Bank of Ireland (NYSE:IRE)
Q2 2013 Results Call
August 2, 2013 4:00 AM ET
Richie Boucher – Group CEO
Andrew Keating – Group CFO
Eamonn Hughes – Goodbody Stockbrokers
Stephen Lyons – Davy
Robin Down – HSBC Global Research
Sachin Shah – Morgan Stanley
Vincent Hung – Autonomous
David Lock – Deutsche Bank
Good morning, everyone and welcome to our Interim Results for the six months to June 30, 2013. Thank you for those who have joined us in Dublin and those who are by conference call and webcast. I am going to give a short presentation, after which Andrew Keating, our Group CFO, will provide a more detailed review of our performance, and then we'll move to the questions and answers.
In the first half of 2013, we continued to deliver on our strategic objectives. The actions we have taken and are taking, are strengthening our customer franchise in Ireland and internationally and are moving us much closer to profitability.
Let me start by sharing some of the performance highlights. Over the last three years, we've restructured our balance sheet, so that it is robust and sustainable. Our loan-to-deposit ratio is at our targeted level. We remain focused on optimizing our deposit volumes and pricing in our core markets in Ireland and in the UK.
We have demonstrated cost effective access to the funding markets, significantly in 2013 we accessed unsecured funding from private investors after the expiry of the exceptional liabilities government guarantee. During the first half of 2013 we repaid a further 6 billion of ECB funding.
Since the start of the Troika Program we have now repaid over 70% or 24 billion of the funding provided by the ECB which is now rapidly approaching normalized levels. We have healthy capital ratios; our core tier-1 ratio under the Basel 2 rules is 14.2% well above the minimum regulatory requirement of 10.5%.
Our pro forma fully loaded CET ratio under the Basel 3 rules including the 2009 preference stock is 8.6%, up from the 8.5% pro forma calculation of a few months ago. We continue to anticipate having a transitional Basel 3 common equity tier-1 ratio of greater than 10%. We are closer to profitability.
Our pre-provision operating profit is building strongly as we continue to restore each of our businesses and divisions to sustainable profitability. Our total income in the first half of 2013 was €1,188 million, an increase of 36% or €313 million over the same period in 2012. This is reflecting primarily the increase in our net interest margin and lower ERG costs.
Notwithstanding the lower interest rate environment, we delivered an ongoing increase in net interest margin achieving an average margin of 1.65% in the first half of 2013 versus 1.2% for the same period last year. Our exit margin at the end of June 2013 was higher than the average for the first half of the year.
We continue to manage the necessary reductions of staff costs which were down 10% excluding pension costs, from the same period last year, through our ongoing redundancy and restructuring programs.
We are proactively working with our various stakeholders to mitigate the deficit in the Group-sponsored pension schemes, which deficit is impacting on the schemes themselves, the Group's capital ratios and the Group's costs. We've reached an important change in this process.
Even after taking an exceptional charge of €100 million, impairment charges continued to reduce and our expectations continues to be that loan loss charges will reduce further in the second half of 2013 and beyond. We are delivering on our strategic objectives. In the two years, since our recapitalization in the summer of 2011 we have remained focused on delivering against the strategic objectives we shared with shareholders during that process.
We have not only maintained but we have also strengthened the strategic shape of the Group. We have agreed with the European Commission to amend our restructuring plan so that we can retain our valuable New Ireland business. New Ireland makes a consistent contribution to our operating profit and is the number two provider of pension life and protection products in the Irish market.
It is complementary to our overall franchise and important to our wealth management strategy. Regrettably, there are substitution measures, which were part of the overall arrangement with the EU. However, we consider that these substitution measures which have been agreed with the Commission can be appropriately managed. We remain focused on our core Irish market with selective international diversification.
In particular, internationally, our partnership with the UK Post Office, where the main contract was extended and strengthened in July 2012 gives us access to the largest financial services distribution network in the UK. We continue to have healthy capital ratios. We successfully generated 4.2 billion of equity capital in 2011 substantially all from private sources.
In addition, we raised €250 million of tier-2 capital in December 2012. We continue to work on actions to mitigate the current pension deficit, and are actively engaging in this process with the relevant staff representative bodies and other stakeholders. The next stage of the process will take place from next week under the auspices of the Labor Relations Commission.
The 2009 preference shares currently held the government are a key priority. We are proactively reviewing all options in relation to the preference shares, and we are focused on developing the best possible outcomes for our various stakeholders. We will, as always, keep the market up to date on material developments.
We’ve improved funding, stability and cost effectiveness. The ELG expired at the end of March 2013 after 4.5 years. The expiry has had no adverse impact on our deposit volumes or pricing strategy, which is to reduce pay rates and change access features. As a proportion of our total funding, customer deposits have increased from 48% in December 2010 to 70% in June 2013.
