Irish bank stocks eye greater heights after outpacing European peers in 2022

Ireland's three listed lenders are set to extend their recent share price surge deep into 2023 as rising interest rates, reduced competition and a strong domestic economy boost income further.

Bank of Ireland Group PLC, AIB Group PLC and Permanent TSB Group Holdings PLC are expected to report sharp year over year increases in revenue and profits for 2022 in their forthcoming earnings and to build on those gains in 2023 as rising interest rates feed through to borrowers and the benefits of recent consolidation in the Irish market emerge, according to S&P Global Market Intelligence estimates data.

The banks have some of the strongest share price growth across the European banking sector. Bank of Ireland's stock has soared more than 90% since the beginning of 2022, followed by AIB at almost 85% and Permanent TSB at close to 60% as investors reacted to the emergence of tailwinds supporting the banks' outlooks. This compares to growth of about 16% for the S&P Europe BMI Banks Index during the same period.

"There's opportunity for upside to consensus estimates in 2023," said John Cronin, financials analyst at Irish stockbroker Goodbody. "I see the potential for further outperformance in 2023."

A lot of interest

Irish banks are among the biggest beneficiaries of rising interest rates as they rely more heavily than many of their European peers on income from lending as opposed to fee-generating products and services or trading. The European Central Bank has raised rates by 300 basis points since July 2022.

Permanent TSB derived almost 87% of its revenues from net interest income — the difference between interest revenue and interest expenses — in 2021, the last full year for which information is available, Market Intelligence data shows. AIB and Bank of Ireland generated almost three-quarters of their revenues from net interest income in the same year.

The largely variable-rate profile of the banks' loan books, which means higher rates are passed on to borrowers within a matter of months, is providing an additional boost to the rate of revenue growth.

"The rise in rates is a game changer for lots of banks, but particularly for retail banks like the Irish where net interest income is a much bigger proportion of total income," said Diarmaid Sheridan, banks equity analyst at Irish stockbroker Davy.

Right-sizing sector

All three have also benefited from consolidation in the Irish banking sector, including the recent exit of Belgium's KBC Group NV and NatWest Group PLC's Ulster Bank Ireland DAC from the Republic of Ireland market. Ulster Bank remains in Northern Ireland.

Bank of Ireland, the country's largest lender, acquired almost €9 billion in loans and €4.4 billion in deposits from KBC in 2022. Permanent TSB, by far the smallest of the three banks, picked up €7.6 billion of assets from Ulster Bank, which also sold a €5.4 billion mortgage portfolio to AIB.

"We now have three [retail] banks left in Ireland and those banks are stronger as a result of what's happened," said Sean Smith, partner, risk advisory, and banking and capital markets leader at Deloitte Ireland. "There are certain economies of scale from having three banks, and it's probably the right size for the sector."

While each of the banks will benefit from their respective transactions, Permanent TSB should have the biggest relative gains due to the additional scale its deal provides, Sheridan said.

"For PTSB, it's by far and away the most important transaction that has happened for them," Sheridan added.

Growth prospects

The healthy outlook for the Irish economy should further support the banks' share prices. Ireland is forecast to have the strongest growth in the eurozone in 2023 and 2024 at 4.9% and 4.1%, respectively, according to the European Commission. This follows 12.2% growth in 2022, 5.5 percentage points more than any other eurozone member, as the country rebounded from the COVID-19 pandemic.

The strength of the Irish economy has partly fed Bank of Ireland's outperformance compared to its Irish peers, the bank being the name most associated with the country and most readily recognized by investors, Cronin said. Bank of Ireland's larger market capitalization and more liquid stock have also been factors, Cronin added.

Risks for the banks include a general election in 2024 that could see center-left party Sinn Féin, which has a strong lead in the polls, win the most seats and lead a coalition government. Sinn Féin is promising a massive homebuilding program to solve the country's chronic housing shortage, which will likely be partly funded by tax increases.

There are also concerns around the Irish economy's heavy reliance on a handful of multinational companies, many of which based their European headquarters in Ireland for tax reasons. Ireland's recent agreement to align its tax regime more closely with other developed economies cast some doubt on the firms' long-term commitment to Ireland. Recent large-scale job cuts by several U.S. tech companies, many of which have large operations in Ireland, in response to poor earnings and weaker forecasts for the global economy have also raised uncertainty.

While the banks may outperform in 2023, they may not do so to the same extent as in 2022, Cronin said.

Strong and stable

Yet Irish banks would be well positioned to absorb any significant deterioration in the economy compared to European peers, which is part of their appeal to investors, Cronin said. The lenders have made strong progress on bad loans and capitalization since they had to be bailed out by the Irish government in the aftermath of the 2008 global financial crisis, Market Intelligence data shows.

The Irish government's plans to sell the remaining shares it holds in the banks should further increase interest among investors. The government sold off the last of its stake in Bank of Ireland in September 2022, taking the total proceeds from its stake to €6.7 billion from €4.7 billion originally invested. The state still owns more than 50% of AIB and almost 75% of Permanent TSB, Market Intelligence data shows.

"The fact that the state has been actively selling down shareholdings in the banks has been supportive of the investment case, as has the return to dividends in the spring of last year," Cronin said.