Ulster Bank Ireland DAC

Transcription

1 CREDIT OPINION 2 August 27 Post Rating Action Update Update Summary Rating Rationale RATINGS Ulster Bank Ireland DAC Domicile Dublin, Ireland Long Term Debt Withdrawn Type Senior Unsecured Dom Curr Outlook Not Assigned Long Term Deposit Baa2 Type LT Bank Deposits - Fgn Curr Outlook Stable Please see the ratings section at the end of this report for more information. The ratings and outlook shown reflect information as of the publication date. Contacts Roland Auquier AVP-Analyst/MDG roland.auquier@moodys.com Maija Sankauskaite Associate Analyst maija.sankauskaite@moodys.com Irakli Pipia VP-Sr Credit Officer irakli.pipia@moodys.com Laurie Mayers Associate Managing Director laurie.mayers@moodys.com Nick Hill MD-Banking nick.hill@moodys.com Ulster Bank Ireland DAC On 2 June 27 we upgraded Ulster Bank Ireland DAC's (UBID) long-term deposit and issuer ratings to Baa2 and Baa from Baa and Ba, respectively. The outlook on both ratings was changed to stable from positive. The upgrade was underpinned by () the upgrade of the bank's adjusted baseline credit assessment (BCA) to baa from ba; and (2) the results of our Advanced Loss Given Failure (LGF) analysis, which leads to a baa2 Preliminary Rating Assessment (PRA) for deposits and a baa PRA for senior unsecured debt. We also upgraded UBID's standalone BCA to ba from ba2. The bank's Counterparty Risk Assessment (CR Assessment) was upgraded to A(cr)/Prime-2(cr) from Baa(cr)/Prime-2(cr). The upgrade of the bank s BCA to ba incorporates: () the successful deleveraging measures undertaken by the bank in order to restore its balance sheet, leading to a reduction of 8% in impaired loans to.7 billion (5.9% of gross loans) at December 26 from the peak level of 9.2 billion (44.6% of gross loans) at December 2; (2) very high capital levels, which will remain elevated despite our expectation of a decline over the outlook period following dividend payments to RBS; () weak, but improving quality of earnings and pre-provision profitability; and (4) balanced funding profile and comfortable liquidity position. The upgrade of bank s adjusted BCA follows the upgrade of the BCA of UBID s parent, The Royal Bank of Scotland plc (RBS, A2/A stable, baa) on 5 June 27, as we continue to incorporate a very high likelihood of affiliate support and our view that UBID remains an integral part of RBS's current strategy. The positive outlook on UBID s long-term ratings is in line with the outlook on RBS's ratings.

2 Exhibit Key Financial Ratios Median ba-rated banks % % 25% 25% 2% 2% 5% 5% % % Liquidity Factors Solvency Factors UBID (BCA: ba) 5% 5% 5% 5.9%.9% Asset Risk: Problem Loans/ Gross Loans Capital: Tangible Common Equity/Risk-Weighted Assets %.4% Profitability: Net Income/ Tangible Assets 2.8% 2.7% Funding Structure: Market Funds/ Tangible Banking Assets Liquid Resources: Liquid Banking Assets/Tangible Banking Assets % Solvency Factors (LHS) Liquidity Factors (RHS) December 26 data for UBID Source: Moody's Banking Financial Metrics Credit Strengths Strong capital ratios, which we expect to decline owing to dividend payments, but to remain adequate in relation to the bank's risk profile; Solid funding profile, primarily made of retail and corporate deposits; and Comfortable liquidity position, supported by a portfolio of high-quality liquid assets. Credit Challenges Sizeable stock of problem loans, although declining and adequately provisioned, and large share of loans in forbearance and negative equity; Weak pre-provision profitability, although expected to gradually improve over the outlook period. Rating Outlook The positive outlook on UBID s long-term ratings is in line with the outlook on it's parent company's, RBS, ratings. Factors that Could Lead to an Upgrade UBID's BCA could be upgraded if the bank continues to strengthen its credit fundamentals, reduces the amount of legacy and nonperforming assets on its balance sheet and improves its pre-provision profitability. UBID's deposit and issuer ratings could be upgraded if RBS's own creditworthiness were to improve further. Factors that Could Lead to a Downgrade UBID's BCA could be downgraded due to a decline in its capital levels beyond that already factored into Moody's assessment; a significant increase in the use of market funding; or a deterioration in the bank's liquidity position. A downgrade of RBS's BCA could result in a reduced capacity to support UBID and therefore downgrades to all UBID's instrument ratings. 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. 2 2 August 27

