DBRS Comments on Allied Irish Banks, p.l.c.’s 1H12 Results; Unaffected at BBB (low), Neg.

DBRS, Inc. (DBRS) has today commented that the ratings of Allied Irish Banks, p.l.c. (AIB or the Group), including its Issuer Rating of BBB (low) are unchanged following the Group’s release of results for the six months ending 30 June 2012 (1H12). The ratings of the Group’s Long-Term Debt and Deposits Guaranteed by the Irish Government remain at A (low). The trend on all non-guaranteed long-term debt ratings is Negative.

From DBRS’s perspective, AIB’s results reflect the challenging operating environment in Ireland, including subdued demand for lending, continued weakness in property values, high unemployment and intense competition for deposits. Nevertheless, DBRS sees indications of progress towards the restructuring of the Group, transformation of the funding profile and restoration of customer confidence. For 1H12, AIB reported an after-tax loss of EUR 1.2 billion compared to a profit of EUR 2.2 billion in 1H11. DBRS notes that 1H11 results benefited from gains on liability management exercises (LME) of EUR 3.3 billion. Excluding LME gains and other exceptional items, AIB reported a loss from continuing operations of EUR 1.1 billion for 1H12 compared to a loss of EUR 3.0 billion a year ago. The reduced, yet sizeable, loss was within DBRS’s expectations. It reflected lower revenue generation and a modest increase in operating expenses, somewhat offset by lower credit costs. Operating expenses were up 7% YoY, however, excluding the impact of the EBS acquisition, operating expenses were up just 1%, reflecting AIB’s success in containing costs. Credit costs remain elevated reflecting the difficult operating conditions in Ireland, but are significantly lower than in 1H11. Impairment charges on loans and receivables totalled EUR 890 million, a 70% improvement from 1H11. Given the headwinds facing the Irish economy and the significant restructuring program that AIB is undertaking, DBRS sees AIB’s return to profitability as a longer-term process.

Total operating income (revenues net of interest expense) was 9% lower YoY at EUR 771 million based on lower net interest income and other income. High cost deposits and an increase in non-performing loans resulted in a 6% reduction in net interest income, which was partially offset by lower ELG Scheme fees. Net interest margin (NIM) continues to be compressed by the heightened competition for deposits and lower interest-earning loan volumes. NIM, excluding ELG Scheme costs, declined 12 basis points to 1.24%. Other income declined 18% YoY due to lower investment banking and asset management fees following the disposals of AIB Investment Managers and AIB International Financial Services as well as lower trading and other income primarily reflecting negative movements in the fair value of credit derivatives. Given the tepid demand for new lending, elevated costs of deposits and the cost of the guarantee scheme, DBRS expects continued margin pressure in the near-term. Nevertheless, DBRS expects that margins will begin to improve over the medium-term as AIB’s actions, including the recently announced increase in its standard variable rate mortgage product, improved pricing for lending in its SME books, and the Group’s focus on bringing deposit costs down, have a positive impact.

AIB continues to make good progress on its deleveraging plan. In 1H12, AIB disposed of EUR 1.8 billion of non-core assets. As a result, as of 30 June 2012, the Group achieved 70% of the three-year deleveraging target of EUR 20.5 billion. Importantly, disposals to date have been achieved at a cumulative discount of 4% which is within the Group’s PCAR assumptions. DBRS views the deleveraging and restructuring plan positively, as it will allow the Group to reduce its reliance on wholesale funding and strengthen the balance sheet.

Stressed household cash flows and weak property markets continue to weigh on asset performance across AIB’s EUR 95.4 billion loan book. Credit quality in the EUR 41.1 billion Irish residential mortgage book continues to deteriorate with past dues and impaired loans continuing to increase. At 30 June 2012, Irish residential mortgages more than 90-day or greater arrears and impaired increased to 18.5% from 15.5% at year-end 2011. Within the SME book, retail domestic oriented SMEs continue to suffer the most with pressure on household disposable income affecting retail sales. Impaired loans in the SME book grew by 7% from year-end to EUR 4.9 billion, or 31% of the book. Impaired loans in the property lending portfolio increased 4% from year-end 2011 to EUR 12.4 billion, or 53% of the book. Provision coverage for impaired loans stood at 58% at the end of June 2012. Given the challenging labour market conditions and weakness in property values, DBRS sees performance of the loan book as remaining challenged over the medium-term and expects impaired loans and credit costs to remain elevated for the remainder of 2012 and into 2013.

AIB continues to strengthen its funding profile. At 30 June 2012, deposits totalling EUR 64 billion, were the largest component of Group funding at 52%, up from 47% at year-end 2011 and 45% at year-end 2010. Since year-end 2011, deposits increased by almost EUR 2.9 billion to EUR 64 billion. Importantly, deposit growth was solid across all business areas of the Group. DBRS views the increase in deposits as evidence that the core franchise has remained intact and that customer confidence is being restored. Moreover, AIB announced that on 17 August 2012 it would withdraw from the ELG Scheme in the U.K. further evidencing the restoration of its franchise. As a result of increasing deposits and the decreasing loan book, AIB’s loans-to-deposit (LTD) ratio, including loans held for sale, improved to 125% from 138% at year-end 2011. As a result, the Group is making good progress towards its target ratio of 122.5% by year-end 2012, a year ahead of plan.

The deleveraging efforts and deposit growth has led to a 17% reduction in wholesale funding. Notably, ECB related funding was reduced by EUR 6 billion since year-end 2011 to EUR 25 billion. During the half-year AIB further diversified its funding by completing a GBP 300 million non-guaranteed RMBS transaction secured by U.K. collateral. Further, the Group has extended the maturity profile of its wholesale funding by utilising the ECB’s LTRO programme for EUR 11 billion in total. While DBRS notes the progress achieved in improving the funding profile, it recognises that the transformation of the funding profile and the full withdrawal from central bank funding will be a longer-term process.

Regarding capital, DBRS views AIB’s capitalisation as solid with a Core tier 1 ratio of 17.3% at 30 June 2012, well above required regulatory levels. As expected, the Core tier 1 ratio declined 60 basis points from year-end 2011 reflecting the loss for the period, partially offset by lower risk-weighted assets (RWAs). RWAs totalled EUR 80.8 billion, 4% lower primarily due to AIB’s ongoing deleveraging efforts and higher provisions, and were partially offset by the weak credit performance of the mortgage book. DBRS sees the strong capital base as affording AIB the cushion required to navigate through the protracted economic recovery in Ireland, while executing on its restructuring plan.

Notes:
All figures are in Euros unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This commentary was disclosed to the issuer and no amendments were made following that disclosure.

This is an unsolicited rating. This rating did not include participation by the rated entity or any related third party and is based solely on publicly available information.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Roger Lister
Approver: William Schwartz
Initial Rating Date: 20 October 2005
Most Recent Rating Update: 18 October 2011

For additional information on this rating, please refer to the linking document under Related Research.