We are accessing private wholesale funding. In May 2013, we successfully issued €500 million of three unsecured senior debt. That issue was 2.5 times oversubscribed. Separately, in March 2013 we issued a €500 million in covered bonds secured on Irish mortgages, that issue was 4.5 times oversubscribed. In January 2013, we supported the sale of the contingent convertible notes of 1 billion by the Irish Government to international investors...
Our progress towards sustainable profitability within a robust balance sheet is gathering considerable momentum. Through the first six months of 2013, it is encouraging to note that every key financial metric, capital, liquidity and funding, total income, net interest margin, operating costs, and impairment charges show positive improvements, highlighting the momentum that continues.
Since 2009 the State has invested 4.8 billion in the Group. We are grateful for this support from the State, and from the tax payers. At this stage, we have returned 3.9 billion in cash to the State, whose investments in the Group now consist of a valuable 15% equity shareholding, in Bank of Ireland and 1.8 billion in 2009 preference shares which carry a coupon of 10.25% per annum.
The tax payers' investment in Bank of Ireland is well in the money. At the same time we continue to minimize and eliminate any risk to the State from Bank of Ireland. The successful expiry of the ELG means that a material risk and contingent liability for the State has now been removed. Separately, the Group is an important investor in the State, holding 5.9 billion in Irish government bonds.
By returning to profitability, Bank of Ireland is ensuring that it can generate the necessary capital and access the necessary funding to support and benefit from Irish economic recovery. We have the capital and liquidity available to support our lending activities and ambitions.
We are actively seeking new growth opportunities in Ireland. In July of 2013, we launched a further 2 billion mortgage fund for first time buyers and movers in response to existing and anticipated bond. We had already approved 1.2 billion in mortgage finance from our October 2012 fund of 2 billion.
In the first half of 2013, we approved new and increased lending facilities for SMEs of 1.9 billion that is up 14% on the same period in 2012. We are on track for a 4 billion in improvements for the year as a whole. We estimate that Bank of Ireland provided half of drawn new and increased non-property SME lending in the first quarter of 2013.
We are actively working with our challenged mortgage and SME customers to sustainably restructure their loans. We have made very progress in the first half of 2013. Our Irish corporate business continues to gain market share with a number of new relationships established over the past six months.
Our Corporate business has also provided significant support to public private partnership initiatives in conjunction with the Irish Government. As the leading Bank in a consolidating sector are supporting and benefiting from the recovery of the Irish economy. We are number – we are the leading universal Bank in a consolidated market with number one or number two market positions across each of our businesses.
We have a strong multi-channel distribution network and we are maintaining our branch footprint while making significant investments in e-banking, mobile banking and in branch technologies. This strategy is designed to protect and enhance our businesses and franchises, facilitating the growth in our revenues from our efficient accessible infrastructure for our customers.
Our Irish corporate franchise has more than 30% market share for indigenous corporates and more than 50% for multinationals, we are a leading provider of treasury products and services in Ireland. We are a well-recognized and respected lead arranger and underwriter of mid-market leveraged finance transactions both in Europe and in the US.
Our IBI Corporate Finance division is consistently ranked the number one Irish advisor. In the UK we continue to strengthen our partnership with the Post Office and extension of the main contract to a minimum 2023 demonstrates mutual endorsement and commitment. The Post Office has an unrivaled distribution network with more branches than all other retail banks in the UK combined.
We are working in conjunction with our partner to continue to build a challenger consumer banking franchise, and expanding the range and financial services that are offered. We continue to invest in this important opportunity for the Group.
We are close to profitability. Our pre-impairment operating profit is building strongly rising to €318 million in the first half of 2013. Impairment charges reduced to €780 million in the first half of this year. The reduction would have been greater but for the exceptional one-off charge of €100 million related to the June 13 Central Bank of Ireland guidelines.
Looking forward, we expect that loan losses will continue to reduce as the Irish economy recovers. We continue to restore each of our businesses to sustainable profitability. Since our recapitalization, in 2011, we have maintained healthy capital ratios; we have completed our balance sheet restructuring. We have grown our deposits at more acceptable pricing.
We have successfully advocated for the removal of the expense of ELG. We have substantially reduced monitory authority funding to normalizing levels. We have managed down our costs while making investments in our core businesses and infrastructure. We have improved our credit quality and grown our income.
We have continued to reward the tax payers for their investment in Bank of Ireland and we have positive momentum throughout our Group. On this basis, it is very important that we have reaffirmed the financial targets which were set at the time of our recapitalization in 2011.
I have emphasized that we remain focused on progressing to profitability. This path has been challenging for all of my colleagues and for all of the Group’s stakeholders. We are now coming much closer to meeting that goal.
As we remain focused on providing our customers with the products and services they need on an efficient empathetic, commercially sustainable basis, actively supporting Irish economic recovery and continuing to develop our core international franchises, rewarding the investment that the Irish tax payers have made in the bank, ensuring that we have strong businesses with enduring franchises capable of generating sustainable returns for our shareholders.
