DBRS Confirms Allied Irish Banks, p.l.c., Issuer Rating at BBB (low), Trend Remains Negative

DBRS, Inc. (DBRS) today has confirmed the non-guaranteed senior debt ratings of Allied Irish Banks p.l.c. (AIB, the Bank or the Group), including its Issuer Rating of BBB (low). The trend on all non-guaranteed ratings remains Negative. Concurrently, DBRS has confirmed the Bank’s intrinsic rating of BB. As such, the final ratings benefit from a two-notch uplift from the intrinsic rating, reflecting DBRS’s view of the continued governmental support that has been, and will be offered to AIB, should it be needed. Today’s rating action does not impact the Group’s Irish Government guaranteed long-term debt ratings, which remain at A (low) with a Negative trend, reflecting DBRS’s rating of the Republic of Ireland. The rating action follows a detailed review of the Company’s operating results, financial fundamentals and future prospects.

In confirming the ratings, DBRS considers the strength of AIB’s well-established domestic franchise and bolstered capital position. In DBRS’s view, these strengths provide the foundation for the ultimate recovery of the Bank from the financial crisis in Ireland. While there are signs of stabilisation in the Irish economy, DBRS nonetheless sees the still challenging operating conditions in Ireland as continuing to be a headwind to AIB’s ability to restore pre-impairment earnings generation to a level sufficient to absorb credit losses. Further, the sustained Eurozone crisis continues to threaten the nascent economic recovery in Ireland, increasing the risk that an expansion in domestic economic activity, which DBRS sees as key for the return of revenue growth, may be delayed. Moreover, while the Bank has made good progress in transforming its funding profile, AIB’s access to wholesale markets, similar to its peers, remains challenged.

AIB’s strong position in Irish retail, commercial and corporate banking provides a solid foundation to the Group’s intrinsic strength. The Bank maintains top-tier market positions across a broad range of products and services, including an estimated 40% share of new Irish mortgage drawdowns and 42% of deposits held by Irish banks (DBRS calculated). While AIB’s domestic franchise remains intact, DBRS sees rebuilding customer confidence that was damaged during the Irish banking crisis as a key challenge for the Bank, as it is for its peers. DBRS views the solid growth in deposits across all AIB’s business segments as an early sign that AIB is making progress in this area. AIB has launched its “One Bank” strategy, which is designed to simplify the Bank and improve its use of technology and on-line products, as AIB evolves to be a more efficient, customer-focused Bank. DBRS views the strategy favourably, but recognises that such reorganisations and transformations take time to produce tangible results.

With a still high impaired loans ratio and elevated credit costs, DBRS views positively AIB’s strengthened capital position and the substantial support afforded the Group by the Irish Government. The Bank’s Core Tier 1 ratio was 17.3% at 30 June 2012, as compared to 9.9% a year ago and 4.0% at year-end 2010. The improved capital ratios since year-end 2010 reflect capital support totalling EUR 11.1 billion from the Irish Government and the capital generating measures taken by the Bank. Deleveraging actions taken by AIB have resulted in risk-weighted assets declining 18% from year-end 2010, contributing to the strengthened capital position. While the capital support resulted in the Irish government owning 99.8% of the Bank’s common stock, DBRS considers the bolstered capital base to better position AIB to navigate through the protracted economic recovery in Ireland, while completing its restructuring efforts.

DBRS views AIB’s earnings power as has having been temporarily impaired by the challenging operating conditions in Ireland. Indeed, AIB’s pre-impairment profitability continues to be pressured. Revenue generation remains constrained by compressed margins, reduced client activity and subdued demand for new lending. Further, pre-impairment earnings continue to be impacted by elevated operating costs and the cost of government guarantees. DBRS sees these headwinds as remaining in place well into 2013. As such, DBRS expects AIB to continue to generate losses for the remainder of 2012 and 2013, with a return to profitability not likely until 2014. Nevertheless, DBRS anticipates that, as the domestic economy gradually recovers, profitability at AIB will be restored to a level consistent with the strength of the domestic franchise. Indeed, upward rating migration will be predicated on AIB’s ability to restore its earnings generation capacity sufficiently to absorb the cost of credit, while also affording investment resources to strengthen and grow the franchise.

