Permanent TSB Group Holdings Plc's new plan to deal with nonperforming loans carries execution risk and is likely to deplete the bank's capital, according to analysts.

Irish banks are reportedly under increasing pressure from European regulators to deal with outstanding bad debt, and Permanent TSB is among the worst exposed. At June-end, its stock of NPLs stood at 28% of gross loans, compared to 19% at Allied Irish Banks Plc and 10% at Bank of Ireland. Its total NPLs were €5.78 billion, little changed from €5.85 billion at the end of December 2016.

This lack of improvement was in spite of the strong macroeconomic backdrop and the "significant" improvements seen in collateral values, Investec Ireland analyst Owen Callan said in an interview.

NPLs 'unsustainably high'

In late July, Permanent admitted that its NPLs were "unsustainably high" and set out measures to deal with them, including accelerated workouts, closures and portfolio sales.

The ECB has urged Irish banks to take "convincing" and "ambitious" measures to tackle NPLs more quickly. But Diarmaid Sheridan, an analyst at Davy Stockbrokers in Dublin, said Permanent had been "successfully executing" its restructure-and-retain approach to NPLs, of which only €2.7 billion were untreated at the end of June.

The bank said in its first-half earnings statement that 35,000 customers had been offered long-term treatments on loans, more than 90% of which were performing to their restructure terms.

But the European regulators' increased impatience means the bank is likely to dispose of the €2.7 billion of untreated loans, Sheridan said in an interview.

Capital erosion, execution risk

"Unfortunately, the ECB's approach would appear to demand sales as the manner to strengthen the balance sheet," he said. Investors are concerned that capital surpluses that may previously have been anticipated will now be eroded, he said.

Write-offs will crystallize losses on the loans, with a 10% "haircut" on the portfolios likely, Callan said. This will impact Permanent's common equity Tier 1 capital ratio, which stood at 15.0% at the end of June. Callan now expects this to climb no higher than about 15.6% through the end of 2019, having previously forecast that it would reach 20% by the end of 2018.

The existing excess capital, which has been viewed as a key part of the investment case for the bank, may now be needed to help reduce the level of NPLs in a shorter time frame, by facilitating a sale below book value, Callan said. Permanent CEO Jeremy Masding admitted on a July 26 conference call with analysts that paying a dividend in 2019 would be "very ambitious" and appeared unlikely "until we make progress on the untreated NPLs."

Permanent wrote to investment banks and accountancy firms in early August seeking advisers for NPL sales, The Irish Times reported Aug. 11. Callan expressed concern that advisers were only now being contacted, and was cautious about the execution risk associated with NPL disposals, in terms of the time and resources needed to value them, and the consideration they may receive versus the currently provisioned book value.

Permanent TSB did not respond to requests from S&P Global Market Intelligence for comment.

Private equity firms remain potential buyers for NPL portfolios. U.S. private equity firm KKR & Co. LP confirmed it remained committed to Pepper Group's Irish loan operations after it completes its acquisition of the Australian-managed financial services group. Pepper administers €17 billion in Irish legacy loans, The Irish Times reported Aug. 15.

Meanwhile, large U.S. investment banks such as Citigroup Inc. and Morgan Stanley are eyeing Europe's NPL market, according to the industry figures speaking to the Financial Times.