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PE firms running the rule over Ireland's Permanent TSB, but conditions for a deal are murky

Majoritystate-owned Permanent TSB GroupHoldings Plc is reportedly attracting private equity interest, butanyone buying into the Dublin-based bank may face a long wait before theinvestment pays off.

The distressedlender's recovery is projected to be gradual, with returns on equity expectedto reach only 4.9% by 2020. Meanwhile the Irish government, now holding 75% ofits shares, is not in dire enough straits to sell at a discount.

Permanent TSB is slowly returning to profitability underJeremy Masding, its CEO since 2012. In 2015, its underlying profit beforeexceptional items totaled €26 million — small beer next to 's €1.2 billionunderlying profit, but nevertheless its first since 2007.

Low-yielding tracker mortgages linked to theECB interest rate comprise 60% of its loan book; rates are equally low for aU.K. book making up 10% of its gross assets. The bank's lending margin hasshown signs of improvement in recent years but, at 1.09%, it remains low.

Thismeans a very slow burn for a buyer, which would expect two potential sources ofmargin uplift, said Constantin Gurdgiev, professor of finance at the MiddleburyInstitute for International Studies at Monterey.

Thefirst, a more aggressive working-out of poorly performing assets, would mean atougher approach to foreclosures and could pose political problems for theIrish government. Even with assurances that anew owner would operate the bank as a long-term franchise, the opposition wouldportray the government as "handing over a loan book to a vulturefund," according to a market source who did not wish to be identified.

Thesecond, access to cheap funding to enhance bank leverage, offers slightlybetter prospects — the bank is able to access ECB funding through severalpreferential lending programs, and market funding is currently cheap. After asale, a new owner could grow its business base by mergers with credit unions,and by using the bank to acquire debt books from distressed debt buyers.

PE interest

PermanentTSB is currently trading at a 60% discount to book value. It listed for €4.50 ashare when it returned to the markets in 2015, repurchasing and floating 25% ofthe government's stake, while also raising €125 million to plug a capital holeidentified in ECB stress tests. On July 26, the shares traded at €2.07.

U.S.private equity fund Apollo GlobalManagement LLC is among the funds reportedly considering acquiringthe bank. Apollo and other PE firms have been active in the Irish market,buying distressed loan books. A potential PE or hedge fund buyer will look fora "significant discount on bank assets' valuations, to allow for risk andmargin cushion," said Gurdgiev.

Thoughthe Irish government had said on several occasions it would prefer the bank toremain independent in order to maintain competitiveness in the banking sector, FinanceMinister Michael Noonan said June 23 that he "cannot discount the possibilitythat a strategic transaction could arise opportunistically at any time … whichcould be in the best interests of the state."

Hesaid M&A could be a way of improving Permanent TSB's long-term viability,after decline in its shares following concerns over margins and bank levies.

Butmergers with Ireland's smaller banks to create a rival to Bank of Ireland and pose problems. Though anUlster Bank IrelandDAC merger could bring cost-side synergies, both banks have legacyIT infrastructure, and more important, problematic tracker back books.

"Allyou're doing is multiplying them and getting a much bigger tracker back bookthat's very low yielding," said Emer Lang, an analyst at stockbroker andasset manager Davy, in an interview.

Anapproach from KBC, with a higher-yielding loan book, could be more attractive.It is currently reviewing its Irish operations, with a decision as to itsfuture — which could involve exiting Ireland, staying, or merging — promisednext year.  

Conditionsfor a PE sale become more viable if Irish public finances become pressured,perhaps in a post-Brexit downturn scenario.

"I'mnot sure that's something that's going to happen any time soon — maybe a littledown the road, it's something that's going to reappear", said Lang.

IrishLife and Permanent formed in 1999 when the Irish Life Group, an insurer, mergedwith the Irish Permanent Building Society, a personal banking and mortgageoperator. It then purchased TSB Bank from the Irish government in 2001.

In2011, following the downturn, the Prudential Capital Assessment Review foundthat the group required €4 billion of capital to meet the central bank's newequity ratio and deleverage the bank's balance sheet. IL&P delisted fromthe Dublin and London stock exchanges, and the Irish government acquired a99.2% stake in the group. The government spun off the profitable Life Group toCanada's Great-west Lifeco in 2013 for €1.3 billion, and the bank hasafterwards traded as Permanent TSB.