Group Performance Review

Transcription

1 Group Performance Review The environment in which the group operates remained challenging in 2009 for our customers and our business, with continuing low levels of economic activity and weak consumer confidence. While the worldwide economic upheaval and associated financial crises continued into 2009, the latter half of 2009 saw some signs of improvement both nationally and internationally. Unemployment growth and asset value deflation have impacted the Irish economy significantly and weakened purchasing power along with investor and consumer confidence. These factors lowered new business volumes and margins across all our businesses and resulted in higher impairment provisions on the group s loan portfolios. The group s priority for 2009 was to support the businesses in responding to the changed environment and driving the change needed to allow them to compete successfully. Several initiatives were commenced and completed during 2009 which leaves the group in a better position heading into The group initiated a cost restructuring programme that aligns staffing levels in the life assurance company to current activity projections and the Irish banking business has initiated plans to deliver on the same agenda in The group made progress in addressing the life assurance persistency variance seen in the Retail Life portfolio in the first half of the year. A funding strategy which focuses on maximising stable sources of funding (retail deposits and long-term funding) continues to be pursued in the bank. In response to the increase in the cost of funds, the group increased the cost of variable rate mortgages in September 2009 and again in February 2010 to address the falling net interest margin. Summarised Group Income Statement The group s income statement on an IFRS basis for the years ended 31 December 2009 and 2008 is summarised on a segmental level below: m m Operating (loss) / profit before impairment provisions - Banking Ireland Banking UK Life assurance (15) Fund management Brokerage and third party administration Other 1 (40) (27) Operating profit before impairment provisions Impairment provisions: - Banking Ireland (343) (189) - Banking UK (33) (15) Operating (loss) / profit (308) 41 Share of associate - General Insurance (2) 23 Share of joint venture - Banking Ireland - (1) Taxation (3) (10) (Loss) / profit for the year (313) 53 Group Key Performance Indicators Total tier 1 capital ratio on Basel II basis (%) Life solvency cover (times) Operating profit before impairment provisions on an IFRS basis ( m) Operating (loss) / profit on continuing operations on an IFRS basis ( m) (308) 41 Adjusted operating return on capital employed on an EV basis (%) 2 (7.1) 9.5 Operating (loss) / profit on an EV basis before impairment of goodwill and tax ( m) (196) 341 Shareholder funds per share EV basis ( ) Other includes reconciliations, eliminations and consolidation adjustments as detailed in Note 3 to the Financial Statements. 8 2 The adjusted operating return on capital employed on an EV basis is calculated by dividing the operating profit after tax, excluding share of associate / joint venture (see Note 4 to the EV basis financial statements) by the average shareholder equity for 2008 and 2009 before non-controlling interest and own share adjustment, excluding associate / joint venture and consolidation adjustment (Note 5 to the EV basis financial statements).

2 Group Performance Review The group made an operating profit of 68m before provisions for impairment in 2009 (2008: 245m). The group made an operating loss of 308m in 2009 (2008: 41m profit) after the provisions for impairment. The result for the year is driven by losses in both the banking and life businesses. The banking businesses loss reflects a higher impairment provision charge and lower net interest income arising principally from higher funding costs. The group s life businesses loss results from negative shareholder property returns, lower fund management and investment contract fee income and the reduction of the value of in-force insurance business principally arising from the change in the risk discount rate. IFRS EV m m m m Insurance and investment business Banking (270) 30 (270) 30 Other* (26) 5 (26) 5 (203) 323 (194) 319 Share of associate / joint venture (2) 22 (196) 341 Impairment of goodwill - (170) - (170) EV operating (loss) / profit (196) 171 Short-term investment fluctuations (73) (190) (68) (640) Effect of economic assumption changes (22) 89 (38) 105 Other IFRS consolidation adjustments (10) (11) (17) - Operating (loss) / profit before tax (308) 41 (319) (364) Share of associate / joint venture (2) 22 Following various restructuring programmes in the group, costs fell year on year by 10% excluding restructuring / non-operational costs of 45m. Including restructuring / non-operational costs in 2009, costs fell 4% year on year to 568m. The 2009 result includes a charge of 18m (2008: 86m gain) in respect of the uplift in the value of Irish Life & Permanent shares held for the benefit of policyholders and also includes a gain of 7m (2008: 12m) in respect of the fall in value of owner occupied buildings held for the benefit of policyholders. These movements impact policyholder liabilities but under IFRS the corresponding movement in the asset is not recognised in the income statement. The following table restates the group s IFRS income statement in a format that is comparable to the embedded value income statement shown in the Supplementary Information for the years ended 31 December 2009 and 2008: (Loss) / profit before tax (310) 63 (319) (364) Taxation (3) (10) 40 (65) (Loss) / profit after tax (313) 53 (279) (429) Attributable to: - Owners of the parent (313) 49 (279) (433) - Non-controlling interest (313) 53 (279) (429) Overview Business Review Corporate Governance Financial Statements *Other includes unallocated corporate costs and the income from brokerage and third party administration subsidiaries. 9

