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Tough at the top for AIB Back  
AIB's chief executive Tom Mulcahy speaks candidly to Finance on the DIRT tax audits, the company's share price and the wider issue of regulation.
The Spanish call it ‘ganas’, desire, hunger, we might say. Where do you start with AIB’s chief executive, Tom Mulcahy, on a Friday morning in July, in the pre-half year results close period, the DIRT tax audits in top gear, preliminary dormant accounts data released by the Department of Finance and the share price, not quite roaring ahead but still up 22 per cent since the 1999 results in February?

You start with the desire, the competitiveness, commercial combativeness that observers say is at the heart of AIB’s culture, and puts the sharp edge in the measured words of its CEO.

So, you can start just as well at the end, the end of a long conversation, the forthcoming end of a long career in banking. Due to retire next June - he readily confirms - what advice would he give to the AIB board in looking at the qualities required of his successor? Diplomatically, and necessarily obtusely, Mulcahy says, ‘Our board are a very wise group and they’ll decide the qualities in whoever should takeover the position. I wouldn’t even dream of suggesting the qualities they should look for, for a number of reasons, not least because it would be self-serving. I’m very happy to leave that in the hands of our board.’ Very well. But leaving aside AIB, what qualities does the CEO of a bank need to have in this day and age to be effective? ‘I’ll say one thing about it. The first thing is that the person really has to want to take on the job… and that’s the only thing I’ll say about it.’

‘My sentiment, not my advice to anybody, would be don’t take it on unless you have the desire to take on it all, the good, the bad, everything else.

Surely that wouldn’t be an issue for most people who would be in a position to be eligible for the top job? ‘If it’s not, that’s wonderful, and if they hadn’t thought about it, they ought to. I’m not saying that people haven’t or have worked these things out, it’s just that it’s very dangerous to make assumptions about people. You can’t generalise, but my experience is that most people perform ahead of their own expectations.’

There it is - desire, competitiveness, performance, even at the heart of the ultimate people management decision, the appointment of the next CEO.

Back to the beginning, to this summer’s concerns. At the press conference announcing the 1999 results last February, Mulcahy and Neil Kennedy, AIB’s chief financial officer, remarked on the fact that it took the press 45 minutes to ask about the issue of the day, DIRT. Starting with DIRT, it was clear that Mulcahy still felt he could say nothing more than point to the notes to the 1999 accounts on the subject. It was an on-going issue for many banks and he didn’t want to comment for that reason.

Outside of AIB, though, in relation to the IFSC, what was his view of the impact of the DIRT issue? There had been considerable controversy surrounding the look-back tax audits at IFSC banks in March, with the Chairman of the Revenue taking the opportunity to address industry representatives at the Finance Dublin conference in March. Had it been resolved or would there be lasting effect for the IFSC?

Mulcahy was careful. ‘I’m not familiar with the individual circumstance of IFSC banks and I’m not really up to date on that. Until the audits are completed, it’s very hard to judge. Until that whole phase is over, I don’t think one can say.’

What does he hear internationally about how this issue may have affected perceptions? ‘Well, generally, internationally, banks look for clarity and whenever there isn’t clarity, there are always questions. To the extent that those questions are unanswered, they take away the attractiveness of the Centre. That applies not only to the IFSC but also to other jurisdictions.

Is the general political and public environment damaging to the development of international financial services?

‘I think it will take a little time to determine that. If a slowdown in the pipeline to the IFSC comes about, well then, maybe, one might pose a question as to what extent the kind of environment you relate could have had an effect. But as I understand it, the environment in the IFSC is, at present, quite positive.’

‘You can only judge people by their actions, ultimately. In a year or two the evidence from the progress of the IFSC in terms of new entrants will show what impact, if any, these situations will have had.’