3 Key Indicators Exhibit 2 Ulster Bank Ireland DAC (Consolidated Financials) [] Total Assets (EUR million) Total Assets (USD million) Tangible Common Equity (EUR million) Tangible Common Equity (USD million) Problem Loans / Gross Loans (%) Tangible Common Equity / Risk Weighted Assets (%) Problem Loans / (Tangible Common Equity + Loan Loss Reserve) (%) Net Interest Margin (%) PPI / Average RWA (%) Net Income / Tangible Assets (%) Cost / Income Ratio (%) Market Funds / Tangible Banking Assets (%) Liquid Banking Assets / Tangible Banking Assets (%) Gross Loans / Due to Customers (%) ,694 2,75 6,484 6, ,9,696 7,84 8, ,84 4,949 6,527 7, ,75 48,745 4,6 6, CAGR/Avg.4 4,879 5,894 7,9, [] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel III - fully-loaded or transitional phase-in; IFRS [] Basel II; IFRS [4] May include rounding differences due to scale of reported amounts [5] Compound Annual Growth Rate (%) based on time period presented for the latest accounting regime [6] Simple average of periods presented for the latest accounting regime. [7] Simple average of Basel III periods presented Source: Moody's Financial Metrics Detailed Rating Considerations The financial data in the following sections are sourced from the UBID's consolidated financial statements unless otherwise stated. Despite rapid deleveraging, the stock of problem loans remains high; downside risks are aggravated by a large share of forborne loans and loans in negative equity UBID was one of the most severely hit institutions by the recent financial crisis, but the bank undertook drastic efforts in loan deleveraging and the restoring of its balance sheet. In 2 UBID s parent company established the RBS Capital Resolution Ireland (RCRI) segment to manage an accelerated reduction in the Group s non-performing capital intensive assets. A portfolio of 4.8 billion of net assets was identified to be managed by RCRI, which has now been entirely run down. The measures undertaken resulted in impaired loans reducing by 8% to.7 billion at December 26 from the peak level of 9.2 billion at December 2. The reduction was primarily driven by the sale of non-performing portfolios, but the pace of migration to newly impaired loans declined as well, as economic conditions in Ireland improved. Nevertheless, UBID s stock of problem loans remains high (.7 billion, or 5.9% of gross lending, at December 26) and continues to weigh down on the bank's standalone assessment. Provision coverage of problem loans at 7% is lower than the level of peers, but when taking into account UBID s higher capital level, we view the overall coverage of problem loans is adequate (problem loans over tangible common equity and loan loss reserves ratio of 47% at December 26 versus a range of 6%-5% for Irish peers). 2 August 27

