Ulster Bank Ireland DAC

Transcription

1 Primary Credit Analyst: Alexandre Birry, London (44) ; Secondary Contact: Sadat Preteni, London (44) ; Table Of Contents Major Rating Factors Outlook: Stable Rationale Related Criteria And Research JANUARY 27,

2 SACP bb+ + Support +2 + Additional Factors 0 Anchor Business Position bbb- Moderate -1 ALAC Support 0 Capital and Earnings Strong +1 Risk Position Moderate -1 Funding Liquidity Average Adequate 0 GRE Support 0 Group Support +2 Sovereign Support 0 BBB/Stable/A-2 Major Rating Factors Strengths Weaknesses Strong capitalization, although we expect further sustained distribution over time. Well-established retail and commercial franchises in the Republic of Ireland (ROI). Ability to leverage the broader capability of the Royal Bank of Scotland (RBS) group. Reducing, but still high level of nonperforming loans (NPLs), and large exposure to low-yielding tracker mortgages. Emerging from a long phase of deleveraging, with restructuring ongoing. Reliance on the relatively small Irish economy. Outlook: Stable The stable outlook on Ulster Bank Ireland DAC (UBI) reflects our stable view of the group credit profile (GCP) of RBS, UBI's ultimate parent. An upgrade or downgrade of RBS in the coming months would result in a similar action on UBI. We could also consider an upgrade if we revised UBI's group status to core from highly strategic, which would enable us to equalize the ratings on UBI with RBS. Such an assessment would primarily require UBI to demonstrate an underlying operating performance and a risk profile in line with that of the parent. Although unlikely, we could take a negative rating action if we observed that the ROI was becoming less integral to the RBS group strategy and the links between UBI and the RBS group were weakening as a result. JANUARY 27,

3 Rationale The ratings on UBI benefit significantly from our assessment of it as a highly strategic subsidiary of the RBS group. We therefore rate it one notch below core subsidiaries of the RBS group. This outcome is two notches higher than its 'bb+' stand-alone credit profile (SACP). Our SACP on UBI reflects the 'bbb-' anchor, which we then adjust for the following bank-specific factors: A well-entrenched position as the third largest Irish bank, albeit materially smaller than its larger peers, and substantially reduced balance-sheet after years of restructuring. A strong capital and earnings assessment, reflecting our projection of a risk-adjusted capital (RAC) ratio of about 13.5%-14.5% in months. This strong capitalization balances our view of residual concentration risks in the bank's portfolio, including to tracker mortgages, despite a material reduction in the past three years in the bank's credit risk profile. The elimination of the need for parental funding support and a significant improvement in the bank's funding metrics over the past years, supported by deleveraging and a resilient deposit franchise. Anchor: 'bbb-' for a bank operating mainly in Ireland Our bank criteria use our Banking Industry Country Risk Assessment economic and industry risk scores to determine a bank's anchor, the starting point in assigning an issuer credit rating. We use an anchor of 'bbb-' for UBI, which is the same as that for a bank operating solely in Ireland. We view Ireland's economic risk as relatively high compared with other developed economies. Businesses, households, and government finances were all hit hard by the fallout from the collapse in property collateral values and the severe difficulties in the banking sector, especially in More recently, a steady rise in property prices and reduction in unemployment levels is helping to reduce the strain on the banks. Nevertheless, in 2017, banks are still left with relatively high stocks of NPLs (defined as impaired loans plus 90 days past due loans that are not impaired), and their mortgage books remain weak by international norms. In our view, the on-going economic recovery, combined with the modest levels of new lending (and much improved underwriting standards) since the financial crisis, will support fairly low systemwide credit losses of basis points over the next two years. Our view of Ireland's industry risk remains somewhat weaker than economic risk. Our industry risk assessment remains constrained by Ireland's weak regulatory track record (notwithstanding the implementation of the eurozone's single supervisory mechanism since November, 2014), limited prospects for pre-provision profitability growth, and government ownership of two of the three largest domestic banks. Table 1 Ulster Bank Ireland DAC Key Figures (Mil. ) Adjusted assets 31,019 33,843 35,375 40,912 44,636 Customer loans (gross) 27,038 37,623 43,098 45,891 47,647 Adjusted common equity 7,548 6,241 4,522 8,135 6,882 Operating revenues ,135 JANUARY 27,