More generally, how does he see the environment in Ireland for the development of international financial services now? ‘One of the potential limiting factors going down the road will be the availability of experienced people in depth, and that will apply to all of us. In the short term, the pressure is going to be quite acute; in the medium term, I’d be far more optimistic, other things being equal, that we’ll get back to more of an equilibrium. We’re going through a bulge factor now. When you look at the growth of the IFSC and the number of new entrants, all requiring experienced personnel, there’s naturally a limit of them. When you have a bulge of activity, it naturally puts pressure on the local resource base to satisfy demand.’

Does he see this in his business too? ‘Yes, absolutely. Technically qualified people are in great demand, he agrees. ‘We tend primarily to grow our own, so we would be a net supplier, as it were. It would be an interesting figure to see what the number of people supplied by the banks had been.’

In the wider context, does AIB act to increase immigration in Ireland, taking in people from Poland for example? The bank has a policy of moving people around for experience purposes, he says, ‘so it wouldn’t be driven in the short term by requirements of suitable supply of personnel. Apart from our on-going work across geographies for development work, we’re not engaged in bringing in large numbers of personnel from other geographies to Ireland. People come here from Poland for a specific period of two years, for example, and then go back to their bases.’

After the ending of the tax ringfence around the IFSC, what does Mulcahy think will be needed for Phase II of international financial services from Ireland?

‘There’ll be a number of characteristics needed - (a) scale of activity, (b) in the medium term an adequate supply of suitably qualified personnel, (c) a clear framework in which companies can conduct their business. I think that we’re making progress on each of those headings.’

As someone who had been involved in its early days, which areas of IFSC business surprised him? ‘I suppose, the scale of the funds side of it was not envisaged by ourselves at the earliest stages. Then, the arrival of the euro also took away some of the attractiveness of the complexity of management of some of the treasury situations out of the IFSC. I think myself that the area of international funds management in the longer term will probably be a central column of the whole edifice of the IFSC. It’s growing all the time, we ourselves have expanded rapidly in the whole area in the last two years. And they’re quite people-intensive and complex businesses. You need good technology, good people and good communications. If one looks then on top of that of the growth in the Europe and the eurozone of risk management, clearly the position of the IFSC looks very well.’

The issue of investment management activity remained. ‘I think the emphasis will be on administration and the custodial side, but there will be also some investment management. As you know some of the EU banks have located their non-domestic fund management activities there, which is quite a compliment to the IFSC in the context of the choices that were available to those institutions.’

There is the suggestion that the AIB investment management business grown as much as some domestic competitors. ‘Well, there’s confusion out there, we have a number of businesses, including one serving the American market. The total funds under management in the AIB Group is E50 billion. We don’t look at it in terms of geography but in the total. There are not too many domestic competitors ahead of us.’

That business has been grown in a very different way to, for example, Bank of Ireland’s. ‘Well, we had a domestic footprint in America and lot of other people didn’t have that. We’re selling mutual funds and so on through the branch network.’

Share price
Mulcahy doesn’t mind that he was very disappointed about the AIB share price at the time of the results last February, and that he had poured a lot of cold water on ‘momentum investing’ then. And then March came for technology stocks. ‘I think I was absolutely right on the money!’

He got an answer more quickly than expected? ‘Yes but I think it that was a factor, not all of the issue’ with the share price. ‘You had the US and the uncertainties there, you look at the Irish economy story and the position of foreign investors - they’re discomforted by the rate of inflation for example, and the fact that our growth has been so terrific in many ways. A lot of investors ask if you haven’t been in, do you want to go in at this stage of the cycle?’

Third, he points to the pension fund equity investing culture here and the need to re-balance portfolios. ‘They have come from north of 30 per cent of a portfolio down to 20, and those shares had to be bought by non-resident investors.’

He adds, ‘In another sense, this is a correction that will only happen once’.

But what does his own shareholder register tell him about this movement? They can’t tell for sure because of nominee shareholders, he says, but the bottom line is that more than 50 per cent of shareholders are outside Ireland, from less than 30 per cent five years ago. Did AIB have a target for that? ‘We expected to be north of 40’, but the issue became ‘more relevant than we would have foreseen’ in the context of portfolio adjustment by domestic institutions arising from the introduction of the euro. There is no specific shareholder diversification target at AIB going forward, he says, ‘the market is the market, but what we can have a target for is the attractiveness of the shares in the major investing markets’. Where you put energy into investor relations will be determined by the major markets, and that means primarily the US and Europe for AIB.

