Credit Opinion: Allied Irish Banks, p.l.c.

Transcription

1 Credit Opinion: Allied Irish Banks, p.l.c. Global Credit Research - 15 Dec 2014 Dublin, Ireland Ratings Category Moody's Rating Outlook Negative(m) Bank Deposits Ba2/NP Bank Financial Strength E+ Baseline Credit Assessment b1 Adjusted Baseline Credit Assessment b1 Senior Unsecured -Dom Curr Subordinate Ba3 B2 Jr Subordinate Caa2 (hyb) Other Short Term -Dom Curr AIB North America, Inc. (P)NP Outlook Negative Bank Deposits Ba2/-- Allied Irish Banks, NY Bank Deposits (ST) --/NP EBS Ltd Outlook Bank Deposits Negative(m) Ba2/NP Bank Financial Strength Baseline Credit Assessment E+ b1 Adjusted Baseline Credit Assessment Senior Unsecured -Dom Curr b1 Ba3 Subordinate MTN -Dom Curr (P)B2 Other Short Term -Dom Curr (P)NP Contacts Analyst Phone Dany Castiglione/London Carlos Suarez Duarte/London Johannes Wassenberg/London Key Indicators ALLIED IRISH BANKS, P.L.C. (Consolidated Financials)[1] [2]6-14 [2]12-13 [3]12-12 [3]12-11 [3]12-10 Avg. Total Assets (EUR million) 110, , , , ,061.0 [4]-6.1 Total Assets (USD million) 151, , , , ,581.0 [4]-5.6 Tangible Common Equity (EUR million) 7, , , , [4]114.7 Tangible Common Equity (USD million) 10, , , , [4]115.7 Net Interest Margin (%) [5]1.1 PPI / Average RWA (%) [6]0.7 Net Income / Average RWA (%) [6]-1.4 (Market Funds - Liquid Assets) / Total Assets (%) [5]16.5 Core Deposits / Average Gross Loans (%) [5]69.1 Tier 1 Ratio (%) [6]13.6 Tangible Common Equity / RWA (%) [6]11.5

2 Cost / Income Ratio (%) Problem Loans / Gross Loans (%) [5] [5]27.7 Problem Loans / (Equity + Loan Loss Reserves) (%) [5]115.9 Source: Moody's [1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel III - transitional phase-in; IFRS [3] Basel II; IFRS [4] Compound Annual Growth Rate based on IFRS reporting periods [5] IFRS reporting periods have been used for average calculation [6] Basel III - transitional phase-in & IFRS reporting periods have been used for average calculation Opinion SUMMARY RATING RATIONALE We assign a Bank Financial Strength Rating (BFSR) of E+ to Allied Irish Banks plc (AIB), which maps to a standalone baseline credit assessment (BCA) of b1. The b1 BCA reflects AIB's: (1) very high - albeit decreasing - stock of problem loans compared to domestic and European peers, partly mitigated by the relatively high levels of coverage; (2) adequate capital levels, supported by the bank's performance under the European Central Bank's (ECB) Comprehensive Assessment; (3) return to sustainable profitability, driven by continuous increase in net interest income and lower impairment charges; (4) rebalanced funding profile and improved liquidity position. AIB is further benefitting from a favourable operating environment in its two largest markets, Ireland (Baa1/Stable) and the UK (Aa1 Stable). AIB is the largest bank in terms of domestic total assets and market share in Ireland. Following a series of capital injections which took place since 2009, it is currently fully owned by the Irish government. In May 2014, the European Commission approved AIB's restructuring plan which entails, among other things, targets on cost reduction and commitment to state-aid repayment. The Ba3 unguaranteed senior unsecured debt rating of AIB incorporates one-notch of uplift from the BCA, embedding our moderate expectation of government support, given the bank's systemic importance in the Irish economy. AIB's Ba2 long-term bank deposit rating incorporates two notches of rating uplift from the stand-alone rating, reflecting the support received by the institution from the Irish government and our expectation that further support for the deposits would likely be forthcoming if needed. Rating Drivers - Strong domestic retail and commercial banking franchise - Stabilisation of asset quality metrics, but downside risks remain - Adequate capitalisation under current rules, albeit uncertainty persists over the replacement of non-qualifying capital instruments under CRD IV - Return to sustainable profitability, although at weak levels - Improving funding profile and liquidity position Rating Outlook The rating outlook on the BFSR is stable, reflecting our expectations that the favorable operating environment will allow AIB to keep on strengthening its credit fundamentals, but also that a material reduction in the stock of problem loans is challenging in the outlook period. The outlook on the senior, subordinated and hybrid instruments is also stable - in line with the outlook on the BFSR and the on the Irish government bond rating. The negative outlook on the deposit ratings takes into account the recent adoption of the Bank Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism (SRM) regulation in the EU. In particular, this reflects that, with the EU legislation underlying the new resolution framework now in place and the explicit inclusion of burden-sharing with unsecured creditors as a means of reducing the public cost of bank resolutions, the balance of risk for banks' senior unsecured creditors has shifted to the downside. Although our support assumptions are unchanged for now, the probability has risen that they will be revised downwards to reflect the

