April 28, 2023
Outlier/Mismanaged Bank(s) or GFC 2.0?
The debate over how interest high rates must go and whether these higher rates will cause a hard, soft, or no landing continued throughout the first quarter. Initially, investors had a more optimistic take on the overall economy following various pieces of economic data, including a blowout jobs report in early February, and markets generally drifted higher. The more upbeat mood was interrupted in early March with the quick demise of Silicon Valley Bank (SIVBQ, Financial), Signature Bank (SBNY, Financial), and Silvergate Bank (SI, Financial) along with the shotgun marriage of European banks Credit Suisse (CS, Financial) and UBS (UBS, Financial). The exact concerns differed slightly at each bank (including cryptocurrency issues at Signature and Silvergate) but all were quickly overwhelmed by an outflow of uninsured deposits and, in the case of the US banks, concerns over certain unrealized losses on government agency securities1. The US government tried to ease depositor concerns by announcing that uninsured depositors at SVB and Signature would not suffer losses. The US government also simultaneously announced a new facility with a very bureaucratic -sounding name: Bank Term Funding Program (BTFP). The program would allow banks to borrow against the par value of government/government agency collateral even if current market values were below par value. In English, this simply meant that a new government program would assist banks should there be further liquidity issues.
Despite the government’s efforts, many watched the SVB saga unfold and quickly decided to move deposits to the largest, “too big to fail” banks as a precautionary measure. While such decisions may have seemed rational at the individual level, the collective action caused ~$360 billion of deposit outflows at banks during March, with the funds moving to other (larger) banks and to higher yielding money-market funds. It is worth noting that there has been a stabilization of deposit trends during recent weeks. While government assurances on SVB and Signature uninsured deposits along with BTFP brought some degree of calm to markets, many will be anxiously watching deposit levels at regional US banks over the coming weeks to see whether depositor outflow continues. Furthermore, the entire SVB episode adds further pressure to the US Federal Reserve as it must balance financial stability against the need for additional interest rate increases to cool inflation.
Sounds awful, no? Certainly, bank closing headlines, Sunday night announcements, and new government programs with hideous acronyms understandably cause flashbacks to the 2008/2009 financial crisis. That said, we do not think the current situation is remotely comparable.
- US banks are meaningfully better capitalized than they were heading into 2007/2008, underwriting standards are far better and the assets causing consternation are not the esoteric, Frankensteinesque collateralized debt obligations full of liar loans but instead are arguably the highest credit instruments around - US treasury and agency bonds.
- SVB, SIG, and SIL had unique business models – focusing on the venture capital industry and certain crypto related businesses – that were not representative of the broader banking sector.
- And all three banks (SVB in particular) simply mismanaged a basic function of risk management: managing the duration between assets and liabilities.
We certainly do not want to imply that banks do not face challenges – they do. Banks outside the largest tier of “too big to fail” will likely have to pay more for deposits (why should I have an account at XYZ community bank versus opening one with JP Morgan?), which will negatively impact their net interest margins. Additionally, regional banks are major lenders to the commercial real estate space. According to Goldman Sachs, 70 percent of bank commercial mortgage holdings sit outside the top 25 largest banks (by assets) – including to the more troubled US office space. Continued work-from-home mandates have deeply depressed occupancy rates at US offices and many banks will likely find themselves owning some of this distressed real estate as large swaths of loans mature over the coming years.
Many banks will restrict credit, and this will undoubtedly have some impact on US economic growth over the coming year(s). Furthermore, it is highly likely there will be more bank failures as the above process plays out. While all of the above may sound scary, we would view these events as part of the normal business cycle activity versus a broader bank crisis. While we do not own any US banks, we have started actively looking given the sheer number of publicly traded banks (~600) and the broad-based selling across the sector. Of course, one of the primary reasons that we have not acted is that we think the equity stories and starting valuation levels are even better across the pond. Outside of Permanent TSB (PTSB) which we will expand on shortly, we have started buying shares in another Irish company and another European financial that we will detail in future letters.