I am very grateful to my colleagues throughout the Group who despite many challenges that we face have remained resilient committed and focused as we deliver on our shared objectives for the Group’s customers and for the Group. My colleagues and I must and we’ll continue to maintain our focus as we strive to reward all of our stockholders for their confidence in the Group as we move much closer to profitability. Thank you. I’d like to now hand over to Andrew, who will take you through our first half results in more detail.
Okay, thank you, Richie. Good morning everyone. I am going to begin by reviewing the Group income statement highlighting the progress that we’ve as we move closer to profitability. I’ll then provide an update on our asset quality and I will conclude by outlining how we continued to optimize our funding and maintaining the strength of our capital position.
So let me start with the group’s income statement. Overall, our story is on a continuing momentum. We increased total income by 36% or €313 million in the first six months of this year. We achieved this by growing our net interest margin to 1.65% and by reducing the ELG fees. We achieved a substantial increase in our operating profit pre-impairments to €380 million. Our impairment charges reduced by 21% or €204 million and as a consequence, we reduced our underlying loss by more than €0.5 billion.
Six months ago, I spoke about our momentum. Let me give you an update on that. The first half of last year was the trough period for the Bank. But, as I highlighted last March, in the second half of 2012, every line item in our income statement and all key financial metrics improved in the second half.
As you can see, this momentum is continuing. What’s also very positive is that we’ve improved performance across the Group and all divisions are supporting the Group’s return to profitability. In 2013, Retail Ireland, Retail UK, Corporate and Treasury and BOI Life all delivered higher operating profits. Significantly, our retail franchises in Ireland and the UK more than doubled their operating profits.
I will now set out more detail on the key components of our income statement, starting with our net interest margin. The significant momentum in our net interest margin is continuing. As you know, the margin troughed at 1.2% in the first half of last year. We grew our margin by 14 basis points to 1.34% in the second half of 2012. In each one of this year, we continued to grow our margin, this time, by a further 31 basis points to 1.65%. And I would note that our exit margin is higher again.
These improvements are as a result of the actions that we continue to take. On assets, we are repricing our bank book where appropriate and we are generating higher margins on all new lending. On funding, as you can see, we are materially reducing the cost of our deposits and other funding. And of course, we are continuing to manage our balance sheet more efficiently.
Looking forward, 2% remains the appropriate net interest margin target for Bank of Ireland. Moving on to the ELG fees. The ELG scheme expire earlier this year. As expected, our ELG fees have declined rapidly from €212 million in the first half of last year to €99 million during the last six months. There was no adverse impacts on our deposit volumes or our pricing strategies associated with the expiry. Looking forward, these fees will continue to reduce in line with the contractual maturity of the corporate liabilities.
Moving on to operating expenses. Our costs peaked at €2.1 billion in March of 2008, since then, we have transformed our cost base sustainably reducing our operating expenses by €0.5 billion. A key focus in achieving this transformation has been to ensure that the costs are eliminated, not deferred and to ensure that the efficiencies are sustained into the future.
Specifically, during the last six months, we reduced our staff costs by 8% or €32 million when compared with the second half of 2012. These reflects the cost savings from ongoing restructuring and redundancy programs.
On pensions, the new accounting rules which came into effect last January have increased the reported costs by €20 million. On other costs, we’ve achieved a reduction of 6% or €26 million over the second half of last year and that reflects ongoing efficiency improvements. We maintain our focus on tightly controlling all of our costs.
Let me now update you on asset quality. Total customer loans at June 2013 were €95 billion before impairment provisions of €8 billion. Mortgages, consumer and SME loans account for three quarters of our loan book. On a geographical basis, our assets are broadly balanced between Ireland and the UK.
On impairment charges, our loan losses are steadily reducing. The impairment charge in the first half of 2013 was €780 million, pardon me. It includes an exceptional charge of €100 million reflecting the revised Central Bank of Ireland guidelines published in June of this year.
I would emphasize that this is a one-off charge in this period and is not expected to repeat in future periods. We do not expect the application of these guidelines to change borrower behavior or the Bank’s collections activities. Underlying loan losses, in the first half of 2013 were €680 million representing a reduction of 13% versus the second half of last year. We have now had three consecutive periods of reducing loan losses.
Our portfolios continue to perform in line with our expectations and the rate of growth in defaulted loans continues to decline. As we look forward, we expect loan losses to reduce further as the Irish economy recovers.
I’ll now provide an update on the credit quality of each of our key portfolios starting with Irish Mortgages. Our owner occupied mortgage book was €21 billion at the end of June and it is performing in line with our expectations. Nine out of ten mortgage accounts are performing.
