These many months of panic in the prices of U.S. bank stocks have been equally savage among some European bank stocks. One diamond in the rough is Allied Irish Banks (AIB), not to be confused with Anglo-Irish Bank, which is also publicly traded. Allied Irish is a well-run institution with a dominant position in the attractive Irish economy and with a well-covered dividend currently yielding over 9%. Importantly, the company has a long history of maintaining and steadily growing the dividend -- a point which distinguishes it from most other European firms.
AIB is indeed very exposed to the crumbling Irish property market and has a big book of risky construction loans but the stock is already 60% off its highs, the bank will certainly survive, and the dividend will almost certainly be maintained through the coming quarters of heavy charge offs. Ireland's strong demographic picture provides light at the end of the property-bust tunnel through which the company is currently motoring, and AIB may well be able to take market share from its weaker principal rival if Irish economic conditions worsen. Details follow.
First, let's dissect the dividend. As is the case with many stocks, and especially ADRs, if you simply punch in the symbol on a stock quote site you will get incorrect dividend information because of lag time in the data stream and varying exchange rates. Like companies in the United Kingdom, Irish firms tend to pay biannual dividends with the first being a smaller "interim" dividend and the second being a larger, end of the financial year "final" dividend. These two payments are usually spaced about 6 months apart.
AIB's last final dividend was 51.20 euro cents and the just declared interim dividend for this year was 30.6 euro cents for 81.80 euro cents total, i.e. 0.818 Euros. At the 28 August 2008 exchange rate of 1.48 dollars per euro, this equals U.S. $1.21 per ordinary share. In turn, there are two ordinary shares bundled into each ADR so one ADR gets $2.42 per year, which, when divided by the current price of $26.00 gives a yield of 9.3%.
Obviously the dollar has been rising against the Euro of late and this will dampen the value of the dividend income to ADR investors if the trend continues. All the same, many investors like the idea of having streams of income coming from multiple currencies.
Having established the precise amount of the dividend, let us turn to coverage and history. Perhaps surprisingly for investors who are accustomed to seeing high pay-out ratios at U.S. banks (e.g. Wells Fargo (NYSE:WFC) at 58%, U.S. Bank (NYSE:USB) at 74%), AIB is currently paying out less than 40% of its earnings. Moreover, they have an excellent record of sustaining and increasing the dividend. By my calculations, it has grown at over 13% per year for the last 16 years. Moreover, those were the steady incremental dividend increases that U.S. investors prefer, not the the volatile percentage of profits-type pay-outs that continental Europeans favor but which we Americans tend to find jarring. It is what is referred to in Anglo-Irish parlance as a "progressive" dividend policy.
You can review AIB's dividend history here.
C. Description of the Business:
Depending on how you judge market share, three to five financial institutions, including Danske (owner of National Irish Bank), AIB, and Bank of Ireland (NYSE:IRE), dominate the market in the Republic of Ireland with AIB itself having about 274 branches. AIB also operates at the retail level in Northern Ireland via First Trust (adding another 50-60 retail branches) and in the UK proper, albeit mostly for commercial accounts. For its part, AIB's capital markets operation accounts for just under one quarter of firm profits; it is certainly not a case of the risky investment banking "tail" wagging the retail "dog" as can occasionally be the case at the likes of Barclays (NYSE:BCS), Citibank (NYSE:C), and J.P. Morgan Chase (NYSE:JPM).
Of note, aside from its wholly owned retail banking and capital markets operations, AIB has four non-core businesses which are each only partially owned and, in a sense, hived off and therefore ready made for sale in the event AIB needs to raise capital in a hurry. These are: just over 24% of Buffalo, NY-based M&T Bank (NYSE:MTB); about 25% of Hibernian Life and Pensions (jointly owned with Aviva); something on the order of half of a card processing joint venture with First Data; and a bit over 70% of Poland's Bank Zachodni WBK [WAR: BZW].
