DBRS Confirms Allied Irish Banks at BBB (low), Trend Remains Negative

DBRS Ratings Limited (DBRS) has today confirmed the non-guaranteed senior ratings of Allied Irish Banks p.l.c. (AIB, the Bank or the Group), including its BBB (low) Non-Guaranteed Long-Term Debt and Non-Guaranteed Long-Term Deposit Ratings. The trend on all non-guaranteed ratings remains Negative. DBRS also confirmed the Bank’s intrinsic assessment (IA) of BB. DBRS maintains a Support Assessment of SA-2 for AIB. The SA-2 reflects 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 Bank’s Irish Government guaranteed long-term debt ratings, which remain at A (low) with a Stable trend, reflecting DBRS’s rating of the Republic of Ireland.

The confirmation of the Bank’s ratings reflects the strong and resilient domestic franchise, and the continuing progress the Bank is making on its restructuring, in particular in its profitability and funding. The Negative trend reflects the extremely high level of impaired assets, and the challenge the Bank faces to return to sustainable profitability. In addition it also incorporates the further restructuring that is still required to enable the Bank to return to public ownership. DBRS also notes that the Bank is required to participate in the European Banking Authority (EBA) stress tests. Depending on the stringency of these tests this may also lead to a further capital requirement, although DBRS is of the opinion that if this is the case the requirement will be substantially lower than the 2011 PCAR required.

Any upward movement in the senior ratings is unlikely until there is a track record of a restoration of sustainable profitability along with, at a minimum, evidence of progress in improving the Bank’s credit metrics. A further reduction in funding from monetary authorities combined with deposits becoming a larger presence in the funding profile and sustained access to wholesale funding markets at reasonable cost could result in upward pressure on the IA. An inability to return to an acceptable level of consistent profitability, which may indicate a permanent weakening of the domestic franchise would be viewed negatively. Further large provisioning requirements that have a notable impact on capital levels would also pressure ratings as would evidence that support from the Irish Government has diminished, or that the Irish Government is no longer willing or able to support the Bank. The ratings on the Government Guaranteed debt are directly linked to DBRS’s rating of the Republic of Ireland and as such, any changes in this rating would be reflected in the rating of the guaranteed debt.

AIB has a well-established domestic franchise and this is a key factor in the Bank’s ratings. DBRS sees the Group as well placed in Ireland with a national operating footprint supported by a diverse distribution network that includes an extensive branch network. AIB has sizeable domestic retail and commercial businesses that hold leading market positions in key products and services and the Bank is also active in corporate lending and capital markets activities in Ireland. The vast bulk of the Bank’s overseas operations have been sold in recent years as part of the Bank’s deleveraging process and this has resulted in the Bank’s franchise becoming far more domestic focused. DBRS also notes and views positively the recent approval of the Bank’s Restructuring Plan by the European Commission (EC). This was required as a result of the significant State Aid received during the financial crisis, which included substantial capital injections and the transfer of assets to the National Asset Management Agency (NAMA). Although AIB has completed a number of restructuring measures since the receipt of the State Aid, the final EC approval also requires further commitments. DBRS, however, notes that these are generally already in line with the Bank’s strategic plans.

DBRS sees AIB’s earnings power as impaired by the operating conditions in Ireland, the low interest rate environment, and the high level of distressed assets on the balance sheet. The 2013 results, however, illustrate the progress that the Bank is making towards rebuilding its earnings power. AIB reported an underlying profit before provisions (excluding exceptional items) of EUR 445 million, up from an underlying loss of EUR 324 million in 2012. The notable improvement primarily reflects a reduction in operating expenses and the falling costs of the Eligible Liabilities Guarantee Scheme (ELG) that expired in March 2013. DBRS also notes that the Bank announced a return to profitability in Q1 2014, with continued income growth and further cost reductions. However the high impairment charge in 2013 led to the Bank reporting a net loss before tax of EUR 1.69 billion. Given the signs that asset quality is beginning to stabilise AIB expects the H1 2014 impairment charge to be materially lower than H1 2013. The Bank continues to make progress on right-sizing its cost base with operating expenses in 2013 down 16% on 2012, reflecting a 24% reduction in staff numbers since June 2012. As a result of this, and the improvement in revenues, the Bank reported a cost-income ratio (excluding exceptional items) of 77% in 2013, still high but a significant improvement on the 123% level in 2012.