3 Group Performance Review Operating Results on Continuing Operations Banking Businesses Operating Results The banking operating loss for 2009 of 270m, compared to a profit of 30m (before impairment of goodwill) in 2008, was principally due to an increase in impairment provisions reflecting the deteriorating macroeconomic conditions in Ireland and to lower net interest income due to higher funding costs. The Republic of Ireland business accounted for 266m of this loss with the UK banking business accounting for 4m of the loss. The net interest margin 3 fell to 83 basis points ( bps ) (2008: 105bps) as a result of the higher funding costs in both the wholesale and retail markets. This resulted in net interest income falling from 473m in 2008 to 375m in An asset re-pricing strategy has seen a 50bps increase applied to Irish standard variable rate mortgages in September 2009 and a further 50bps increase was applied in February Net interest income includes a credit of 7m in relation to deferred acquisition costs; this incorporates a credit arising from the reassessment of expected cash flows from mortgages due to the lower redemption rate experienced in the portfolio in This helped offset the negative impact of mismatches which arose between the fees charged on fixed rate mortgage switches and the cost of closing fixed rate positions in the early part of 2009 (impact on net interest income was circa 30m). A provision was made during 2009 in relation to outstanding settlements on certain closed derivative contracts (impact on net interest income was 15m). The cost of the Government guarantee for the four months ending December 2008 was 8m and this increased to 29m for the twelve months ending December The provision for impairment on loans and receivables was 376m (2008: 82m). This charge consists of a specific provision charge of 213m (2008: 16m) and a collective / incurred but not reported provision ( IBNR ) charge of 163m (2008: 66m). This brings the provision coverage 4, net of write-offs, to 1.2% at the end of 2009 (2008: 0.3%) included a provision for impairment on debt securities of 122m. During 2009, resulting from the continued focus on cost management; the aggregate banking businesses were successful in reducing their costs by 7%. Excluding restructuring / non-operational costs, the cost base fell 10% year on year. The bank has announced a further efficiency programme to be concluded in 2010 with the amalgamation of eleven branches and further reductions in staffing levels. These actions will lead to further cost reductions in Life Assurance and Fund Management Operating Profit The group s life assurance and fund management divisions made an operating profit (before shortterm investment fluctuations ( STIFs ) and economic assumption changes) of 93m for 2009 (2008: 288m). This fall in profits reflects investment contracts and fund management fees falling by 45m year on year due to lower fund balances in 2009 resulting from a fall in markets in The change in shareholder value of in-force (net of short-term investment fluctuations and economic variances) fell by 101m year on year mainly due to lower insurance sales and poor persistency. Also included in the operating profit was the fall in the shareholder expected return of 18m and the increase of 18m in exceptional expenses principally due to the life restructuring costs. Resulting from the economic downturn, 2009 saw an increase in surrenders and withdrawals as investment markets continued to fall and economic conditions worsened. The adverse persistency resulted in a combined negative experience variance and assumption changes of 26m in the 2009 IFRS earnings (2008: 7m positive). With the assistance of a new persistency infrastructure, the Retail Life business has seen persistency improve in the latter half of 2009 while it is expected that Corporate Life will see persistency experience moderate in A restructuring programme in the life assurance and fund management businesses has been successfully completed resulting in a 10% fall in operational costs excluding restructuring / non-operational costs. Life assurance new business written (excluding investment sales for Irish Life Investment Managers, ILIM ), was 348m (2008: 511m) on an APE basis. The decrease was due to the 36% and 30% reduction in Retail Life and Corporate Life sales respectively. In the 2009 statutory profits, new business contribution was 2m negative, compared to a nil contribution in ILIM full year sales of 191m (2008: 203m) were 6% behind the same period last year. 3 Net interest margin is the ratio of net interest income and the average interest earning assets for the year Provision coverage is the ratio of the year end loans and receivables to customers balance (before impairment provision and deferred fees, discounts and fair value adjustments) and the impairment provision balance.

4 Group Performance Review Life Assurance and Fund Management STIFs and Economic Assumption Changes In 2009, STIFs were 73m negative compared to 190m negative in This result includes a loss of 18m (2008: a gain of 86m) in respect of the movement in the year on the value of own shares. These are shares in the company held in policyholder funds entirely for the benefit of policyholders. Under IFRS, the increase in policyholder liabilities as a result of the rise in value of the shares is recognised as a loss but the corresponding rise in value of the asset is not included. The STIFs also include the negative impact resulting from the direct shareholders exposure to property investment (excluding losses on owner occupied properties) of 64m (2008: 55m). Economic assumption changes were 22m negative in 2009 compared to 89m positive in 2008 principally due to the increase in the risk discount rate from 7.0% to 7.5% as a result of the increase in Irish medium-term gilt yields. General Insurance Operating (Loss) / Profit The group s share of the loss in Allianz, (a general insurance business in which the group has a 30% interest) was 2m (2008: 23m profit). A negative underwriting result in 2009 includes negative claims experience in the last quarter resulting from adverse weather conditions at the end of the year. The 2009 performance also includes restructuring costs. Allianz made a dividend payment to the group of 15m in 2009 (2008: 30m). Brokerage and Third Party Administration Operating Profit In 2009, the operating profit on this business segment of 4m (2008: 21m) was impacted by the impairment charge on property and intangibles of 4m (2008: nil) and the lower level of life assurance sales resulting from pay cuts in the public service. Operating Results on an Embedded Value Basis The falls in property markets, increase in unemployment and the continuing dislocation in credit markets significantly impacted the year end valuation of the group s banking and life businesses resulting in the loss after tax, on an Embedded Value ( EV ) basis, of 279m (2008: 429m loss after tax) attributable to equityholders. At operating level, the group s pre-tax loss was 196m for 2009, compared to a profit in 2008 of 341m (before the impairment of goodwill of 170m). Short-term Investment Fluctuations The continued impact of weak property markets on the embedded value of the group s life business has resulted in negative short-term investment fluctuations of 68m in Albeit a negative variance, there was a significant improvement on 2008 s negative fluctuation of 640m. The charge principally resulted from the fall in the value of shareholder property holdings of 97m (2008: 128m negative) and negative movement in the cost of financial options and guarantees of 15m (2008: 62m negative) being offset partially by the positive market effect on unit-linked management fees of 50m (2008: 383m negative). Economic Assumptions The effect of revised economic assumptions was a negative 38m in 2009 (2008: 105m positive). This movement includes the effect of the increase in the risk discount rate from 7.0% to 7.5% as a result of the increase in Irish medium-term gilt yields. Return on capital employed Total embedded value for the group for 2009 fell 10% to 2.5bln (2008: 2.8bln). The adjusted operating return on capital employed on an EV basis for the group (excluding associate / joint venture, non-controlling interest and own share adjustment) was 7.1% negative (2008: 9.5% positive). Overview Business Review Corporate Governance Financial Statements 11