3 new framework. For further details, please refer to our Special Comment entitled "Reassessing Systemic Support for EU Banks," published on 29 May What Could Change the Rating - Up Upward pressure on AIB's ratings could develop from increased clarity over its capital structure, in particular in relation to the replacement of the hybrid instruments. Other elements that could exert upward pressure on the bank's BCA in the medium term are (1) further improvements in profitability and efficiency; (2) additional improvements in the bank's fully loaded capital and leverage metrics; (3) maintaining a sound liquidity profile; and/or (4) a significant reduction in the stock of problem loans along with positive net lending, albeit at a moderate pace. An upgrade of the bank's debt and deposit ratings could be triggered by an improvement in its BCA. What Could Change the Rating - Down AIB's ratings could be adversely affected by (1) a reversal in the bank's improving asset-quality trend; (2) an unexpected deterioration in the bank's profitability metrics; (3) material deterioration in its liquidity profile or funding position; and/or (4) a reduction in Moody's systemic support expectations. Negative pressure on the bank's long-term debt and deposit ratings could result from a lowering of the bank's BCA. DETAILED RATING CONSIDERATIONS STRONG DOMESTIC RETAIL AND COMMERCIAL BANKING FRANCHISE AIB has a strong domestic franchise in Ireland, being market leader in a number of areas: the group's estimated share of the domestic new mortgage lending for H was approximately 37% (as reported by AIB, keeping in mind that there is limited demand for mortgages). While we believe that, as soon as the operating environment will materially improve, foreign banks will come back to Ireland thus potentially eroding the AIB's market share, we consider its franchise sustainable and consequently a key rating driver in our assessment. Following the approval of its restructuring plan, AIB is in the process of simplifying its business model and focusing on its core target customers, identified in retail, SMEs and corporate sectors. The bank is also undertaking a series of initiatives to streamline its organisation and develop a digital offering to its customers, targeting mobile and on-line users. Furthermore the new management, appointed in 2011, engaged the organization in reviewing its risk management system and creating a fully dedicated structure to manage problem loans, whose results are already visible. While AIB is primarily focused on Ireland, with 79% of its loan book located in its home country as of end-1h2014, it also has some operations abroad and in particular in UK, which accounts for 18% of the lending portfolio at the same date and provides some geographical diversification. Given its importance in the domestic banking system, AIB bank is one of the `pillar banks' for the Irish economy, following the restructuring of the domestic banking sector. STABILISATION OF ASSET QUALITY METRICS, BUT DOWNSIDE RISKS REMAIN Asset quality metrics are strengthening on the back of a favorable operating environment, improved work out strategies and sale of non-performing assets. However AIB's risk profile remains weak, weighted down by the very large stock of problem loans. The amount of problem loans decreased to EUR26 billion at end-1h2014 from EUR28.9 billion of end-2013, bringing the problem loans to gross loans ratio to 32.5% (coverage at 59.1%) from 34.9% of end-2013 (coverage at 59.1%). Despite the improvement, problem loans over the sum of loan loss provisions and equity remained elevated at 105% (2013:112%), indicating that downside risks are still material. While we appreciate the positive trend in asset quality metrics, with problem loans further going down to EUR24.3 billion at end-3q2014, and the increase in transparency, since the various regulatory exercises and stress tests have largely uncovered the risks in AIB's loan book, thus reducing the potential unexpected credit losses, we note that the stock of problem loans remains much higher compared to domestic peers and equally rated banks in Europe and acts as constraint to the bank's rating. The main areas of concern for the bank continue to be the Irish mortgage and commercial lending portfolios. Irish mortgages over 90 days in arrears and/or impaired have risen to EUR9.3 billion at end-1h2014, representing 23% of the lending book. Asset quality is worse in the buy-to-let book, where 52% was impaired or over 90 day in