AIB’s PE and RoE
AIB’s return on equity in the early to mid-twenties is still at odds with its p/e of around 11, and Mulcahy points to explanations about the market’s expectations about future earnings. ‘Markets are primarily about sentiment, and we can only influence sentiment by performance’. Relative to the risk free rate of capital, isn’t a 23 per cent return on equity a very high rate for banking in general? Shouldn’t the return be less relative to the risk-free rate?

‘Not necessarily. What the stockmarket is also doing is recognising that because Ireland is such a competitive market place there will be further margin pressure, and there has been a lot of margin pressure. Our net interest margin has fallen by one-third in five years and we’ve had no increase in fees since 1992. But look at performance over that period. That tells you how efficient we’ve become.’

Warming to the theme, Mulcahy continues, ‘The other fallacy that’s out there’, he says, relates to banking margins relative to the UK. ‘Our domestic net interest margin today is more than 100 basis points below the UK rate. When you look at UK banks, you’re looking at the aggregate margin which takes into account wholesale syndicated, international lending which has a dilutory effect on the domestic net interest margin, but if you want a proper comparison, and I speak for ourselves, our net interest margin is more than 100 basis points lower than the equivalent for UK banks.’

Has the recent high level of return on equity changed internal decision making about a required return on equity for proposed new projects or acquisitions? First, Mulcahy points out that equity ‘has been reduced by acquisitions. You should normalise the return on equity - what you’re looking at is a post-goodwill return on equity, you have actually work back the goodwill in all cases to compare on a normalised basis other banks. And while we’re in the top quartile, we’re not uniquely there in terms of European banks.’

Looking at hurdle rates for acquisitions, ‘we look at it on a number of fronts, we have IRR, dilution recovery, EPS impact, periods to get the EPS alignment right, and then going forward with our business, we run it primarily on a ‘RAROC’ basis - risk adjusted return on capital. We look at things in relation to alternative use of funds and whether you can enhance earnings per share growth.’

At that level of efficiency he had spoken about, it must make acquisitions all the more difficult to find? ‘Yes definitely, and one of the downsides of having a low price earnings ratio is that acquisitions, to the extent that they’re ahead of that, in terms of the inward price, can be dilutive. So you need to be very certain about the strategic fit and dilution recovery so that you can get back to where you were. In a low P/E environment, acquisitions are very difficult.’

It makes the business look more towards organic growth. ‘We actually have grown a lot of businesses, we spend about E100 million a year, discretionary, through our P&L account. Accounting convention doesn’t recognise that, but we’re in the long term game, not the earnings per share per quarter game.’

Does AIB have the level of post-acquisition execution capability needed going forward, compared for example, to that of Banc One in the US (as highlighted by Prof. Anthony Hourihan at UCD)?

‘Well, he was writing about Banc One as a success story, but now it’s almost bust.’ Mulcahy is not terribly impressed by consultants’ analysis of excellent companies going forward, citing some of the big names mentioned by Tom Peters in the eighties, now shadows of themselves.

Point taken, but what is the limit of acquisition strategy for AIB? After Poland, where next? Aren’t there a lot of countries like Poland, even among aspiring EU member states? ‘With price-earnings ratios in the market at the moment, the bulk of our efforts at the moment will go into developing our existing franchise. That’s not to say that if something special came along with a special fit and we could do something unique with it, we wouldn’t be averse to looking or to taking it on. So, where next is essentially a factor of the time you ask the question. One thing that is certain in business is that you can’t have rules of engagement that are set in one time and last forever. If we had had that we wouldn’t be in Poland now.’

At the same time, he says, the opportunities are ‘essentially over’ in the Czech Republic and Hungary, the largest of the other EU aspirant member States.

