Investing in the New Pillar Banks

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Note: This article has been amended to better reflect state ownership in Bank of Ireland.

Investors, or even everyday news watchers, will remember the actions taken by the American government to rescue the banking system and ensure it had sufficient capital in the wake of the 2008 financial crisis. But the process of bank recapitalizations continued in Europe for another few years and only recently was completed in Greece. The result: a series of pillar banks given their positions in the recapitalized banking industry by the governments that rescued them.

Pillar banks: Ireland

Prior to the economic collapse, Ireland was a hub of financial activity. With low corporate tax rates and membership in the Eurozone, the financial system in Ireland became a centerpiece of the country’s economy. Unfortunately, the Irish financial system managed to inflate a property bubble and, as American investors have also learned, property bubbles rarely have happy endings.

As a result of the mortgages associated with this bubble, the Irish banking industry experienced a system-wide meltdown. Some banks, like Anglo Irish Bank, were deemed too unhealthy to reorganize and the government began to wind them down. But Ireland still needed an overall banking strategy, and the government decided that a system of two pillar banks would be the best way to reform the system.

Among the least wounded of Ireland’s banks were Bank of Ireland (NYSE: IRE) and Allied Irish Banks. Of course this is relative to the condition of the other Irish banks. Both BofI and Allied Irish still required billions of euros in capital to meet requirements, with BofI managing to raise it partially through government and partially through private investment. Allied Irish, on the other hand, raised nearly all its capital from the government bailout funds, giving the government nearly all of the bank.

But going forward, Ireland will have only two main pillar banks running the system, along with a smaller part of Irish Life and Permanent that will still exist. If Ireland can start to show significant growth again, these two banks could play a larger role in the Irish banking system than they ever could have before due to a sharp reduction in competition. BofI may have the upper hand in returning value to shareholders due to its comparatively healthier state to begin with and the fact it still is mostly in private hands (although with a significant government stake of around 15 percent).

While Allied Irish may become financially stronger due to this reduction in competition, its nearly complete ownership by the government adds the risk of politics to the mix. This political uncertainty has been seen at Royal Bank of Scotland Group (NYSE: RBS) in recent months as the U.K. government struggles over what to do with the 81 percent stake it owns. Even though RBS is projected to post profits over the next few years, its shares still trade below what the government paid for them, leading to proposals from politicians ranging from a complete privatization to a complete nationalization. Even if Allied Irish starts to post meaningful profits, it could still fall into this government ownership limbo, where RBS finds itself, in which future uncertainty clouds return for investors.

Greek pillars

When investors discuss the problems currently facing the Eurozone, the discussion almost always involves Greece at some point. While the nation itself has been bailed out, Greek banks also needed to be recapitalized in the wake of the crisis. Like in Ireland, Greece decided to create a multi-pillared banking system, but unlike Ireland’s system, Greece’s would have four pillar banks.

Among the survivors would be National Bank of Greece (NYSE: NBG), Alpha Bank, Piraeus Bank, and Eurobank. However, this four pillar bank system does not reduce competition down to as few players as the Irish two pillar bank model. Regulators in Greece were even against the mergers of banks seen when they blocked a merger between NBG and Eurobank out of fears the combined institution would find it too difficult to raise sufficient capital.

But Greece’s top concern right now is not as much about bank competition; it’s more about bank solvency. However, recent recapitalizations, with some funds coming from private investors and others coming from the Greek government, have at least temporarily calmed these fears. While the need for future capital injections cannot be ruled out, Greece’s banks and their investors are more focused on a Greek economic recovery than on future aspirations of a bank oligopoly.

Post crisis banks

Investors looking to capitalize on an Irish or Greek economic recovery need to have a long-term horizon for their investment. In the case of these nations’ banks, the pillar bank system is expected to result in fewer competitors in the largest bank part of the industry. This could give these banks an advantage in terms of economies of scale and a possible position of oligopoly. However, this does come with its fair share of risks and costs. Most of the Greek and Irish banks are partially, if not majority, government-owned, throwing the uncertainty of politics into the mix. Recent events surrounding RBS show that this can be a drag on share prices with the future for government-owned banks remaining unclear. If treated like the American banks, a recovering economy could have these Irish and Greek banks re-privatized rather quickly. But this is still all up in the air, and the next few years will play a critical role in shaping the future of these banks and the value of their shares.

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Alexander MacLennan has no position in any stocks mentioned. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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