Less Financial Gray in Europe…And a Far Greener Landscape in The Emerald Isle
The US crisis began to unfold just as we journeyed back to the Emerald Isle for follow-up meetings with the Irish banks (including (PTSB (LSE:PTSB, Financial))), government officials, and numerous industry participants. You know the weather has been bad when a trip to Dublin offers better prospects for sun versus the incessant rain during the first 3+ months in northern California (we don’t expect sympathy cards). In any event, after touching on the US banking issues, it is worth noting that European banks are less exposed to deposit outflows as opposed to their stateside counterparts, and that Irish banks and PTSB, in particular, are even more insulated. We provide a bit more detail in an appendix to this letter for those interested (or for those fighting insomnia), but at the highest level, European COVID fiscal programs (while still enormous) were smaller than the US and thus there was less rapid deposit growth. Additionally, money market funds (which have sucked funds from lower interest deposit US accounts) are less developed than in the United States, and on a more technical level (see appendix) there is no reverse repo facility in Europe.
As for Ireland, there are only three banks left and this level of concentration leaves depositors with few options. Additionally, higher tax rates on interest income and a bank levy that discourages higher interest payments offer further comfort on the “stickiness” of Irish deposits. More flighty corporate deposits comprise only ~5 percent of PTSB’s deposit base. Nearly 80 percent of PTSB’s retail deposits are below the €100,000 insurance threshold. While previous letters have focused on the bank’s assets and earnings potential, the “right side” of PTSB’s balance sheet is a pillar of strength and we are highly confident in PTSB’s deposit franchise in the context of a rock-solid Irish deposit backdrop.
We were encouraged by PTSB’s year-end results (reported in early March). PTSB reported an underlying profit, excluding a large “badwill” gain on the Ulster loan purchase described in previous updates. Perhaps most importantly, PTSB updated its medium-term guidance higher and provided forecasts (including a €0.60 medium term EPS target) that are trending closer to our own projections. This update was particularly gratifying to see as we had pressed the company to speak about guidance in clear EPS terms, rather than providing somewhat vague ranges for return on equity. We continue to ultimately see €0.50-0.60 of earnings potential with over €1+ euro per share in capital return over the next several years, even assuming that the European Central Bank (ECB) deposit rates drop to 2.25% by 2025 (from 3 percent currently); we think that rates are as likely to stay steady or rise (which would be more beneficial to PTSB) as they are to fall.
PTSB CEO Eamonn Crowley was upbeat during our meeting and the commercial momentum of PTSB’s business is now palpable. Eamonn seems particularly excited about PTSB’s opportunities in the small and medium enterprise (SME) loan portfolio, spearheaded by the newly acquired asset finance business (Lombard). The Irish government has made substantial progress selling down its stake in the other two banks: The government sold the last shares of Bank of Ireland (BIA) in September of 2022 and its stake in Allied Irish Banks (AIB) has been reduced to ~53 percent2 from over 70 percent at the beginning of 2022. The government’s AIB stake will likely drop below 50 percent in the coming months. We continue to believe there will be considerable investor interest in PTSB as its tradeable float increases as a result of government sales and we believe a ”re-IPO” can occur sometime in 2024. While PTSB shares have moved higher over the last several months, we continue to believe that increased share liquidity can drive a far more meaningful rerating, especially considering the projected ramp in earnings over the next several years.