5 Group Performance Review Summarised Group Statement of Financial Position The group s consolidated statement of financial position for the years ended 31 December 2009 and 2008 are summarised below: IFRS Basis EV Basis m m m m Assets Financial assets 32,228 24,761 32,228 24,761 Loans and receivables to customers 38,592 40,075 38,592 40,075 Loans and receivables to banks 4,925 4,775 4,925 4,775 Shareholder value of in-force business ,076 1,080 Other assets 3,546 3,951 3,476 3,831 Total assets 80,021 74,349 80,297 74,522 Liabilities and equity Deposits by banks 18,713 18,546 18,713 18,546 Customer accounts 14,562 14,118 14,562 14,118 Debt securities in issue 13,262 10,899 13,262 10,899 Investment contract liabilities 24,032 21,118 24,060 21,110 Insurance contract liabilities 4,034 4,007 4,034 4,007 Other liabilities 3,412 3,313 3,181 3,066 Equity including non-controlling interest 2,006 2,348 2,485 2,776 Total liabilities and equity 80,021 74,349 80,297 74,522 Loans and Receivables to Customers permanent tsb is focused predominantly on retail lending with 99% of its loan portfolio secured on assets, 89% of which consists of residential mortgages. As a result of adopting a low risk approach to its lending activities, the group is not engaged in business, corporate or property development lending and as a consequence the group is not transferring any loans to the National Asset Management Agency ( NAMA ). The bank continued to focus during 2009 on its core customer lending franchises residential mortgages for owner occupiers and consumer finance in Ireland. Due to the uncertainty with regard to residential property prices, the associated lower transaction volumes and the tightening of credit criteria across all loan products, total loans and receivables to customers of 40.1bln at the end of 2008 fell during the year by 4% to 38.6bln. The loans and receivables to customers balance over principal business lines for the years ended 31 December 2009 and 2008 are summarised as follows: Gross Lending m m ROI residential lending 27,256 27,931 UK residential lending 7,484 7,171 Consumer finance 1,749 2,381 Commercial lending 5 1,939 1,978 Other ,639 39,813 Provision for loan impairment (477) (139) Deferred fees, discounts and fair value adjustments Total lending 38,592 40, Commercial lending excludes loans of 447m (2008: 425m) to the group s life assurance operations including loans held for the benefit of unitlinked policyholders.

6 Group Performance Review Credit Quality A summary of the credit quality of total loans and receivables to customers under the rating system 6 applied by the group is outlined in the following table: Neither past due nor impaired Change m m % Excellent risk profile 23,841 27,458 (13) Satisfactory risk profile 7,885 7,567 4 Fair risk profile 2,877 2, ,603 37,268 (7) Past due but not impaired 3,208 2, Impaired ,036 2, Total loans and receivables to customers 38,639 39,813 (3) Loans classified as past due but not impaired and impaired increased by 59% year on year while loans rated with an excellent risk profile fell by 13%. This reflects the deteriorating trends in economic activity and employment. Further details are available in Note 34 Financial Risk Management. A summary of the loans and receivables impairment provision balances for 2009 and 2008 are outlined below: Specific Collective Total Specific Collective Total m m m m m m As of 1 January Charge to Income Statement Other 7 (9) (29) (38) (5) (13) (18) Following an increase in arrears numbers and falling property values, impairment provisions increased by 338m year on year to 477m, with specific provision increases accounting for 204m of this increase. These provisions represent 58% of the impaired loan balances at the end of 2009 (2008: 69%). This level of provisioning is regarded as appropriate with the majority of the portfolio being secured on assets. The collective / IBNR provision has increased by 134m. The higher charge reflects the fact that collective / IBNR provisions have been provided across all portfolios in acknowledgement of the deterioration of the economy. Future Loan Impairments The group estimates future levels of loan impairments by modelling the bank s loan book against a range of economic assumptions. Increased levels of unemployment, negative GDP growth and falling house prices are the key drivers of impairment and provisioning. Current estimates for the three years ending 2011 indicate an aggregate impairment provision in the range 800m to 900m of which 376m was charged in Overview Business Review Corporate Governance Financial Statements 6 The group uses the 25-point Basel II scale for the internal ratings approach ( IRB ) for credit risk. 7 Other movements comprise amounts written off during the year together with exchange movements. 13

