Credit Opinion: Ulster Bank Ireland Limited

Transcription

1 Credit Opinion: Ulster Bank Ireland Limited Global Credit Research - 26 Mar 2015 Dublin, Ireland Ratings Category Outlook Bank Deposits Baseline Credit Assessment Adjusted Baseline Credit Assessment Senior Unsecured MTN Subordinate Commercial Paper -Dom Curr Other Short Term Ult Parent: 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 Moody's Rating Rating(s) Under Review *Baa3/*P-3 b3 **baa3 **(P)Baa3 **Ba2 **P-3 **(P)P-3 Rating(s) Under Review ***Baa2 ****B1 *****B1 (hyb) *****B1 (hyb) *****B2 (hyb) ****(P)B2 ***P-2 ***(P)P-2 * Rating(s) within this class was/were placed on review on March 19, 2015 ** Placed under review for possible downgrade on March 19, 2015 *** Placed under review for possible downgrade on March 17, 2015 **** Rating(s) within this class was/were placed on review on March 17, 2015 ***** Placed under review for possible upgrade on March 17, 2015 Contacts Analyst Phone Dany Castiglione/London Carlos Suarez Duarte/London Johannes Wassenberg/London Maija Sankauskaite/London Key Indicators Ulster Bank Ireland Limited (Consolidated Financials)[1] [2]12-13 [2]12-12 [2]12-11 [2]12-10 [2]12-09 Avg. Total Assets (EUR million) 35, , , , ,992.0 Total Assets (USD million) 48, , , , ,160.3 [3]-8.7 [3]-9.7 Tangible Common Equity (EUR million) 4, , , , ,076.0 [3]3.1

2 Tangible Common Equity (USD million) 6, , , , ,848.0 [3]2.1 Problem Loans / Gross Loans (%) [4]31.9 Tangible Common Equity / Risk Weighted Assets (%) [5]14.5 Problem Loans / (Tangible Common Equity + Loan Loss Reserve) (%) [4]103.4 Net Interest Margin (%) [4]1.3 PPI / Average RWA (%) [5]1.0 Net Income / Tangible Assets (%) [4]-6.6 Cost / Income Ratio (%) [4]60.8 Market Funds / Tangible Banking Assets (%) [4]39.3 Liquid Banking Assets / Tangible Banking Assets (%) [4]13.8 Gross Loans / Total Deposits (%) [4]160.8 Source: Moody's [1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel II; IFRS [3] Compound Annual Growth Rate based on IFRS reporting periods [4] IFRS reporting periods have been used for average calculation [5] Basel II & IFRS reporting periods have been used for average calculation Opinion SUMMARY RATING RATIONALE On March 19 we placed Ulster Bank Ireland Limited (UBIL)'s long-term deposit and senior unsecured debt ratings of Baa3, as well as the bank's Ba2 subordinated debt rating, on review for downgrade. We also placed UBIL's short term deposit/cd Program rating of P-3 and Commercial Paper rating of P-3 under review for downgrade. Moreover, we placed UBIL's adjusted Baseline Credit Assessment (BCA) of baa3 on review for downgrade: while we are still of the opinion that the bank benefits from a very high likelihood of support coming from Royal Bank of Scotland plc (RBS - rated Baa1/Baa1 on Review for Upgrade; ba1), we believe that UBIL would not potentially benefit from the systemic support that is incorporated in the ratings of RBS. The very high level of parental support incorporates our view that the Ulster Bank Group (including both Ulster Bank Limited - UBL - incorporated in Northern Ireland and its wholly-owned subsidiary - UBIL - incorporated in the Republic of Ireland) remains as an integral part of RBS's current strategy. The bank's b3 BCA remains unchanged and reflects (1) the bank's significant asset quality challenges, (2) the downside risks associated with RBS' planned cost restructuring and disposals and (3) UBIL's ongoing dependence on parental support for funding and capital (if required). The review for downgrade on the deposit, senior and subordinated unsecured debt ratings, as well as for short term deposits and adjusted BCA, for UBIL was underpinned by the bank's standalone credit strength and also takes into account the introduction of our new methodology, and specifically our advanced Loss Given Failure (LGF) analysis. The review will use 2014 full year results and, as a consequence, the ratios listed in the analysis below may change or be reviewed. UBIL'S BCA IS UNDERPINNED BY ITS MODERATE MACRO PROFILE The `Moderate' macro profile of UBIL is driven by its exposure to Ireland. Irish banks benefit from a dynamic and open economy with a very high level of wealth, which counterbalance the country's relatively small GDP. Ireland's very high institutional strength allowed policymakers to effectively address the ramifications of the financial crisis through successive administrations, while susceptibility to event risk is low and primarily driven by external factors. Despite the material deleveraging of the private sector over the past three years, the stock of private debt remains elevated and will continue to weigh down banks' credit fundamentals. Funding conditions have materially improved, but we expect banks' access to capital to remain limited. Additionally, even though the industry structure is highly concentrated, the barriers to entry are relatively low compared with other non-european countries. RATING DRIVERS - Ongoing asset quality challenges pose downside risks