4 Table 1 Ulster Bank Ireland DAC Key Figures (cont.) (Mil. ) Noninterest expenses Core earnings 1,098 2,226 (4,479) N/A N/A N/A--Not applicable. Business position: Third largest bank in the Republic of Ireland We view UBI's business position as moderate compared with larger and more diverse peers such as market-leaders Allied Irish Banks PLC (AIB) and Bank of Ireland (BOI). With total customer loans of about 25 billion as of end-september 2016, UBI is the third largest bank in the ROI. Other than AIB and BOI, UBI's main rated peer active in the Irish banking industry is Permanent TSB PLC, while the broader Irish peer group includes foreign-owned bank KBC Bank Ireland Ltd. and Barclays Bank Ireland. Peers outside Ireland include Spain-based Bankinter S.A., and Portugal-based Banco BPI S.A. and Banco Comercial Portugues S.A. These banks have similar business models as UBI and operate in systems with similar industry risks as Ireland. Following the strategic review of the Ulster Bank group in 2014, RBS decided to separate the businesses corresponding to Northern Ireland and ROI. The Northern Irish business (Ulster Bank Ltd.) is included in the UK Personal & Banking (UK PBB) division of RBS and the ROI business is now separated under Ulster Bank ROI. UBI's operations are concentrated in the ROI only. It is involved in both retail and commercial banking, although retail banking is the dominant segment, accounting for about two thirds of total revenues and three quarters of customer loans. We consider that UBI benefits from a meaningful franchise in both retail and corporate banking, ranking as the third largest bank across most products, with market shares above 10%. We observe that new mortgage lending has increased in the past few quarters, to reach a market share of 19% in the third quarter of 2016, underpinning the bank's renewed focus on expanding the franchise and improving operating performance. The bank is emerging from a long period of statutory losses ( ) and restructuring. Unlike other Irish banks, UBI did not benefit from transfer of assets to the National Asset Management Agency and has historically reported a higher stock of NPLs than its peers. However, management has been focused on deleveraging legacy assets and, as a result, total assets have reduced by close to 40% since In 2013, RBS formed RBS Capital Resolution Ireland (RCRI) for a faster run-down of the legacy assets. UBI transferred 4.6 billion of assets to RCRI with the aim of disposing this portfolio within three years. Only a marginal part of this book was still outstanding at end-september After a strategic review done by RBS in October 2014, it confirmed UBI's strategic position within the group and its intention to develop UBI as a challenger bank to the domestic pillar banks. Accordingly, we continue to expect that UBI will have a meaningful role to play in the small but concentrated market that is emerging in Ireland. We consider management's strategy of cost rationalization--investing in operational simplification--to be a logical response to improve efficiency, and therefore profitability, which has been dependent on net provision write-backs since JANUARY 27,

5 Table 2 Ulster Bank Ireland DAC Business Position (%) Total revenues from business line (mil. ) , ,135.0 Commercial banking/total revenues from business line Retail banking/total revenues from business line Commercial & retail banking/total revenues from business line Other revenues/total revenues from business line Return on equity (66.6) (30.9) (43.2) Capital and earnings: We expect capitalization to remain strong despite latest dividend announcement We view UBI's capital and earnings as strong based on our expectation of a RAC ratio of around 13.5% to 14.5% by end Our RAC ratio at end-2015 stood at 27%. Adjusted for our improved assessment of the economic risks that banks face in ROI in January 2016, the pro-forma ratio is slightly above 30%. Our projection that the ratio will decrease in the next two years, while remaining strong, is based primarily on the following assumptions: In November 2016, RBS announced that UBI will pay a dividend of 1.5 billion to RBS. We have assumed further material distribution to the group of UBI's capital above the group's target over the next couple of years. Some gradual recovery in net interest income, based on our assumption of a return to modest growth in net customer loans (and risk weighted assets), and some moderate recovery in the net interest margin. Annual single-digit reductions in operating expenses as restructuring initiatives start to bear fruit. No further net provision write-backs in , but credit losses to remain moderate given the adequate provision coverage of NPLs. UBI's Basel III fully loaded common equity tier 1 (CET1) ratio of 29.6% at end-december 2015 is the highest among its peers. The ratio increased significantly from 21.1% at end-2014, driven by massive net provision write-backs and a significant deleveraging. Even after payment of the announced 1.5 billion dividend, the company estimates that the CET1 ratio remained above 24%. We expect further material dividend payments in the coming years as the stabilization of the bank's risk profile continues to progress steadily, allowing management to focus on returns and a more efficient capital structure. By comparison, the RBS group target CET1 ratio is 13%. We also observe that UBI's regulatory risk-weight density is higher than Irish peers', largely due to the point in time models it uses, which may allow some optimization over time. UBI reported a profit before tax of 1 billion in 2015 after reporting a profit of 2 billion in its first since The positive result in 2015 continued to be driven by significant write-backs ( 0.9 billion), although to a lesser extent than in Net interest income was negatively impacted by the significant deleveraging undertaken during the year and the effect of reduction in the European Central Bank's headline rate on its tracker mortgages. Operating expenses were also higher driven by continued investment in upgrading its IT systems and processes. However, this was partially offset by other cost management measures such as a reduction in staff. In the nine months to September 2016, operating revenues were still down 8% over 2015, while a 25% increase in expenses was attributable to a conduct and litigation charge of 118 million in relation to the industrywide examination of tracker mortgages. Net JANUARY 27,