7 Group Performance Review Loans and Receivables to Banks Loans and receivables to banks year on year remained stable at 4.9bln (2008: 4.8bln). At the end of 2009 the balance included 2.5bln (2008: 2.0bln) repayable on demand. Financial Assets The following table provides further analysis on financial assets, on an IFRS basis, for the years ending 31 December 2009 and 2008: Financial Assets m m Debt securities 15,780 10,929 Equity shares in units and unit trusts 13,510 10,390 Derivative assets 1,169 1,162 Investment properties 1,769 2,280 Total 32,228 24,761 Debt Securities The growth in debt securities of 44% to 15.8bln at the end of 2009 includes the 4.5bln increase in securities classified as available for sale. Government bonds account for 66% of the 2009 balance (2008: 59%). The change in value of available for sale ( AFS ) financial assets at 31 December 2009 was 42m positive (2008: 43m negative) which, in accordance with the IAS 39 accounting treatment applied to AFS assets, was taken into other comprehensive income. Included in debt securities is the bank s asset portfolio of 7.4bln. This is principally held in sovereign bonds (48%), highly rated bank Floating Rate Notes (44%) and prime (non-us) euro denominated Residential Mortgage Backed Securities ( RMBS ) (8%). There are no sub-prime assets held within the portfolio. The portfolio is rated 33% AAA, 54% AA, 10% A and 3% BAA/BA/B. rates. This is due to the fact that the non-linked insurance and investment liabilities and the shareholder value of in-force are calculated using assumptions regarding investment returns and interest rates. To the extent that actual returns and interest rates differ from the assumptions used, variances will arise, which may be positive or negative. The group s life business is a relatively low risk operation. Its unit-linked portfolio of 24bln represents 92% (net of reinsurance) of the life assurance and fund management businesses contract liabilities. The unit-linked investment risk is primarily borne by policyholders. In the non-linked insurance and investment portfolio, the group s policy is to match liability flows with high quality assets, principally sovereign bonds. The average duration of the non-linked liabilities is 9.9 years while the average duration of the assets matching these liabilities is 9.8 years. The credit profile of the fixed-rate securities held in the non-linked portfolio is as follows: Credit Profile % % AAA AA 22 9 A The increase in AA rated securities reflects the impact of the downgrading of sovereign bonds held in the portfolio year on year. Given the close duration match of assets and liabilities, any mark to market adjustments in the portfolio due to changes in yield curves are generally matched by equal and opposite movements in the value of the liabilities. 14 The balance of debt securities, 8.4bln, is held at fair value through the profit or loss in the life assurance and fund management businesses. Unit-linked funds account for 6.6bln of this balance while 1.8bln is held in non-linked funds at the end of Equity Shares and Units in Unit Trusts Shares and units in unit trusts are held in listed and unlisted entities and are all designated as fair value through profit or loss. 99% of these balances are held in unit-linked funds on behalf of policyholders. Life Asset Portfolio The value of the group s life operations is exposed to market movements in assets, currencies and interest The life company s shareholder funds of 566m are principally invested in cash and owner occupied property. An analysis of the life shareholder fund investments as at 31 December 2009 is set out in EV supplementary information Note 5. Investment and Insurance Contract Liabilities The increase in investment contract liabilities during the year includes premium receipts of 3.4bln (2008: 4.3bln) and market movements of 2.5bln (2008: 7.7bln negative) being offset partially by 2.9bln (2008: 2.8bln) in claims. Insurance contract liabilities, which are 73% non-linked (net of reinsurance), remained constant year on year at 4bln ( 2.2bln net of reinsurance).