Dirt Cheap Millicom Draws Attention of an Activist
Our media and telecom names continue to trade at nearly incomprehensibly low levels – most could double and still be dirt cheap relative to the broader market – but there was mixed news flow within the group. Millicom (TIGO, Financial) –please see our Q2 2022 letter for a fuller discussion of TIGO - attracted the interest of telecom activist Xavier Niel who at the time of this letter now owns ~22 percent of outstanding shares. Niel’s expanded stake (Niel first reported a 7 percent interest in TIGO back in November) follows reports in January of this year that Apollo and former Softbank executive Marcelo Claure were considering a bid for TIGO. Niel’s intentions are less clear; perhaps he simply sees a crazy cheap name and wants exposure or (more likely) he would be potentially interested in participating in some sort of buyout. Regardless, his involvement is likely positive for the story as it likely helps prevent private equity players from “stealing” the company. While TIGO faces some headwinds in certain of its Central American markets, the company seems poised to earn $500+ million of owned free cash flow by 2025 (against a current market capitalization of ~$3 billion). Assuming that the vast majority of free cash flow is used to repay debt, we believe leverage ratios can trend towards 2x over the next 3 years. Additionally, TIGO is planning on monetizing some/all its cell phone tower portfolio, which could be sold for 2-2.5x higher multiples relative to TIGO’s current Enterprise Value/EBITDA valuation. Little has to go right for TIGO’s bombed out stock to produce exceptional returns from current levels. Of course, the presence of a possible activist adds another catalyst for the name.
LILAK: Waiting for Godot?
Liberty Latin America (LILAK, Financial) reported mixed fourth quarter results with continued strength at its Caribbean unit (CWC) but somewhat disappointing mobile results at its Puerto Rico operations.3 The Puerto Rican unit has been hurt by more aggressive mobile competition from T -Mobile. Meanwhile, the larger synergies from the AT&T (T) deal4 do not materialize until the back half of 2023. The Puerto Rican mobile underperformance partially stems from the shackles imposed by T’s 3-year transition service agreements (TSA) that LILAK must operate under until later this year. Once these are removed and LILAK has full control over mobile plan packaging/pricing, the company believes that its mobile results will show improvement.
All of this sounds rational, but the company must execute as an exhausted shareholder base needs to see further tangible results versus promises of “wait until next year.” We believe that LILAK’s free cash flow will eventually expand well beyond the $300 million guided to in 2023, driven by organic growth and large synergies from the Puerto Rico, Costa Rica, and Panama acquisitions described in previous letters. We suggested to LILAK’s management team that some type of medium-term guidance would be helpful to investors. Thus far, they have chosen not to do this.
To be clear, LILAK is far from the only statistically cheap LATAM telecom name; providing multi-year guidance would not provide a “silver bullet” to the company’s lowly valuation. Operating execution is certainly most important. That said, we would note that LIALK’s pedestrian ~$1.7 billion market capitalization and the lack of questions during the company’s quarterly conference calls signal a complete abandonment of the name by the investment community. Given the company’s bombed-out valuation, aggressive share repurchases (which must be judged net of LILAK’s more generous stock compensation) make strategic sense and the company has suggested that these should ramp up with higher free cash flow. LILAK’s value potential is blatantly obvious. That said, for new investors to get behind a somewhat complicated situation, execution needs to improve, and the company must demonstrate intelligent capital allocation in the quarters/years ahead.
Mexican Cable Update: Chasing Fiber in the Bush vs. Merger in Hand?
After spending considerable time with Megacable’s (MEX:MEGACPO, Financial) management team, multiple local Mexican investors (Gracias por su tiempo y ayuda) as well as several other MEGA and Televisa (TV) investors, the odds of an immediate Mega/TV merger appear lower than we thought at the time of our Q4 letter. Absent a deal with Megacable (please see our Q4 letter for a fuller discussion), we still believe that TV will be a share donor and therefore even a more expensive deal is superior to no deal from TV’s vantage point. MEGA has apparently concluded the same, and, given this negotiating leverage, MEGA appears to have asked for the cable equivalent of the sun, moon, and stars -- including a special dividend funded out of TV’s pocket versus out of the combined company cash flow and a “put” provision at a high multiple for the Bours family. Thus far, TV has declined this laundry list of demands and TV sounds unlikely to accept shorter-term.
Additionally, with fiber competitor TotalPlay slowing down its fiber rollout because of funding concerns, MEGA appears to have increased confidence in its plan to profitably double the size of its footprint. As noted in prior letters, this aggressive rollout could produce strong returns, but success is far from guaranteed considering the checkered history of overbuilding. Taking all the above into account, we reduced our outsized MEGA position size during the first quarter and will continue to reevaluate the name based upon the company’s operational and capital allocation performance over the coming quarters. MEGA’s dirt cheap valuation and low leverage limit downside risk and the early results from the expansion project look promising. That said, MEGA must show continued progress on its rollout in order for us to maintain our position. MEGA has a path to nearly triple its share price from current levels, but this assumes the company acts rationally. Unfortunately, it is more difficult to conclude that the controlling Bours family is committed to creating shareholder value.
