DBRS Comments on Bank of Ireland’s 1H12 Results; Rating Unaffected at BBB (high), Negative Trend

DBRS, Inc. (DBRS) has today commented that the ratings of The Governor and Company of the Bank of Ireland (Bank of Ireland or the Group), including its Issuer Rating of BBB (high) are unchanged following the Bank’s release of results for the half-year ending 30 June 2012 (1H12). The ratings of the Bank’s Long-Term Debt and Deposits Guaranteed by the Irish Government remain at A (low). The trend on all senior ratings, guaranteed and non-guaranteed, is Negative.

In DBRS’s view, Bank of Ireland’s results reflect the continuing challenging economic conditions in Ireland and the impact of the low rate environment. However, DBRS sees evidence of the Group’s progress in restructuring and reshaping the Group whilst strengthening the funding profile and restoring customer confidence. For 1H12, the Group reported a loss before tax of EUR 1.3 billion compared to a loss before tax of EUR 556 million in 1H11. On an underlying basis, excluding non-core items, the Bank reported a loss before tax of EUR 907 million compared to an underlying loss of EUR 722 million a year ago. Non-core items include charges on the movement in fair value of own debt, cost of restructuring programmes, gain on liability management exercises, losses on deleveraging actions and other items. DBRS notes that the loss was within DBRS’s expectations.

The loss reflects continued pressure on income (revenues) owing to the low rate environment, continuing deleveraging actions, and subdued demand for new lending. On an underlying basis, total operating income, net of insurance claims was 11% lower YoY at EUR 900 million. Within revenues, net interest income declined 17% YoY to EUR 857 million, owing to a 9% reduction in average interest earning assets and continuing margin compression, driven by heightened competition for deposits, and higher wholesale funding costs partially offset by asset repricing efforts. The cost of government guaranteed funding declined to EUR 212 million from EUR 239 million a year ago, reflecting successful reduction in the average covered volume of liabilities under the scheme. On an underlying basis, excluding government guarantee fees, net interest margin (NIM), declined 13 bps to 1.20%. Given the tepid demand for new lending and the competitive deposit market in Ireland, DBRS expects continued margin pressure in the near-term. However, DBRS expects Bank of Ireland to rebuild its NIM over the medium-term as the Group’s actions, including the gradual lowering of deposit pricing, the announced increase in its standard variable rate mortgage product and other asset pricing initiatives in its SME and corporate loan books, have a positive impact.

Operating costs were EUR 842 million broadly unchanged from a year ago. Higher pension levy costs introduced by the government offset modestly lower staff costs and other costs, which included on-going investments in customer service and technology related initiatives. DBRS notes, however, that the cost of the pension levy is expected to reverse in 2H12 as the costs are passed onto the pension scheme members. The lower revenue generation and stable expenses resulted in a 65% YoY reduction in operating profit before impairments (IBPT) to EUR 58 million. While IBPT generation remains weak, DBRS expects that the Bank of Ireland’s ability to generate IBPT, will recover with base rate increases, expansion in new lending at higher margins, and as the Bank progresses in lowering funding costs and disengages from the government guarantee scheme. Nevertheless, DBRS sees the restoration of underlying profitability as a key challenge, and given the headwinds generated by the current economic conditions in Ireland and the restructuring programme underway at the Group; one that will take some time to achieve.

