Bank of Ireland's underlying operating profit shrank by two-thirds in the first half of 2011 on steeper funding costs, a signal the country's top lender has not fully recovered despite a fresh investor base and healthier loans book.
As the only domestic lender to avoid nationalization after an unprecedented property bubble burst, Bank of Ireland's success in attracting private capital has helped fuel a rally in Irish sovereign debt prices.
But the company, which along with Allied Irish Bank will form the core of a radically pared-down domestic banking industry, faces a challenge in growing its top line as funding conditions remain tough and Irish consumer demand continues to spiral down.
The cost of the government guarantee of Bank of Ireland's liabilities rose 58 per cent from a year ago to €239-million in the half.
Excluding that, a higher cost of wholesale funding and increased cost of deposits cut net interest income 14 per cent.
"The capital question has been dealt with but how do they increase profitability with the funding conditions the way they are, and lack of demand in the Irish economy?" said Oliver Gilvarry of Dolmen Securities in Dublin.
The group expects its net interest margin – the gap between what a bank charges for loans and what it pays to borrow – to bottom out this year as asset sales and wind-downs reduce its dependence on expensive wholesale funding.
"Previous guidance was, in retrospect, slightly too optimistic as wholesale funding costs rose and deposits fell faster than anyone could have anticipated," said Niall O'Connor, analyst at Credit Suisse.
"But I do think the net interest margin has got pretty close to a trough now."
Operating profit before provisions fell two-thirds to €163-million, but its underlying pretax loss nearly halved to €723-million after impairments dropped by 22 per cent.
Bank of Ireland's lower provisioning charge, aided by around half its loan book being sourced outside Ireland, contrasted with rival AIB where the impairment bill rose nearly a third in the same period.
Bank of Ireland's funding difficulties, which predate current problems for Italian and Spanish banks, and a continuing downward spiral in Irish property prices and domestic demand, have been shrugged off by North American investors who paid €1.1-billion for a 35 per cent stake in it last month.
"They share our view that the Irish economy is facing up to its challenges and its difficulties, it will come through this, driven in particular by the strength of the export sector," said chief executive Richie Boucher.
The U.S. investment and a successful rights issue cut the government's stake in Bank of Ireland to 15 per cent.
Bondholders also have a 19 per cent share of the lender after a debt-for-equity swap. They receive their shares on Friday.
Shares in Bank of Ireland were up more than 8 per cent at 10 cents in morning trade, in line with the price of its recent rights issue, as global equity markets recovered.
Bank of Ireland's reliance on emergency funding from the European Central Bank and its own central bank fell to €29-billion from €31-billion at the end of December.
Deposit levels remained stable at €65-billion at the end of June, from the end of December, but that included some €3-billion deposited by the debt management agency which was repaid in July when the bank raised its capital levels.
The lender lost around €20-billion in ratings sensitive corporate deposits last year.
Unlike domestic rivals, which remain locked out of term funding markets, Bank of Ireland has raised €2.9-billion in term loans in June and July and Mr. Boucher said he hoped to generate more funding via term issues before the year-end.
Bank of Ireland, which has to sell around €10-billion of loans, and run-down around €20-billion by the end of 2013 as part of efforts to wean it off a dependency on ECB funding, said current market volatility had not derailed its sales plans.
"We are quite well advanced on the sale process of a number of portfolios," Mr. Boucher said, adding he expected to make announcements on deals in the next few months.
The Wall Street Journal reported Bank of Ireland had sold its $1.4-billion (U.S.) American commercial real estate loan portfolio to Wells Fargo & Co. , citing people familiar with the matter.
Mr. Boucher declined to comment on the report.
Provisions in Bank of Ireland's Irish residential mortgage book rose 30 per cent from a year ago, bucking the downward trend seen in other lending categories, and Mr. Boucher said he expected them to peak in mid-2012.