DBRS: Bank of Ireland’s Progress Continues, BBB (high) Rating Underpinned by Capital Transactions

DBRS Ratings Limited (DBRS) views positively the completion by Bank of Ireland (BoI or the Bank) of capital transactions in relation to the EUR 1.837 billion of 2009 Preference shares (2009 Prefs) held by the National Pensions Reserve Fund Commission (NPRFC). The Bank, which is rated BBB (high) for long-term senior debt and deposits, has successfully placed equity to redeem EUR 537 million of the 2009 Prefs and pay expenses related to the transaction, and the remaining EUR 1.3 billion of the 2009 Prefs have been also sold by the NPRFC to a Special Purpose Vehicle (SPV). The SPV has in turn issued perpetual non-cumulative Notes (Notes), secured on the remaining EUR 1.3 billion of the 2009 Prefs, to private investors, thereby allowing the Irish State (State) to exit from its preference share investment in the Bank. Importantly as part of this transaction the SPV acquirer of the 2009 Prefs has waived the right to the original redemption step-up clause, thereby removing potential further cost for the bank.

The impact of these transactions is positive for the Bank’s capital profile as the equity component of its core tier 1 capital base has increased. In addition, the remaining EUR 1.3 billion of 2009 Prefs will maintain their common equity tier 1 treatment until end-2017, the cash dividend on the 2009 Prefs will reduce by approximately EUR 55 milion per annum, and the potential cost of the redemption step-up has been removed. In DBRS’s view these transactions therefore underpin the BBB (high) long-term senior debt and deposit ratings of the Bank.

With the completion of these transactions BoI will have fully reimbursed the Irish State for the 2009 Prefs, and in total the Bank, since 2009, will have returned EUR 5.9 billion to the Irish State, having received EUR 4.8 billion cash from the State. DBRS views the increasing separation of the Bank from the State positively as the Bank returns to a more normal capital and ownership structure and notes that the State investment in the Bank now only consists of its 14% equity stake. This reduced from 15.1% as the Government did not participate in the placing.

The sale of the EUR 1.3 billion remaining 2009 Prefs to private investors means that they will be grandfathered until end-2017, thereby maintaining their common equity tier 1 treatment, however DBRS would expect them to be redeemed in 2016 as the Bank has said: (i) that it does not intend to recognise them as regulatory common equity tier 1 capital after July 2016 (unless de-recognition would mean that an adequate capital buffer cannot be maintained above applicable regulatory requirements); and (ii) that it does not expect to redeem the Notes sold to private investors prior to 1 January 2016, save in certain limited circumstances. DBRS also notes that the restrictions on equity dividend payments will also be removed as a result of the sale of the 2009 Prefs.

Following the Balance Sheet Assessment (BSA) undertaken by the Central Bank of Ireland (CBI), BoI announced on December 2, 2013 that the Bank is not required to raise further capital. However DBRS notes that the potential adjustments to provisioning levels and to risk-weighted assets by the CBI in the BSA would lead to a substantial reduction in the Bank’s capital ratios. Although DBRS understands that the outcomes remain subject to ongoing engagement between the CBI and the Bank the BSA does highlight the need for the Bank to continue its progression to return to profitability to enable it to increase capital levels through earnings retention.

The BBB (high) senior debt and deposit ratings of the Bank continue to reflect DBRS’s view on the strength of the Bank’s domestic franchise, the diversity gained through its sizeable UK operation, its reinforced capital position, and the progress the Bank is making on its restructuring plan. In DBRS’s view, these strengths provide the foundation for the ultimate recovery of the Bank from the financial crisis in Ireland. However, the Bank still faces significant asset quality challenges, and any revision of the trend to Stable from Negative is unlikely until there is a sustained improvement in mortgage arrears trends, and evidence that the current favourable trends in the Bank’s profitability can be sustained.

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

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