get something wrong or am missing nuance please let me know.

Here's the broad strokes of how I've been thinking about banks.

-There are two things that determine profitability: Interest rates and how concentrated the banking sector is.

Concentrated markets such as Australia have entrenched oligopolies in growing demographies and therefore are very profitable having revenue/risk-weighted assets of 7-8% on the other side of the spectrum you have German and Japanese regional banks that have extreme competition as well as dying demographics making them structurally unprofitable.

Then somewhere in the middle you have U.S and Irish banks. Revenue to RWA is around 4-5% both have much more stringent regulations and CET1 requirements after their respective banking crises, both have growing demographics.

The big difference is the Bank of Ireland 10y is about 0% while the US is sitting about 1.8%. So while AIB has the oligopoly it doesn't have rates on its side.

Here's the question. Right now all EU banks are being valued extremely cheap because of the low and even negative interest rates. In domiciles with competition and bad demographics I see why this is. But should a company that controls effectively 1/3 of the banking in a country with a growing population be trading at rock bottom valuations? Won't the highly oligopolistic nature make sure they don't suffer the fate of Deutsche? Are they throwing the baby out with the bathwater?

As an absolute newbie I appreciate all corrections and criticism let me know what you think.
Title: Re: A5G.IR - AIB Group PLC
Post by: ValuePadawan on December 07, 2019, 09:40:38 PM
https://www.spratings.com/documents/20184/3025551/Irish+Banks+Recovery+Phase+Draws+To+A+Close/01e7ff3e-2cff-ef95-ece6-a906e9495d70

For a bit of background.
Title: Re: A5G.IR - AIB Group PLC
Post by: no_free_lunch on December 08, 2019, 07:24:15 AM
I will admit that this is worth investigating.

Did this wipe out the shareholders during the GFC?  Is it different now?  Maybe higher tier 1 ratios.

On the surface, it is at a low P/B (0.6?), high dividend (>5%), high tier 1 ratio. 

I also do like the irish economy.  In the past they have been quite the capitalists.  I remember headlines about google setting up shop there for the low tax rate.  Could be a good place for some money.

Quote
In its autumn 2019 Economic Forecast, it predicts that Irish gross domestic product (GDP) will grow by 5.6% for 2019.

That is up from a predicted rise of 4% in its summer forecast, and the highest in the European Union for 2019.

This compares to a predicted EU average growth rate of 1.4% for this year and for 2020 and 2021.

It says GDP growth in Ireland is expected to moderate to 3.5% in 2020 and to 3.2% in 2021, on the back of increasing capacity constraints and an expected slowdown in Government expenditure.

https://www.newstalk.com/news/irish-economy-see-highest-growth-eu-2019-922452
Title: Re: A5G.IR - AIB Group PLC
Post by: BroKon on December 08, 2019, 10:01:10 PM
ValuePadawn,

The problem with the Irish banking market is that its oligopolistic nature is actually due to its unattractiveness, and hence there are no foreign entrants. Three main reasons:

- Capital treatment of Irish mortgages is incredibly harsh due to the how badly they performed during the crisis
- NPLs: Irish banks have been unable for political reasons to actively repossess houses if the mortgage went into arrears, which obviously caused more arrears. They have solved this problem by selling their NPLs to US "vulture" funds, but that has been an expensive exit.
- Central bank mortgage rules: the ability for an individual to take out a mortgage has been severely restricted, as the central bank has enforced rules to make the banking system safer.

The combination of the above three has meant that other European banks have been generally trying to exit the market rather than enter it.

However there has been some better news recently, the banks have done a decent job of cleaning up their NPL problem (as well as the tracker mortgage scandal), and there is an awareness (as well as a new governor) at the central bank that maybe they have been too restrictive with their mortgage rules. Not enough yet for a turnaround in the fortunes of the share prices but at least its a start. On a more macro level the ECB seems to be beginning to realise that there are limits to its negative rates policy.

So all that said, while its not going to be any easy investment, there is potential for a re-rating of the banks over the next two years. I personally own BKIR, but I think AIB and BKIR will be pretty interchangeable when it comes to any re-rating of the sector.

