Just over a year ago at Bank of Ireland’s British headquarters on the edge of the City of London and close to St Paul’s Cathedral, the bank’s chief executive Francesca McDonagh began what would be the start of a four-hour marathon presentation to inves tors. It was the culmination of a months-long review of the bank since her arrival from HSBC in late 2017.
McDonagh set out ambitious plans for the bank’s future under her tenure. Bank of Ireland, she said, would become the country’s “national champion bank”. Between 2018 and 2021 the bank would grow its loan book by a fifth, both in Ireland and abroad. It would boost its share of the business lending market and look to generate more income from selling insurance products and providing wealth management services. There would also be efforts to generate more profits from its British business, which was lagging behind the returns it was getting in Ireland, as well as cost-cutting to slim down its headcount.
At the centre of it all was a plan to transform how the bank did business with its customers by making a huge investment in overhauling its technology systems. It would provide customers with up-to-date apps to carry out transactions and allow the bank to sell services much more efficiently. It would cost the bank a staggering €1.4 billion when the technology upgrade was complete, including the outlay on stripping out costs.
In the weeks after McDonagh’s plan was announced the bank’s share price bounced higher, a sign that its investors (who include the Irish state which still owns 14 per cent) were confident the plan would deliver higher profits. Just over a year ago Bank of Ireland’s share price hit a high of €7.63. Yet it has now fallen back by more than a third and in recent weeks hit a one-year low. In just over a week’s time McDonagh will preside over Bank of Ireland’s latest set of financial results. The CEO is also likely to face questions on the progress of her strategic plan.
Part of the problem for Bank of Ireland is that McDonagh’s strategy coincided with a wider change in sentiment towards European banking stocks. That shift, caused by investors fretting about the impact of continuing low interest rates in the future, has been compounded by the fact that about 40 per cent of its business is done in Britain with a potential hard Brexit, as well as concerns that the technology upgrade remains on track to be rolled out and on budget.
Technology is key to the future of banks. Well-funded start-up banks like Revolut and Monzo have stolen a march on the traditional retail banks by signing up a younger generation of customers with the lure of instant payments, money transfers and other perks. By contrast, the high street banks are saddled with legacy software systems starved of investment, creaking payments processing and websites and apps that do not allow customers to do more than basic banking transactions. If they don’t spend to catch up with nimbler challengers that have neither legacy issues nor costly branches to maintain, the incumbents risk missing out on the future of finance.
When Bank of Ireland embarked on its IT revamp under former chief executive Richie Boucher the cost was estimated at €900 million. McDonagh boosted the investment by €250 million directly into technology itself and a further €250 million for restructuring costs, bringing the overall bill to €1.4 billion - one of the largest investments ever by an Irish company. But projects of this incredible scale always struggle to come in on time and are notoriously hard to keep to budget. Speculation has been rife that Bank of Ireland is finding it hard to do both.
That has not been helped by the unexpected departure of the man overseeing it. As part of a wider management reshuffle last month, the bank said that Steve Collier would be leaving, a surprise move given that he had been one of the senior executives who was among the presentation team to analysts and investors in London in June 2018. Overall responsibility for the IT project now rests with Jackie Noakes, who joined Bank of Ireland as chief operating officer last August. In a statement last month announcing the executive reshuffle, Bank of Ireland said the “underlying foundations of the new core banking platform have been delivered and the first customers have been tested on the system successfully. The focus of the next phase of the systems transformation is on delivering customer improvements, including the new mobile app”.
That app and its launch, which is due this year, is vital for the bank to get right given how far behind it had been in developing digital banking channels.
“We expect management to explain how the focus of the multi-year transformation programme is evolving as it shifts onto the next phase of project delivery, in particular customer improvements including the new mobile banking app,” Investec analyst Owen Callan said.
For analysts, the wider technology investment is the key difference that marks Bank of Ireland out from its rivals. If it gets it right, even the bits customers don’t see, it could have a huge impact on the bank’s ability to reduce its costs and generate more income.
Bank of America Merrill Lynch analysts said, once the “heavy lifting phase” is done, it should result in a better bottom line. For instance, they estimate that if Bank of Ireland’s revenues were to rise 12 per cent between this year and 2022, the benefits of the cost savings and the IT investment would lift profits by 60 per cent.
Getting the overhaul of its systems done on time and on budget would help lift part of the weakness in the bank’s share price. The other issues may be outside of its control.
The Brexit factor
When McDonagh spoke at the capital markets day in London, pretty much everyone had assumed that European Central Bank interest rates would rise in 2019 after almost a decade at practically zero. For Irish banks, who are still weighed down with tracker mortgages, even the smallest rise in rates would result in higher profits. It’s been estimated that a 1 per cent rise in the main ECB rate would be worth as much as €100 million in income to Bank of Ireland and AIB. With the Central Bank now openly talking about moving rates even lower to combat the lack of inflation in Europe, it means any improvement on the bank’s interest income will have to come from its front book of customers and not those on trackers.
That is just one of the other factors weighing on it. The other is Brexit. While much of the drop in the shares in Bank of Ireland, AIB and Permanent TSB can be blamed on the ECB, it is also down to the prospects for the Irish economy and the fact that Brexit is causing drag on lending growth. Small and medium-sized firms show no appetite right now for taking on debt and continue to pay off their borrowings while mortgage lending activity - although ahead of last year - is not growing as quickly as expected.
For Bank of Ireland, Brexit could have a real impact. What was once seen as a strong defence against its reliance on the Irish economy now has the potential to cause problems. As McDonagh noted last year, the return on equity it generates in Britain was already only in single digits and not acceptable. A restructuring has seen it sell off its credit card portfolio and focus on more profitable segments of the banking market. Who knows what an abrupt exit would do to Britain’s banking sector.
“Progress in repositioning the business within the highly competitive British banking sector would be a welcome development given the significant turnaround that management is hoping to achieve there,” Investec’s Callan said.
There are more immediate issues for McDonagh to deal with. Perhaps the biggest personnel concern is replacing Andrew Keating, who said he is stepping down as chief financal officer later this year. Keating is very well regarded by the markets. Together with former chief executive Richie Boucher, he oversaw the return of the bank to health. He is a huge loss. It will mean that come the start of 2020 most of the bank’s top executives are fresh faces. The new British division head Ian McLaughlin was only announced earlier this year.
As she approaches two years in the job, McDonagh can point to plenty of achievements. The external environment is beyond the influence of any individual so investors will judge her performance on her strategy and the ability to deliver on it. Getting the technology transformation over the line, and into use by staff and customers, will be vital to the success of her plans.