Warner Brothers Discover Media Adventures: Rocky Horror Guidance Cuts…Fairy Tale Deleveraging?
Moving stateside, we repurchased the Warner Brothers Discovery (WBD, Financial) shares that we sold for tax purposes at the end of 2022. WBD shares have moved higher in early 2023, notwithstanding a recent pullback following a rather pedestrian streaming presentation, as investors reconsidered the bombed-out name as free cash flow visibility has increased. As we discussed in our Q1 2022 letter, legacy media companies face a vastly more challenging business environment as linear viewers continue to decline. Additionally, pivots to streaming have been expensive and there is considerable uncertainty surrounding the long-term viability of this business. That said, various media players (Disney, Neflix, Viacom, etc) (finally) have recognized the unsustainability of content spending, and nearly every public media company has promised some combination of spending cuts and/or streaming price increases. The early days of the Discovery/Timer Warner merger (the deal closed in April 2022) were horrendous as higher contractual spending at Time Warner forced WBD to reduce its EBITDA and free cash flow guidance issued at the time of deal’s announcement (May 2021) . There is a documented history of underperformance of large-scale mergers and WBD initially gave little confidence that this deal would buck the historical trend.
That said, a large chunk of bad news (and more) was reflected in WBD’s stock price at year end. Despite headwinds in the advertising trends, operating performance has stabilized, and the company has increased synergy targets. WBD has forecast that gross leverage should drop to 2.5-3x by the end of 2024 (from ~5.4x gross leverage at 12/31/22). While some in the popular press (and certain “analysts” on Twitter) love to make sensational statements about WBD’s debt levels, the reality is that WBD’s debt is cheap (average cost=4.3%) and long-dated (14-year average duration). It is true that a severe recession (which would cause large declines in high margin advertising revenue) could elongate the debt paydown schedule. That said, even in stressed scenarios, WBD will produce prodigious amounts of free cash flow over the next several years and therefore we believe there is substantial visibility on debt paydown. We believe that current higher debt levels are a key factor for the company’s bombed-out valuation. Many public investors simply cannot own a name at current leverage levels, but this should change over the next 18 months. Despite the messy beginning, the Discovery/Time Warner megamerger does provide additional scale for the company to compete in the brave new streaming world. Finally, we would note there is another path towards value realization. There is an obvious scale issue with Comcast’s media assets (NBC Universal/Peacock) and Brian Roberts (Comcast’s CEO) has shown a predilection for expensive media mergers every couple of years. Obviously, a merger is far from assured and there is a risk that WBD CEO David Zaslav chooses to elephant hunt rather than accept an outside bid.
At $20 per share (~50 percent above current levels), WBD would trade at a roughly 13-14% free cash flow yield based upon our 2024 estimates. While the timing of our initial reentry into WBD was less than ideal, we similarly mistimed our purchases of Discovery when the merger with Scripps Networks (SNI) closed in early 2018. After the SNI deal closed, DISCA increased synergy targets multiple times, paid down debt, and shares moved meaningfully higher over the next two years. We think odds are high that history repeats, or at least rhymes, and shares can quickly jump as debt is repaid. Of course, substantially higher upside is possible should the business achieve some degree of streaming success.
LSXMA: Discount Widening, New Car Blues
Longtime holding Liberty Sirius (LSXMA, Financial) had an awful first quarter. Our basic thesis has been that LSXMA traded at wide discounts (35-50% at various points) to its primary asset: an 82 percent stake in music satellite business Sirius XM Holdings Inc. (SIRI). We also believed that under Liberty’s stewardship – Liberty’s management team has successfully narrowed/eliminated multiple tracking stock discounts in the past – LSXMA’s discount would be chipped away via share repurchases and ultimately eliminated via a LSXMA/SIRI merger. In the interim, the large discount allowed us to own shares of a strong cash flow generating, recurring revenue business at a “look through” multiple of under 10x free cash flow per share.