4 Exhibit The bank's deleveraging efforts resulted in a substantial improvement in asset quality, but the stock of problem loans remains relatively high Impaired loans, bn (LHS) Loan loss reserves/impaired loans, %(RHS) Impaired loans/gross loans, % (RHS) Problem Loans/(Tangible Common Equity + Loan Loss Reserve), %(RHS) 2 % 8 9% 6 8% 4 7% 2 6% 5% 8 4% 6 % 4 2% 2 % % Source: Moody's Banking Financial Metrics We expect the bank to continue to reduce the stock of non-performing assets, aided by the favourable operating environment in Ireland. However, we anticipate a material slowdown in the rate of improvements: now that the disposals of distressed loan portfolios have largely been complete, the vast majority of the remaining problem loans is concentrated in the bank s retail portfolio (.4 billion impaired, or 9% of lending to individuals). For comparison, the bank s commercial property portfolio, which reduced to. billion at December 26 ( 2.8 billion at December 25), is 8% impaired, and its non-property commercial loan book has 4% of impaired loans. As for other domestic banks, we expect that UBID s non-performing residential mortgages will require a long time to be worked out, given the current low level of repossessions by banks, which is not expected to materially change in the near term. In addition to the overall high level of problem loans UBID has a large portion of loans in negative equity - 4% of loans had loan-tovalue ratio in excess of % at December 26. Although the share of loans in negative equity has been reducing, supported by strong recovery in the Irish house prices. Another area of concern is the large amount of forborne loans ( 5. billion at December 26), which we believe have a higher probability of falling back into non-performing. We also view negatively that the bank is overly reliant on less sustainable solutions for customers, such as payment concessions (62% of forborne loans). Given the remaining downside risks from a large stock of impaired loans, a large share of forborne loans and loans in negative equity, we assign a caa Asset Risk score to UBID. Strong capital ratios which, although expected to decline, will remain adequate for the bank s risk profile Owing to the historical capital injections from RBS, deleveraging and improved profitability over the past two years, UBID now benefits from solid capital levels. Its Common Equity Tier (CET) was broadly unchanged at 29.8% at December 26 as the reduction in riskweighted assets during the course of 26 offset the.5 billion dividend payment to the parent. We calculate a tangible common equity to tangible banking assets ratio of.9% at December 26 for UBID. The bank currently has the highest capital ratios among peers. But we expect the capital levels to decrease in the near term. Given the progress in deleveraging and de-risking of the bank and the return to statutory profitability, we expect that UBID will continue to repatriate capital to its parent over the outlook period. Nevertheless, any capital repatriation is subject to the approval of the joint supervisory team of the European Central Bank (ECB) and the Central Bank of Ireland who have set minimum capital guidance and conditions for dividend payments. We therefore expect that UBID will maintain a level of capitalisation adequate to its risk profile. Despite the expected decline, we continue to view ample capitalisation as UBID's key rating strength, as reflected in the assigned Capital score of a2. The score also takes into account future dividend payments to the parent, the bank's currently weak ability to generate capital organically as well as the vulnerability of the capital position to a potential stress in the the still sizeable stock of problem loans. 4 2 August 27

