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Bank stocks now less risky than Irish property Back  
Stuart Draper examines how bank stocks can be used to grow the wealth of the private client in 2003.
‘If you can make one heap of all your winnings, and risk it on one turn of pitch-and-toss, and lose, and start again at your beginnings’.

Well if you can, yours is the earth and everything that’s in it, and which is more, you are likely to make a lot of money from bank stocks in 2003.

In Dolmen, we have not always been bullish during the past three very difficult years for the world’s stock markets. In the European telecom sector, we issued sell recommendations on Eircom and on Deutsche Telekom. In the European financial sector, we issued sell recommendations on Abbey National and on Royal & Sun Alliance, and in the European food sector we issued sell recommendations on Glanbia and on Unilever.

However, our view currently is that after three years of equity market weakness, it is now possible to purchase shares in a number of excellent companies at very low risk prices.

The analysis in this article will focus on the European bank sector, and will explain how the share prices of a number of Irish and international banks are now less risky at current levels than the current prices of Irish property.

Investors very often consider property as a risk-free investment, where prices only move in one upward direction. However, a number of significant risks now exist with respect to Irish property prices at current levels. History is full of examples of markets outperforming for a decade and then under-performing for several years. Remember negative gains have already started with respect to Irish commercial property, with prices falling in 2002 for the first time since 1991.

However, private clients more frequently consider investment in the Irish housing market as an alternative to equities, and that market too has now risen for the 12th year in a row. Is it reasonable to expect another year of double-digit gains in 2003?

The first risk to be aware of with respect to Irish house prices is the basic supply and demand equation, with supply having risen substantially in recent years to match demand. In 1993, less than 25,000 new houses were built in the Republic of Ireland, but by 2001 this had risen to 52,600, with a further 55,000 new houses expected to have been recorded as being built in 2002, once official Department of the Environment figures are published. Putting the 2001 figure in its international context reveals that the national housing stock increased by a massive 4 per cent in the Republic of Ireland in that year, compared with an increase of only 0.8 per cent in the UK.

With supply continuing to increase substantially, there is now the risk that in 2003, demand may start to soften somewhat. The first risk is from a slowdown in employment growth, with the vast majority of 2002 public sector employment growth unlikely to be repeated in 2003, and the unemployment rate already starting to rise. Looking out to 2004 and 2005, there is also the risk of the ECB raising interest rates to combat its inflation fears, which would also dampen Irish housing demand by reducing affordability levels. Indeed, the particularly favourable current interest rate environment may have led to some recent demand having been borrowed from future demand, and may also have led to some recent demand having been artificially borrowed from the tenant market.

The recent softening of rents at the same time as house prices continued to rise would be consistent with this effect.

Finally, a major factor behind Irish housing demand in recent years has been the entry of the 1970’s baby boom generation into the housing market.

However, after 2006, there is projected to be no increase in the important 20-34 year old prime house buying age group. This could particularly weaken demand for entry-level housing and apartments, which is the most usual type of property investment for the Irish private client. Therefore, a number of significant risks exist with regard to Irish property now, which are not taken account of by current prices.


In contrast, following three years of stock market weakness, there are now fewer risks surrounding a number of Irish and international bank stocks at current levels. Such stocks contain a number of attractive investment features, which do not appear to be fairly taken account of by current prices.

Firstly, it is now possible to find a number of low risk bank stocks, with strong market shares within their domestic markets, trading at single digit price to earnings multiples, but which have double-digit earnings growth prospects in 2003 and in 2004.

Some of these bank stocks now also provide dividend yields of over 4 per cent, with Lloyds TSB in the UK, for example, currently yielding over 8 per cent. Additionally, unlike demand for Irish property, which would reduce significantly in the event of higher interest rates in 2004 and 2005, the earnings growth of these banks would not necessarily be damaged by higher interest rates. Indeed, higher interest rates more often than not help the profitability of banks by increasing their net interest margins. So do the risks to Irish property values explained above threaten the future earnings growth prospects of the Irish banks?

The short answer is not materially; in that current loan to value ratios are sufficiently low to absorb quite comfortably a fall in Irish property values of up to 10 per cent. Additionally, Bank of Ireland and Anglo Irish Bank have substantial general provisions, which could be used to further protect future earnings growth from any increase in non-performing loans over and above lending growth rates.

However, the issue does highlight how international bank stocks can be used to effectively diversify an individual’s wealth away from the Irish economy. An Irish private client will most likely have his business or his job highly influenced by the performance of the Irish economy. Given our high home ownership levels, a substantial portion of his wealth is likely to be tied up in his house, the value of which will also be largely determined by the state of the Irish economy.

Therefore, bank stocks enable such an individual to diversify his exposure away from one small open European economy, whilst at the same time increasing the liquidity of his wealth. This is why at Dolmen we are now researching more and more international companies for our clients. Such investments also have the added advantage of being free from the one per cent stamp duty payable on the purchase of Irish shares.

In conclusion, following twelve years of rising house prices, a number of significant risks now exist with regard to Irish property values, which are not taken account of by current prices. In contrast, following three years of stock market weakness, a number of attractive investment features now exist with regard to several bank stocks, which are also not taken account of fairly by current prices.

Therefore, the share prices of a number of Irish and international bank stocks are now less risky at current levels than the current prices of Irish property. As a result, the probability of generating double-digit returns for investors in 2003 from such bank stocks is higher than the probability of generating such returns from Irish property.

However, it is becoming increasingly important these days for the private client stockbroker to keep in regular contact with his client. This is because of the increased volatility of the world’s stock markets, which could continue for a number of years, as well as the increased speed with which news can become reflected in a share price.

For example, a broker may be happy to see a client invest in a particular company at the start of the year, but six months later its share price may have risen sharply, and some profit-taking may then be advisable.

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