4 arrears at the same date, compared with 18% in the owner-occupied book. At the same date, EUR5.4 billion of Irish mortgages were subject to some kind of forbearance, 63% of which were impaired or in arrears. As for other domestic banks, we expect that the legacy portfolio of residential mortgages will require a long period of time to wind down, given the current low level of repossessions operated by banks, which is not expected to materially change in the next two years. However we note that: (1) the increase in property price is mitigating the pressure on the portfolio - the weighted average Loan-to-Value ratio for AIB's residential mortgage book went down to 95% in August 2014, compared to 108% of August 2013, as the property prices went up by 14.9% in the year to August; (2) residential mortgage portfolios are generally more granular, liquid and transparent compared to other asset classes. Albeit still very weak, the asset quality metrics in the other portfolios are improving: the commercial real estate book was 60% impaired at end-1h2014 (67% at end-2013), with a provision coverage of 68% (64% at end-2013). The non real-estate commercial and corporate lending book was 26% impaired at the end-1h2014 (29% at end- 2013). We expect the metrics in these categories to improve at a faster pace, as AIB demonstrated a successful track-record in restructuring the loans in these books. We view positively the outcome of the ECB's Asset Quality review, since the proposed negative adjustment was very limited (equal to 35 bps to the bank's Common Equity Tier 1 - CET1 - ratio as of December 2013 or approximately 1% of the bank's provisions of EUR17.1 billion at the same date) and only related to the corporate portfolio. Additionally, we believe that AIB has already addressed at least part of the suggested adjustments. In our view, this limited proposed adjustment reflects the outcome of the Balance Sheet Assessment performed by the Central Bank of Ireland in 2013, which advised AIB and other Irish financial institutions to make adjustments on their coverage. ADEQUATE CAPITALISATION UNDER CURRENT RULES, ALBEIT UNCERTAINTY PERSISTS OVER THE REPLACEMENT OF NON-QUALIFYING CAPITAL INSTRUMENTS UNDER CRD IV AIB reported a transitional CET1 ratio of 16.1% (fully loaded 11.8%) as of end-1h2014, up from a pro-forma 15.0% (10.5%) of 1 January 2014, mainly due to the bank's return to profitability in the first half of 2014 and other revaluation components. The large gap between the transitional and the fully loaded ratios is driven by the material amount of Deferred Tax Assets (DTAs), which accounted for EUR3.7 billion or 39% of the CET1 capital at end- 1H2014. While we see DTAs as weakness for AIB, we note that: (1) DTAs deduction will be phased in over 10 years from 2015; and (2) part of them will be converted into tax credits, as AIB is returning to profitability. Excluding the 2009 preference shares, fully owned by the government, which will be considered as CET1 capital until end-2017, the fully loaded end-1h2014 CET1 ratio goes significantly down to 5.9%. The potential challenge the bank may face to replace these capital instruments is a negative rating driver and we believe that a clarification of AIB's capital structure is needed if the Irish government wants to go ahead with the plan of returning AIB to private investors. However we see this uncertainty more as a regulatory issue rather than something that may affect the solvency profile of the bank because we note that: (1) AIB does not need to cover any shortfall, as the capital is already there; and (2) in the scenario where the bank would not be able to convert the preference shares into common equity, these instruments will be considered as lower Tier 2 notes, and as such, still bail-in-able: consequently the nominal value of the loss absorbing liabilities of the bank will not change. The ECB's Comprehensive Assessment confirmed the bank's adequate capital position on a transitional CRD IV basis. The bank's capital ratios exceed the ECB's CA thresholds both under the base and the adverse scenarios over the time horizon. In addition, as the bank's restructuring plan was approved after 31 December 2013, AIB's balance sheet was assessed on both a static and dynamic basis, resulting in a capital in excess of the 5.5% minimum required threshold of 1.42% and 4.76% CET1 respectively under the adverse scenario. RETURN TO PROFITABILITY, ALTHOUGH AT WEAK LEVELS AIB's return to profitability reflects the actions taken by the bank to restore its business model, the improved economic environment and a effective implementation of its restructuring plan. We believe that the return to profitability is sustainable and should increase over the next two years, albeit at moderate pace. AIB reported a profit before tax of EUR437 million in the first six months of 2014 compared to the EUR838 million loss accounted a year earlier. The bank's return to pre-tax profitability is primarily underpinned by the significant reduction in impairment charges to EUR92 million from EUR738 million registered in the first half of 2013, reflecting the stabilization of asset quality and the writeback of some provisions due to the improved economic environment. Net interest income went up by 17% year-on-year (yoy), with also net interest margin increasing to 1.6% as of June 2014 from 1.28% a year earlier, excluding Eligible Liability Guarantee (ELG) fees, on the back of lower

