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Stressed Banks Are Still Haunted by Sins of the Past in Ireland

  • Irish lenders were among worst performers in European tests
  • Bad loans continue to weigh on the nation’s financial system

It’s almost a decade since the worst banking crash in western Europe, but the mistakes of loans past still haunt the Irish financial system.

The results of European Banking Authority stress tests revealed in late July showed Bank of Ireland Plc and Allied Irish Banks Plc among the worst performers. S&P Global Ratings said last week about a fifth of Irish loans are still not being fully repaid and banks now have to contend with the economic fallout from the U.K.’s decision to exit the European Union.

“While Irish banks have made substantial progress, they remain vulnerable,” Dhruv Roy, an analyst at S&P in London, said in a report after the stress test results came out.

All this comes as the government prepares to start selling AIB, seeking to recover the 21 billion euros ($23.4 billion) of taxpayers’ money used to save the lender during Ireland’s meltdown starting in 2010. As a gauge of the concern among investors, the yield on AIB’s November 2025 subordinated bonds surged 70 basis points to more than 6 percent for the first time in almost a month.

While the Irish government ensured banks survived, the bailout didn’t address the quality and sheer quantity of the loans. Ireland’s household debt-to-disposable income ratio was 168 percent at the end of 2015, according to S&P. That compares with 127 percent in the U.K. and 64 percent in Italy.

The tests had no pass/fail mark and didn’t specify capital shortfalls, but the conclusions provide pointers to where weaknesses lie. In the “adverse scenario” produced by the EBA, AIB’s capital buffer fell to 4.3 percent. Only Italy’s Banca Monte dei Paschi di Siena SpA, which plans to offload 28 billion euros in doubtful loans, was worse.

AIB said the tests weren’t indicators of its future performance, while Bank of Ireland said its capital position was “strong.” In addition, analysts suggested the examination didn’t account for unique factors within the Irish banks.

For example, the two banks held contingent convertible notes, securities known as CoCos, worth about a combined 2.5 billion euros at the end of 2015. Both companies repaid those notes, which carried a coupon of 10 percent, and have no plans to issue more, yet the tests assumed they would be replaced with similarly expensive securities.

“The stress test methodology was extremely harsh for the Irish banks,” said Philip O’Sullivan, an economist at Investec Plc in Dublin. “With that being said, the banks still have issues.”

Brexit Fallout

Concern has been amplified by Brexit. In the wake of the June 23 vote, S&P cut its forecast for Irish economic growth next year to 3.2 percent from 3.8 percent, and warned that loan losses could rise should Britain’s departure from the EU have a greater impact. The U.K. is Ireland’s biggest trading partner after the U.S.

“Between now and year-end we will be looking to see if there is greater visibility on the impact of Brexit,” said Diarmaid Sheridan, an analyst at Davy, Ireland’s largest securities firm. “The various surveys since the Brexit vote haven’t been particularly positive. That suggests a cautious outlook."

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