DBRS Downgrades Ireland to “A” on Higher Bank Losses, Trend remains Negative

DBRS Inc. (DBRS) has today downgraded the Republic of Ireland’s Long-Term Local Currency and Long-Term Foreign Currency ratings from A (high) to “A”, and maintained the Negative trend on the ratings.

The downgrade is the result of higher bank recapitalisation costs to cover newly expected loan losses following the publication of the capital and liquidity stress tests yesterday, which will increase the fiscal deficit and public debt ratios. The Negative trend reflects DBRS’s ongoing concerns over the stability of the banking system and the strength of the recovery, in addition to uncertainty regarding the ability of Ireland to resume borrowing in the international markets by the second half of 2012.

Notwithstanding these developments, Ireland’s political commitment to fiscal consolidation and the economy’s long term growth prospects support the ratings in the “A” category. Ireland has taken significant steps to put public finances on a sustainable path, implementing deficit-reduction measures totalling 9% of GDP from 2008 to 2010. Consolidation measures this year total an additional 3.8% of GDP. With a strong majority in parliament, the recently elected coalition government has expressed a clear commitment to reduce the deficit below 3% by 2015, a year later than previously expected but still in accordance with the excessive deficit procedure.

The financial assistance program provides Ireland with a secure source of funding and attempts to give the government time to consolidate public finances and restructure the banking system. The EUR85 billion IMF-EU program helps cover Ireland’s public financing needs through 2013 and provide contingent capital support to the Irish banking system.

The flexibility and strong long-term growth prospects of Ireland’s economy underpin the ratings. Ireland is a highly open economy with a flexible labor market, a young and educated workforce and a pro-business environment. Due in part to sizeable competitiveness gains over the last two years, Ireland is quickly unwinding external imbalances. The current account deficit narrowed from 5.6% of GDP in 2008 to 0.7% in 2010, and Ireland is expected this year to run its first current account surplus since 1999. Moreover, export growth is leading the recovery. Goods and services exports expanded 9.4% in 2010.

However, the fiscal cost of recapitalising Ireland’s banking system has increased since DBRS’s previous assessment in December 2010. The Central Bank of Ireland announced yesterday that bank recapitalisations will total EUR70.3 billion (46% of 2010 GDP), up from a previous estimate of EUR46.3 billion (30% of GDP). It is important to note that the additional EUR24.0 billion includes recapitalisations needed to cover (1) newly expected loan losses, (2) additional capital in order to remain above 10.5% core tier one capital in the baseline scenario and 6% in the adverse scenario, and (3) a EUR5.3 billion buffer. The capital requirement also takes into account expected capital losses generated from the deleveraging program. Private capital, asset disposals or liability management exercises could reduce the fiscal resources necessary to meet the recapitalisation requirements.

Nevertheless, funding conditions remain highly stressed. Stabilisation of the deposit base and normalisation of funding conditions will be important for the banking system’s ability provide credit to productive sectors of the economy and support Ireland’s recovery.

If there is clear progress on stabilising the banking sector and reducing the deficit, the trend could be changed to Stable. However, the economic and financial situation in Ireland is evolving. DBRS is likely to downgrade the ratings if: (1) budgetary consolidation is not carried out in line with the principles of the government plan, (2) further recapitalisation needs – above those announced yesterday – add to public debt, or (3) the economic recovery underperforms, delaying debt stabilisation.

Notes:
All figures are in Euros (EUR) unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on our website under Methodologies.

The sources of information used for this rating include The Central Bank of Ireland’s Financial Measures Programme Report, The Republic of Ireland’s National Recovery Plan 2011-2014, the Budget 2011 issued by the Department of Finance, The Economic Adjustment Programme for Ireland (European Commission) dated February 2011, and the EU/IMF Programme of Financial Support for Ireland dated 1 December 2010. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: Michael Heydt
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 21 July 2010
Most Recent Rating Update: 15 December 2010

For additional information on this rating please refer to the linking document located below.