5 funding costs and NAMA bonds repayments. AIB's performance in the first half of the year also benefited from the ELG costs' reduction by 91 million or 74% yoy, as a result of the expiration of the ELG scheme in March However, the bank's mortgage yields will remain constrained, since 40% of its Irish mortgage book was on tracker rates at end-1h2014. The group has also been able to significantly improve its efficiency metrics following a cost reduction of EUR68 million (9%) yoy, primarily driven by the 10% reduction in employees since June 2013 as part of the voluntary severance/early retirement schemes. AIB's cost to income ratio decreased to 59% in the first half of 2014 from 109% in the same period of 2013, according to our own calculations. The bank is in good shape to meet its EUR350 million cost reduction target in 2014 relative to 2012 levels. AIB also benefited from the reduction in losses stemming from non-recurring transactions, mainly related to absence of losses on disposals of loans to NAMA, which accounted for EUR211 million loss in the first half of The positive trend in profitability visible in 1H2014 continued also in the third quarter of the year, the internal capital generation capacity allowed the bank to increase its transitional CET1 ratio to 16.5%. IMPROVING FUNDING PROFILE AND LIQUIDITY POSITION The drastic loan deleveraging and early NAMA bonds repayments, combined with an increasing focus on long term funding, have materially reduced AIB's funding gap and its reliance on central bank's funds, bringing its funding profile to a normalised level. AIB has demonstrated a consistent capacity to access the wholesale markets over the last years and improved its liquidity position. These elements are key rating drivers in our assessment. AIB's funding profile continues to improve, underpinned by its reduced reliance on Monetary Authorities funding, which has declined to EUR2.4 billion as of end-3q2014 from EUR12.7 billion at end As a result, retail funding as percentage of total funding went up to 64% as of end-1h2014, compared to 60% of end-2013, reflecting broadly stable customer deposits at EUR67 billion as of end-1h2014 (end-2013: EUR65.7 billion) and the deconsolidation of Ark Life's assets and liabilities following its disposal in May The bank's sustained deleveraging process has resulted in a continued reduction of its gross loan to deposit ratio, which stood at 119% at the end-1h 2014 (end-2013: 131%), as calculated by Moody's. Aside from the impact of negative net lending, we do not expect significant improvement in this ratio, as non-core deleveraging is now complete. The liquidity position of the bank is satisfactory and supported by EUR20 billion debt securities portfolio, primarily composed of Irish Government bonds. In terms of Basel III liquidity requirements, AIB reported a Liquidity Coverage Ratio of 115% and a Net Stable Funding Ratio of 114% as of end-3q2014. Finally, AIB continued to show access to wholesale markets through the issuance of a EUR500 million 5 year senior unsecured issue and EUR500 million 7 year ACS in the first half of the year. These key issuances indicate a renewed market appetite for AIB debt, potentially leading the way to a more normalised access to market funding. Global Local Currency Deposit Rating (Joint Default Analysis) AIB's long-term global local currency (GLC) deposit rating is Ba2. This incorporates two notches of rating uplift from the stand-alone rating, reflecting the explicit support received by the institution from the Irish government and Moody's expectation that further support for the deposits would likely be forthcoming in the event of need. This is based on the supportive attitude of the Irish government towards depositors as witnessed by the 2011 transfer orders to sell the deposits of Anglo Irish Bank and Irish Nationwide Building Society to Allied Irish Banks and Irish Life & Permanent. The outlook is negative. Notching Considerations As detailed above, unguaranteed senior unsecured debt is rated Ba3. The outlook is stable in line with that of the bank's BFSR. Foreign Currency Deposit Rating Moody's assigns ratings of Ba2/Not-Prime to AIB's foreign currency deposits. The outlook on the ratings is negative. Foreign Currency Debt Rating