3 - RBS' restructuring plan affects Ulster Group's strategy - Reliance on high level of support from RBS for capital and funding - Change in affiliate support assumptions Rating Outlook The review on UBIL's long-term deposit, senior unsecured and subordinated ratings, as well as on the bank's adjusted BCA, was triggered by the introduction of our new methodology, and specifically our advanced LGF analysis, which applies to UBIL given that it is subject to an operational resolution regime under the Bank Recovery and Resolution Directive (BRRD). The review will focus on the liability structure, in particular the amount of deposits and senior long-term debt outstanding, and the amount of debt subordinated to both instruments. We expect the ratings of deposits, senior unsecured and subordinated debt to be either affirmed or downgraded by one notch, depending on the degree of loss-given-failure. The review for downgrade is also based on the review of our affiliate support framework for UBIL. WHAT COULD CHANGE THE RATING UP Given the gradual improvement in the operating environment in Ireland, upward pressure on UBIL's BCA could develop from (1) the successful deleveraging and or disposal of the non-core commercial assets in a capital accretive manner; (2) a related decrease in funding needs resulting in a substantial reduction in the dependence on RBS for funding; (3) improvement in the asset quality of the remaining core loan book; and (4) a return to sustainable profitability. A positive change in the bank's adjusted BCA would likely affect all instrument ratings. UBIL's deposit and senior debt ratings could also be upgraded if the bank were to issue significant amounts of senior and/or subordinated long-term debt. WHAT COULD CHANGE THE RATING DOWN Negative pressure on UBIL's BCA and adjusted BCA could develop following (1) any indication of RBS' intention to weaken its ties to Ulster Bank Group; (2) unexpected losses beyond those that Moody's presently estimates will follow the workout of Ulster Bank Group's assets in the RBS Capital Resolution (RCR), resulting in a deterioration of capital levels; or (3) a downgrade of RBS standalone rating with implications for UBIL affiliate support assumptions. A downward movement in UBIL's adjusted BCA would likely result in downgrades to all instrument ratings. DETAILED RATING CONSIDERATIONS ONGOING ASSET QUALITY CHALLENGES POSE SIGNIFICANT DOWNSIDE RISKS Ulster Bank Group (core and RCR) reported a problem loan ratio (defined as Risk Elements in Lending - REIL - over gross loans) of 43.4% at end-2014, slightly below the 45.2% of end-2013 and significantly above the average problem loan ratio of Irish rated banks of about 24.3% at end-1h2014 (see note 1). Overall, we consider Ulster Bank Group's asset quality as a key weakness for the bank's rating, as reflected in our assigned score of caa3 for the Asset Risk. While we expect the improvements in the asset quality in the short-term, we believe the problem loan levels will take a few years to stabilize. The asset quality of Ulster Bank Group's mortgage portfolio has performed relatively better than its Irish peers. The problem loan ratio for this portfolio was 19.4% at end (when the Irish average of mortgage arrears was 25% at end-1h see Note 2). This is partly explained by the lower proportion of buy-to-let mortgages (12% of the portfolio as of end-2014 against an Irish average of 22% as of end-1h Note 3). Impairment charges have decreased materially, as the Group actually did write-backs for GBP172 million in 2014 against loan impairment charges of GBP235 million in A large part of Ulster Bank Group's asset quality issues arise from the exposure to commercial real estate, most of which is being wound down as part of the RCR. Commercial real estate loans in the RCR were 99% impaired at end While this reflects past risk management failures it also reflects the fact that, unlike the domestic Irish banks, Ulster Bank Group did not transfer its CRE development loans to the National Asset Management Agency (NAMA) in 2010.