Corporate services
Mulcahy says that AIB has had as much success in cross-selling services to corporate customers as to retail customers. Is there any way of quantification of it? ‘There is, but we don’t talk about it, because so much going on. I would describe it as very successful.’

‘Corporate customers are looking for choice, service and realistic pricing. I’d say that the initiatives that our capital markets division have taken have been well-recognised by our customers and that our business has never been better.’

In corporate banking, he says, ‘If want to be successful, we have to have very good focus not only in terms of the relationship with the customer, in terms of the delivery of the service, but also that the parts that we’re offering have to stand up compared with any other institution, it could be a monoline producer, it could be whatever. It’s all about focus. You’re product has to be as good as what is around by segment. A relationship per se will get you nowhere unless you have the product to go with it.’

Is the growth coming more from outside Ireland than Ireland, especially in the non-SME sector? ‘In the corporate market sector, our business is growing through customers buying more products and having more customers, in Ireland, and the same applies in the UK, in Poland. There’s a very strong corporate customer base in America, where we are a national cash-management player.’

How much price pressure have you been under in corporate lending? ‘We haven’t been under price pressure for years, because that took place years ago. We’re down to risk-reward judgements like every other institution, so if anybody wants to step out of line, they’ll do that for a short period, but ultimately, they can’t do that forever.’

In terms of corporate services, software development and cash management, AIB had invested in ‘tens of millions of pounds, in Ireland’ he adds, with emphasis, ‘but we don’t put that in the newspapers’. Cash management is still delivered primarily by financial institutions, he says, and he doesn’t see many software companies competing on that ground.

As for the EU trend towards issuance of paper by corporates as a replacement for bank loans, Mulcahy says that the trend suits AIB as well, through its investment banking wing. ‘There’ll definitely be more corporate paper traded in the future. If you go back to earlier comments about the growth in the non-cash, non-bond investment world, the instruments that will be held in portfolios will include properties and corporate paper.’

‘I would see it on balance as an opportunity. Your moving the risk on to someone else, you’re providing a service and obviously making a margin of some sort. So you’re using your infrastructure well. But we’ve been doing this for ten years, so it’s not new to us.’

In relation to the European trend, Mulcahy draws attention to the distinction between corporate bond and term paper issuance.

The AIB Chief Executive pointed out that there are many corporate who might want to issue paper that the like of Goldman Sachs or Morgan ‘wouldn’t get togged out for’ because of their size. That reflects the size of the Irish economy and the size of companies in it.

On the wider issue of regulation, and the European Central Bank’s concern about banking consolidation as it relates to prudential supervision, Mulcahy thinks it is logical for the ECB to study prudential issues EU-wide. He’s not sure that this would inevitable mean a drive towards more central regulation for the EU. ‘But if EU authorities don’t take a view on what is in the wider EU interest as regards mergers and acquisitions activities there, it will put us at a competitive disadvantage relative to the US, for example’. ‘There needs to be a view as to what is the relevant market for regulatory policy’.

As for the Irish situation and the awaited decision over the Single Regulatory Authority, does it matter what the outcome is? It’s back to the reticence about DIRT and similar issues, ‘On that issue, the less I say the better. All the representations have been made, so I wouldn’t want to add to anything that has been said before.’

Back to the wider economy, finally, and banking within it. Is there excessive credit growth - 28 per cent - in Ireland? Is it a problem? ‘We’re several percentage points behind the average. But I’d be concerned, and I think you always have to be concerned about credit growth like that. We’ve all revisited our credit criteria many times in the last year. And our credit quality is the best it has ever been.’ On the business lending side, he said, ‘the quality is excellent’. AIB’s loan to value ratios of mortgage lending in the Irish economy is around 60 per cent.

The key, he says, to the future here, ‘is the sustainability of employment. That is where the national finances have benefited most, more people at work, more spending power in the economy.’
Thus speaks the man with less than 12 months to go at the head of the largest bank in the country. And after that date next June? After competing, the desire, the hunger? ‘A rest! Some people take on too much after retirement. I don’t intend to make that mistake, but I won’t disappear either.’

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