6 Moody's assigns a rating of Ba3/Not-Prime to AIB's unguaranteed senior unsecured foreign currency debt. The outlook on the ratings is stable. Rating Factors ALLIED IRISH BANKS, P.L.C. Rating Factors [1] A B C D E Total Score Qualitative Factors (50%) D+ Factor: Franchise Value D Market share and sustainability x Geographical diversification x Earnings stability x Earnings Diversification [2] Factor: Risk Positioning D Corporate Governance [2] x - Ownership and Organizational Complexity x - Key Man Risk - Insider and Related-Party Risks Controls and Risk Management x - Risk Management x - Controls x Financial Reporting Transparency x - Global Comparability x - Frequency and Timeliness x - Quality of Financial Information x Credit Risk Concentration Borrower Concentration Industry Concentration Liquidity Management x Market Risk Appetite x Factor: Operating Environment B- Economic Stability x Integrity and Corruption x Legal System x Financial Factors (50%) D- Factor: Profitability E PPI % Average RWA (Basel III - transitional phase-in) -1.09% Net Income % Average RWA (Basel III - transitional phasein) -4.59% Factor: Liquidity E+ (Market Funds - Liquid Assets) % Total Assets 16.21% Liquidity Management x Factor: Capital Adequacy A Tier 1 Ratio (%) (Basel III - transitional phase-in) 12.27% Tangible Common Equity % RWA (Basel III - transitional phase-in) 11.69% Factor: Efficiency E Cost / Income Ratio % Factor: Asset Quality E Problem Loans % Gross Loans 31.00% Problem Loans % (Equity + LLR) % Trend

7 Lowest Combined Financial Factor Score (15%) E Economic Insolvency Override Neutral Aggregate BFSR Score D Aggregate BCA Score ba2 Assigned BFSR E+ Assigned BCA b1 [1] - Where dashes are shown for a particular factor (or sub-factor), the score is based on non-public information. [2] - A blank score under Earnings Diversification or Corporate Governance indicates the risk is neutral. This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history Moody's Corporation, Moody's Investors Service, Inc., Moody's Analytics, Inc. and/or their licensors and affiliates (collectively, "MOODY'S"). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. ("MIS") AND ITS AFFILIATES ARE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODY'S ("MOODY'S PUBLICATION") MAY INCLUDE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY'S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODY'S OPINIONS INCLUDED IN MOODY'S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. MOODY'S PUBLICATIONS MAY ALSO INCLUDE QUANTITATIVE MODEL-BASED ESTIMATES OF CREDIT RISK AND RELATED OPINIONS OR COMMENTARY PUBLISHED BY MOODY'S ANALYTICS, INC. CREDIT RATINGS AND MOODY'S PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS AND MOODY'S PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. NEITHER CREDIT RATINGS NOR MOODY'S PUBLICATIONS COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODY'S ISSUES ITS CREDIT RATINGS AND PUBLISHES MOODY'S PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL, WITH DUE CARE, MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE. MOODY'S CREDIT RATINGS AND MOODY'S PUBLICATIONS ARE NOT INTENDED FOR USE BY RETAIL INVESTORS AND IT WOULD BE RECKLESS FOR RETAIL INVESTORS TO CONSIDER MOODY'S CREDIT RATINGS OR MOODY'S PUBLICATIONS IN MAKING ANY INVESTMENT DECISION. IF IN DOUBT YOU

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