8 Group Performance Review Funding and Liquidity The global economy and financial system continued to experience turbulence and uncertainty during While funding conditions improved over the course of the second half of the year, the terms on which such funding was secured remained onerous and expensive when compared with the terms available historically. This impacted the profitability of the group s banking operations. The regulatory protocol, under which the group operates, requires levels of liquidity based on various cash flow stress tests. The key limits applied are that an institution must have sufficient available liquidity to cover 100% of outflows over the next eight days and 90% of outflows over the coming 9 30 days. As a consequence of the industry-wide wholesale funding difficulties experienced during the first half of 2009, the Financial Regulator agreed to a temporary easing of the liquidity requirements noted above. This easing applied from April to September The standard liquidity requirements applied again since September 2009 and the group operated comfortably within these limits. In early 2009, the group discovered it had inadvertently breached a regulatory reporting requirement and promptly notified and co-operated with the Financial Regulator. The Financial Regulator investigated the matter and entered a settlement agreement with the company. On reaching that agreement, the Financial Regulator acknowledged that Irish Life & Permanent had co-operated fully and had been open and transparent throughout the process and that the company had taken prompt and complete remedial action to fully rectify the breaches. The company was reprimanded for the incident and paid a penalty of 600,000. The matter is now closed. The bank s total funding is well diversified across markets as shown below: Funding Profile % % Customer accounts Long-term debt Short-term debt At 31 December 2009, 60% of the bank s funding comprised customer accounts and long-term debt, down slightly from 62% at the start of the year. At 33%, customer accounts reflected a year on year increase of 23% in retail deposits and a decrease of 12% in corporate deposits. The latter reflected an outflow of overseas deposits in early 2009 which were replaced to a large extent by domestically sourced funds. The success in growing the retail deposit base resulted in a higher cost of funding given the highly competitive nature of the deposit market during the year. The bank is working towards having 70% of funding sourced through retail deposits and long-term funding in the medium term. The loan-to-deposit ratio at the end of 2009 was 246%, an improvement on the 2008 ratio of 271%. The group continues to work to reduce this ratio. Short-term Debt The group has a pool of collateralised assets that are capable of being used as security with a range of counterparties including the European Central Bank ( ECB ). During 2009, an element of assets was used as security for ECB drawings with an average level of drawings for the year of 10.9bln (2008: 7.9bln). The maximum level of drawings during 2009 was 13.5bln (2008: 14.4bln) while drawings at 31 December 2009 were 9.8bln (2008: 11.8bln). ECB drawings, reported in the statement of financial position as deposits by banks, are included in the short-term debt portfolio. Customer Accounts and Deposits In 2009 through a process of leveraging the group s distribution channels in both the bank and life company as well as launching a range of competitively priced products, customer accounts increased to 14.6bln in 2009 from 14.1bln in Retail deposits proved to be a stable and resilient funding source, despite the intense competition in the marketplace. Retail customer account balances increased by 23% ( 1.8bln) year on year to 9.9bln at end Corporate deposit balances at end 2009, including deposits held for the benefit of unit-linked policyholders, were down 12% year on year at 5.8bln, reflecting the outflow of overseas deposits in the early part of 2009 and strong growth in Irish deposits thereafter. Term Funding Notwithstanding the group s focus on deposit growth, the duration of the assets on the balance sheet is such that the appropriate management of duration risk requires that a significant portion of the group s funding should be long term. 15 Overview Business Review Corporate Governance Financial Statements

9 Group Performance Review Funding and Liquidity (continued) The Credit Institutions (Financial Support) Scheme 2008 (the Scheme ) and the Credit Institutions (Eligible Liabilities Guarantee) Scheme (the ELG Scheme ) have been critical in providing Irish financial institutions with access to funding. During the course of 2009, the group successfully secured term funding of 3bln from international investors under the Scheme which expires on 29 September The ELG scheme, which Irish Life and Permanent plc and its subsidiary Irish Permanent (IOM) Limited joined on 4 January 2010, facilitates debt issuance for terms up to five years. These schemes, coupled with improving investor sentiment towards Ireland, enables the group to secure longer term funding, as evidenced by the issuance under the ELG Scheme of a 3-year US $1.75bln bond in January 2010, and a in March Further issuance under the ELG Scheme will take place over the course of 2010, which will increase the proportion of long-term funding. The group will also continue to explore alternative term funding opportunities in the senior unsecured and securitisation markets which would contribute to the management of duration risk. Credit Ratings At 31 December 2009 the group was rated BBB+ by Standard & Poor s and A2 by Moody s Investor Service. Capital Management The group has a flexible capital structure with the ability to improve and strengthen its capital base over the next few years. The group s core capital objective is to meet or exceed all relevant regulatory capital requirements and to hold sufficient economic capital to withstand a worst case loss in economic value due to risks arising from business activities. The worst case loss is derived through statistical models influenced by the group s target debt rating. Capital Resources The group s capital resources, on an IFRS basis, as at 31 December 2009 and 2008 are as follows: m m Shareholders equity 2,006 2,347 Non-controlling interest - 1 Undated loan capital Dated loan capital 1,117 1,111 Total capital resources 3,650 4,047 Regulatory Capital The group is regulated by the Irish Financial Services Regulatory Authority ( Financial Regulator ) which sets and monitors regulatory capital requirements in respect of the group s operations. While there are a number of regulated entities within the group which have individual regulatory capital requirements, the two principal regulated entities are Irish Life & Permanent plc, the group s banking operation (trading as permanent tsb), and Irish Life Assurance plc, the group s principal life assurance operation. Regulatory capital is the level below which the group s capital must not fall. The group s policy is to manage the capital base so as to meet all regulatory requirements while maintaining investor, creditor and market confidence and ensuring that there is adequate capital to support future growth in the business. In addition, the relationship between the level and composition of regulatory capital and the shareholders return on capital is monitored to ensure that there is an appropriate balance between equity and debt capital within the overall regulatory capital held. The group manages its capital base through its Internal Capital Adequacy Assessment Process ( ICAAP ). The Irish Life & Permanent ICAAP is designed to allow capital requirements to be risk-weighted and to fully reflect the risk profile and appetite of the group. The ICAAP incorporates a detailed process to identify all material risks for the group and ascertain whether they are to be addressed through management or mitigation (or a combination of the two) and whether capital is required to be held against each risk. The regulatory capital requirement follows existing European capital requirement directives as established under EU legislation. Regulatory capital adequacy is established via comparison of risk-weighted assets and their associated minimum total capital requirements (currently established as 8% of risk-weighted assets), with the regulatory available capital resources of the group. Bank Capital From 1 January 2008, the minimum regulatory capital requirement of the group s banking operations has been calculated in accordance with the provisions of Basel II as implemented by the European Capital Requirements Directive and the Financial Regulator. 16 Resulting principally from the 2009 loss after tax of 313m, total capital resources fell by 397m during the year ended 31 December 2009.