One final comment, if you are going to look at European banks there are much easier places to start, for example Lloyds in UK, while a lot more expensive on value metrics, is a capital generation machine when you remove the PPI issues - which have finally come to an end.
Title: Re: A5G.IR - AIB Group PLC
Post by: BroKon on December 08, 2019, 10:11:12 PM
I should add that if you want to avoid UK/Brexit issues, then I think ABN AMRO in the Netherlands is worth a look too, and nearly as cheap as the Irish banks (due to a money laundering issue which should resolve itself in 2020 with a fine that is already priced in.
Title: Re: A5G.IR - AIB Group PLC
Post by: ValuePadawan on December 09, 2019, 09:09:07 AM

So all that said, while its not going to be any easy investment, there is potential for a re-rating of the banks over the next two years. I personally own BKIR, but I think AIB and BKIR will be pretty interchangeable when it comes to any re-rating of the sector.


BroKon,

Just curious when discussing the differences between AIB and BKIR, obviously BKIR is larger and has more assets (100.5 B in interest earning assets vs AIB at 85.9B in interest earning assets and holds more market share but it has a lower net interest margin such that they both earned about the same amount of operating income in the first half of this year (1.4B).

In addition BKIR has markedly more operating expenses at 903M vs AIB at 744M so I guess you've made me wonder why you prefer BKIR?
Title: Re: A5G.IR - AIB Group PLC
Post by: ValuePadawan on December 09, 2019, 09:13:44 AM
In addition frankly speaking I'm glad that the other European banks have decided not to try to enter Ireland whether it be due to regulatory issues or because its a small market to spend a lot of time and money to get into.

If you're an Irish citizen with the banking crisis fresh in your mind and some British or European bank starts opening up branches in your county are you going to switch from the bank you and your parents and their parents have always gone to? I don't think so but if I'm missing something do let me know please.
Title: Re: A5G.IR - AIB Group PLC
Post by: BroKon on December 10, 2019, 03:55:53 AM
Fair point.
When I initiated the buy, BKIR seemed cheaper than AIB. Also, as a general rule I try to remain disciplined and not churn the portfolio, so I stayed with BKIR.
That said, AIB has since materially under-performed BKIR so maybe its time to do some further work on AIB to see if its worth switching.
Title: Re: A5G.IR - AIB Group PLC
Post by: BroKon on December 10, 2019, 06:01:03 PM
Ok had a look at both again and I am not sure I changed my mind about preferring BKIR, even though AIB looks cheaper (and potentially has more capital to distribute).

AIB's NIM seems to be rapidly approaching BKIR's, and even though as you say BKIR has a higher cost/income ratio, that also gives it more levers to pull when cutting costs (and indeed it is on the better cost trajectory at the moment). BKIR is also further along in terms of NPL reduction.

So on the basis that I think the forward probably looks slightly more positive for BKIR I will probably stay with that one, but as I said earlier, I think they either both do well or both struggle.
Title: Re: A5G.IR - AIB Group PLC
Post by: ValuePadawan on December 10, 2019, 09:08:27 PM
Ok had a look at both again and I am not sure I changed my mind about preferring BKIR, even though AIB looks cheaper (and potentially has more capital to distribute).

AIB's NIM seems to be rapidly approaching BKIR's, and even though as you say BKIR has a higher cost/income ratio, that also gives it more levers to pull when cutting costs (and indeed it is on the better cost trajectory at the moment). BKIR is also further along in terms of NPL reduction.

So on the basis that I think the forward probably looks slightly more positive for BKIR I will probably stay with that one, but as I said earlier, I think they either both do well or both struggle.

I really appreciate the second opinion BroKon, you're right if they can cut costs to the level AIB has BKIR will be very valuable in the future. If it does that and it can close the ROE gap it could be an excellent investment for decades as the Aussie and Canadian banks have been.

Something else I was reading about but hadn't considered is because the Irish gov't has a 71% stake in AIB the Irish gov't has put a cap on top executive salaries. Due to this other banks such as BKIR that only have a 14% gov't ownership can effectively buy all the top talent that AIB develops.

Now I'm not saying it takes a rocket scientist to run a bank with 30% market share in AIB's case or near 40% in BKIR's but it's another advantage BKIR will have until the gov't monetizes their majority stake in AIB. AIB's CEO left last year due to disagreement with the government over reinstating market based pay packages.

So far for me this goes in the too hard pile but I'm going to keep diggin to try to better understand the dynamics.

Who knows by the time when Brexit goes through the domestic market will panic and maybe AIB's share price will drop back down to the low 2s and I'll  be comfortable enough to dip my toe in.