5 Pre-provision profitability is weak, but we expect it to improve over the outlook period Similar to the previous two years, UBID s profitability in 26 was supported by write-backs of loan loss provisions ( 8 million, down from 929 million in 25). We do not consider the release of loan impairment charges a sustainable profitability driver and anticipate the bank's bottom-line profitability will decrease to a more modest level over the outlook period, as the bank's cost of risk (measured as impairment charges over gross loans) starts to normalise. On the positive side, we expect gradual improvements in pre-provision profitability, as the bank replaces legacy low-yielding tracker mortgages (.8 billion, or 49% of the loan book) with new lending and implements its costs saving programme. Exhibit 4 Substantial write-backs of loan loss provisions contributed to profitability in Loan loss provisions, bn (LHS) Net income/tangible assets, % (RHS) 6 % 5 5% 4 % 2-5% - -% -2-5% Source: Moody's Banking Financial Metrics UBID s net interest income increased by % to 489 million in 26, as improved lending margins and re-pricing actions taken on deposits outweighed the lower income on free funds and the negative impact of loan book reduction. The bank s net interest margin improved to.47% in 26 from.9% in 25, according to our calculations, but remains low compared to higher rated peers, due to a larger proportion of tracker loans. Reported non-interest income decreased from to 77 million from 242 million in 25, driven by reduced income on interest rate swaps, lower fees receivable as a result of reduced loan volumes and lower gains on asset disposals. The bank's cost base remains elevated ( we calculate 5% cost-to-income ratio in 26, or 85% if adjusted for conduct charges which the bank reports in operating costs) and is a drag on profitability. In 26 UBID commenced a bank-wide transformation programme, and realigning operating expenses to the resized balance sheet is one of its central areas of focus. We expect investments in the bank's digitalisation and simplification to start materialising into cost savings towards the end of the outlook period. Following the launch of the Tracker Mortgage Examination by the Central Bank of Ireland (CBI), UBID recorded a 98 million provision charge in 26 in respect of potential non-compliance. In addition, UBID provisioned for customer redress related to the Financial Conduct Authority s review of complex fees charged to SME customers during the period CBI requires that banks complete the identification of impacted tracker mortgage customers by the end of September. We therefore believe some further conduct provisions are likely in 27, but do not expect them to be at the level recorded in 26. We assign a Profitability score of b to the bank, which reflects our anticipation of a gradual improvement in UBID's core profitability, but also takes into account the volatility of earnings and a possibility of unexpected further conduct charges or credit losses. Stabilised funding profile and sufficient liquidity We consider UBID s funding structure a relative strength. The ongoing loan deleveraging, combined with an increased focus on long term funding, has materially reduced UBID s funding gap and its reliance on parent funding, bringing its funding profile more in line with its Irish peers. The intra-group funding was fully repaid in 25. The bank's gross loan-to-deposit ratio is still high at 2% at December 26, but we expect it to decline further: the bank has demonstrated strong growth in deposit balances in 26 (up 5% to 9 billion), while the loan book has continued to shrink. We calculate market funds over tangible banking assets ratio of 2.8% at December 26, the level broadly in line with Irish peers. We do not expect any material changes in the bank's funding structure in the near term and therefore assign a Funding Structure score of a. 5 2 August 27

6 The liquidity position is another relative strength for UBID s BCA, as indicated by our assigned score of baa2, and has notably improved over the last couple of years, largely driven by deleveraging and limited new business lending. The bank's liquid banking assets to tangible banking assets ratio was 2.6% at December 26 and we expect it to remain broadly stable over the outlook period. Notching Considerations Affiliate Support UBID's adjusted BCA of baa is based on our assessment of a high probability of affiliate support coming from its parent, RBS, and resulting in one notch of uplift from the BCA. As a reference point for the creditworthiness of RBS to arrive to UBID's adjusted BCA, we use the parent's BCA of baa. RBS has reiterated its commitment to position UBID as a challenger bank to the domestic pillar banks in Ireland. Consequently, we expect that RBS will continue to maintain a high level of commitment toward UBID. Loss Given Failure UBID is subject to the EU Bank Recovery and Resolution Directive, which we consider to be an Operational Resolution Regime. As a result, in accordance with our methodology, we apply our LGF analysis, considering the risks faced by the different debt and deposit classes across the liability structure should the bank enter resolution. We assume residual tangible common equity of % and losses post-failure of 8% of tangible banking assets, a 25% run-off in junior wholesale deposits, a 5% run-off in preferred deposits, and assign a 25% probability to deposits being preferred to senior unsecured debt. We also assume that the junior proportion of UBID's deposits is in line with its estimated EU-wide average of 26%. These are in line with our standard assumptions. RBS Group plc has determined with its regulator that it would apply a so-called Single Point of Entry resolution strategy. Nevertheless, Moody's considers that, in the event of a failure of UBID, the risk of the bank's liabilities would likely be determined by its own balance sheet characteristics, rather than being fungible with those of the UK subsidiaries of RBS Group plc. The agency therefore performs its Advanced LGF analysis on the basis of UBID's own liability structure. Our advanced LGF analysis indicates that UBID's deposits are likely to face low loss-given-failure due to the loss absorption provided by the presence of a modest amount of subordinated debt in the UBID's liability structure, as well as the substantial volume of deposits themselves. This results in the preliminary rating assessment (PRA) of baa2, one notch above the baa adjusted BCA. The bank's issuer rating of Baa reflects the moderate loss-given-failure it is likely to face driven by the combination of no senior unsecured debt in the liability structure and the modest amount of debt subordinated to it. This results in a PRA at the same level as the adjusted BCA. Government Support The implementation of the BRRD has caused us to reconsider the potential for government support to benefit certain creditors. We now expect a low probability of government support for UBID's deposits and senior unsecured debt, resulting in no uplift from the PRA. Counterparty Risk Assessment UBID's CR Assessment is positioned at A(cr)/Prime-2(cr). The CR Assessment, is positioned three notches above the adjusted BCA of baa, based on the cushion against default provided to the senior obligations represented by the CR Assessment by subordinated instruments. The main difference with our Advanced LGF approach used to determine instrument ratings is that the CR Assessment captures the probability of default on certain senior obligations, rather than expected loss, therefore we focus purely on subordination and take no account of the volume of the instrument class. 6 2 August 27

