Stock to Watch: Bank of Ireland

Amid the focus on multi-billionaire Wilbur Ross's backing Virgin Money to buy Northern Rock, it is interesting to note how this turnaround financier and a few others bought into Bank of Ireland last July.

An 11 November interim management statement was as resilient as can be expected in the circumstances and it looks worth following this potential recovery share.

Not everything Ross touches can turn to gold, that is why he diversifies, but it is worth bearing in mind how the proverbial "rescue rights issue" (or share placing) is often a key step for recovery.

Obviously the risks for the banking sector remain high, especially while it looks like the eurozone is disintegrating into chaos - you can't predict what damage will emerge. Bank of Ireland is a high risk/reward play that in no way can be defined as an "investment", more a gamble currently, yet over time its risk/reward profile should improve.

For more on investing in financial shares, read:Analysing... Banks.

It is exactly a year since Ireland was forced to call in the International Monetary Fund, resulting in a €90 billion rescue package for its crippled banking system - largely the result of reckless lending to property developers.

Such a profile is apparent from Bank of Ireland's 14 October announcement about divesting €5 billion of non-core loan portfolios, within a wider goal to divest €10 billion of non-core loans by end-2013. The details involved US and UK commercial property loans, UK mortgage loans, project finance and corporate banking. Proceeds are being applied to reduce funding from the monetary authorities.

Although Bank of Ireland reports in euros, it is possible to deal in its shares in sterling: currently a price of 7.0p is offered to buy via an online broker, versus €0.08 you may see quoted on information systems. Bank of Ireland is the only listed Irish bank that has not had its equity diluted right down after rescue by the Irish government, which owns 15% compared with 99% of Allied Irish Bank and Irish Life & Permanent. So arithmetically there is far more upside potential for outsiders investing in Bank of Ireland than the other banks.

The price struck last July, for a €1.1 billion share placing, was €0.10, so the market price is currently down 20% on this amid the wider financial turmoil. Besides Wilbur Ross, other American investors who came in were Fairfax Financial Holdings, Capital Group, Fidelity Investments and Kennedy Wilson.

In a snapshot, the shares are bumping along a chart bottom after lending losses should now have been provided for and the bank is recapitalised. Sentiment is weak because of the wider economic woes in Europe and deposit outflows that have affected Irish banks. Bank of Ireland has reduced this negative effect by selling some of its loan book, albeit at discounts up to 20% of book value, and there is scope for further sales until depositor confidence returns.

In the first six months of 2011, like-for-like operating profit slumped from €479 million to €163 million while impairment charges on loans and assets reduced by over 30% - but were still a chunky €885 million total. Despite interest margins under pressure, the cost of wholesale funding being high, and an intensely competitive environment for deposits, the chief executive asserted "good progress" against targets. Costs are being very tightly managed, credit quality is being closely monitored and asset deleveraging is on track. In terms of capitalisation the bank is now "in a strong position to deliver on our financial and strategic objectives..."

I cannot detail Bank of Ireland's investment credentials because frankly they don't exist.

What I can relay however is a gut feel that when you look at key issues, Bank of Ireland shows signs of being an attractive, early-stage recovery speculation. It is the strongest of the surviving Irish lenders, one of just two main "pillar" banks left (also Allied Irish Bank) after the sector's restructuring. It is not immune to fallout from the eurozone disintegrating, but this is more a timing issue than identifying broad recovery potential.

The latest interim management statement cited national accounts showing the Irish economy in recovery with annualised real GDP growth of 2.3% in the second quarter of 2011 and real GNP increasing by 1.1%. Asset quality is broadly in line with expectations, albeit that relatively improved performances in unsecured consumer, UK mortgage and corporate banking has been offset by some deterioration in the Irish mortgage book. Irish business customers continue to face difficult conditions, which are impacting on their credit profiles, however Bank of Ireland re-asserts that it believes total impairment charges have peaked.

Dividends were suspended after 2008 and although losses are on a declining trend it is going to be a while before forecasting becomes realistic. With a share like this you are required to take a long-term punt on recovery and defer specifics maybe for two years. It really depends how deep and long might be the recession that may soon follow the eurozone woes.

The disciplined investor inside me is cautious to bide time lest the eurozone debacle leads to credit controls and a confidence shock. Yet my nose for recovery situations smells the early stages of turnaround, already backed by some leading American investors.

The next trading update will likely be mid-February, then prelims in April, 2012. If the European economy can avoid a shock then Bank of Ireland rates a long-term speculative buy right now, but in the circumstances I'd put them on the list and see how messy this political-economic crisis gets.

So the real difficulty here is timing, but at some point Bank of Ireland should prove a rewarding recovery play, like the Americans sense.

For more information see www.bankofireland.com.

Looking for more expert opinion? Read Edmond Jackson's previous stocks to watch.