10 Group Performance Review The group s capital ratios, after applying the interim capital requirement, remained strong at 31 December 2009 with a Tier 1 and total capital ratio of 9.2% (2008: 9.2%) compared to a regulatory minimum of 8%. The capital base has no Tier 1 hybrid capital in the structure and the Tier 2 capital is only 30% of that permitted under the regulations. The following table sets out the regulatory capital position of Irish Life & Permanent on a Basel II basis at 31 December 2009 and 2008: Available Capital m m Tier 1 capital 3,938 4,174 Tier 2 capital Subordinated liabilities 1,167 1,230 Other ,200 1,311 Tier 1 + Tier 2 5,138 5,485 Life company and other deductions (3,280) (3,426) Total available capital (Tier 1) 1,858 2,059 Required Capital m m Pillar 1 1,313 1,454 Interim capital requirement ( ICR ) at 23% Total required capital 1,615 1,788 Excess own funds Total risk-weighted assets before ICR 16,411 18,173 Total risk-weighted assets after ICR 20,185 22,353 Risk asset ratio (all Core Tier 1) Before the application of the ICR 11.3% 11.3% After the application of the ICR 9.2% 9.2% Basel II The objective of Basel II is to align bank regulatory capital more closely with the economic capital required to support the risks being undertaken. The capital required to cover credit, operational and market risks is required to be explicitly measured under the Basel II methodology. In implementing Basel II, the group has adopted the Internal Ratings Based ( IRB ) approach to credit risk and was awarded IRB accreditation in late Under the IRB approach, the bank uses internally generated risk models to compute the capital required to support credit risk by calculating the probability of default ( PD ) and the loss given default ( LGD ) in all of its various portfolio exposures. The capital requirement for operational risk is calculated according to the standardised approach, in which all of the institution s activities are divided into eight standardised business lines: corporate finance, trading and sales, retail banking, commercial banking, payment and settlement, agency services, asset management and retail brokerage; with individual operational risk weightings applicable to each. Value at risk, an industrywide practice, is the methodology which the group has adopted in regard to the measurement of capital required to support market risk. Under Basel II, as outlined in the above table, riskweighted assets ( RWA ) reduced by 10% from 18.2bln in 2008 to 16.4bln in The group s available capital reduced to 1.9bln giving an end 2009 capital ratio of 11.3% (2008: 11.3%). The 11.3% capital ratio compares with a Basel II regulatory minimum of 8%. 17 Overview Business Review Corporate Governance Financial Statements

11 Group Performance Review Bank Capital (continued) The Pillar 2 capital requirement under Basel II has yet to be determined. In the meantime an interim capital requirement ( ICR ) is applied equal to 23% of Pillar 1 RWAs. Adding this ICR reduces the capital ratio to 9.2%, versus the regulatory minimum of 8%. The application of the ICR effectively prevents a release of capital. However, it is the group s expectation that the Pillar 2 capital add-on will be less than the ICR and will give a capital ratio somewhere between the 11.3% and 9.2%, versus the regulatory minimum of 8%. The group continues to review developments and proposals issued by the Basel Committee on Banking Supervision in order to ensure that it remains appropriately capitalised and prepared for any additional requirements adopted by the EU. Life Capital Irish Life Assurance plc ( ILA ) operates to an internal target solvency cover of 1.6 times the minimum required (2008: 1.6 times). The group considers this to be an appropriate level of capital to manage the business having regard for the basis of calculating liabilities and the insurance and operational risks inherent in the underlying products. The solvency cover for Irish Life Assurance plc, the group s main life assurance operation, at 31 December 2009 is 1.6 times (2008: 1.6 times) the minimum requirement of 416m (2008: 410m). This is summarised below: Solvency Cover m m Minimum capital Regulatory capital Net worth Perpetual debt Other assets available Inadmissible assets (108) (104) The table below sets out the movement in life regulatory capital in 2009 and 2008: m m As at 1 January Capital generated from existing business New business strain (74) (88) STIFs and economic variances (106) (228) Bank dividend (13) (15) Other (10) (2) As at 31 December In 2009, the existing book of life assurance business generated cash flows of 194m compared with 377m in Both the new business strain and the net capital generated were helped by the 22m (2008: 125m) new business strain reinsurance arrangement which was put in place at the end of This arrangement reduced the new business strain by 44m (2008: 59m) and impacted by capital generated from existing business 22m negative (2008: 66m positive). In 2009, the negative STIFs and economic variances of 106m (2008: 228m) were largely due to the tangible asset valuation reductions which the group suffered on property assets and debt securities. In line with the group s capital management policy, whereby all surplus capital above targeted minimum levels is remitted to the group, ILA paid a dividend of 13m (2008: 15m) to the bank holding company. Solvency II The calculation of minimum regulatory capital for the life assurance business is currently based on the EU Solvency I Directive. New requirements will be established under the Solvency II Directive which was formally adopted in 2009 and is expected to be implemented in Solvency II will require the calculation of solvency and reserving requirements on a realistic market consistent basis. Given the low risk nature of its life business, on the introduction of Solvency II the group expects to achieve a significant reduction in the reserves required to support its insurance and investment contract liabilities (December 2009: 26bln net of reinsurance) which would result in an increase in the statutory capital surplus. In light of the expected increase in available capital resources, the group believes it is reasonable to seek to access a limited part of this capital increase at this stage. The group is in discussion with the Financial Regulator and an international bank with a view to securing a value of in-force facility of 200m. 18