Using rough math and drawing on Morningstar's $97 fair value estimate for M&T Bank, the ever fluctuating value of WBZ on the Warsaw exchange, and the vagaries of the zloty exchange rate, the value of these two stakes in BZW and M&T are alone worth about U.S. $7-8 billion versus AIB's current market capitalization trading around $11-12 billion.
D. Financial Statements:
Relative to to its principal competitor, Bank of Ireland, AIB is better capitalized with, among other measures, equity to assets standing at about 5% versus 3.5% at IRE. As another basis of comparison, Lloyd's TSB Group (NYSE:LYG) in the UK has about a similar level of leverage as IRE, which is to say that AIB is just a tad more conservative. Meanwhile, Jamie Dimon and his much ballyhooed "fortress balance sheet" at J.P. Morgan, is, I believe, a bit over 7%. Obviously these figures vary depending upon whether one is looking at tangible equity or goodwill-infused equity.
AIB's tier 1 capital is a quite decent 7.7%. My basic point is one of relative comparison rather than an absolute measurement. Viewed in this way, AIB is no fortress but it compares well to its peers and has credit ratings from the major agencies in the single A to double A range. In recent years, AIB has been growing its loan book with funds borrowed in the credit markets but, for the most part, it has a large base of traditional retail deposits from branches and the generally solid credit ratings from all three major agencies reflect this as the source of strength that it is.
In terms of the tightness of the ship, so to speak, AIB's efficiency ratio roughly jogs equal to, or better than, U.S. Bank and that's a tough jogging partner to pace.It is also more efficient than its main domestic competitor, Bank of Ireland. Similarly, the company has regularly put up returns on equity better than 20%, often better than well-regarded Wells Fargo. Granted, AIB's net interest margins are tighter than those seen at the best U.S. and UK banks, but they do nicely best Bank of Ireland in its local playing field.
E. The Loan Portfolio:
While better reserved than its main peer, the Bank of Ireland, compared to its international peers, AIB is, I would assert, under reserved. Its provisions for loan losses as a percent of gross loans are about 0.60%. That compares to PNC (NYSE:PNC) here in the U.S., hardly one of the strongest, at about double that (i.e. 1.20%) and Jamie Dimon's dreadnought coming in at over 2.5% --at least before the Fannie (FNM)/Freddie (FRE) preferred stock write-downs.
On top of the light reserves, AIB's loan book has a goodly helping of traditionally risky construction loans. It should be noted that AIB does have a conservative lending record (low LTVs) and so its light reserves reflect this. All the same, what prospective buyers of the stock should focus on at this time is the fact that its low pay-out ratio positions the bank to take big reserve builds in the quarters ahead without having to mull the comparatively easy to cover dividend.
I especially like the fact that AIB management was very open and forthright about the deterioration of their construction loan book in the last earnings announcement. It knows it has challenges ahead and it is acting accordingly. Aside from reserve building, one manifestation of its intent to act was the fact that it grew retail deposits faster than the loan book over the past 6 months, thus lessening its reliance on outside funding. And, it did this without squeezing the net interest margin.
In the unlikely scenario that AIB needs to raise outside capital, it is fortunate to have four businesses (as described in section C above) which have already been hived off (or where never fully consolidated to begin with) and can be readily disposed. The M&T stake would be especially attractive for disposal. M&T has a certain halo around it since Berkshire Hathaway (NYSE:BRK.A) is a major shareholder. While M&T is a great bank with an outstanding record of growth which helps to diversify AIB's overall profile, the position weighs on AIB's credit rating due to the Federal Reserve requirement that significant stakeholders in U.S. banks be prepared to fork over capital in a distress situation.