Defaulted loan growth continues to slow and was €108 million in the first half of this year. As we look at the external environment, we see encouraging signs. The unemployment rate is reducing, perhaps more importantly, employment levels are stabilizing and in fact have increased modestly in each of the last three quarters and of course house prices are stabilizing. We remain focused on sustainably restructuring our customers who are in financial difficulty and we are meeting our target in this regard.
On a relative basis, our level of default arrears is significantly better when compared with the rest of the industry and it is rolling at about half of the level of the other banks. Moving on to our buy-to-let portfolio; eight out of ten of these mortgage accounts are performing.
Defaulted loan growth remains in line with our expectations. The performance in the last six months is in line with the performance in the second half of last year and it’s significantly better than the performance in the first half of 2012. We achieved these outcomes despite rising repayments as interest only period come to an end and we require our customers to move to capital repayment.
As with the owner occupied book, we see some encouraging signs in the external environment, specifically, private sector rents continue to increase particularly in Dublin and in other urban areas.
Moving on to our UK residential mortgage book. At June, this book amounted to £22 billion and it represents over a quarter of our total loan book. In the external environment, house prices and rents have been rising modestly. Unemployment is reducing and the overall economic outlook is improving. Our residential book continues to perform strongly in line with our expectations and better than the industry average.
Moving on to SME and corporate loans. Overall, asset quality remains stable across each of our SME and corporate portfolios. In Ireland, our SME portfolio was €11 billion, at June and it is diversified across sectors. While those sectors correlated with consumer spending and property remain challenged, our impairment charges are declining.
In the UK, we have an SME portfolio amounting to £2 billion. The economic outlook is improving and the level of defaulted loans remain stable. Our corporate loan books were €8 billion at June and these portfolios are also performing satisfactorily.
Let me finally turn to property and construction loans. Our investment and portfolio amounted to €14.2 billion at the end of June. We have reduced the level of assets in this portfolio by €1.4 billion or 9% since last December.
The portfolio is balanced geographically; about half of the assets are in the Republic of Ireland and half are outside. The portfolio is also diversified across sectors albeit with a retail focus. In Ireland, we have seen increased liquidity in the commercial property markets reflecting the international demand for assets.
The land and development portfolio amounted to €3.2 billion at June, 94% of that portfolio is impaired and it has a coverage ratio of 63%.
Before I move on, let me recap on the key aspects of asset quality. Our loan portfolios are performing in line with our expectations. The rate of growth in defaulted loans continues to decline. The trends of lower impairment charges is continuing. And looking forward, we expect that loan losses will continue to reduce as the Irish economy recovers.
Let me now turn to funding and capital. As you can see, we have transformed our funding profile in the last three years. In December of 2010, deposits made up less than half of our total funding base. We had €70 billion of wholesale funding and half of that was from the ECB and we had a loan-to-deposit ratio of 175%.
Today, as you can see, it’s a very different picture. Retail and business deposits make up the substantial majority of our funding base accounting for 70% at the end of June. We’ve reduced our requirements for wholesale funding by 56%, that’s nearly €40 billion and that includes repaying €24 billion to the ECB.
Stepping back, over the last three years, we have transformed the profile, the availability and the cost of our funding base.
I’ll now elaborate on each component of our funding, starting with our customer deposits. Our deposit strategies leverage our strong retail and business franchises in Ireland and the UK. In Ireland, we did experience any impact on deposit volumes from the expiry of the ELG.
In the UK, we reduced our deposit volumes as part of our planned strategy to lower the level of excess liquidity. Across each of our portfolios, we continue to make significant progress on repricing our deposits.
Moving on to wholesale funding. During the last six months, we reduced the requirement for wholesale funding by €8 billion. During that time, we demonstrated consistent access to the private funding markets. A particular milestone was accessing the unsecured term markets when we issued €500 million of three year unsecured senior debt last May.
During the past six months, we repaid €6 billion of ECB drawings. Outside of the NAMA bonds, our monetary authority usage is now quickly approaching normalized levels.
Let me turn to capital. Our core Tier-1 ratio at June 2013 was 14.2% compared with a regulatory requirement of 10.5%. On a Basel 3 basis, we estimate that our common equity Tier-1 ratio on a fully loaded pro forma basis was 8.6% at June including the preference shares.
We expect that the Basel 3 regulatory requirements for Bank of Ireland will be 10% and we anticipate maintaining a buffer above that level on a transitional basis. As Richie mentioned earlier, we continue to assess a range of options in relation to the preference shares.
Let me summarize the headlines of our interim results. We continue to deliver on our strategic objectives. We’ve retained New Ireland. We’ve transformed the profile, the availability and the cost of our funding base and we have healthy capital ratios. We continue to invest in each of our strong core franchises and specifically, in the last six months, we’ve improved our net interest margin, controlled our costs and reduced our impairment charges.
We are close to profitability and that momentum will continue. Thank you very much. We are now happy to take your questions.
We can take the first question from Dublin and Eamonn Hughes from Goodbody.