12 Group Performance Review Reinsurance Treaty In November 2008, the group finalised the terms of a stop-loss reinsurance treaty in relation to new business with Swiss Re, which will reduce the new business strain in ILA over the next three years. As a result of this treaty ILA s capital requirements for 2009 were reduced by 22m (2008: 125m). Dividend In the context of the extraordinary challenges in financial markets, the introduction of the Government Guarantee Scheme and the approach being adopted by financial institutions both in Ireland and internationally, the board have proposed that there will be no dividend for This approach is consistent with the priority to conserve capital in the group in the current economic environment. This compares to a total dividend per share in 2008 of 22.5 cent. Overview Business Review Corporate Governance Financial Statements 19

13 Divisional Performance Review Banking Operating Review Banking Key Performance Indicators Operating (loss) / profit before impairment of goodwill and tax ( m) (270) 30 Banking margin (bps) Impairment provision balance ( m) Lending book ( bln) Total Tier 1 ratio after ICR (%) Retail deposits balance ( m) 9,889 8,047 Customer satisfaction index (%) In 2009 the group s banking businesses faced significant challenges and, for the Irish business in particular, continued to be adversely affected by the deterioration in the Irish economy, lower consumer confidence, transaction volumes and falling property prices. Resulting from the decision to concentrate on protecting the group s key Irish mortgage and consumer franchises together with the general slowdown in the Irish housing market, overall gross new lending in 2009 fell 84% to 1.2bln from 7.1bln in Total loans and receivables fell by 4% in 2009 to 38.6bln compared to 40.1bln at 31 December Notwithstanding the deterioration in the Irish economy, the bank s customer acquisition strategy continued to be successful in 2009 with the bank using its sales strengths to re-focus its efforts in growing retail deposits. Retail deposit balances increased 23% on 2008 to 9.9bln at the end of During the year, the bank continued to focus on its customer service ethos through its Customer Central programme. In 2009, permanent tsb s customer satisfaction index score reduced slightly from 82.7% to 82.5% Net interest margin 8 ( NIM ) for the year declined to 83 basis points (bps) from 105bps for the full year This resulted in net interest income falling 21% to 375m for 2009 from 473m for This fall principally reflects the higher funding costs associated with the sharp rise in the marginal cost of attracting retail and corporate deposits as well as the cost of refinancing maturing wholesale debt. This pressure was partially offset by the higher asset margins on the Irish mortgage business facilitated by the re-pricing of standard variable rate mortgage products during the year. Net interest income includes a credit of 7m in relation to deferred acquisition costs; this incorporates a credit arising from the reassessment of expected cash flows from mortgages due to the lower redemption rate experienced in the portfolio in This helped offset the negative impact of mismatches which arose between the fees charged on fixed-rate mortgage switches and the cost of closing fixed-rate positions in the early part of 2009 (impact on net interest income was circa 30m). The fall in the net interest margin to 83bps is detailed in the following table: bps Funding costs (18) Liability margins (17) Asset margins 21 Other (8) Portfolio Growth As a result of the unprecedented liquidity conditions in the financial markets, coupled with the economic decline in the bank s core markets, the bank continued to adopt a cautious approach to new lending and balance sheet growth in 2009 and focused on the bank s core customer lending franchises - residential mortgages for owner occupiers and consumer finance - in Ireland. All other lending was suspended. The change in the balances over principal business lines was as follows: Gross Lending m m ROI residential lending 9 27,256 27,931 UK residential lending 6.6bln (2008: 6.8bln) 9 7,484 7,171 Consumer finance 1,749 2,381 Commercial lending 10 2,386 2,403 38,875 39,886 Money market funds Deferred fees, discounts and fair value adjustments ,516 40,639 Inter-group loans and receivables (447) (425) Impairment provisions (477) (139) Total lending 38,592 40, Net interest margin is the ratio of net interest income and the average interest earning assets for the year. 9 Including securitised mortgages. 10 Commercial lending includes loans of 447m (2008: 425m) to the group s life assurance operations including loans held for the benefit of unitlinked policyholders.