While SIRI shares held up well during 2022, 2023 has been far worse. SIRI cut its financial guidance as new and used car sales volume fell throughout 2022 and reached nearly 10 -year lows. These declines limited the number of new trials which SIRI is dependent on to increase its “funnel” of new subscribers. Additionally, SIRI has been hit with increased royalty rates, which are tied to consumer price inflation indices, and capex is elevated because of spend on new satellites5. Self-pay subscriber additions should improve as new car and used sales eventually rebound. That said, SIRI is likely closer to full penetration for new car sales (~80 -85 percent). There is room for additional penetration on the used car side (50-55% percent currently) but a good bit of the incremental penetration for new and used vehicles is occurring in lower-cost models. These car buyers are likely more sensitive to a premium subscription service. On the positive side, churn rates are at all-time lows (below two percent for over a decade) and consumers give the satellite service high marks in customer satisfaction surveys. Additionally, SIRI’s 360L platform, which provides a better music recommendation/curation experience to subscribers as well as valuable data to SIRI, has only penetrated 7mm of SIRI’s total ~150 million enabled fleet. 360L new car penetration is expected to approach 40 percent of new car trials by the end of 2023 and should continue to rise over time. 360L users have higher engagement and conversion levels and a continued 360L rollout should help expand SIRI’s streaming rollout. To continue drawing new subscribers, however, SIRI will likely need success in attracting younger, streaming focused customers. SIRI is relaunching its streaming application later this fall, acknowledging some of the shortcomings with the application and technology platform that have partially led to higher churn rates on its streaming product.
LSXMA has not repurchased its shares as aggressively as we had hoped, and the discount between LSXMA’s share price versus its net-asset-value has widened (not shrunk) during the period we owned the stock. Higher interest rates made it more difficult for LSXMA to refinance some of the exchangeable bonds 6 issued in prior years. Additionally, the reattribution of Live Nation shares to LSXMA back in 2020 (please see our Q2 2020 letter for further details), while value accretive on a net asset value basis, increased the asset’s perceived complexity and this likely had some impact on the size of the LSXMA/SIRI discount. At its November 2022 analyst day, LSXMA announced that it will split off the Live Nation stake into a separate tracker. This separation should remove some portion of the discount as investors are forced to value separately traded LYV shares. While SIRI should continue generating robust free cash flow in the years ahead, the stock could remain unpopular until there are further signs of operational improvement and/or increased capital return. Liberty has issued something of a “mea culpa” for the weaker performance of LSXMA and hinted that a merger of LSXMA/SIRI could soon follow the LYV tracking stock. While the recent decline has been painful, some combination of a narrowing discount, improvement at SIRI and/or a LSXMA/SIRI merger should help rerate shares from current bombed-out levels.
GTX: Downshifting from Preferred to Common
Shortly before going to press, turbocharger market leader Garret Motion (GTX, Financial) -- insert your favorite Gone in 60 Seconds reference here and see our Q3 2021 letter for a fuller description of the holding -- announced that it will beconverting the Series A preferred stock that we currently own into common shares with ~$0.14 per share of dividends to be paid in cash and another ~$ 0.85 to be paid in cash or additional common shares at the expected July 3, 2023 closing. As part of the transaction, the two largest shareholders (Centerbridge and Oaktree) will be partially monetized, with their combined stakes dropping to ~30 percent from ~55 percent currently. GTX believes the move will clean up GTX’s somewhat funky capital structure. There will now only be one class of stock and no individual holder will own greater than ~15 percent of outstanding shares. Additionally, eliminating the preferred dividend will unlock ~$100 million of free cash flow after accounting for the additional debt required to partially monetize Centerbridge and Oaktree. GTX believes this move will allow a wider base of shareholders to own GTX stock and that this increased trading volume likely makes it easier for sell side analysts to cover the name and/or for GTX to be included in various passive indices.