Eamonn Hughes – Goodbody Stockbrokers
Thanks, Richie. Maybe just two or three, if you don't mind actually I hope will be quick.
Only larger with your Eamonn.
Eamonn Hughes – Goodbody Stockbrokers
Just the LDR was – well, it’s a 119% at the half year. Just in terms of – you made a comment earlier on about not pricing aggressively for deposits. So, just wondering would you be comfortable with an LDR setting over time, maybe 110% plus, if that's a kind of a reasonable stab, 110%, 115%, that's the first question and your views on that.
Secondly, just given the topicality and I asked this question yesterday with the Barclays Capital ratio just the leverage ratio on the UK. I know that PRA is quite a more stressed leverage ratio figure of 3%.
But where would you be in relation to kind of the Basel 3 numbers on that leverage ratio? And finally, just, Andrew, I'm intrigued by your comment in terms of the 2% margin achievable. Can we take that's it 2014 or a year later? Thank you.
I think if I go through the first one and then we’ll work our way backwards. And we set these targets in 2011 and myself and my colleagues and our Board take the targets that we set in of shareholders extremely seriously. When we set the target in 2011, the interest rate curve was predicted to move upwards and obviously that would have had a fair wind to our back.
It's transpired differently, but our responsibilities are very important to us and let me say it’s very important to us so we work very, very hard to deliver. We’ve managed the balance sheet. We’ve changed our pay rates; we proved the resilience and strength of our franchise by some of the pricing actions we’ve taken.
And I think we got strong momentum Eamonn. We have coming after 1.65 for an average, we’ve signaled that the exit margin would have been higher than that. I think in the previous sessions, this year we’ve talked in particular about the continued repricing of our UK deposit base.
I think we’ve talked about in the past the nature of that deposit base, the way where we have seen pay rates in the market, generally in the UK moving. We are obviously more of a price taker in that market and the nature of the deposit base which consists of a quite a significant proportion has contractual maturities of six and twelve months. And we would expect to see that rolling after in the course of the year. And you can use your calculator then.
But with that 2% is, I think in March, when Andrew and I were asking that question, we said it was a target and we said it was achievable but there were quite some challenges. I would think that we have dealt with some of those challenges. So it remains a key focus for us. And we would also say that, 2% shouldn’t be the end of it. I mean, we must continue to aspire within a robust balance sheet to have more products compared to this but also to generate acceptable returns.
We are seeing the loan books slowly repricing and that’s all benefit to us. We’ve done lot of repricing actions. I think we have some further ones we can take and obviously we are actively seeking new lending opportunities in our core franchises.
And Andrew also did mentioned that we have been managing our balance sheet and in particular the dynamics of our UK subsidiary where we had proven to ourselves and proven to the regulatory authorities that our deposit bases were resilient.
Part of that process was to have periods of excess liquidity and we are managing the balance sheet towards that. And with regards to the LDR, bear in mind the nature of our balance sheet, about 50% of our balance sheet is mortgages and so. The LDR – I wouldn’t disagree with the kind of momentum that you are talking about.
I think, we would bear in mind the structure of our balance sheet, the nature of the available funding we have in that and as far as very importantly for us, is the focus on liquidity coverage ratios and the net stable funding ratios as well. And we feel that a termed-out wholesale funding will always be a part of our funding structures bearing in mind the nature of our balance sheet. And on the leverage ratio, maybe I'll let Andrew come in.
Just a minute very quick on the leverage ratio of a fully loaded pro forma basis and including the preference shares at the end of June, our leverage ratio was above 3% and we would expect to be above and remain above 3% on a conditional basis on the leverage side..
We have, our Board has just gone through a very significant process which is looking at an ICAP, that’s our capital assessment up to 2018. We look at a best case scenario and look at a stress case scenario and our Board and ourselves would obviously have considered a wide range of ratios and would have been cognizant of the fact that leverage ratio was something that we are getting increased focus.
I mean, we also note that our balance sheet is quite a simple balance sheet. There is not a lot of huge complexity in our balance sheet. Our risk-weighted assets are very visible. Operational risk et cetera is quite visible.
Stephen? Stephen Lyons from Davy
Stephen Lyons – Davy
Thanks very much. Just looking for some further guidance if you are able to provide it on the run rate or your future profitability from the retention of New Ireland, if you could please?
Well, I think what we tracked in the sights in the presentation Stephen is, if we look at – there is 39 million operating profit in the first half of 2012, roughly the same figure and moving to 42 million in the second half and 42 million in the first half. I think that, one of the key features about our New Ireland business is that it is a predictable income stream.
During quite a challenging period in the nature of its business. Persistency ratios have moved very well there in that business. As you know, as we talked about in the past, it is a business which isn’t subject to significant business risk in terms of we reinsure a huge amount of the risk and 95% of the product is unitized.