If I figure anything out I'll be sure to post it.

Cheers
Title: Re: A5G.IR - AIB Group PLC
Post by: BroKon on December 10, 2019, 09:31:41 PM
All three Irish banks are subject to the salary cap (BKIR got an exemption for their CEO as her salary was structured to match that of her predecessor, but that is it), so they all keep losing their top talent. The politics in Ireland around banks is pretty toxic, and continues to have repercussions on the profitability of the banks, so I don't blame you for wanting to put it in the too hard pile, but for a long term holder, I am not sure there is much downside, so if you can buy them 10-15% lower (they have the advantage of being volatile), it may be worth doing the work. Anyway, thanks for starting this thread, always useful questioning my thesis.
Title: Re: A5G.IR - AIB Group PLC
Post by: ValuePadawan on December 10, 2019, 09:35:02 PM
Something else I worked out is that BKIR has about 380M in interest earning assets per branch. [100.5B interest earning assets / 265 branches (BKIR 2019 interim report pg 50)]

Meanwhile AIB has 421M in IEA per branch. [85.9B/204 branches (AIB 2019 interim report pg 105)]

Somehow AIB is getting more assets per branch, maybe it's wealthier customers or they have branches in larger population centres with more customers/branch while more of BKIR's are in villages with smaller populations per branch.

It's a crude way of measuring the banks performance per branch. It seems like AIB is attracting 11% more assets per branch.

BKIR should either close down some of its smaller branches or figure out a way to increase its assets.

If I figure it out I'll let you know but that ratio is something else to keep an eye on.

Also thanks for the info that all banks are fighting with one fist tied behind their back when it comes to attracting talent, at least they are on an even pitch.
Title: Re: A5G.IR - AIB Group PLC
Post by: Spekulatius on December 11, 2019, 04:03:54 AM
I believe that Ireland will benefit from Brexit, perhaps tremendously. At least some business that were located in the UK may find it easier to business with the EU from within the EU, so Ireland will be a natural spot.

Then on the other hand, I like the prospects for the banking business in the UK better. The reason is that the UK keeps their GBP and their own central bank and most likely never will have the negative interest rates that are destroying the banking system in Europe.
Title: Re: A5G.IR - AIB Group PLC
Post by: Cigarbutt on December 11, 2019, 06:21:38 AM
If you know or believe that coming out of the low rate rabbit hole is likely and without consequences, and if you think that rates will rise and reach escape velocity, then the AIB Group, or its oligopolistic peers, is a nice place to be. I think that low rates (for banks, including the Irish ones) are a solution that is (and will be) turning into a problem. AIB's net interest margin is starting to show that IMO.

-----)
...
Then on the other hand, I like the prospects for the banking business in the UK better. The reason is that the UK keeps their GBP and their own central bank and most likely never will have the negative interest rates that are destroying the banking system in Europe.
This is nothing short of fascinating. In another period, Great Britain obtained the first-mover advantage (sort of) when it decoupled from the golden standard. This marked the end of an era, triggering a protectionist race to the bottom as others followed suit. There are periods where achieving domestic economic goals supersedes everything else, including your neighbor. And now, the UK has figured out that it may be better off the European Standard and may be, again, playing the first-mover card. I would say that higher rates now in the UK are tied to the transitional uncertainty and the decoupling may allow more flexibility in dealing with internal issues but of one of the outcomes may involve competitive devaluations and, overall, an absolutely deeper hole.
https://www.ft.com/content/718c8a62-e91d-11e9-a240-3b065ef5fc55
(-----

Irish banks (including AIB) are still numb from the GFC but have done relatively well compared to European peers. Looking at the net interest margin evolution over the last few years, this appears to be related to the relative lack of competition in the domestic markets and to lower funding costs, both factors somewhat related to the continental "macroprudential" policies.
https://www.centralbank.ie/docs/default-source/publications/financial-stability-notes/no-10-irish-retail-bank-profitability-2003---2018-(nevin).pdf?sfvrsn=4

Opinion: Irish banks, like many of its European sisters, have become zombies in an environment that, somehow, needs to deflate.
-Dialogue coming from a classic financial textbook:
Alice         “But I don’t want to go among mad people,”
The Cat    “Oh, you can’t help that, we’re all mad here. I’m mad. You’re mad.”
Alice        “How do you know I’m mad?”
The Cat    “You must be, or you wouldn’t have come here.”