Thus, just as Merrill (MER) sold its Bloomberg stake, in a real pinch, AIB could probably fetch about $1.5 to 3 billion for the M&T Bank stake, or more if it made a deal with a regionally sensible strategic buyer like PNC Financial. Such a sale would have a disproportionately large positive impact on its credit rating. Odds are, though, it will never need to even think about such steps and will be able to continue to grow over time with M&T's excellent management, because AIB can fund the charge offs and provisions that lay ahead with existing cash flow. Still, it is nice to have something like the M&T stake in the pocket and at the ready.
F. Worst Case Scenario:
Morningstar and other research outfits have often written about how nicely oligopolistic the UK and Canadian banking markets are relative to the fractious U.S. And, Ireland is also squarely in this category. As previously noted, there are three to five main players. That dominance is important because AIB is much stronger financially than its principal competitor, Bank of Ireland.
If property prices in Ireland do crash harder and faster than anyone is currently inclined to discount, Bank of Ireland will have to "cry uncle" first and I suspect AIB will be able to steal market share just as Wells Fargo and US Bank are presently doing in America. Plus, AIB is such a crucial underpinning to the Irish market, even more so than, say, RBS (NYSE:RBS) or Lloyds or Barclays in the UK, that any teetering on the edge of a worst case scenario would surely result in a full rescue from the Irish central bank. Granted, that could wipe out the equity holders were it to occur, but I think AIB is too intertwined in the Irish economy for it to mete out too much punishment on the equity holders.
In the end, under a worst case scenario, the company would get sweetheart loans from the Irish Central bank, which otherwise has little to do now that monetary policy is being decided by Jean-Claude Trichet and the ECB. EU competition authorities would carp under such a scenario but the French get away with this sort of national champion prop-up job all the time and the increasingly Euro-skeptic Irish electorate will probably be more interested in supporting its own hometown bank than heeding the diktat of Brussels. In sum, AIB is tiny relative to the overall European banking sector but a giant in the emerald isle where it is most definitely too big to fail.
G. Institutional Sponsorship for the Stock:
AIB also has excellent institutional "sponsorship," so to speak, with T. Rowe Price Equity Income's Brian Rogers and Southeastern Asset Management's Longleaf funds being major new holders. Longleaf even has a nice recorded piece on its website in which Mason Hawkins and Staley Cates praise AIB in the course of lamenting their losses in UBS (NYSE:UBS).
H. Demographic Tailwind:
A final point is with respect to the Irish property market itself. It will surely swoon in the short term and is very overheated. Thus, AIB's stock price is rightfully down nearly 60% from its highs. But, over time, at least in developed countries, property prices are driven by demographics and Ireland is a star on this front. Data from the U.S. Government are quite compelling in this regard.
Simply put, Ireland is probably the fastest growing developed country around. The birth rate, percentage of population under 14, immigration, and the overall population growth collectively demonstrate a populace that is younger and growing faster than the U.S., the EU broadly, Canada, China, Russia, the UK or Brazil. India nudges it out on overall population growth (1.578% versus 1.133%) but not by as much as one might think. By comparison, the U.S. and UK come in with 0.883% and 0.276% population growth respectively.
Some of this heady population growth in Ireland will slow as the stereotypical migrant worker from the new EU member states (e.g. Polish plumbers and Latvian builders) go back to their homeland now that the Irish economy is cooling. But, the Irish growth story also has more fundamental pillars like low taxes, broad English language skills, high levels of education, and, with respect to population growth, the matter of Catholicism and its taboos on birth control working in tandem with the family-engendering prosperity of the decade past.
AIB is a buy at these prices. It may take a very long time for the Irish property market to bottom and recover but a reasonably safe 9% dividend yield with a good management team should steel investors to wait out the short-term share price fluctuation. In any event, the foregoing is food for thought while you are next enjoying a pint of Guinness or shot of Bailey's.
As a humorous aside, if you go to YouTube.com and search on "bzwbk" and "john cleese" you will get a video of a short TV commercial for AIB's Polish operation starring Mr. Cleese.
Disclosure: The author holds a long position in AIB, MTB, and LYG.