And we see that the market is consolidating and we continue to drive efficiencies. I think also as we look, we’ve run the business for three years and it’s been run well by the team. But it has been under EU rules, that’s run under what called a whole separate structure. If we look at that business now that we were carrying that we can look at the other range of options that we have within the Group and the Group’s product range with that business.
And so, I mean if I was trying to look at a model for it, I would see that one could barring some exceptional circumstances, but the profit trajectory is predictable and as the economy recovers, we would expect that business to improve and on the other side, the substitution measures that we have in the primarily focused on our businesses, right.
A good business, we would prefer to have got them, but we have to do a deal and I think we are comfortable and we have quite a lot of experience of managing business and run down and I think we are comfortable that we will be able to successfully manage our business run down. I think the run down period would take some time.
So therefore income will flow and to the extent that we make disposals and look to make disposals, our track record over the last period of time is when we make disposals, we have been able to do so whilst protecting the Group’s capital and capital ratios.
Stephen Lyons – Davy
I’m sorry, maybe just as a follow-up point just as you talk there, but UK book, to the extent that your interest earning asset base may decline further through – further core book to leveraging here. Given that you are deleveraging your UK book, do you have an ability to supplement core loan book to leveraging here through other measures internationally to protect that base?
Well, I think, one of the key features of our renegotiation of our post office contract is increased ability to originate assets through that business. So we remain to have an ability to use the vast distribution network of the post office and for example, we are originating mortgage assets through our post office business and we are originating those assets at the pricing that’s prevailing in the market today and leveraging finance business is a very important international business to us.
It’s proved to be very stable from a credit quality point of view and our teams and our people are well rewarded and well recognized. So we get opportunity to – and in Ireland, we are seeing some growth in opportunities and we certainly feel our proposition the fact that we have worked very, very hard to restructure our business and we can grow faster than the economy.
We have competitors who are exiting. We have competitors where the customers are confused about their strategic intent and so we are taking opportunities. I would note that some of the reduction in interest earning assets was as Andrew has alluded to, planned by us and there is obviously an exchange rate factor.
We have roughly 45% of our assets are in sterling and there has been this exchange factor. From our realistic planning targets, we would consider that on a constant currency basis, €90 billion in loan and assets remains an appropriate figure up for us to be considering and for investors to consider. Liquid assets will be reflectable to that as well.
Stephen Lyons – Davy
Okay, we have a couple of questions from London and if I could take the first one please and because I can’t see you, would you mind introducing yourself? Thank you.
(Operator Instructions) Our first question comes from Robert Down from HSBC.
Robin Down – HSBC
Hi, good morning. It’s Robin Down for HSBC. There are a couple of quickies and I guess I’ll save the rest for the London Meet next week. Maybe, somewhere in the accounts, but I haven’t seen it, but have you got a P&L for the assets you have to space off under the new state requirements. I can see this is a balance sheet metric, but not an income statement to go with that.
And then second question, on liquidity, obviously your run down liquid asset base quite rapidly in the first half of the year. How much more can you deal on that from and have you got an LCR ratio, I haven’t seen that yet within the accounts? Thanks.
I am going to take a tiny break, so I let Andrew take these.
Okay, so we haven’t given a formal P&L Robin for the assets that we are deleveraging. We do said that was in the appendix at the slide deck some additional detail and information in relation to those assets which should help you.
And in terms of the liquidity, I guess the movement in the liquidity in the last six months was imparted by a number factors then maturity of the IBRC or the termination of the IBRC legal compassion was about €3 billion.
In terms of the strategy to run down the excess liquidity in our UK subsidiary, at December we had about €3 billion in our disclosures. We had about €3 billion of excess liquidity at that time and the level of excess liquidity today is about €1 billion.
Half of that reduction came from the transfer of assets from the Dublin balances to the UK and approximately half came from managing down the higher rates deposits in that business. And on the liquidity coverage ratio, I don’t think we have provided a ratio for that particular metric in these results.
I think if I was looking also the disclosures we’ve given on the balance sheet on our risk weighted assets which are part to the run down assets, we’ve also in the slides given the average asset yields for the Group. I think the nature of those assets would be that the yield of those assets would be below the Group’s average.
Robin Down – HSBC
Great, that’s helpful. Thank you.
Our next question comes from Sachin Shah from Morgan Stanley. Please go ahead.
Sachin Shah – Morgan Stanley
Thanks for taken the call. Just a question, I think you may have described obviously on the previous call, but the accounting treatment for the step up in the preference share, could you talk how that will run through the P&L and if at all have any impact to these 2014 numbers?
Having the CFO is an accountant, so.
Yes, so in terms of – if in these circumstances that the step-up was triggered, there would be no accounting impact at that time. The accounting impact of the step up only arises the day we write the check back to the stage.
