DBRS Confirms Ratings The Governor and Company of the Bank of Ireland at BBB (high), Trend Negative

DBRS, Inc. (DBRS) today has confirmed the non-guaranteed debt ratings of The Governor and Company of the Bank of Ireland (Bank of Ireland, the Bank or the Group), including its Issuer Rating of BBB (high). The trend on all non-guaranteed ratings remains Negative. Concurrently, DBRS has confirmed the Bank’s intrinsic rating of BBB (low). 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 would be expected to be offered to the Bank of Ireland, 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 recognises the strength of the Bank’s domestic franchise, the diversity gained through its sizable UK operation, its reinforced solid capital position and the progress the Bank is making on its restructuring and recovery plan. In DBRS’s view, these strengths provide the foundation for the ultimate recovery of the Bank from the financial crisis in Ireland. Further, the rating action considers the Bank’s recent access to private funding without the benefit of the government guarantee. DBRS notes, however, that restoring consistent access to wholesale funding markets at reasonable costs will require more progress. 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 Bank of Ireland’s ability to restore pre-impairment earnings generation to a level sufficient to absorb credit losses. Moreover, 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.

Bank of Ireland maintains a strong and defensible domestic franchise, supported by leading market positions in all of its principal product and market segments, including current accounts, mortgages, as well as corporate and SME lending. While Bank of Ireland’s domestic franchise remains intact, DBRS sees restoring customer confidence, which was damaged during the Irish banking crisis, as a key challenge for the Bank, as it is for its peers. From DBRS’s perspective the solid growth in Irish retail deposits is an early indication that the Bank is making progress in this area. DBRS sees the U.K. Financial Services segment, and the joint venture with the UK Post Office, which has been extended to 2023, as broadening the U.K. franchise. The U.K. operations provide a level of geographic and earnings diversity, as well as an important channel for deposit growth. Importantly, despite the challenging environment, Bank of Ireland continues to invest in its core franchises introducing new products and services, all of which DBRS sees as positioning the Bank for growth once domestic economic activity begins to expand.

While DBRS views the franchise as strong, DBRS considers earnings as not being at a level commensurate with the overall position and strength of the franchise. Indeed, the Bank’s earnings generation ability has been temporarily compromised in DBRS’s view. Revenue generation remains constrained by compressed margins, reduced client activity and subdued demand for new lending. Meanwhile, pre-impairment earnings continue to be impacted by the level of operating costs and the cost of government guarantees. Further, DBRS sees these headwinds as remaining in place well into 2013. Although DBRS expects losses to continue at the Bank of Ireland through 2013, DBRS sees losses narrowing as margins improve, funding costs gradually moderate, cost reduction initiatives take hold, and the Bank disengages from the ELG Scheme. DBRS anticipates that, as the domestic economy gradually recovers, profitability at Bank of Ireland will be restored to a level consistent with the strength of the overall franchise. The potential for upward ratings migration remains limited until the Bank of Ireland’s ability to restore earnings generation capacity is sufficient to readily absorb the cost of credit and build capital, while affording investment to not only protect, but grow the franchise.

Bank of Ireland’s overall weak asset quality metrics and stressed lending book are factors considered in the intrinsic rating. Credit performance continues to be challenged 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. Nevertheless, DBRS sees Bank of Ireland’s better than peer performance across most lending categories as evidencing the Bank’s historically more conservative risk appetite and solid risk management. Importantly, DBRS sees arresting the trajectory in residential mortgage arrears as a key challenge for Bank of Ireland, similar to all Irish banks. High unemployment and continuing austerity measures have pressured household income and the repayment capacity of Irish households. As a result, Irish owner-occupied mortgages more than 90-days past due stood at 7.03% at 30 June 2012 compared to 4.55% a year ago, but lower than the industry average of 10.9%. DBRS notes that Bank of Ireland 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, Bank of Ireland has signalled that it sees impairment provisions as having peaked in 2009.

Bank of Ireland has made good progress with its restructuring and recovery plan. At 30 June 2012, Bank of Ireland had completed its EUR 10.0 billion deleveraging plan well ahead of the 31 December 2013 target date. Importantly, from a capital preservation perspective, the Bank completed the deleveraging at an average discount of 7.9%, which is below the 2011 Prudential Capital Assessment Review (PCAR) Base Case scenario. 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, Bank of Ireland’s funding profile remains challenged with access to private market funding still limited. Positively, Bank of Ireland issued a EUR 1.0 billion three-year covered bond and a EUR 250 million Lower Tier 2 subordinated note issuance in December 2012. DBRS notes both issuances were executed without the benefit of a guarantee from the Irish Government. Further, Bank of Ireland’s funding profile continues to evolve to a more deposit-oriented model. In November 2012, Bank of Ireland had EUR 74 billion of deposits, up 4% from year-end 2011. As a result, the Bank’s loan-to-deposit ratio (LTD) improved to less than 130% from 144% and approaching the 122.5% that is required by the Central Bank of Ireland under the PCAR stress tests by December 2013.

With still elevated levels of impaired loans ratio and high credit costs, DBRS views positively Bank of Ireland’s sizeable capital cushion above regulatory requirements. The Bank’s Core Tier 1 ratio was 13.9% at the end of October 2012, which is well above the Central Bank of Ireland’s PCAR requirement of 10.5%. Deleveraging actions taken by Bank of Ireland have resulted in risk-weighted assets declining 11.3% from year-end 2011, contributing to the strengthened capital position. DBRS notes that in January 2013 the Irish Government sold its EUR 1.0 billion of contingent capital notes in Bank of Ireland to private investors. DBRS sees this as further evidence of the strength of the Bank’s franchise and progress in recovering from the financial crisis.

The Negative trend on the non-guaranteed long-term debt and deposits reflects DBRS’s view that the environment in Ireland remains uncertain with an uneven recovery likely for the economy and the banking sector. While the Negative trend reflects DBRS’s expectations that Bank of Ireland will continue to be loss-making through 2013, ratings could come under pressure should the pace 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 Bank of Ireland’s credit metrics, improving profitability supported by expanding margins and volumes. Continued improvement in the overall funding profile supported by an expanding retail deposit base accompanied by normalised access to private market funding would also be viewed positively.

Also, DBRS has today removed the ratings of certain subordinated instruments of the Bank of Ireland from Under Review with Negative Implications, where they were placed on 13 June 2011, and assigned a Negative trend. The ratings of these instruments remain at ‘C’. The action takes into account that certain improvements in the financial stability of the Bank have led to a reduction in the likelihood of an imminent threat of extraordinary actions towards these instruments, although the instruments’ very low ratings reflect the high level of ongoing risk to noteholders.
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 unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organizations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments, Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments, and Rating Bank Preferred Shares and Equivalent Hybrids. All 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.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Roger Lister
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 6 September 2005
Most Recent Rating Update: 22 November 2012

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