4 As part of RBS's new strategy for its legacy portfolio announced in November 2013, most of Ulster Bank Group's commercial real estate loans have been targeted for accelerated disposal over the next three years. Between June and December 2014, Ulster Group reduced its commercial real estate loan portfolio by 18.5% to GBP10.1 billion. Additionally, the coverage for impaired commercial real estate loans in the RCR increased to 82% at end from 79% as of end-1h2014. In our view, this reduces the downside risk generated by these exposures and will likely help to improve Ulster Bank Group's asset quality metrics. However, as long as these assets remain on UBIL's balance-sheet, any potential deterioration in the commercial lending market in Ireland would pose negative pressure on the bank's capital ratios because it will limit its ability to sell assets in a capital-accretive way. RBS' RESTRUCTURING PLAN AFFECTS ULSTER GROUP'S STRATEGY Ulster Group's profitability rebounded in 2014, owing to loan provision releases adding up to GBP365 million compared to GBP1.8 billion charges recorded in 2013 following the creation of RCR. Despite the positive result, pre-impairment income remains subdued, because of limited new business activity and the still high proportion of tracker mortgages in the bank's balance sheet (64% of mortgages at end- 2014). We do not consider the reversal in loan impairment charges a sustainable profitability driver and we anticipate the bank to generate only modest results over the outlook period. Based on these elements, we consider the very weak internal capital generation a drag on the bank's rating, as reflected in our caa3 assigned score for the Profitability. The cost-to-income ratio of Ulster Bank Group's is lower than most of its Irish peers as the entity's cost structure benefits from its integration with RBS. However, RBS announced that it is currently reviewing the cost structure of its core businesses including Ulster because it targets a sizable reduction in its cost base. Although we see this as credit positive, we believe that it may carry execution risk since the bank would like to avoid damaging its franchise. RBS has reiterated its commitment to continue doing business in Northern Ireland and to position UBIL as a challenger bank to the domestic pillar banks in the Republic of Ireland. Restructuring costs could have a negative effect in the short to medium term and diminish the franchise value. However, the bank will likely benefit from the gradual recovery of the Irish economy and lower impairment charges as it reduces the size of its non-core portfolio. RELIANCE ON HIGH LEVEL OF SUPPORT FROM RBS FOR CAPITAL AND FUNDING Retail and corporate deposits accounted for about 66% of UBIL's funding at year-end 2013 and the bank relied on RBS and other related parties for 20% of its funding, as reflected in a two-notch downward adjustment to the macro score based on historic ratio and resulting in an assigned Funding Structure score of b1. However, we note that a decrease in its dependency on RBS' funding and a successful run down of the bank's legacy assets would help to improve UBIL's funding profile. Overall, we see the bank's funding profile as a key strength for the rating. We also penalize the Liquidity Resources score taking it down to b1 for the same reason: UBIL's liquidity is primarily driven by deposits from the parent. Despite this negative adjustment, we consider the bank's liquidity position as a positive rating driver. Reflected in the assigned Capital score of b2 is the fact that Ulster has also received significant capital support from RBS over the past years: between 2009 and 2013, UBIL has received a cumulative EUR13.5 billion of capital contribution from RBS. Given the substantial support provided in the past, we assume RBS will continue to support UBIL's compliance with minimum regulatory capital and liquidity requirements. This assumption drives the high level of parental support uplift in UBIL's ratings. Note 1 - Please refer to the Banking Sector Outlook for Ireland, published on 2 March 2015 Note 2 - Source: Central Bank of Ireland "Residential Mortgage Arrears and Repossessions Statistics" Note 3 - Source: Central Bank of Ireland "Residential Mortgage Arrears and Repossessions Statistics" NOTCHING CONSIDERATIONS AFFILIATE SUPPORT UBIL's current adjusted BCA of baa3 is based on our assessment of a very high probability of parental support from its parent RBS. As reference point of the creditworthiness of RBS to arrive to UBIL's adjusted BCA we are currently considering the parent's Baa1 long-term deposit rating, implying that UBIL may indirectly benefit from the