So, on the 1st of April, or balance sheet of next year, if the step-up was triggered, our balance sheet and P&L would look exactly the same as it did on the 31st of March and it’s only when we return the money and repay the preference shares, thus the step-up gets recorded as a charge in our balance sheet.
Sachin Shah – Morgan Stanley
Thank you, very clear. And would you be putting out any guidance on structures around that preference shares?
As we’ve always tried to do in the past and we’ve been dealing with a range of number of issues successfully over the past four years. This is a big area of our focus for us, big area of focus for investors and other stakeholders and we are very carefully evaluating a range options. I would note that in the past, we haven’t always dealt with an issue by one single play.
We’ve often had interlinked actions to deal with issues and when we have something which we believe is capable of execution, then we will come to the market. So I wouldn’t like to put a timeframe on it, but I would like to confirm as with a wide range of other things we are taking this very seriously as very important and we are giving a lot of attention.
Sachin Shah – Morgan Stanley
Our next question comes from Vincent Hung from Autonomous. Please go ahead.
Vincent Hung – Autonomous
Hi, good morning. My first question is, what’s the long-term improvement in the net interest margin be front-loaded this year and are you saying that, if gets to the 2% NIM without you see these rate increases now, my second question is, you mentioned you’d be allowing customers to pull that track is over to near houses but a cost of an extra 100 basis points, have you seen much demand for those products?
My other question is, you still got about €8 billion of – non-resi mortgage loans on your book. Is it’s something you are concerned about and then the last question is, do you think that the comprehensive plan on the preference shares should be done sooner or rather later, because I am just mindful that the law of primary and secondary – bank activity going on in the UK and Ireland region in the next couple of months? Thanks.
Okay so, perhaps I’ll take the first question, I’ve been just in relation to the net interest margin and as we set out in our presentation, we believe that 2% is the appropriate target for Bank of Ireland and taking account of the current economic and interest rate environments, the improvements that we have seen in the second half of last year and in the first half of this year are as a result of actions that are ongoing in relation to the assets side of the balance sheet.
Also in relation to the ongoing work we are doing to reduce the cost of funding and to manage our balance sheet more efficiently. And the – we are obviously having significant progress in the last six months, we signaled on the call that the exit margin is higher and that the momentum is continuing.
On the tracker question, where Vincent that is a product that we have offered to customers. We are having customers taken up. We – like with all of our businesses we would allocate a pool of funding, a pool of capital to that. I wouldn’t, if I am looking at it from an investor’s point of view, I think it’s a product which can work with some cohort of our customers.
But if I was thinking about this as an investor’s point of view, I wouldn’t consider that this product will have a significant impact one way or the other on an investment case. But nevertheless, I think it’s important that we can meet customer demands on a commercially sensible basis and this is a particular demand which we’ve identified and which we can serve.
On forbearance obviously, we are very conscious about any forbearance outside of an existing contract with the customer is something that the bank is foregoing. Forbearance is something that the bank is foregoing. So we would prefer not to have to do forbearance but when we do it, it is what we think is sustainable, structured for the customers.
We only forbear for example in mortgages where the customers are able to fully service interest on those mortgages on SMEs and corporates that’s a normal part of forbearance, normal part of restructuring and we would see that the number of customers that are moving into default has continued to slow.
So in each of our portfolios, including for example the Irish Mortgage Book, the issues are becoming much more containable, I think in particular in Ireland I would note that collateral values in commercial real estates, residential mortgage, where collateral values are stabilizing.
So if we look at on both sides, the PDEs, the probability defaulters is reducing and the LGD, i.e. the loss given default is also containable. So we think that this is something that is manageable and the guidance that we have given on where we see loan loss charges is very reflective of an in-depth forward review into each of our portfolios and using the economic assumptions that we adhere.
On the plan, yeah, I would be like you and like to announce the old singing plan tomorrow – we have a track record of calling the stuff of capable of execution. We have various stakeholders who have a wide interest in the preference shares, they are part of capital.
So obviously there is a regulatory perspective. They are owned by the government. So they own them. We are very conscious as Board and a management team of deposition of our existing shareholders as well. So, that is the constituents that we focus on and we are hopeful that we will come with solutions that may not be one single solution. There may be a range of solutions. And yes we’ve got a pretty good track record on delivery.
Vincent Hung – Autonomous
Okay. Thanks, just two follow-up questions. How much of the €8 billion in forborn loans would you say the customers are in terms of cash flow difficulty as opposed to o just being forborn because of the change in the covenant or bridges covenants? And my second question is, is there any update on the pension deficit, because I thought we may have got and be getting an update today, thanks.
Just if I go to – I think, whereas a covenant change or something like that, it’s almost entirely was due to like the sum change in the customers’ cash flow circumstances.
And that’s again very significant disclosure in the document and Vincent page 127 that you have given a detailed table setting out the different types of forbearance including covenant not enforcement. On the pension deficit Richie.
