DBRS Upgrades Bank of Ireland to A (low); Trend Now Stable

DBRS Ratings Limited (DBRS) has today upgraded the non-guaranteed senior ratings of The Governor and Company of the Bank of Ireland (BoI, the Bank or the Group) to A (low), including its Issuer Rating, and its Non-Guaranteed Long-Term Debt and Non-Guaranteed Long-Term Deposit ratings. The Bank’s R-1 (low) Non-Guaranteed Short-Term Debt and Deposit ratings were confirmed. BoI’s long-term Critical Obligations Rating (COR) was upgraded to A (high) from A, the short-term COR was upgraded to R-1 (middle) from R-1 (low), and the Perpetual Preferred Securities (issued by Bank of Ireland UK Holdings plc) were upgraded to BBB (low) from BB (high). The trend on all of the ratings is Stable. The Bank’s intrinsic assessment (IA) was upgraded to A (low) and the Support Assessment was maintained at SA3. As a result, the Bank’s Issuer and Senior ratings are positioned in line with the IA. In addition the direction of the review on the Bank’s Dated Subordinated Debt was changed to Positive from Negative.

The ratings upgrade reflects the progress achieved by the Bank in recent years which has resulted in a much improved financial profile. In particular the upgrade takes into account the improving asset quality, the solid and increasingly stable earnings, the increase in the Bank’s capital and the improved funding profile. Further upward pressure on the ratings is unlikely in the near future, however it would require further improvement in asset quality indicators, as well as maintaining strong and stable earnings, and robust capital and funding profiles. Negative rating pressure could arise from a reversal in asset quality improvement, significant weakening in key segments of the Bank’s franchise, or in the capital and funding profiles, or if either the Irish or UK economies were to deteriorate such that BoI’s financial fundamentals were substantially impacted. The Trend on the Bank’s Issuer Rating is Stable. This takes into account that although DBRS expects that the Bank may face some earnings pressure as a result of the UK leaving the European Union, the much improved operating environment in Ireland and the improved capital and funding position of the Bank mitigates this.

With total assets of EUR 123 billion as of end-2016 (approximately USD 130 billion) Bank of Ireland is the largest Irish bank. BoI has a diverse domestic franchise that combines retail banking, commercial banking, asset management and life insurance. In Ireland, BoI holds market leading positions across many principal product lines in retail and commercial banking and is the country’s only bancassurer. In Northern Ireland BoI is a full service bank with a strong business franchise while in the UK it is focused on mortgage lending and consumer banking mainly through its partnership with the Post Office. The Group also operates in the European and US acquisition finance business. DBRS continues to view Bank of Ireland’s strong domestic franchise combined with its solid position in the UK as a key rating driver.

For the full-year 2016, BoI reported underlying profit before tax of EUR 1,071 million, down 11% on 2015. The reduction was primarily driven by the impact on net interest income of the fall in sterling, the low interest rate environment and reduced liquid asset income due to bond sales. The Bank’s net interest margin (NIM) was 2.19% for the full-year, however DBRS notes that in the second half of 2016 the NIM was 2.27%, with the increase being driven by ongoing mix changes in the lending book, the lower cost of deposits, especially in the UK, and the maturity of the 10% Coco in July 2016. DBRS also notes that the 2016 result included EUR 171 million of additional gains (2015: 237 million), primarily driven by the sale of shares in VISA Europe (EUR 95 million) and the final rebalancing of the liquid asset portfolio (63 million). Costs remain well managed and in 2016 underlying operating expenses were flat on 2015 at EUR 1,747 million (2015: EUR 1,746 million), helped by a EUR 46 million benefit from FX movements. Total expenses were, however, up 4% year-on-year (YoY) reflecting the Bank’s investment in its core banking platforms and increased regulatory charges of EUR 109 million. On an underlying basis the Bank’s cost to income ratio was 58% in 2016. The solid underlying performance in 2016 was further supported by another reduction in the Bank’s impairment charges. In 2016 the total charge was EUR 178 million, down from EUR 296 million in 2015. The improvement was evident across all portfolios and DBRS notes that the figure incorporates a EUR 142 million reversal on the residential mortgage portfolio. The Bank expects its impairment charge to remain at similar levels in 2017.

