DBRS Confirms Permanent TSB at BB (low), Trend Remains Negative

DBRS Ratings Limited (DBRS) has today confirmed the non-guaranteed ratings of permanent tsb p.l.c. (PTSB or the Bank), including its BB (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 B, and maintains a Support Assessment of SA-2 for PTSB. DBRS sees PTSB as important to ensuring competition in the Irish retail banking market to the two pillar banks. As such, DBRS maintains an SA-2 support assessment for PTSB and views PTSB as systemically important to Ireland. From DBRS’s perspective, this is further supported by the continued support of the Irish government for the Bank’s restructuring plan as well as the EUR 2.7 billion capital infusion provided to the Bank in 2011. While DBRS does not anticipate PTSB requiring any further substantial support, the SA-2 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 two notch uplift of PTSB’s final rating of BB (low) from its IA of B. 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 rating confirmation reflects the continued progress that the Bank is making, as well as the substantial challenges that the Bank continues to face. These challenges include: reinvigorating the franchise, while completing a far reaching restructuring of the organisation, managing the elevated arrears level in the residential mortgage book, and further improving the funding profile. DBRS sees these challenges, along with the low interest rate environment and still difficult macro-economic situation in Ireland, as delaying PTSB’s return to profitability. The IA continues to 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. In addition, the replenished capital base of the Bank, which benefited from the capital infusion from the Irish Government, is key to the IA. Although DBRS expects some further reduction in regulatory capital, the increased capital has provided the Bank with the necessary time to rebuild and restructure, whilst still absorbing credit costs associated with the difficult operating environment in Ireland.

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 incorporates the further restructuring that is still required to enable the Bank to return to public ownership, including the approval of its EU Restructuring Plan. 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, the outcome may also lead to further capital requirements, although DBRS is of the opinion that, if this is the case, the requirement will be substantially lower than that required by the 2011 PCAR.

Any upward movement in the senior ratings is unlikely until there is approval of the Bank’s EU Restructuring Plan, and further improvement in the funding profile, including successfully addressing the large level of maturities in early 2015. Restoration of profitability along with sustained improvement in credit performance would also be viewed positively. An inability to return to an acceptable level of profitability within the anticipated timeframe, which may indicate that the franchise is too weak to compete effectively in the Irish market, would be viewed negatively, as would credit losses that materially impact capital levels. A downgrade of the sovereign rating or a change in DBRS’s opinion that support from the Irish Government has diminished, or that the Irish Government is no longer willing or able to support the Bank would also be viewed negatively. 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.

In DBRS’s view, PTSB’s earnings power remains impacted by the prevalence of unprofitable tracker mortgages (69% of total lending) on the balance sheet and still relatively high funding costs. Ultimately, PTSB’s key challenge is to rebuild the earnings power of the franchise to a level that allows PTSB to absorb credit costs, while investing in the franchise and generating organic capital. In 2013, the Group reported a loss after tax of EUR 261 million as compared to a loss of EUR 996 million in 2012; however, in both years the Group generated a loss from continuing operations of EUR 977 million. Over the medium-term, DBRS expects earnings to remain under pressure, as revenue growth is likely to remain weak and provision charges are likely to remain elevated given the still challenging macro-economic environment. However, the expiry of the Eligible Liabilities Guarantee Scheme (ELG) in March 2013 will reduce expenses considerably. DBRS expects that several other actions taken by PTSB, including reducing the cost of deposits, will have a positive impact in 2014. Importantly for the IA, PTSB’s pre-impairment earnings continue to be insufficient to absorb credit costs. DBRS sees PTSB’s ability to align its cost base with the new Group structure as an important component in eventually returning to a level of sustainable earnings. Excluding exceptional items, the Group’s cost income ratio remained high in 2013, at 119%, but substantially lower than the 145% level in 2012. As a result of further cost-cutting plans, DBRS expects that operating expenses will be lower in 2014.

PTSB has been making progress in strengthening its funding and liquidity profile while reducing its reliance on central bank funding. Although deposits increased in 2013 they continue to account for only 56% of the funding base at end-2013. As a result reliance on wholesale funding, and especially monetary authority funding, remains significant. At end-2013, PTSB had EUR 6.9 billion, or 29% of total funding from monetary authorities, down from EUR 14 billion, or 35% of total funding, at year-end 2011. Included in this amount is PTSB’s EUR 5 billion long-term refinancing operation (LTRO) facility with the European Central Bank (ECB) that matures in February 2015. As a result of the large debt maturities in 2015, further growth in deposits is a key challenge for the Bank. However, DBRS notes that the Bank has substantial ECB eligible collateral. Importantly, in November 2013 PTSB returned to the securitisation market with a Residential Mortgage-Backed Securities (RMBS) issue of EUR 500 million. The underlying collateral for this transaction is Republic of Ireland (ROI) mortgages. DBRS views the successful placement of this issue as a sign of restored market confidence in both the Irish property market and PTSB’s longer-term viability.

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. Although arrears continued to increase in 2013 with impaired loans reaching 23.7% of the total loan book at end-2013, DBRS notes that PTSB commented in its interim management statement (IMS) for Q1 2014 that both early and late arrears are now falling in each of the loan portfolios, and that total arrears for owner-occupier and buy-to-let mortgage lending are now approximately 10% lower than its peak at end-2013. However, given the significance of PTSB’s mortgage portfolios, DBRS is unlikely to consider a change in the trend to Stable, until there is a sustainable improvement in the change of trend in the arrears levels.

At end-2013, the Bank’s Basel II Core Tier 1 ratio stood at 13.1%, compared to 18.0% at year-end 2012, with the reduction reflecting the significant loss recorded during the year and the impact of the balance sheet assessment (BSA) that was conducted in the second half of 2013 by the Central Bank of Ireland. The BSA exercise, which was a precondition for Ireland to exit the EU/IMF bailout programme, resulted in PTSB increasing its risk-weighted assets on defaulted loans. On a pro-forma basis, the CRD IV transitional Common Equity Tier 1 (CET1) ratio would have been 13.4% at end-December 2013, however the fully loaded CET1 ratio would have been lower, at 10.9 %. Given the expectation of further losses, DBRS expects PTSB’s capital ratios to decline further, emphasising the need for the Bank to return to profitability to enable capital to be replenished internally.

Concurrently DBRS has also withdrawn the D rating, at its discretion, on the Bank’s remaining outstanding dated subordinated debt. As a result of the liability management exercises carried out in 2011 only EUR 19 million of this debt remains outstanding.

Notes:
All figures are in 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 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.

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:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

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

Lead Analyst: Ross Abercromby
Rating Committee Chair: Roger Lister
Initial Rating Date: October 27, 2009
Most Recent Rating Update: April 23, 2013

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