AIB has continued to make substantial progress in its attempts to return to a more normalised funding profile, and in 2013 the Bank issued its first unguaranteed senior unsecured debt since 2009, following on from the issuance of secured debt in 2012 and 2013. As a result of the Bank’s deleveraging, and the stable domestic deposit base, the loan-to-deposit ratio has improved to 100% at end-2013 (including repos), down from 115% at end-2012, and 165% at end-2010. With the improvement in the Bank’s market access and the reduction in the Bank’s loan portfolio the liquidity position of the Bank has also improved and at end-2013 the total available liquidity pool was just under EUR 14 billion, of which EUR 13.4 billion was ECB eligible. This compares to short-term borrowings of EUR 1.575 billion at end-2013. While AIB has made progress in strengthening its funding and liquidity profile, the Group continues to be reliant, albeit to a much lower degree than in recent years, on central bank funding. At end-Q1 2014 monetary authority funding was approximately EUR 9 billion, down from EUR 12.7 billion at end-2013, and from EUR 31 billion at end-2011, helped by the lower wholesale funding requirement and the improved ability of the Bank to access market funding.

The performance of AIB during the financial crisis revealed significant failures in risk management at the Bank. In the period since AIB’s new management team has restructured and strengthened the risk management function of the Bank and this, together with the slowly improving Irish economy, is beginning to be reflected in the Bank’s asset quality metrics. However as a result of the still difficult economic conditions in Ireland, and the substantial falls in both residential and commercial property values, the asset quality of the lending book remains extremely weak. At end-2013 impaired loans remained very high at EUR 28.9 billion or 34.9% of the total gross loan portfolio. This weakness is a significant driver factored into the low intrinsic rating. Positively the coverage ratio improved in 2013 partly driven by the balance sheet assessment carried out by the Central Bank of Ireland in late 2013 that led to a total credit provision charge in 2013 of EUR 1.9 billion. A key rating driver going forward will be the performance of the Bank’s Irish loan portfolios. The performance of the small- and medium-sized enterprises (SME) and property books currently remain weak reflecting the substantial fall in commercial property values and the challenging economic conditions, especially for the more domestically focused companies. In the Irish mortgage portfolio impaired loans remain extremely high. In the owner-occupier mortgage book, which account for 81% of the portfolio, the impaired ratio was 16.7% at end-2013 while impaired buy-to-let mortgages accounted for 49% of the portfolio. DBRS notes that AIB commented in its interim management statement (IMS) for the first quarter of 2014 that total arrears in the Irish residential mortgage portfolio were stable in the quarter and that arrears in the owner occupier book were declining. However given the size and importance of this book a change in the trend to Stable is unlikely until there is a sustained improvement in mortgage arrears trends.

As end-2013 AIB had an estimated transitional Basel III common equity tier 1 (CET1) ratio of 15%, however the fully-loaded Basel III CET1 ratio is lower at 10.5%. This emphasises the need for AIB to return to profitability to enable the Bank to replenish capital internally especially as the EUR 3.5 billion of preference shares issued to the government in 2009 will not qualify as CET1 capital under Basel III from January 1, 2018. The Bank has indicated that discussions have commenced with the Department of Finance regarding the capital structure of the Bank and DBRS expects that AIB will convert its EUR 3.5 billion of preference shares into further government equity. A simplification of the Government’s shareholding (currently the Bank has approximately 521 billion shares in issue, of which 500 billion were issued to the Government in 2011) is also likely to be discussed as this would be an important step to allowing the Group to ultimately return to private ownership.

Concurrently DBRS has also withdrawn the D ratings, at its discretion, on the Bank’s remaining outstanding dated subordinated debt. As a result of the 2011 Subordinated Liabilities Order the maturity on this debt was extended to 2035, and the mandatory coupon payments were changed to be payable at the option of the bank. As a result DBRS does not expect payments on these instruments to recommence. Additionally as a result of the liability management exercises carried out on 2011 only EUR 36 million of this debt remains outstanding. DBRS has also withdrawn the D ratings on the perpetual preferred securities issued by various AIB funding subsidiaries. These securities ceased to exist in 2011 following the liability management exercises.

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 following: DBRS Criteria: Support Assessment for Banks and Banking Organisations and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities. These can be found can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include company reports and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository, see:
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Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Ross Abercromby
Rating Committee Chair: Alan G. Reid
Initial Rating Date: October 20, 2005
Most Recent Rating Update: December 20, 2012

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