Irish banks, who a little over a decade ago were consistently misjudging the losses they would end up taking on bad loans following the property crash, are now underestimating how much money they’ll make from rising interest rates – eye-watering and all as their new targets may seem.
Take AIB. Only three months ago the State’s largest mortgage lender said it expected to post profits in 2024 equivalent to at least 13 per cent of tangible equity shareholders (ROTE) hold in the business. It marked an upgrade from the 9 per cent target AIB had previously set for 2023, which itself was double the return AIB delivered in 2019, before the Covid-19 pandemic.
In the cocktail of acronyms used to measure the health of a bank – from CET1 capital to LDR deposit gauges and CIR cost-to-income ratios – ROTE is possibly the most important, telling investors, regulators and clients whether it is making enough money to justify its existence. The Holy Grail is 8-10 per cent.
But even AIB’s chief executive, Colin Hunt, conceded on a call with analysts on Wednesday, after the bank reported a better-than-expected 19 per cent jump in net profits in 2022, that it would “materially exceed” its own target this year.
AIB’s €3 billion net interest income forecast for this year is based off an ECB deposit rate of 3.5 per cent this year. The ECB has lifted its rate from minus 0.5 per cent to 2.5 per cent since July and a further half-point hike next week is in the bag as higher inflation remains sticky. Financial markets are pricing in further increases that would lift the rate to 4 per cent by the end of the year.
Bank of Ireland’s new chief executive, Myles O’Grady, upgraded his group’s profitability goal on Tuesday as part of strategy refresh. Less than four months into the job, he is setting his sights on the bank achieving a ROTE of about 15 per cent in each of the years between 2023 and 2025. But even that objective is grounded on a conservative view that the ECB deposit rate will be 3 per cent at the end of this year and fall to 2.75 per cent in 2024.
Meanwhile, Permanent TSB (PTSB) seemed destined only a few years ago to chug along at a sub-par return on equity of below 5 per cent – that is, before it moved to take over much of Ulster Bank’s loan book and central bank rates started to increase – is now up there with the big boys, targeting a return of 13 per cent over the medium term. That is premised on an ECB deposit rate of 3.25 per cent.
But for all the domestic hand-wringing over rising mortgage costs, Irish banks have been way behind European peers in passing on ECB hikes to borrowers. It’s hard to shed a tear for tracker mortgage holders, who have been automatically hit by each increase, given that they had enjoyed unnaturally low rates over the past decade.
But banks have only passed on a fraction of the official rate hikes on new fixed-rate business – the segment of the mortgage market has been the most active in recent years.
Barclays analyst Aman Rakkar described Irish mortgage pricing on a call with Bank of Ireland executives this week as bordering on being “very irrational”, given how market funding rates have jumped. Euro zone banks are much more reliant on market funding than the Irish.
While euro zone banks have increased the average rate of a new mortgage by 1.85 percentage points to 3.16 per cent in the 12 months to January, Irish banks – which until recently had rates that were double that of the wider currency area – had only increased the average rate by 0.17 of a point to 2.93 per cent, according to Central Bank figures published this week. (The data, of course, does not capture more recent moves)
But it’s come at a price – to Irish depositors, most of whom are earning nothing on their savings at a time when the ECB is paying banks 2.5 per cent for excess cash stored with euro zone central banks. The three remaining banks had €67 billion of surplus money stored with the Central Bank as of the end of last year, according to figures in their annual reports.
While banks have moved in recent times to introduce new term deposit products, the rates are derisory. And lenders have been careful to put caps on the savings that can benefit.
PTSB this week increased new fixed home loans by 0.75 of a percentage point, raising, for example, the cost of three-year fixed mortgages on a property where the loan-to-value ratio is 60-80 per cent to 4.35 per cent. It only increased its deposit rate for savings locked up for three years to by half a point to 1.5 per cent.
Those with on-demand deposits – capped at €50,000 – are being offered half that rate. The best on-demand rate in the retail market is 1 per cent, offered by AIB, according to price comparison website Bonkers.ie.
Essentially, depositors are subsidising borrowers and doing much of the work for the banks as they target higher returns – and plot to return billions of euros of excess capital to shareholders over the coming years.
AIB signalled to analysts this week that its “deposit beta” – the portion of ECB rate hikes it expects to pass on to customers – will be less than 30 per cent this year.
Savers have little bargaining power. Unlike during the financial crisis when banks were paying hand over fist to attract customer deposits, remaining banks are sitting on way more cash then they need, resulting from a surge in household savings over the past decade, accelerated during the pandemic, and the decisions by Ulster Bank and KBC Bank Ireland to quit the market.
By making depositors, rather than borrowers, do the heavy lifting in boosting earnings, banks are minimising non-performing loans as households deal with the wider cost-of-living crisis. Each of the chief executives of the three banks said in the last 10 days that they have not yet seen any uptick in problem loans in recent times.
Banks argue, of course, that they protected most savers from negative rates when the ECB was pursuing a policy of charging banks for excess cash stored with it.
But when it comes to the key role that commercial banks are supposed to play in passing through central bank monetary policy, Irish lenders are among the weakest links in Europe.