14 Divisional Performance Review The contraction of the Irish housing market, which commenced in 2007, continued to accelerate in Demand for new residential mortgages reduced as consumer confidence fell as a result of a combination of economic uncertainty, house price falls (per the permanent tsb / ESRI House Price Index house prices fell on average 18.5% in 2009, having fallen by 9.1% in 2008), and less availability of credit. New Irish mortgages issued by the group of 0.8bln in 2009 showed a reduction of 81% on the 4.2bln issued in As a result, Irish residential mortgage balances outstanding fell by 2% to 27.3bln compared to 27.9bln at year-end A lower level of early redemption activity reflecting market conditions generally was also experienced in The UK residential mortgage book, which was closed to new business in 2008, fell by 3% year on year to 6.6bln. Banking Operating Review - Ireland The pre-tax operating performance of the group s Irish banking business for the years ended 31 December 2009 and 2008 are set out below: m m Net interest income Other non-interest income Other income Trading income (4) 5 Government guarantee charge (29) (8) Investment return Administrative expenses / depreciation / amortisation (276) (289) Impairment of property, equipment and intangible assets (2) - Operating profit before impairment provisions Impairment provisions (343) (189) (266) 18 Impairment of goodwill - (170) Operating loss before tax (266) (152) Against the background of a sharp contraction in economic activity, higher funding costs and a weak Irish housing market, the group s Irish banking business delivered a pre-tax loss of 266m, down from a profit of 18m before impairment of goodwill in The 2009 loss was principally due to the impairment provision charge of 343m up from 189m in 2008 and lower net interest income. As a result of exchange rate movements, this book in euro terms, increased to 7.5bln at the end of New consumer finance loans fell 72% to 0.3bln from 1.1bln in 2008 mainly reflecting reduced demand in the new car finance market. The portfolio fell 27% to 1.7bln (2008: 2.4bln) reflecting the short term nature of this portfolio. With new commercial lending being discontinued in 2008, the portfolio fell by 1% to 2.4bln. Regulatory Capital The total Tier 1 regulatory capital ratio (after the ICR) for 2009 was 9.2% (2008: 9.2%). The ratio remains higher than the regulatory minimum of 8%. Net interest income Net interest income in 2009 at 336m was down 21% when compared to the 2008 outturn of 428m. This was due to the higher funding costs associated with both deposits and wholesale funding in In response to the higher funding costs, the pricing of the standard variable-rate mortgage product was increased in September 2009 by 50bps and a further 50bps in February Overview Business Review Corporate Governance Financial Statements 21

15 Divisional Performance Review Banking Operating Review - Ireland (continued) Net interest income accruing from the mortgage book includes a credit in relation to deferred acquisition costs; this incorporates a credit arising from the reassessment of expected cash flows from mortgages due to the lower redemption rate experienced in the portfolio in This helped offset the negative impact of mismatches which arose between the fees charged on fixed charged on fixed rate mortgage switches and the case of closing fixed rate positions in the early part of Other Income Other income of 44m is up 5% compared to 42m achieved in This reflects higher resource fee income and general insurance commission offset by lower bureau de change. Other income excludes the contribution from bancassurance sales generated through the bank, which are reported in the pre-tax profit of the group s life assurance business. Sales of life and pension products through the bank were 29m in 2009 compared to 55m in 2008 with the reduction reflecting a lower level of lump sum investment and protection sales on foot of weaker investment markets generally and the reduced level of mortgage lending. Government Guarantee Charge The Government guarantee charge for 2009 was 29m compared to 8m in 2008 which covered the period from 30 September 2008 to year-end. This cost is calculated as a percentage of the liabilities which are covered by the scheme and is payable on a quarterly basis. Investment return The 2009 investment return of 8m resulted from the purchase of Auburn and Fastnet securities (securities issued by the group) in the market. In 2008, a gain of 29m was achieved on the disposal of the bank s Held to Maturity debt securities portfolio in the first quarter of Costs Administrative expenses including depreciation and amortisation for 2009 were 276m, a 4% fall on the 2008 outturn of 289m. Excluding 2009 restructuring / non-operational costs of 13m, costs in 2009 fell by 9% year on year. Cost management continues to receive significant management attention in 2010 and by the end of 2010 the bank plans to reduce its branch network by 11 branches and reduce headcount by a further 140 full time equivalents. Portfolio analysis The continued deterioration in the general economic environment and the low levels of activity in the residential property market has impacted credit quality. As the decline in property prices in Ireland (18.5% for 2009 per the permanent tsb / ESRI House Price Index) continued in 2009, the loan to values ( LTVs ) of the group s lending portfolio, indexed against industry market values reported by the above mentioned house price index, have risen accordingly resulting in an increase in the number of cases in negative equity. The average indexed LTV of the Irish mortgage portfolio, for residential mortgages and residential investment property ( RIP ) loans now stands at 63% with cases over 100% representing 22% of the portfolio. The deterioration in the Irish economy and in particular, the acceleration of unemployment has resulted in the number of Irish residential mortgage accounts in arrears increasing by 79% year on year to 6.1% of the portfolio. The number of residential mortgage accounts in arrears greater than 90 days has increased from 3,711 in 2008 to 7,228 in 2009, 3.9% of the residential mortgage portfolio. Notwithstanding the level of arrears, 93% of all loan accounts are up to date at the end of 2009 (95% at the end of 2008). Arrears management and customer affordability continues to benefit from the historically low interest rate environment. The key priority for the group in these challenging economic conditions is to minimise the losses arising from credit impairments. Resourcing has significantly increased in the credit and collections areas across all portfolios with particular focus being placed on those arrears arising in more exposed parts of the loan portfolio. There were 7,835 residential mortgage accounts on a moratorium at the end of 2009 representing 4.3% of this portfolio. During 2009, permanent tsb welcomed the introduction, on a statutory basis by the Financial Regulator, of a code of conduct for mortgage arrears. This code ensures that both borrowers and lenders engage with each other pro-actively to address any mortgage repayment difficulties. 22