Bank of Ireland's capital adequacy ratios have suffered a sharper than expected drop after the Irish central bank said, following an industry-wide review, that the Bank of Ireland needed to make extra loan loss provisions.
The health checks, carried out just before Ireland exits its European Union/International Monetary Fund bailout, are seen as a preview for the European Central Bank's (ECB) own tests of euro zone banks next year, when capital holes running to 10s of billions of euros are expected to be uncovered.
"Maybe there is an extra layer of conservatism built into this balance sheet assessment because Ireland is set to leave its (bailout) programme," said Ciaran Callaghan, an analyst at Merrion Capital.
"The extent to which that is true we won't know until Europe does its tests," he said.
"But investors may look at these results and say that based purely on this it appears that the ECB means business and that they are potentially going to take a hard line with other banks."
Bank of Ireland said it was not required to raise additional capital after the central bank review and said it was in talks with the central bank about its estimates.
"The outcome of this engagement cannot be anticipated with certainty and actions taken following engagement with the Central Bank of Ireland may adversely impact capital ratios," Bank of Ireland said in a statement.
Under the review the bank's Core Tier 1 capital adequacy ratio fell to 9.85 per cent of risk-adjusted assets from 13.8 per cent as of June 30, calculated on the basis of a gradual introduction of tougher global capital rules.
Bank of Ireland said it expected to maintain a Core Tier 1 capital ratio above 10 per cent on that basis.
In a note, Citi said it believed Bank of Ireland had a significant capital shortfall relative to its UK and European peers and reiterated its sell rating.
Expectations Bank of Ireland will have to raise its full-year impairment charge dented its stock ahead of plans to repay €1.8 billion ($2.98 billion) of state-owned preference shares.
Shares in the bank, which have risen three-fold over the past 12 months as it has recovered faster than domestic rivals that are hampered by larger loan losses and weaker margins, were 2.1 per cent lower at €0.28 on December 02 11:15 GMT.
In its review the central bank estimated that Bank of Ireland needed to set aside an extra €360 million to cover potential loan losses on Irish mortgages, an additional €486m to cover potential losses on business loans and €547m on defaulted loans.
The central bank also increased Bank of Ireland's risk-weighted assets, usually loans adusted for the likelihood of non-payment, by €6.8b.
Local analysts said that as the central bank's review was based on data as of June 30 this year, it did not take into account improvements in the bank's main markets of Ireland and Britain and in its loan book performance.
In a trading update last month, Bank of Ireland said its net interest margin continued to grow in the third quarter and that mortgage arrears had stabilised, with the level of borrowers falling into early arrears declining.
"The exercise appears to crudely apply industry-wide experience to Bank of Ireland's loan book performance with scant detail revealed," said Emer Lang, an analyst at Davy Stockbrokers, "We note the outcomes are not set in stone."
The central bank said it had no further comment to make on the exercise.
Bank of Ireland said last week that it may raise new equity to help repay €1.8b of state-owned preference shares the bank had to issue as part of its 2009 bailout.
It will raise between €500m and €600m of equity as early as this week and the rest by issuing debt to private investors, a source familiar with the deal told Reuters.
Lang said the timing of Monday's announcement was "unhelpful" when the bank was assessing options around the shares.
In a brief statement, state-owned Allied Irish Banks said it would consider the findings of the review in the preparation of its full-year results and that based on an initial assessment it believed it remained well capitalised and in excess of minimum regulatory requirements.
Permanent tsb, Ireland's third domestic lender, said only that its capital position remained above the minimum regulatory requirements based on the outcome of the review.