6 provision write-backs during the period totaled a smaller 82 million. We consider UBI's quality of capital to be solid, with the capital base entirely made up of common equity. However, earnings capacity remains constrained by relatively low margins--dragged down by tracker mortgages--and high costs, which we expect to gradually decrease on the back of efficiency measures being implemented. Table 3 Ulster Bank Ireland DAC Capital And Earnings (%) Tier 1 capital ratio S&P RAC ratio before diversification 27.1 N.M. N.M. N.M. N.M. S&P RAC ratio after diversification 24.8 N.M. N.M. N.M. N.M. Adjusted common equity/total adjusted capital Net interest income/operating revenues Fee income/operating revenues Market-sensitive income/operating revenues Noninterest expenses/operating revenues Preprovision operating income/average assets Core earnings/average managed assets (11.7) N/A N/A RAC--Risk-adjusted capital. N/A--Not applicable. N.M.--Not meaningful. Table 4 Ulster Bank Ireland DAC Risk-Adjusted Capital Framework Data (Mil. ) S&P Global Ratings RWA Average S&P Global Ratings RW (%) Credit risk Government and central banks Institutions Corporate 11, Retail 12, Of which mortgage 10, Securitization 0 20 Other assets 1, Total credit risk 25, Market risk Equity in the banking book 3 20 Trading book market risk Total market risk Insurance risk Total insurance risk 0 -- Operational risk Total operational risk 1, JANUARY 27,

7 Table 4 Ulster Bank Ireland DAC Risk-Adjusted Capital Framework Data (cont.) S&P Global Ratings RWA % of S&P Global Ratings RWA Diversification adjustments RWA before diversification 27, Total Diversification/Concentration Adjustments 2,614 9 RWA after diversification 30, Tier 1 capital Tier 1 ratio (%) Total adjusted capital S&P Global Ratings RAC ratio (%) Capital ratio Capital ratio before adjustments 7, , Capital ratio after adjustments 7, , *Exposure at default. Securitization exposure includes the securitization tranches deducted from capital in the regulatory framework. Exposure and S&P Global Ratings' risk-weighted assets for equity in the banking book include minority equity holdings in financial institutions. Adjustments to Tier 1 ratio are additional regulatory requirements (e.g. transitional floor or Pillar 2 add-ons). RWA--Risk-weighted assets. RW--Risk weight. RAC--Risk-adjusted capital. Sources: Company data as of Dec. 31, 2015, S&P Global Ratings. Risk Position: Large exposure to tracker mortgages We view UBI's risk position as moderate as we believe that our assessment of the capital position does not capture the risk concentration in the bank's exposure to tracker mortgage ( 11 billion exposure at end-september 2016) and, to a lesser extent, commercial real estate ( 1.6 billion). This is also underpinned by the fact that normalized losses, as calculated by our capital model, are significantly lower than the average of actual credit losses reported for the past 12 years. We note the substantial balance sheet de-risking executed by the bank, with the RBS group support, since This has been realized primarily through asset transfers and sales, and increased provisioning levels. Our assessment also takes into account our view that its 2013 provisioning exercise has substantially recognized embedded losses in its weakest portfolios, thus reducing the exposure to future unexpected losses. This was demonstrated by the large impairment releases that UBI reported in 2014 ( 1.7 billion) and 2015 ( 0.9 billion). UBI's lending is concentrated in Ireland, which forms 98% of its lending portfolio. Irish mortgages dominate its loan book, accounting for 73% of gross loans at end-september 2016, almost half of which are in the form of tracker mortgages. At end-december 2015, the average loan-to-value (LTV) of the total mortgage book was 65%, with 21% of the book still in negative equity, although this number should have decreased in 2016, supported by further house price growth. The average LTV decrease from 78% in 2014 to 65% in 2015 was helped by deleveraging, particularly the sale of some high LTV buy-to-let mortgages. Commercial real estate (CRE) represents the bulk of the corporate exposure. Of the 1.6 billion CRE book at end-september, 0.5 billion was development finance. Nonperforming assets (NPAs), measured as impaired loans plus loans that are 90 days past due but not impaired, remain high at 24% of average customer loans as of end-december However, we note that it has been decreasing continuously from its significantly high level of 49% in 2012, and the trend continued in This is driven JANUARY 27,

