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The Anglo File: Luck of the Irish Runs Out for Alliance & Leicester

Disagreements with the better-positioned Bank of Ireland scupper a much-criticized merger.

The collapse of the proposed merger between the British mortgage bank

Alliance & Leicester


Bank of Ireland


has led to speculation the two banks are now takeover targets. While the failed merger has done little to enhance the reputations of management, for different reasons the banks are probably safe for now from any hostile bids.

Alliance & Leicester on Wednesday placed the blame for the breakdown of the proposed merger squarely on the shoulders of the Bank of Ireland board of directors. In a tersely worded statement, it said that the Bank of Ireland board had "requested changes to key items that had previously been agreed."

Whatever the truth in this, disagreements between the two sides gave them an excuse to call off a deal that had been roundly criticized by analysts, shareholders and the press alike.

Guinness Me, That's Doesn't Seem Fair

Based on the respective market capitalization of the two institutions, Alliance & Leicester would have owned 45% of the merged company, while Bank of Ireland would own the other 55%. As a result, Bank of Ireland shareholders would have swapped shares in a bank in the high-growth Irish market for shares in a bank that is exposed to the more mature and competitive U.K. mortgage market. Not the best deal in the deck.

Joe Hall, equity strategist at

Deutsche Bank

, also questioned the economics of the proposed deal. "We ran the numbers and if you paid full price of 10 pounds per share for Alliance & Leicester, to get a return on investment of 8.5% you would need to take out 30% of the costs, which is a bit of a tall order," Hall says. Deutsche Bank has no investment banking relationship with either bank.

There were regulatory hurdles to overcome, namely which financial supervisor, London or Dublin, would have ultimate responsibility for oversight of the merged entity. The Bank of Ireland board was also castigated by the public and the investment community for giving up too much control to Alliance & Leicester.

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Investors had already shown their displeasure with the proposed deal. Shares of Bank of Ireland on Wednesday were 12% below their price on the day before the initial announcement was made on May 24. On Thursday, though, Bank of Ireland closed up 2.9% at 1106 pence and Alliance & Leicester ended up 3.9% at 911 pence.

So where does this leave the two banks?

Red Faces

"In terms of management credibility it has to be said it's been tarnished now that they've tried a merger and failed," says Michael Lever, banking analyst at

HSBC Securities

. HSBC has an add rating on Alliance & Leicester and no investment banking relationship with the U.K. institution.

Aside from a lot of egg on their faces, the managements of both banks have made it clear to the market that they are willing to engage in partnerships, which, inevitably, has spawned rumors of the firms now being takeover targets.

However, Alliance & Leicester still enjoys the five-year protection from any hostile bid that it was granted by the British government when it demutualized two years ago. HSBC's Lever says the attempted merger will make it more difficult for Alliance & Leicester's management to adopt a "holier-than-thou attitude" should a prospective suitor arrive on the doorstep, but this protection should still deter any unwelcome suitors.

Bank of Ireland enjoys no such protection in its charter. However, Eamonn Hughes, banking analyst for

ABN Amro

in Dublin, believes an outright bid for Bank of Ireland is a "no runner" because of capital write-off implications and limited cost-cutting opportunities.

"However, having indicated that it is receptive to merger discussions, Bank of Ireland may be open to approaches from a more favorable merger partner," says Hughes, who has reinstated his buy recommendation on Bank of Ireland after downgrading it to hold following the initial merger announcement last month. ABN has no investment banking relationship with Bank of Ireland.

In the meantime, Alliance & Leicester said Wednesday it intends to continue a share buyback program it suspended while the merger talks were ongoing. Bank of Ireland is looking to get shareholder approval later this year to buy back its own shares, something its charter does not currently allow.

For now it seems as though the banks will be safe from any unwelcome attention. How safe the jobs of management are is not so assured. As ABN's Hughes says: "There's a lot of disgruntled people out there and they have a lot of explaining to do. They have a big job ahead of them."