AIB’s overall weak credit quality metrics and stressed lending book are key factors considered in the intrinsic rating. Credit performance continues to deteriorate due to the elevated levels of domestic unemployment and the limited activity in the property markets, which continues to pressure both commercial and residential property values. At 30 June 2012, 28% of the Bank’s EUR 95.4 billion loan book was impaired. Importantly, DBRS sees arresting the trajectory in residential mortgage arrears as a key challenge for AIB. High unemployment and continuing austerity measures have pressured household income and the repayment capacity of Irish households. As a result, Irish mortgages more than 90-days past due plus impaired stood at 18.5% at 30 June 2012 compared to 7.9% a year ago. DBRS notes that AIB has introduced a number of advanced forbearance strategies under its Mortgage Arrears Resolution Strategy (MARS) program, which are designed to aid borrowers in difficulty. However, the overall effectiveness of these programs in stemming the inflow of troubled loans is yet to be proven. Positively, AIB has signalled that it expects impairment provisions to decline materially in 2012 from 2011 levels. Nevertheless, given the weak domestic economy, subdued consumer spending and softness in property values, DBRS sees managing the earnings impact of credit costs as remaining a key challenge for the Bank for the near-to medium term.

Another positive is AIB’s progress with its deleveraging plan. In 1H12, AIB achieved net loan reduction of EUR 1.8 billion of non-core assets. As a result, by the end of October 2012, the Group had achieved EUR 17 billion of deleveraging or 83% of its three-year deleveraging target of EUR 20.5 billion. Importantly, losses to date represent a cumulative discount of only 4% on disposals and amortisation, which is significantly less than 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.

While market sentiment towards Irish issuers has recently improved, AIB’s funding profile, similar to its Irish banking peers, remains challenged with access to private market funding very limited. Positively, AIB recently issued a EUR 500 million three-year covered bond without an Irish government guarantee. The issuance was AIB’s first public covered bond issuance since June 2007 and AIB’s second issuance in the funding markets in 2012 following the issuance of GBP 395 million Sterling Prime RMBS in May. Nevertheless, AIB remains reliant on funding from central banks with 25% of total funding raised from central bank facilities. However, deleveraging actions and growth in the deposit base have allowed AIB to reduce funding from monetary authorities to EUR 30 billion at the end of June 2012, down from EUR 36 billion at year-end 2011. As part of its restructuring plan, AIB is endeavouring to better align its funding profile with its asset base and become a more deposit funded institution. Deposits increased approximately 5% in 1H12 to EUR 63.6 billion and now constitute 52% of total funding, up from 45% at year-end 2010. Importantly, AIB generated deposit growth across all business segments.

The Negative trend on the non-guaranteed long-term debt and deposits reflects DBRS’s view that the economic recovery in Ireland will be prolonged and uneven, remaining a significant headwind for AIB’s recovery, as well as the recovery of the rest of the Irish banking sector. While the Negative trend reflects DBRS’s expectations that AIB will continue to be loss-making through 2013, ratings could become pressured should the rate of losses not slow and the likelihood of improved future earnings recede. Moreover, the Negative trend reflects the potential that external factors, such as continued uncertainty in the Eurozone and its adverse impact on Ireland, could exert pressure on the rating. Conversely, the trend could be revised to Stable, if DBRS were to revise the trend on the sovereign to Stable, and if DBRS were to see favourable trends in AIB’s credit metrics, improving profitability supported by expanding margins, and substantially reduced reliance on funding from monetary authorities that was accompanied by improved access to private market funding.

DBRS maintains a Negative trend on the long-term guaranteed debt and deposits reflecting DBRS’s rating of Republic of Ireland.

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 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 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
Rating Committee Chair: Alan G. Reid
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.