Weakening household disposable income and falling property values continue to weigh on credit performance across most Irish loan books. Impaired loans at 30 June 2012 totalled EUR 15.4 billion, or 15% of the loan book, up from EUR 13.5 billion, or 12% at 31 December 2011. Within the EUR 21 billion Irish owner occupied loan portfolio, arrears more than 90 days increased to 7.03%, up 143 bps from year-end 2011, while still elevated, arrears remain below the industry average. DBRS views the performance of the owner-occupied mortgage portfolio as illustrating the impact of the challenging operating conditions in Ireland partially mitigated by actions taken by management to proactively work with customers in distress through loan restructuring or other long-term arrangements. In the EUR 7 billion Irish BTL loan portfolio, arrears increased to 13.99%, a significant 323 bps increase from 31 December 2011, reflecting the impact of borrowers moving to full amortisation from interest only periods. In the investment property portfolio, impaired loans stood at EUR 5.3 billion, 16% higher than year-end 2011, due to lower levels of rental income, particularly in the retail sector. Performance in the non-property and SME book was mixed with International Corporate benefiting from more favourable economic conditions globally and impairment charges in the U.K. SME book reduced in the face of a slowing economy in the U.K. The Irish SME portfolio remains under pressure with impaired loans increasing to EUR 2.5 billion or 23% of the book. The increase reflects pressure on Irish SME’s from weak consumer sentiment, higher business insolvencies and general economic pressure on the sector. Positively however, credit trends in the Group’s EUR 29 billion U.K. residential mortgage book continue to be favourable, with arrears at 1.51%, 27 bps lower than at year end 2011. Group-wide provision coverage stood at 46% of impaired loans at the end of June 2012. Given the challenging labour market conditions and weakness in property markets, DBRS sees asset performance as remaining challenged over the medium-term and expects impaired loans as well as credit costs to remain elevated for the remainder of 2012 and into 2013.

The results evidenced continued progress towards certain restructuring plan targets. During 1H12, the Group completed its EUR 10 billion divestment target ahead of schedule and at prices well within the PCAR base case discounts. Moreover, in raising EUR 1.2 billion of deposits since year-end 2011, combined with the successful divesting of non-core assets, the Bank continues to advance its strategy of becoming more deposit funded. The Bank’s loan-to-deposit ratio was lowered to 136% from 144% at 31 December 2011 and 175% in December 2010, and well advanced towards the 2013 target of below 122.5%.

DBRS views Bank of Ireland as making good progress in strengthening its funding profile while disengaging from government guarantee schemes. Total deposits increased 2% in 1H12 to EUR 71.7 billion. In a highly competitive market for deposits, Bank of Ireland continues to focus on reducing deposit pricing in support the rebuilding of margins. Despite these actions Retail Irish deposits were only 3% lower than at year-end 2011, and within the Group’s expectations, at EUR 35 billion. DBRS views this as demonstrating the strength and resiliency of the domestic franchise. Importantly, DBRS notes that EUR 22 billion, or only 30% of Group deposits are covered by the ELG Scheme compared to EUR 26 billion at year-end 2011. Wholesale funding increased from year-end reflecting the Group’s EUR 2.8 billion Irish Government guaranteed repo transaction with IBRC and the Group’s participation in the ECB’s second LTRO programme in February 2012. As a result, 56% of wholesale funding at 30 June 2012 had a remaining term of greater than one-year. However, excluding monetary authority related funding, 69% of wholesale funding matured in more than one year. Furthermore, near-term maturities are manageable in DBRS’s view with EUR 0.4 billion of unsecured term funding maturing in 2H12, EUR 2.6 billion in 2013, and EUR 0.1 billion in 2014.

With regards to capital, Bank of Ireland reported a Basel II Core Tier 1 ratio of 14.9%, 20 bps lower than at year-end 2011, reflecting the after-tax loss somewhat offset by the impact of the deleveraging efforts on risk-weighted assets. At EUR 61.7 billion, risk-weighted assets were 8% lower than at the end of 2011. Importantly, the Bank estimates that its Core Tier 1 ratio, under the EBA/PCAR stress test basis, was 14.0% at 30 June 2012, compared to the 2011 PCAR requirement of 10.5%. DBRS notes that the Core Tier 1 ratios mentioned above do not include the conversion of the EUR 1.0 billion of contingent capital issued in July 2011. Together with the deleveraging that has been achieved, and management’s plans for additional risk reduction, DBRS sees the solid capital position as affording the Bank of Ireland the cushion required to absorb future losses while providing the necessary time to restructure and reshape the Group.

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

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the DBRS Criteria – 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 and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

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

Lead Analyst: Roger Lister
Approver: William Schwartz
Initial Rating Date: 6 September 2005
Most Recent Rating Update: 18 October 2011

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