In 2016 BoI’s asset quality indicators continued to improve, in line with the trend since 2012, supported by the strong positive momentum in the macroeconomic environment in Ireland and the Bank’s success in dealing with problematic loans. At end-2016 the ratio of the bank’s non-performing loans (defined as defaulted loans plus probationary residential mortgages) to gross loans was 9.6%, down from 13.2% at end-2015. The defaulted loans (impaired loans plus residential mortgages which are greater than 90 days in arrears) ratio also reduced considerably in 2016, ending the year at 8.4%, from 11.6% at end-2015. Total coverage ratios were 49% of non-performing loans and 56% of defaulted loans at end-2016, unchanged on end-2015. Given the continuing improvement in the macroeconomic environment in the Republic of Ireland DBRS anticipates further improvement, however the potential implications on the Irish and UK economies of the UK leaving the European Union have not yet become clear. DBRS will continue to monitor this closely.

The Banks funding and liquidity profile remains robust. At end-2016 the loan to deposit ratio reduced further to 104% (2015: 106%), and DBRS also views positively that at end-2016 BoI had no eligible liabilities under the ELG Scheme, which guaranteed certain liabilities of Irish banks. In DBRS’s view this confirms the Bank’s return to a normalised funding profile, and in addition it means that no further fees will accrue. Liquidity management remains prudent and the Bank has an ample liquidity buffer to cover wholesale funding maturities. At end-2016 Bank of Ireland reported a Liquidity Coverage Ratio of 113% and a Net Stable Funding Ratio of 122%, up from 108% and EUR 120% at end-2015, respectively.

BoI reported a fully loaded Basel 3 Common Equity Tier 1 (CET1) ratio of 12.3% at end-2016, up 100 basis points (bps) YoY, primarily driven by the Bank’s retained earnings and by the reduction in the IAS 19 accounting deficit on the Bank’s defined benefit pension schemes. The fully loaded Basel 3 leverage ratio stood at 6.4% at end-2016 (2015: 5.7%). DBRS notes that the Bank now plans to re-commence dividend payments in the first half of 2018, reflecting the full year 2017 results. DBRS would expect any dividend payments to be at a low level to begin with, only increasing to the 50% of sustainable earnings target level over time.

DBRS also notes that, following discussions with the Single Resolution Board (SRB) and the Bank of England, the Bank has been advised that the preferred resolution strategy for the Group consists of a single point of entry bail-in strategy through a group holding company. As a result BoI has announced that it plans to establish a holding company, “Bank of Ireland Group plc” through a scheme of arrangement with this planned to take pace in July 2017. DBRS understands that this is not expected to have an impact on the Bank’s CET1 ratio, however it may have an impact on the Total Tier 1, Total Capital and leverage ratios, although this will not be substantial. DBRS also notes that the Perpetual Preferred Securities (issued by Bank of Ireland UK Holdings plc) will be redeemed on June 7 2017.

DBRS previously rated BoI’s Dated Subordinated Debt at BBB, Under Review with Negative Implications (see “DBRS Places Certain Sub Debt of 27 European Banking Groups Under Review With Negative Implications”, published on January 13 2017). However the direction of the review has been changed to Positive from Negative. This reflects that with the upgrade of the IA to A (low) the Dated Subordinated Debt is already rated two notches below the IA. If at the end of the review period DBRS decides that the one notch differential to the IA is appropriate then the ratings would be upgraded, or if the notching is widened to two notches then the ratings will likely be confirmed.

RATING DRIVERS

Upward pressure on the ratings would require further substantial improvement in asset quality indicators, as well as maintaining strong and stable earnings, and robust capital and funding profiles. Negative rating pressure could arise from a reversal in asset quality improvement, significant weakening in key segments of the Bank’s franchise, or in the capital and funding profiles, or if either the Irish or UK economies were to deteriorate such that BoI’s financial fundamentals were substantially impacted.

Notes:
All figures are in Euros unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (July 2016). Other applicable methodologies include the DBRS Criteria: Support Assessments for Banks and Banking Organisations (March 2017), DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2017), Guarantees and Other Forms of Support (February 2017) and Critical Obligations Rating Criteria (February 2017). These can be found can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include SNL Financial, company disclosures and the Central Bank of Ireland. DBRS considers the information available to it for the purposes of providing this rating to be 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.

This rating is under review. Generally, the conditions that lead to the assignment of reviews are resolved within a 90 day period. DBRS reviews and ratings are under regular surveillance.

For further information on DBRS historical default rates published by the European Securities and Markets Authority (“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, Senior Vice President, Global Financial Institutions Group
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global Financial Institutions Group and Sovereign Ratings
Initial Rating Date: September 6, 2005
Most Recent Rating Update: April 22, 2016

DBRS Ratings Limited
20 Fenchurch Street
31st Floor
London
EC3M 3BY
United Kingdom
Registered in England and Wales: No. 7139960

Information regarding DBRS ratings, including definitions, policies and methodologies, is available on www.dbrs.com.