8 by the deleveraging of legacy assets, especially in the assets assigned to RCRI. The largest decrease was reported in the property portfolio, which decreased by almost 77%. The property portfolio NPAs decreased from 55% of total NPAs as of 2014 to almost half, at 26% of the NPA portfolio as of end We believe that UBI follows a conservative provisioning policy with a coverage ratio of the nonperforming portfolio historically higher than most of its Irish peers. We see market risk as negligible, supported by the bank's limited market operations. The bank is exposed to some operational risk, some of which is legacy risk, as illustrated by the 118 million 2016 litigation charge linked to tracker mortgages. Table 5 Ulster Bank Ireland DAC Risk Position (%) Growth in customer loans (28.1) (12.7) (6.1) (3.7) (4.2) Total diversification adjustment / S&P RWA before diversification 9.4 N.M. N.M. N.M. N.M. Total managed assets/adjusted common equity (x) New loan loss provisions/average customer loans (2.9) (4.2) Net charge-offs/average customer loans Gross nonperforming assets/customer loans + other real estate owned Loan loss reserves/gross nonperforming assets RWA--Risk-weighted assets. N.M.--Not meaningful. Funding and liquidity: Balanced funding profile Our assessments of UBI's funding position as average and of its liquidity as adequate reflect the substantial progress the bank has made in rebalancing its funding and liquidity profile. In our view, the bank's coverage of stable funding needs by customer deposits and wholesale funding maturing after more than a year have improved materially between end-2011 and end The improvement in the S&P Global Ratings stable funding ratio to 120% from 75% between end-2010 and end-2015 illustrates this trend. This has been supported by the significant deleveraging through the years and an associated reduction in funding requirements. UBI's loan-to-deposit ratio has also improved considerably from 217% at end-2011 to 129% at end-september However, it still remains high compared with peers. We believe that UBI's funding position benefits from access to diversified funding sources. Of note, borrowing from the RBS group decreased from close to 11 billion at end-2011 to close to nil at end The ratio of broad liquid assets to short-term wholesale funding, as measured by S&P Global Ratings, was 5.3x at end-2015, up from 2.5x in We expect these ratios to remain high at end Table 6 Ulster Bank Ireland DAC Funding And Liquidity (%) Core deposits/funding base JANUARY 27,

