Bank of Ireland (LSE:BIRG, Financial) (8.1% portfolio weight) – Bank of Ireland hasspent the last twelve years repairing itself from the Global Financial Crisis and the subsequent European Sovereign Crisis. It has been an arduous process of working out and selling off a large portfolio of non-performing loans, a reformation of its lending standards, enormous cost cutting and investments in IT infrastructure, all while being compelled to accumulate large amounts of additional capital with which to fortify itself and meet ever-growing regulatory capital requirements. One very compelling illustration of the amount of progress that has been made is that, per consensus estimates8, Bank of Ireland is expected to produce a return on equity of 8.25% in 2021 in the midst of one of the worst interest rate environments in history, from a banking perspective. Further, should this be accomplished, it would be done while using one of the lowest levels of balance sheet leverage the bank has carried in decades.
If our investment thesis was hinged entirely upon buying a well-capitalized bank at 50% of book value that is producing an 8.25% return on that book value9, with future interest rate increases more likely than decreases, and a high likelihood of increasing capital returns to shareholders, that might well be sufficient. Yet, what is less well followed—given how small the Irish banking market is in the context of Europe, let alone the globe—is that the Irish bank industry is on the cusp of a rapid consolidation from five major banks to three. This step-change should be expected to add further scale and cost efficiency for the remaining three and, hopefully, further pricing discipline as well. It is anticipated that Ulster Bank’s banking operations will be divided between Allied Irish Bank and Permanent TSB, while KBC’s Irish bank will exit Ireland with the bulk of its performing loans and customer deposits being taken on by Bank of Ireland. Separately, it was announced in July that Bank of Ireland has reached an agreement to purchase J&E Davy Holdings, Ireland’s largest capital markets and wealth management business. Davy had fallen into trouble as a result of scandal and was compelled to sell itself under governmental pressure. The acquisition of a business that is balance sheet light and derives most of its revenue from fee income will further diversify Bank of Ireland’s revenue sources away from the current challenges of net interest margin10 and, very likely, substantially boost returns on equity. Both transformative deals are expected to close within the next few quarters. If Bank of Ireland were to find itself in an even slightly improved interest rate environment with the added scale and efficiencies gained from industry consolidation and new sources of fee income, it should prove to be a very powerful mix for returns.
From the Third Avenue Value Fund (Trades, Portfolio)'s third-quarter 2021 commentary.
