DBRS Comments on Proposed NAMA & ELG, Bank of Ireland’s Ratings Unaffected, Senior at AA, UR-Neg.

DBRS has today commented that the ratings of The Governor and Company of the Bank of Ireland (Bank of Ireland or the Bank), including the AA rating on the Long-Term Debt and Deposits, maturing after 29 September 2010 are unaffected following the announcement by the Irish Government of the National Asset Management Agency (NAMA) Act of 2009 (the Act) and the Credit Institutions (Eligible Liabilities Guarantee) Scheme of 2009 (the ELG Scheme). The ratings of the Long-Term Debt and Deposits, maturing after 29 September 2010, remain Under Review Negative, where they were placed on 9 March 2009. The Short-Term Deposits and Short-Term Debt ratings on the debt maturing on or before 29 September 2010 remain at R-1 (high), with a Stable trend. The ratings of Bank of Ireland’s Long-term Deposits and Long-Term Debt maturing on or before 29 September 2010 remain at AA (high), with a Negative trend, reflecting DBRS’s internal assessment of the Republic of Ireland.

Today’s comment follows the 16 September, release by the Irish Department of Finance which indicated that, by mid-2010, NAMA is expected to purchase loans with a book value of approximately EUR 77.0 billion from five Irish banks, including the Bank of Ireland. The Bank of Ireland is expected to transfer loans with an estimated book value of EUR 16.0 billion to NAMA. The NAMA draft legislation provides the Irish banks the mechanism by which the banks can de-risk their balance sheets by removing certain, and often, stressed assets, primarily land and development loans and related loans, from their balance sheets. The loans will be acquired at a discount from book value, which, on average is estimated to be circa 30%. DBRS notes that this 30% “haircut” is only an industry-wide estimate and the discount will vary from loan-to-loan and thereby could be significantly different from institution-to-institution.

While in the long-term, DBRS believes that the Bank of Ireland will benefit from this transfer, although, in the near-term, the Bank will experience a level of earnings and capital pressure from the realization of losses associated with the transfer. However, given the quality and composition of the estimated EUR 16.0 billion loan book, however, DBRS notes that the Bank has stated that it believes that the discount could be significantly less than the estimated aggregate discount of 30%. DBRS will monitor the “haircut” which will only be known on completion of transfer. Moreover, the projected EUR 1.2 billion to EUR 1.4 billion of impairment provisions on the land and development loans, at 30 September 2009, will likely also temper the impairment. DBRS expects that the Bank will record a noteworthy, yet manageable write-down. This will have a negative impact on capital levels during the transfer period, which is expected to last until mid- 2010. DBRS’s continued review will consider the ultimate impact of the NAMA transfer and its impact on capital and the Bank’s ability to replenish capital, if required.

Although capital levels may be reduced by the losses recorded associated with the transfer, the risk shedding benefits of NAMA will lower the level of risk-weighted assets (RWA) on the Bank’s balance sheet, thereby reducing the ultimate level of capital required. However, 5% of the total consideration to the Bank of Ireland is expected to be in the form of subordinated bonds thereby providing NAMA a level of loss absorption should the NAMA assets not perform to expectations. Future impairments of these bonds may negatively impact the Banks’ capital.

Considering the anticipated benefits of the NAMA and the other support mechanisms put into place by the Irish Government, DBRS believes that Bank of Ireland will likely be successful in generating any needed capital through the market sources. However, given the statements of the Irish Government, and DBRS’s view that Bank of Ireland is a critically important banking organisation in Ireland, DBRS would expect that, in the event of a capital raising difficulty, the Government would provide any needed capital to the Bank, should it be required.

Liquidity will also benefit from the proposed NAMA. By removing the larger, less liquid, and often distressed assets from the bank’s balance sheets, NAMA is expected to provide a level of liquidity relief to the banks. Moreover, the senior bonds, which are received by the banks in consideration of the transfer, are expected to be “pledgeable” collateral for central bank funding facilities, which could provide a low cost means to additional liquidity. Further, the improved liquidity position of the banks may drive a level of stabilisation for deposit margins owed to reduced competition for deposits, thereby potentially lowering the costs of deposits for the Irish Banks.

Moreover, DBRS sees the Bank of Ireland’s liquidity position benefiting from the Irish Government’s proposed ELG legislation. The proposed ELG Scheme provides covered institutions, which includes the Bank of Ireland, the option to issue government guaranteed securities with maturities beyond 29 September 2010, the expiry for the current government guaranteed debt Scheme (the CIFS Scheme). The proposed ELG Scheme allows guarantees for deposits, commercial paper, certificates of deposit and senior unsecured debt with maturities up to five years incurred by participating banks from the Commencement Date until 29 September 2010. The lengthened guarantee period of the ELG Scheme should enhance Bank of Ireland’s ability to improve the duration of its funding profile and ladder its maturity schedule which will reduce refinancing risk.

Longer term, DBRS sees the Bank of Ireland’s prospects as benefiting from the proposed legislation, as the uncertainty of the impairments related to these assets will be limited and liquidity is expected to be enhanced. Yet the economic landscape in Ireland causes a level of concern. DBRS remains concerned that the outlook for a prolonged recessionary environment of substantial depth in Ireland will negatively impact the Bank’s future earnings generation ability. Credit loss provisions are expected to remain elevated, while the costs of the current government guarantee and the proposed guarantee should the Bank participate, will further pressure earnings. Accordingly, DBRS’s review will focus on the Bank’s ability to generate pre-provision earnings sufficient to offset the anticipated heightened levels of credit costs. DBRS continues to monitor the ability of the Bank to navigate the current crisis without suffering permanent damage to its earnings generation ability or franchise, which are key factors underpinning Bank of Ireland’s rating

The Negative trend on the long-term guaranteed debt reflects DBRS’s internal assessment of the sovereign and DBRS’s view that, although Ireland’s most recent plans to stabilise public finances, contain the economic downturn, and restructure distressed bank loans might succeed, however the downside risks remain. Should significant financial sector or fiscal deterioration occur, DBRS could take negative rating action on the internal sovereign assessment. Conversely, if Ireland’s policy measures help to stabilise the bank balance sheets and restore investor confidence, DBRS would likely return the trend to Stable.

Note:
All figures are in EUR unless otherwise noted.

The applicable methodologies are, Analytical Background and Methodology for European Bank Ratings, Second Edition and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.