Yes, on the pension deficit, Vincent, we have been in dialogue and negotiations and discussions with in particular the employees representative. So when it is a stock counsel or several trade unions, we have made good progress on those discussions and there was still somewhat of a gap between ourselves and representatives.
But the gap was not significant to stop us moving to the next appropriate stage in the process which is the labor relations commission which operates in Ireland and is a mediation environment. Those talks in the labor relations commission are starting next week and the bank would be very conscious that if it enters into those things, it would enter into on an expectation and hope of success.
We don’t like to waste our time or other people’s time. So, we are going into that on the basis that we would hope to make progress, obviously I can’t guarantee that and what’s one way or the other, the pension deficit issue is not going to go away. The existence of the pension deficit impacts on the schemes. It impacts on the benefits, defined benefits for staff and for pensioners.
It impacts on the capital of the depending kind of it impacts on the cost base and we would hope our track record again is to deal with things through negotiations and we would hope to make progress on that.
Vincent Hung – Autonomous
Okay, great. Thank you.
Our next question comes from David Lock from Deutsche Bank. Please go ahead.
David Lock – Deutsche Bank
Good morning Rich and Andrew. Thank you for your clear presentation. Can you hear me okay?
Yes, we can David. Thanks.
David Lock – Deutsche Bank
I just had a couple of questions, the first is on deferred tax assets. I wonder if you could give any color, clearly we’ve been seeing across the year this being moves and speculation in the prices about moving to solution on deferred tax assets in Spain and Italy and alike.
I wonder if you could give any color on any such negotiations or potential in Ireland, because that obviously that would be a very important step for you. And then second question is on deleveraging, I know you reiterated the €90 billion net loan target.
I wondered that if you could kind of give a little bit of color on where you see loans trending in the next six months. So I can completely agree that growth will eventually come back obviously across the portfolios.
But just in the near term it looks like there is some headwinds from the deleveraging plans that you have to fund up to and the Irish economy. So I just wondered if you could give a little bit more color on where you see that troughing basically. Thank you.
Okay, David, I‘ll take the question on the deferred tax assets and in our balance sheet, at the end of June we are recognizing the full amount of deferred tax assets and it’s under the existing legislations and in terms of the types of initiatives that other European countries have looked us in relation to converting some of the deferred tax assets and those jurisdictions into things like tax credits et cetera and that clearly will be helpful to the financial institutions in those jurisdictions if that had lot of deferred tax assets.
I guess, one of the features of that initiative that we would note, which may get challenging in the Irish jurisdiction is the fact that the tax credit would effectively become a liability of the stakes and therefore it would impact on the debt economics of the county.
And so, I can’t speak for the policy makers and the tax authorities are in the development of finance and there are challenges in some of those initiatives that we think will be difficult in an Irish context. Do you want to take the deleveraging, Richie?
On the deleveraging, I think again, David, I’d obviously point out there is some impact for us from exchange rates which are somewhat outside of our control obviously though to reaffirm that, we hedge your capital and the – from a liquidity and funding point of view, we are funding – very much funding now sterling by sterling assets. So there is an exchange rate impact on that.
I think, on the deleveraging initiatives, they will have some impact, but in the times ago, you were talking about, I am not sure will that have a massive impact and it indicates which gives some flavor on the yield. I think, I would note that different capital intensity and the predictability of the income streams from New Ireland as opposed to some of the substitution basis as well.
And €90 billion, I think remains on a constant currency basis remains an achievable target. And, I think, my colleagues in the frontline of our businesses have been very, very focused on running the businesses while we have been doing a lot of restructuring and cost reduction plans et cetera in the Group.
That generation of revenue has a huge focus, but generation of revenue at commercial returns and margins we will deliver to lose some business in order to drive pricing and margins as where we feel is appropriate and are appropriate and acceptable return. And I sit down with my colleagues and review their business and also I ask them to tell me what business they’ve lost on pricing grounds.
But from a loan and deposit point of view the focus is hugely on margins as well as having sustainable balance sheet. I am strongly of the view that €90 billion remains of the right target and we still as I have mentioned – I think people do have a focus on the gradual growth in the Irish market.
I believe we can outperform that growth in the Irish market given the strength of our franchises and the fact that we are open for business and have been consistently open for business and we have competitors who are in a different position than us.
We have a leader with the post office which we are working strongly on and we can generate assets and business through that and that is through a branch network which is obviously a sustainable way to generate assets and revenues and obviously we have our leverage finance business which is a fine business. €90 billion is there.
I can’t give you an exact guarantee on exactly which is the business that you are going to outperform the others, but my colleagues are very focused on achieving our targets and I am encouraging them to do that.
David Lock – Deutsche Bank
There are no further questions.
Well, on my behalf and Andrew, thank you very much everyone for joining us this morning. I appreciate your interest in the company and I know that we will be meeting a number of people over the course of next few weeks. But thanks again for this morning, cheers.
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