DBRS Comments on Bank of Ireland’s 2012 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 Bank), including its Issuer Rating of BBB (high) are unchanged following the Group’s release of full year 2012 results. 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 a still challenging operating environment, Bank of Ireland reported a statutory loss before tax of EUR 2.2 billion compared to a loss of EUR 190 million in 2011. DBRS notes that 2011 results benefited from a EUR 1.8 billion gain on liability management exercises. Excluding the loss on deleveraging of assets, charges on the movement of own debt, restructuring costs and gains on liability management exercises, Bank of Ireland reported an underlying loss of EUR 1.5 billion slightly lower year-on-year (YoY). Importantly, the Bank’s underlying loss declined 36% in 2H12 compared to 1H12, demonstrating that actions taken by management to rebuild margins and remove costs are delivering benefits and beginning to provide a pathway to the restoration of earnings. The sequential reduction in losses reflects margin expansion, lower operating expenses and reduced impairment charges. While DBRS views the positive movement in multiple lines across the Bank’s income statement favourably, DBRS sees the Bank as likely to remain loss making in 2013, albeit with losses narrowing as compared to 2012, as economic activity in Ireland remains uneven and credit costs continue to be elevated, although on a downward trajectory.

Total operating income, net of insurance claims, was 9% lower YoY at EUR 1.9 billion. Within operating income, net interest income was 12% lower at EUR 1.7 billion primarily due to a 7% reduction in average interest earning assets and further reduction in margins. Indeed, continued high cost of deposits especially in 1H12 resulted in net interest margin (NIM) declining 8 basis points (bps) YoY to 1.25%. However, in 2H12 Bank of Ireland’s actions to lower rates offered on deposits, increasing the standard variable rate on mortgages in Ireland and the U.K., and repricing loan portfolios in Ireland resulted in NIM expanding by 14 bps to 1.34%. DBRS expects margin to continue to expand in 2013 as additional pricing actions are implemented, as the Bank lowers deposit rates further and as new lending is priced at favourable spreads. Mitigating earnings pressure, government guarantee fees were 14% lower YoY at EUR 388 million. Importantly, for the restoration of earnings, the Irish Government announced that the Eligible Liabilities Guarantee (ELG) Scheme will be withdrawn on 28 March 2013. Given that approximately 70% of the Bank’s EUR 26 billion of eligible liabilities mature in 3 months or less, DBRS expects guarantee fee expense to dramatically decline as 2013 progresses supporting the Bank’s movement towards profitability.

From DBRS’s perspective, the Bank’s results evidence that more work is to be done on aligning the cost base with the smaller operating footprint. Operating costs were essentially flat YoY at EUR 1.6 billion as lower staff costs were offset by investments in the franchise, regulatory costs and an adverse movement in foreign currency. As a result, Bank of Ireland’s efficiency ratio stood at 87% compared to 79% in 2011. DBRS notes that operating costs were 5% lower on a half-year linked basis in 2H12, evidencing management actions to remove costs are beginning to flow to the income statement.

Credit costs continue to be elevated driven by the difficult operating environment in Ireland, however, the overall trajectory in impairment charges is positive, reflecting slowing formation of new arrears in the Irish residential mortgage book and stabilisation in certain portfolios in the SME book. Impairment charges on loans and advances to customers totalled EUR 1.7 billion for 2012, an 11% improvement from 2011, and were 17% lower in 2H12 from 1H12. Performance within the Irish residential mortgage book remains challenged; however, signs of stabilisation in unemployment, albeit at a high level, moderation in the rate of decline in property values and an increase in the Bank’s efforts to engage customers in difficulty has resulted in a reduction in the pace of mortgage arrears, particularly in the owner-occupied book. Within the Irish owner occupied loan portfolio, arrears volumes more than 90 days increased to 9.5% compared to 7.4% at year-end 2011, but the rate of increase has declined every quarter since 1Q12. DBRS notes that the level of arrears volumes in the owner-occupied book is notably lower than the industry average. In the buy-to-let loan portfolio, arrears were high at 20.5%, 370 bps higher YoY, but similar to the owner-occupied book, the pace of increase has declined every quarter since 1Q12, and the overall arrears rate remains below the industry average. Given the weak labour markets and the continuing pressure on household income from austerity measures, DBRS sees arresting the trajectory in residential mortgage arrears in 2013 as a key challenge for Bank of Ireland.

The Bank continues to reduce its reliance on wholesale funding and transform its funding model. In 2012, customer deposits grew 6% to EUR 75 billion despite Bank of Ireland leading the market for lower deposit pricing, illustrating the strength of the franchise. Deposit growth was underpinned by solid growth in U.K. retail deposits and corporate deposits. As a result of deposit growth and deleveraging activities, Bank of Ireland’s loan-to-deposit ratio improved to 123% from 144% at year-end 2011 and 175% at year-end 2010, and well within the 2011 Prudential Capital Assessment Review (PCAR) requirement of 122.5% by December 2013. Importantly, during 2012, the Bank re-accessed the capital markets, successfully issuing a EUR 1.0 billion covered bond backed by Irish residential mortgages and issuing a EUR 250 million subordinated bond. Near-term refinancing needs are minimal with only EUR 2.6 billion of unsecured term funding maturing in 2013. Indeed, at 31 December 2012, 61% of private market funding had a remaining term of greater than one-year.

Regulatory capital levels remain comfortably above regulatory requirements as a 16% reduction in risk-weighted assets due to deleveraging and loan repayments largely offset the impact of the loss for the year. The Bank of Ireland’s Core Tier 1 ratio, under the EBA/PCAR stress test basis, was 14.4% at year-end 2012, up slightly from year-end 2011, and ahead of the 2011 PCAR requirement of 10.5%. DBRS notes 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.

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

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]