DBRS Confirms the Non-Guaranteed Debt Ratings of permanent tsb p.l.c. at BB (low), Trend Negative

DBRS, Inc. (DBRS) has today confirmed the non-guaranteed debt ratings of permanent tsb p.l.c. (PTSB or the Bank), including its Issuer Rating of BB (low). The trend on all non-guaranteed ratings is Negative. Further, DBRS has lowered the Bank’s intrinsic assessment (IA) to B from B (high). Concurrently, the ratings have been removed from Under Review with Negative Implications, where they were placed on 5 July 2012. 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.

Given the consolidation in the Irish banking sector since 2008, including withdrawal of foreign competition, DBRS sees PTSB as important to ensuring competition in the retail banking market to the two pillar banks. As such, DBRS maintains an SA2 support assessment for PTSB and views PTSB as systemically important to Ireland. From DBRS’s perspective, this is further supported by the Irish government’s approval of the Bank’s restructuring plan as well as the EUR 2.7 billion capital infusion provided to the Bank. Moreover, the Irish government continues to support PTSB’s restructuring plan with the Troika and the European Commission (E.C.). While DBRS does not anticipate PTSB requiring any further support, the SA2 designation reflects DBRS’s expectation that further timely support would likely be forthcoming, if needed, although such support could be constrained by external factors. This expectation is reflected in the now two notch uplift of PTSB’s final rating of BB (low) from its IA of B, which is widened from the prior one notch ascribed to support.

The lowering of PTSB’s IA to B reflects the noteworthy challenges facing the Bank, including, reinvigorating the franchise, while completing a far reaching restructuring of the organisation, managing the elevated arrears level in the residential mortgage book, and transforming the funding profile to be more deposit centric. The perverse combination of low mortgage yields that reflect the very low index rates and yet high funding costs that reflect financial markets is difficult to overcome. Important to the intrinsic rating, DBRS sees these headwinds along with the outlook of a slow and uneven recovery in the Irish economy as delaying PTSB’s return to profitability. While the rating action considers the challenge of rebuilding the franchise, the intrinsic assessment does recognise the importance of the Bank’s underlying franchise, which DBRS sees as benefiting from a national operating footprint, multi-channel distribution network, and a well-known brand. Moreover, the ratings consider the replenished capital base of the Bank that benefited from the capital infusion from the Irish Government. Although DBRS does not expect regulatory capital to remain at the current high levels, DBRS sees the level of capitalisation as affording the Bank the necessary time to rebuild and restructure, whilst still absorbing credit costs associated with the difficult operating environment in Ireland.

Under the Bank’s restructuring plan, which was approved by the Troika and submitted to the E.C. for formal State Aid approval, PTSB will operate three strategic business units. The core bank will focus on the Irish retail banking market, offering residential mortgages, current accounts and other personal savings and lending products. The plan calls for the inclusion of the Bank’s Capital Home Loans (CHL), subsidiary, which is predominately a U.K. buy-to-let (BTL) mortgage lending unit. The plan also includes the establishment of an Asset Management Unit (AMU), a specialist unit to deal with legacy assets including those in arrears, unprofitable mortgages, and those assets that no longer fit PTSB’s new operating model or risk appetite. While the specific assets to be included in the AMU have not been publicly disseminated, DBRS anticipates that the Bank’s commercial lending exposure (EUR 2.2 billion at year-end 2012) and the majority of the Bank’s EUR 21.8 billion tracker residential mortgage book (of which EUR 14.7 billion was Irish tracker mortgages and EUR 7.1 billion U.K. residential tracker mortgages at YE12) would be included. DBRS notes that the restructuring plan has not yet received approval from the E.C., and as such, the Negative trend incorporates the risk that the plan could be materially altered by the E.C. or not approved; however, DBRS does not anticipate such an outcome.

PTSB’s earnings generation ability has been weakened primarily due to the sizeable level of tracker mortgages in its lending book with their low yields driven by low ECB rates. At the same time, funding costs remain high as rates paid by banks reflect their own risks and the high rates for sovereign debt, at a time when banks are seeking to reduce their reliance on wholesale funding. With lower pre-provision income, PTSB is struggling with elevated impairment charges that are being driven by weakness in Irish economy and still declining house prices. DBRS expects these headwinds to remain through 2013. Importantly for the IA, visibility into the timing of a return to profitability is clouded. In late 2012, PTSB implemented initiatives designed to begin the rebuilding of profitability. Amongst these actions were lowering deposit pricing, repricing assets where possible and reducing the operating cost structure to better align it with the smaller scope of the Bank.

PTSB’s overall weak asset quality metrics and stressed lending book are important factors considered in the IA. High unemployment and continuing austerity measures have pressured household income and the repayment capacity of Irish households resulting in elevated levels of arrears in the Irish residential mortgage portfolio. As such, DBRS sees arresting the trajectory in residential mortgage arrears as a key challenge for the Bank. DBRS notes that PTSB has made substantial investments in its workout team and 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 demonstrated. Mitigating the pressure stemming from the mortgage portfolio is the Bank’s substantial capital base. At 31 December 2012, the Bank’s Core Tier 1 ratio was 18.0%, which is well above the Central Bank of Ireland’s minimum requirement of 10.5%.

PTSB’s funding profile remains challenged with reliance on ECB funding still elevated. At 31 December 2012, 29% of PTSB’s total funding was sourced from central banks. However, DBRS notes that the Bank has not utilised emergency liquidity assistance (ELA) funding since April 2012. Going forward, PTSB endeavours to have a funding base that is centred on deposits. To this end, deposits grew 16% in 2012 to EUR 16.6 billion. As a result of deposit growth and a lower lending balance, the Bank’s loan-to-deposit ratio improved to a still elevated 191% from 227% at year-end 2011.

The Negative trend takes into account 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 PTSB will continue to be loss-making through 2015, ratings could come under pressure should the pace of losses not moderate and visibility towards the restoration of positive earnings not improve. The Negative trend also reflects the potential that external factors, such as continued uncertainty in the Eurozone and its potential adverse impact on Ireland, could exert pressure on the rating. Conversely, the trend could be revised to Stable, should the restructuring plan be approved by the E.C., and if DBRS were to see favourable trends in PTSB’s credit metrics, as well as narrowing of losses supported by expanding margins and volumes. Further reduction in central bank related funding accompanied by an expanding deposit base and sustained access to private market funding at reasonable costs would also be viewed positively.

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.

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: 27 October 2009
Most Recent Rating Update: 22 November 2012

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