7 Rating Methodology and Scorecard Factors Exhibit 5 Ulster Bank Ireland DAC Macro Factors Weighted Macro Profile Strong Factor Historic Macro Ratio Adjusted Score Credit Trend Assigned Score Key driver # Key driver #2 Solvency Asset Risk Problem Loans / Gross Loans 27.8% caa caa Quality of assets Long-run loss performance Capital TCE / RWA.9% aa2 a2 Capital retention Stress capital resilience Profitability Net Income / Tangible Assets.4% ba b Earnings quality Combined Solvency Score Liquidity Funding Structure Market Funds / Tangible Banking Assets 2.8% a a Expected trend Liquid Resources Liquid Banking Assets / Tangible Banking Assets ba ba2 2.6% baa2 baa2 Expected trend Combined Liquidity Score Financial Profile Business Diversification Opacity and Complexity Corporate Behavior Total Qualitative Adjustments Sovereign or Affiliate constraint: Scorecard Calculated BCA range Assigned BCA Affiliate Support notching Adjusted BCA baa Balance Sheet in-scope (EUR million),75 8,954 4,26 4, ,694 Other liabilities Deposits Preferred deposits Junior Deposits Junior subordinated bank debt Equity Total Tangible Banking Assets 7 % 2 August 27 baa ba A baa-ba2 ba -baa % in-scope 4.9% 6.8% 45.7% 6.%.%.% % at-failure (EUR million),75 8,954,25, ,694 % at-failure 4.9% 6.8% 4.4% 2.%.%.% %

8 Debt class Counterparty Risk Assessment Deposits Senior unsecured bank debt Instrument class De Jure waterfall De Facto waterfall Notching LGF Assigned Additional Preliminary LGF notching Rating Instrument Sub- Instrument SubDe Jure De Facto Notching Guidance notching Assessment volume + ordination volume + ordination vs. subordination subordination Adjusted BCA a (cr).%.% baa2.%.%.% - baa Loss Given Failure notching Counterparty Risk Assessment Deposits Senior unsecured bank debt Additional Preliminary Rating Notching Assessment a (cr) baa2 baa Government Support notching Local Currency Rating A (cr) Baa2 Baa Foreign Currency Rating -Baa2 -- Source: Moody's Financial Metrics Ratings Exhibit 6 Category ULSTER BANK IRELAND DAC Outlook Bank Deposits Baseline Credit Assessment Adjusted Baseline Credit Assessment Counterparty Risk Assessment Issuer Rating -Dom Curr ST Issuer Rating -Dom Curr Moody's Rating Stable Baa2/P-2 ba baa A(cr)/P-2(cr) Baa P- ULT PARENT: THE ROYAL BANK OF SCOTLAND GROUP PLC Outlook Senior Unsecured Subordinate Jr Subordinate Pref. Stock Pref. Stock Non-cumulative Preference Shelf Commercial Paper Other Short Term Stable Baa Ba2 Ba2 (hyb) Ba2 (hyb) Ba (hyb) (P)Ba P- (P)P- Source: Moody's Investors Service 8 2 August 27

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