DBRS: AIB Returns to Profit in 1H14; Impaired Loans Fall

Summary:
• AIB reports profit before tax of EUR 437 million in 1H14, a EUR 1.275 million improvement YoY.
• Impaired loans reduced by EUR 2.9 billion in 1H14, however asset quality remains extremely weak.
• Funding profile improved with substantial reduction in monetary authority funding.
• DBRS rates Allied Irish Banks at BBB (low), with a Negative trend, for Non-Guaranteed Long-Term Debt & Deposits.

DBRS Ratings Limited (DBRS) considers the 1H14 results of Allied Irish Banks plc (AIB or the Bank) as strong, and illustrate the significant progress that the Bank is making. These results mark AIB’s first half-year profit since 2008, excluding the first half of 2011 which incorporated a substantial one-off profit from liability management exercises. AIB reported income before tax and provisions (IBPT) of EUR 560 million, up from EUR 165 million in 1H13, and this, together with a substantial reduction in the impairment charge led to profit before tax of EUR 437 million. The Bank’s NIM (net interest margin), excluding the cost of the Eligible Liabilities Guarantee Scheme (ELG) was 1.60%, a substantial improvement in the 1.28% in 1H13, reflecting repricing of assets, the lower impact of the NAMA bonds as the balance of these declines, and a significant reduction in the cost of funds. Operating expenses reduced by 9%, with the main driver being a 10% reduction in staff numbers since end-1H13. As a result of the cost reductions, and the higher revenues, the Bank reported a cost-income ratio of 55% in 1H14, a substantial improvement on the 82% level in 1H13.

The Bank’s impairment charge in 1H14 was EUR 92 million, down from EUR 738 million in 1H13, reflecting lower levels of new impairments and the writeback of some provisions due to the restructuring of loans. Positively, total impaired loans reduced by EUR 2.9 billion year-on-year (YoY), however DBRS notes that there was a small increase in the level of impaired loans in the Irish residential mortgage book. Overall, the Bank’s coverage ratio of impaired loans remained unchanged from end-2013 at 55%. Nevertheless, overall asset quality remains extremely weak, with impaired loans accounting for 32.5% of the EUR 80 billion total loan book. This highlights the need for the Bank to continue to improve its asset quality and to deliver a sustained improvement in mortgage arrears trends. As a result of the ongoing process of restructuring Irish mortgage loans, and the improving property market, DBRS is of the view that the Bank should be able to further improve its asset quality metrics in the second half of 2014.

DBRS also notes the substantial reduction in the use of monetary authority funding by the Bank. The reduction to EUR 3.7 billion, from EUR 12.7 billion at end-2013, reflects the repayment of NAMA senior bonds, a EUR 1.1 billion net loan reduction, debt issuance in the period of EUR 1 billion and an increase in customer deposits. The Bank’s loan to deposit ratio was 96% at end-1H14, a further improvement on the 100% level at end-2013.

As of 1H14 the Bank’s fully-loaded Basel III common equity tier 1 (CET1) ratio was 11.8%, and under the transitional rules the ratio was 16.1% (both of these ratios include the 1H14 profit). However, DBRS notes that these ratios include the EUR 3.5 billion of preference shares that will cease to qualify from 2018. Although the Bank has indicated that it is likely to discuss converting the preference shares into equity, DBRS is of the view that it is important for AIB to continue to improve its profitability to enable it to increase capital levels through earnings retention.

DBRS rates Allied Irish Banks at BBB (low), with a Negative trend, for Non-Guaranteed Long-Term Debt & Deposits. 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.

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