We have mixed feelings on the deal. GTX has proven itself to be a solid operator in an oligopoly type industry. GTX has high revenue visibility as 80 percent of GTX’s auto original equipment manufacturer revenue is booked through 2026. There is a real upside case for GTX’s common stock as we noted in our Q4 2021 letter. That said, we enjoyed clipping regular dividends as well as having structural seniority to common shares, especially as GTX still operates in the highly volatile auto space, which is impacted by nearly every macro risk imaginable (GDP growth, currency fluctuations, supply chain challenges, etc.). We believe these two features were key reasons the preferreds held up well during the past year of market volatility. A forced move towards electric vehicles via government mandate is a real risk for GTX and this concern could limit the amount multiple investors pay for GTX’s business (i.e., a “terminal value” concern) . GTX has made multiple smaller investments into electric vehicle technology. Over fifty percent of GTX’s research and development budget (or about two percent of sales) is dedicated towards electrification technologies. GTX has been awarded $350 million of zero emission vehicle contracts, and the company is targeting $1 billion of zero emission vehicle revenue (excluding hybrids) by 2030 – this would equate to over twenty-five percent of 2023E sales. That said, the presence of the two heavyweight shareholders acts as a ballast against possible delusions of grandeur from GTX’s management team – i.e., attempts by GTX to buy its way into a highly competitive electric vehicle market in scale unless a deal is truly compelling from an operational and financial perspective. GTX’s free cash flow should remain robust as the company continues to gain turbocharger market share. The company has also approved a meaningful $250 million share repurchase program. While shares could trade meaningfully higher (in which case, buybacks would be preferred versus dividends), our preference would be for additional dividends (versus buybacks) given possible “terminal value” concerns around GTX’s business.
In Conclusion…
In closing, we would again reiterate that SVB and other bank negative bank headlines have caused increased volatility and a certain amount of fear. But we do not believe that current concerns remotely compare with what transpired during the 2007/2008 financial crisis. While a recession is entirely possible, we believe the US banking sector is well capitalized and SVB/other bank failures are more one-off situations, not the start of another global financial meltdown. That said, we believe the risk/reward in the European financial sector is even better than the United States, with Ireland’s consolidated banking sector the most attractive in Europe and PTSB the best risk/reward of the three remaining Irish banks. We outlined recent developments (good and bad) at several holdings and how reality compares against our investment thesis. Not all investments will “work” at the same time, and we simply will be wrong in certain cases. That said, we strongly believe that a couple of potentially big winners from the group above can drive attractive portfolio returns over time.
Thanks for your support.
Patrick
1 Under US GAAP rules, unrealized losses on held-to-maturity securities do not flow through the income statement but instead are recognized directly in the balance sheet through comprehensive income. By contrast, unrealized losses on available-for-sale securities must be recognized directly in the income statement. SVB was forced to sell bonds at unrealized losses when deposit outflows accelerated, and these sales flashed a spotlight on unrealized losses throughout the US banking sector.
2 Includes €215 million directed buyback announced on April 25, 2023.
3 Puerto Rico is the company’s largest single market
4 LILAK completed its acquisition of AT&T’s wireless and wireline operations in Puerto Rico and the U.S. Virgin Islands on October 31, 2020, based on an enterprise value of $1.95 billion on a cash- and debt-free basis.
5 Capex spend on four new satellites will continue through 2027/2028. After this period, there will be minimal satellite capital expenditures for nearly another decade.
6 LSXMA has two classes of exchangeable bonds whereby the principal at maturity can be satisfied via cash or by SIRI shares held by LSXMA. The bonds also had “put/call” provisions whereby LSXMA could “call” the bonds or holders could “put” them back to the company. Volatility in credit markets and a drop in SIRI’s price has forced LSXMA to retain cash to help with expected put obligations in 2023 and 2024. Additionally, LSXMA management believes a less leveraged LSXMA could help facilitate a LSXMA/SIRI merger.