5 UK government support in case of need. Following the introduction of the EU BRRD and in accordance with our methodology, we believe that the currently used reference point for UBIL is no longer valid and that the parent's BCA should instead be used. The change in the reference point is expected to result in a 2-notch downgrade of UBIL's adjusted BCA. However we still expect that RBS will continue to maintain a high level of commitment toward UBIL and the Ulster Group. LOSS GIVEN FAILURE AND ADDITIONAL NOTCHING UBIL is subject to subject to the EU BRRD, 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 3% 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. These are in line with our standard assumptions. For UBIL's deposits, our initial LGF analysis is not conclusive and our review will consider the likely impact on loss-given-failure, due to the loss absorption provided by subordinated debt and, potentially, by senior unsecured debt should deposits be treated preferentially in a resolution, as well as the substantial volume of deposits themselves. Our preliminary analysis indicates a potential outcome of low loss-given-failure, which would result in a Preliminary Rating Assessment (PRA) one notch above the adjusted BCA. For the bank's senior unsecured debt, our initial LGF analysis is less conclusive and our review will consider the likely impact on loss-given-failure of the combination of its own volume and the amount of debt subordinated to it. We expect this will result in a PRA at the same level of the adjusted BCA. For subordinated debt we expect a high loss-given-failure due to the loss absorption provided by its own volume and the amount of debt subordinated to it. 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 UBIL's deposits, resulting in no uplift from the PRA. We expect to assign the same support probability to senior unsecured debt once our review is complete. About Moody's Bank Scorecard Our Scorecard is designed to capture, express and explain in summary form our Rating Committee's judgment. When read in conjunction with our research, a fulsome presentation of our judgment is expressed. As a result, the output of our Scorecard may materially differ from that suggested by raw data alone (though it has been calibrated to avoid the frequent need for strong divergence). The Scorecard output and the individual scores are discussed in rating committees and may be adjusted up or down to reflect conditions specific to each rated entity. Rating Factors Ulster Bank Ireland Limited Macro Factors Weighted Macro Profile Moderate Financial Profile Factor Solvency Asset Risk Problem Loans / Gross Loans Historic Ratio Macro Adjusted Score Credit Trend Assigned Score 44.6% caa3 caa3 Quality of assets Key driver #1 Key driver #2 Long-run loss performance

6 Capital TCE / RWA 11.9% ba1 b2 Expected trend Stress capital resilience Profitability Net Income / Tangible Assets Combined Solvency Score Liquidity Funding Structure Market Funds / Tangible Banking Assets Liquid Resources Liquid Banking Assets / Tangible Banking Assets Combined Liquidity Score -12.1% caa3 caa3 Loan loss charge coverage b3 caa1 28.1% ba2 b1 Market funding quality 16.3% ba2 b1 Stock of liquid assets ba2 b1 Financial Profile b3 Qualitative Adjustments Adjustment Business 0 Diversification Opacity and Complexity 0 Corporate Behavior 0 Total Qualitative Adjustments 0 Expected trend Market access Sovereign or Affiliate constraint Scorecard Calculated BCA range Baa1 b2 - caa1 Assigned BCA b3 Affiliate Support notching -- Adjusted BCA baa3 Possible Instrument Class Loss Given Failure notching Additional notching Preliminary Rating Assessment Government Support notching Local Currency rating Deposits Baa3 RUR Possible Foreign Currency rating Baa3 RUR Possible Senior unsecured bank (P)Baa3 RUR debt Possible Dated subordinated Ba2 RUR

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