9 Table 6 Ulster Bank Ireland DAC Funding And Liquidity (cont.) (%) Customer loans (net)/customer deposits Long term funding ratio Stable funding ratio Short-term wholesale funding/funding base Broad liquid assets/short-term wholesale funding (x) Net broad liquid assets/short-term customer deposits (4.3) (52.8) Short-term wholesale funding/total wholesale funding Narrow liquid assets/3-month wholesale funding (x) Group Support: Highly strategic to RBS The long-term counterparty credit rating on UBI is two notches higher than its SACP of 'bb+', reflecting our view that it is highly strategic to the RBS group. In the past, the group has provided a huge level of capital and liquidity support to UBI and we doubt that its supportive stance will alter in the future. In particular, we no longer consider that there is downside risk in relation to the strategic importance of UBI to the RBS group. This reflects a combination of RBS' Oct. 31, 2014 announcement that UBI offers a good strategic fit following a strategic review of its ROI operations, and our opinion that UBI's earnings prospects in a group context are now healthier than they once were. Still, a higher assessment is precluded until such time that UBI demonstrates an underlying operating performance in line with its parent's targets. Related Criteria And Research Related Criteria General Criteria: Guarantee Criteria, Oct. 21, 2016 Banks: Bank Rating Methodology And Assumptions: Additional Loss-Absorbing Capacity, April 27, 2015 Banks: Bank Hybrid Capital And Nondeferrable Subordinated Debt Methodology And Assumptions, Jan. 29, 2015 General Criteria: Group Rating Methodology, Nov. 19, 2013 General Criteria: Methodology: Use Of 'C' And 'D' Issue Credit Ratings For Hybrid Capital And Payment-In-Kind Instruments, Oct. 24, 2013 Banks: Quantitative Metrics For Rating Banks Globally: Methodology And Assumptions, July 17, 2013 Banks: Revised Market Risk Charges For Banks In Our Risk-Adjusted Capital Framework, June 22, 2012 Banks: Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 09, 2011 Banks: Banks: Rating Methodology And Assumptions, Nov. 09, 2011 Banks: Bank Capital Methodology And Assumptions, Dec. 06, 2010 General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009 Banks: Commercial Paper I: Banks, March 23, 2004 Related research Ulster Bank Ltd. Long-Term Rating Raised To 'BBB+' On Intragroup Transfers; Outlook Stable, Jan. 13, 2017 Banking Industry Country Risk Assessment: Ireland, Jan 13, 2017 Various Positive Rating Actions Taken On Irish JANUARY 27,

10 Banks On Reduced Economic Risk, Jan. 13, 2017 Anchor Matrix Industry Risk Economic Risk a a a- bbb+ bbb+ bbb a a- a- bbb+ bbb bbb bbb a- a- bbb+ bbb+ bbb bbb- bbb- bb bbb+ bbb+ bbb+ bbb bbb bbb- bb+ bb bb - 5 bbb+ bbb bbb bbb bbb- bbb- bb+ bb bb- b+ 6 bbb bbb bbb- bbb- bbb- bb+ bb bb bb- b+ 7 - bbb- bbb- bb+ bb+ bb bb bb- b+ b bb+ bb bb bb bb- bb- b+ b bb bb- bb- b+ b+ b+ b b+ b+ b+ b b b- Ratings Detail (As Of January 27, 2017) Ulster Bank Ireland DAC Counterparty Credit Rating BBB/Stable/A-2 Certificate Of Deposit A-2 BBB Short-Term Debt A-2 Counterparty Credit Ratings History 07-Jul-2016 BBB/Stable/A-2 19-Jan-2016 BBB/Positive/A-2 09-Jun-2015 BBB/Stable/A-2 03-Feb-2015 BBB+/Watch Neg/A-2 16-Jul-2013 BBB+/Negative/A-2 13-Feb-2013 Sovereign Rating Ireland (Republic of) A+/Stable/A-1 Related Entities National Westminster Bank PLC Junior Subordinated BB Junior Subordinated BB- Preference Stock BB- BBB+ Short-Term Debt A-2 Subordinated BB+ RBS Securities Inc. JANUARY 27,

11 Ratings Detail (As Of January 27, 2017) (cont.) Royal Bank of Scotland N.V. (Milan Branch) Royal Bank of Scotland PLC (Connecticut Branch) (The) The Royal Bank of Scotland Group PLC Commercial Paper A-3 Junior Subordinated Junior Subordinated B+ Junior Subordinated Preference Stock B+ Preferred Stock B+ Short-Term Debt A-2 Short-Term Debt A-3 Subordinated Subordinated The Royal Bank of Scotland N.V. Certificate Of Deposit Foreign Currency A-1 Local Currency Short-Term Debt A-2 Subordinated The Royal Bank of Scotland PLC Certificate Of Deposit Foreign Currency A-2 Commercial Paper Foreign Currency A-2 Junior Subordinated Junior Subordinated Greater China Regional Scale Short-Term Debt A-2 Subordinated Ulster Bank Ltd. BBB-/Stable/A-3 B BBB+ BB BB+ BBB+/A-2 BBB+ BB+ BB BB- BBB- BB- cna+ BBB+ BB+ *Unless otherwise noted, all ratings in this report are global scale ratings. S&P Global Ratings credit ratings on the global scale are comparable across countries. S&P Global Ratings credit ratings on a national scale are relative to obligors or obligations within that specific country. Issue and debt ratings could include debt guaranteed by another entity, and rated debt that an entity guarantees. JANUARY 27,

12 Additional Contact: Financial Institutions Ratings Europe; JANUARY 27,

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