Appendix: European and Irish Bank Deposit Characteristics
Two gold stars for readers who have made it this far. For those interested, we provide a bit more detail on differences between the US and Europe relating to the recent financial headlines. We also briefly expand on the uniqueness of the current Irish banking market in the context of these current concerns.
Deposit growth, while rapid in Europe, has been slower than in the United States. Although quantitative easing expanded banking deposits on both sides of the Atlantic, European fiscal stimulus programs, while large, were far smaller than the more behemoth packages stateside. Smaller European stimulus programs limited the ultimate deposit growth and therefore the size of securities portfolios relative to their US brethren. Additionally, more recent quantitative tightening has been more aggressive in the United States than the Eurozone, causing more pressure on deposit outflows.
The accounting rules for investment securities are also different for Irish banks than US banks. Gains/losses on held-to-maturity securities do not flow through the balance sheet and the assets are simply reported at cost. For all three Irish banks, the duration of these securities is ~3-4 years and the composition is primarily sovereign bonds, not mortgage agency securities where duration expands (fewer prepayments) as rates rise. So, even if the Irish banks had to incorporate unrealized losses, there is not the same material impact that many US banks are experiencing.
In the United States, large portions of deposit outflows have moved to money market funds (~$6 trillion+ currently from $5.5 trillion in June 2020), which pay higher interest rates relative to bank deposits. Money market options are less developed in Europe (and even less frequently used in Ireland) than in the United States. On a more technical level, it should also be noted that there is no European equivalent to the reverse repo facility, which allows money market funds to directly deposit reserves at the Fed in exchange for securities (versus purchasing securities via other bank accounts). The reverse repo facility is thought to be a major factor in draining deposits from the US banking system.
https://www.economist.com/finance-and-economics/2023/03/21/americas-banks-are-missing-hundreds-of-billions-of-dollars (We attach this article in the back of this write-up.)
As previously noted, deposit stability is likely stronger in Europe versus the United States, but it is far better in Ireland versus the rest of Europe. Again, there are only three banks remaining in Ireland and this greatly limits options for yield-hungry depositors. PTSB’s deposit composition is particularly strong because it has few corporate deposits (~5% of its total deposit base) and 80 percent of its retail deposit base is below Ireland’s €100,000 maximum insurance level. On the various liquidity and funding ratios (liquidity coverage ratio (LCR), net stable funding ration (NSFR), loan to deposits (LTD), Encumbrance), PTSB screens better than European averages and in some cases meaningfully so. While the level of uninsured deposits is slightly higher for BIA and AIB, it is still below aggregate US bank averages and reflects a highly consolidated banking market in which lower deposit accounts are more evenly disbursed among the Irish banks. And while AIB/BIA have larger corporate deposit percentages than PTSB, these accounts are generally smaller businesses, not global multinationals (Google, Facebook, etc.). The Irish banks generally have not required deposits as a condition for a loan as opposed to a pair of US west coast banks that have been in the headlines. In fact, rather than promising low-cost corporate lending lines, BIA/AIB aggressively restricted credit availability during COVID (angering many customers…and opening up an opportunity for PTSB) and charged negative interest rates on many of their corporate accounts before the recent ECB rate tightening. Despite all of this, corporate accounts continue to be relatively sticky. Finally, all three banks have significantly grown deposit levels over the past 1-2 years given the Ulster/KBC exits, and cash levels remain healthy and are exceptionally high for AIB/BIA.
Additionally, there are some structural reasons why deposit betas will likely be lower in Ireland. Interest on most Irish deposit accounts is paid after a deduction of the Deposit Interest Retention Tax (DIRT), which is charged at a rate of 33 percent. Where interest is paid or credited on other deposit accounts (e.g., where interest is credited at maturity), income tax is deducted at source. The higher tax rate limits the after-tax benefit from chasing higher deposit rates. Furthermore, Ireland’s bank levy system is based on this DIRT. The levy went into effect following the Global Financial Crisis and encourages lower deposit rates (higher deposit rates=higher taxes on interest income=higher bank levy).
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