DBRS Confirms Bank of Ireland at BBB (high), Trend Remains Negative

DBRS Ratings Limited (DBRS) has today confirmed the senior ratings of The Governor and Company of the Bank of Ireland (BoI, the Bank or the Group), including its BBB (high) 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 BBB (low). DBRS maintains a Support Assessment of SA-2 for BoI due to the Bank’s systemic importance within Ireland, and the explicit support provided to the Bank. This reflects DBRS’s expectation that some form of timely systemic support would be provided to the Bank, if needed, and leads to a two-notch uplift of the final rating from the IA. 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 franchise that the Bank has in Ireland and Northern Ireland, as well as the consumer banking franchise in the UK, and the continuing progress that the Bank is making, most recently highlighted by the return to profitability in 1H14. DBRS also notes that the approval of the revised EU Restructuring Plan in 2013 means the Bank is no longer required to sell its life assurance subsidiary, meaning that the strong Irish franchise has been relatively unaffected. The Negative trend reflects the still very high level of impaired assets, and some uncertainty with regards to the outcome of the European Banking Authority (EBA) stress tests later in 2014. Depending on the stringency of these tests, this could potentially lead to a further capital requirement, although DBRS considers this is relatively unlikely and is of the opinion that even if it were the case the Bank would likely be able to raise equity from shareholders.

Upward movement in the IA would require a continuation of the trend of improvements in the Bank’s profitability and capital levels, along with further progress in the Bank’s asset quality indicators. An inability to return to an acceptable level of consistent profitability, would be viewed negatively by DBRS, as would further large provisioning needs resulting in capital depletion. Evidence that the Irish Government is no longer willing or able to support the Bank may lead DBRS to reduce or remove the uplift to the ratings associated with government support. A downgrade of the sovereign rating could also negatively impact the Bank’s rating. 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.

BoI reported a net profit of EUR 344 million in 1H14, marking the first half year profit since 2008, excluding periods which incorporated substantial one-off profits from liability management exercises. The return to profitability was helped by a substantial improvement in 1H14 of the Bank’s Net Interest Margin (excluding the cost of the Eligible Liabilities Guarantee Scheme (ELG)) to 2.05%, as well as the Bank’s focus on controlling the cost base. In addition to the improved underlying performance, the Bank’s results in 1H14 also benefited from a substantial reduction in the impairment charge. Despite the improvement in the impairment charge, it still remains elevated at 97bps of loans and advances. However due to the high level of impairments taken to date, and the ongoing recovery in the Irish domestic economy, DBRS expects future impairment charges to be at lower levels and this should, together with the improving revenue generation, lead to the Bank’s return to profitability being sustainable.

BoI continues to make progress in strengthening its funding and liquidity profile while reducing its usage of central bank funding. As of end-1H14 deposits now account for 74% of total funding compared to 48% at year-end 2010 and DBRS believes that this evidences the strength of the Bank’s domestic franchise and the progress the Bank is making in restoring customer confidence, especially given the Bank’s focus on lowering the cost of retail deposits. With the substantial deleveraging that has taken place in recent years the loan-to-deposit ratio has improved markedly and at end-1H14 stood at 112%. The Bank’s reliance on monetary authority funding has also reduced substantially and is now at EUR 5.8 billion. During 1H14 the Bank also continued to improve its access to private funding markets and DBRS views this progress in regaining access to the wholesale markets positively. Liquidity remains satisfactory and at end-1H14 the Bank’s NSFR was 116% and the LCR was 104%.

A key factor in the Bank’s relatively low IA is its weak asset quality and the still stressed lending book. DBRS notes that the Bank reported that defaulted loans (defined as impaired loans plus loans more than 90 days in arrears) reduced in 2H13 for the first time in several years, and this trend has continued in 1H14. This is ahead of domestic peers, and the Bank’s credit performance throughout the financial crisis has generally been better than domestic peers reflecting the Bank’s historically more conservative risk appetite. However, when compared to global banking peers, the Bank’s asset quality metrics, while reflecting the impact of the economic conditions in Ireland, also indicate a prior level of weakness in risk management. DBRS therefore views positively the improvements in the risk management framework that have taken place in recent years and that the profile of risk within the organisation is now much higher.

At end-1H14 impaired loans remained elevated at EUR 16.7 billion or 18.2% of the total gross loan portfolio. As a result of the increased impairment charge taken in 2H13 following the balance sheet assessment carried out by the Central Bank of Ireland, and then further provisions taken in 1H14 the coverage ratio (impairment provisions as a % of defaulted loans) has increased to 50% from 44% at end-1H13. Importantly, the recent reduction in defaulted loans has continued to be seen across all of the Bank’s major loan portfolios. Although overall asset quality remains weak, DBRS is of the view that the Bank’s asset quality will continue to improve, helped by the ongoing recovery in the economies of Ireland and the UK.

The Bank has continued to strengthen its capital position in 1H14 with the transitional Basel III Common Equity Tier 1 (CET1) ratio increasing by 90 basis points (bps) to 13.2%, whilst the fully-loaded ratio was 10%, an increase of 100 bps. In December 2013, Bank of Ireland was able to complete a capital package involving the 2009 Preference Shares (2009 Prefs) meaning that the Bank has fully reimbursed the Irish State for the 2009 Prefs, and in total the Bank, since 2009, has now returned EUR 6.0 billion to the Irish State, having originally received EUR 4.8 billion in capital support. 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. The sale of the EUR 1.3 billion remaining 2009 Prefs to private investors resulted in the instruments being grandfathered until end-2017 and maintaining their common equity tier 1 treatment. As a result, DBRS notes that the Bank’s current fully loaded and transitional Basel III CET1 ratios include the EUR 1.3 billion of remaining 2009 Preference Shares (2009 Prefs). Excluding these instruments, which the Bank intends to do by July 2016, the pro-forma fully loaded CET1 ratio would be 7.3% at end-1H14. Although this is an increase of 100bps from end-2013, it highlights the need for the Bank to continue recording increased earnings in order to enable further capital growth.

Concurrently DBRS has also taken rating actions on the Bank’s subordinated liabilities. The D ratings on the Primary Capital Notes and on those Perpetual Preferred Securities that ceased to exist in 2011 following the liability management exercises (LMEs), have been withdrawn. The D rating on the Dated Subordinated Debt class rating has also been withdrawn reflecting that most of the Bank’s Dated Subordinated Debt was extinguished in 2011 following the LMEs which DBRS viewed as coercive. However as the Bank has since issued new Dated Subordinated Debt DBRS has assigned a new rating of BB for dated subordinated debt issued since 2011. This rating class can be found on the DBRS website titled “Dated Subordinated Debt (issued after 2011)”. In addition the dated subordinated debt and the perpetual preferred securities that were not extinguished in 2011 have been upgraded to BB and B (high), from C, respectively. The notching of the subordinated debt from the IA reflects the European Commission’s updated State Aid rules of September 2103 which provides the framework needed for regulators in Europe to treat subordinated and hybrid debt as a source of capital in a failing bank, as well as the precedent already established in Ireland to impose losses on subordinated debt if required.

Notes:
All figures are in EUR unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2014). Other applicable methodologies include the DBRS Criteria: Support Assessment for Banks and Banking Organisations (January 2014) and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (December 2013).These can be found can be found at: http://www.dbrs.com/about/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.

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: Alan G. Reid
Initial Rating Date: September 6, 2005
Most Recent Rating Update: April 3, 2014

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