Why Now Is the Right Time To Buy Bank of Ireland Stock

Flickr / Kevin Dooley.

The Governor and Company Bank of Ireland is an interesting bank turnaround play for investors looking for an asymmetric payoff profile.

With strongly rebounding normalized operating profits, improving asset quality and more dynamic growth in the Irish economy, the Bank of Ireland has outsized rebound potential.

Most investors concentrate solely on U.S. banking firms and the U.S. financial crisis, though Ireland also experienced a serious shock in its financial system in 2008. And there are significant parallels to the United States indeed: Lax banking regulation, thin capital layers, a red-hot property market and a high risk-tolerance of all players involved ultimately worked their toxic mix and required Irish banks to be recapitalized by the taxpayer.


In addition, Ireland had to be kept afloat by a European Union emergency funding package in the amount of Euro 67 billion which required harsh austerity measures.

The government ultimately invested Euro 4.8 billion in Bank of Ireland and received a payback amounting to Euro 6.0 billion while retaining a 14% equity stake in the bank. Similar to the U.S., the government benefited from a stake in Irish banks.

Irish indebtedness rose sharply during the financial crisis
Ireland is still doing fairly poorly from an economic point of view: Government debt has skyrocketed to 123.9% of gross domestic product in 2013 and GDP growth remains sluggish.

Source: Google, Eurostat

In fact, Ireland's government debt ratio is even higher than Iceland's 96.4% and Iceland was one of the heaviest hit countries and one of the first dominos to fall as the financial crisis spread around the world.

So, why would you want to buy an Irish bank anyway?

Asymmetric return profile
Most investors are still put off when it comes to bank investments. This is true for the United States, but also for Ireland and Greece; all countries had to massive inject capital into their respective banking sectors.

However, looking a couple of years down the line, many banks that are now hated and neglected are set to deliver strong rebounds as the economy improves and investor confidence returns.

Bank earnings are cyclical in nature. As the economy grows and banks are stimulated to lend and to invest, their earnings profiles should materially improve for two reasons: First, higher loan- and investment activity should immediately boost their earnings and secondly, higher average asset quality should lead to lower impairment charges.

Loan charge-offs and provision expenses are usually high at the beginning of a recession and subside over time as the company works through its legacy issues.

The U.S. banking sector still has a lot of ground to recover, but most banks have recovered meaningfully from their respective lows in 2008 and March 2009. An encouraging reminder that banks are indeed extremely cyclically investments.

Irish economy will keep on improving
One of the counterintuitive things about the stock market is, that many distressed investments can be returned to sustainable profitability after a period of restructuring, just look at AIG.

The Irish economy is still not great, but has made decent progress over the last couple of years. For instance, the Irish national deficit is expected to come in somewhere in the neighborhood of 3% in 2015. This is still slightly below the 3% target set by its lenders, but a national deficit of around 3% is clearly a defensible ratio and  clearly doesn't imply lavish government spending.

Rebounding operating profit and cyclically improving asset quality

Source: Bank of Ireland Investor Presentation

As can be seen in the chart on the left, Bank of Ireland's pre impairment operating profit improved materially over the last two years.

While the bank posted an underlying operating profit of Euro 187 million in the second half of 2012, this profit increased to Euro 380 million in the first half of 2013 and to Euro 685 million in the second half (an increase of 103% and 266% respectively).

In the second half of 2013, defaulted loan volumes also contracted by 6% indicating that the worst may be over the bank. Investors can be optimistic, that defaulted loan volumes have already seen their peak and that the Bank of Ireland will be able to improve its earnings profile even more going forward.

Recurring operating profits are rising across all divisions
A look at Bank of Ireland's normalized operating profits across divisions suggests, that its core business of providing deposit, loan and mortgage services is fairly healthy and should benefit from further momentum in the Irish economy.

The Foolish Bottom Line
Investors should have learned from the U.S. financial crisis, that banks can deliver strong turnarounds as their asset quality improves, loan charge-offs decline and the economy starts to grow more dynamically.

The same is likely true for Ireland. Going forward, Ireland's economy should continue to grow and provide cyclical tailwinds to Bank of Ireland's earnings.

Ultimately, investors who want to pursue an investment in Bank of Ireland bet, that the worst is already behind the bank and asset impairments have bottomed.

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The article Why Now Is the Right Time To Buy Bank of Ireland Stock originally appeared on Fool.com.

Kingkarn Amjaroen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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