Bank of Ireland's (IRE) CEO Richie Boucher on Q2 2014 Results - Earnings Call Transcript

Aug. 1.14 | About: The Governor (IRE)

Bank of Ireland (NYSE:IRE)

Q2 2014 Earnings Conference Call

August 1, 2014 3:00 AM ET

Executives

Richie Boucher – Group CEO

Andrew Keating – Group CFO

Analysts

Emer Lang – Davy Stockbrokers

Fiona Hayes – Cantor Fitzgerald

Ciaran Callaghan – Merrion Capital

Eamonn Hughes – Goodbody Stockbrokers

David Lock – Deutsche Bank

Chris Canns [ph] – Autonomous Research

Emmet Gaffney – Investec

Diarmaid Sheridan – Davy Research

Dermot O’Leary – Goodbody Stockbrokers

Scott Sheridan – Nomura

Alastair Ryan – Bank of America

Robin Down – HSBC

Richie Boucher

Good morning, everyone, and welcome to our Interim Results for the six months through the June 30, 2014. And thanks to those who have joined us here in Dublin, and those who are joining us on the conference call and by webcast. I’d like to give a short presentation, after which, Andrew Keating, our Group CFO, will provide more detailed review of our performance and then we’ll move to questions and answers.

As you know, we’ve been on a journey from recovery to profitability and we’re obviously pleased to report a profit for the first half of 2014. We’ve also made very strong progress on our capital position and increased our tangible net asset value.

Our financial performance is a function of the actions we have taken and continue to take as well as the improving macroeconomic environment. In Ireland, we continue to support and benefit from the accelerating economic recovery. Our new lending in 2014 makes us the largest lender to the Irish economy. We’re seeing positive momentum across our Irish and international businesses.

Turning to the income statement. Overall, we generated an underlying PBT of €327 million in the first half of 2014. That’s an increase of over €700 million against the same period last year. We’ve grown our total income by €290 million, which is up 24% year-on-year. Higher net interest income and lower ELG fees, both contributed to this growth.

As we said in March, we have significant operating leverage. This is demonstrated in our first half performance. Our costs are flat and the higher income has gone through to the bottom line. Our loan impairment charges have been reduced by over €300 million in the first half of 2014, reflecting our improved asset quality, whilst maintaining prudent coverage ratios. Our performance in the first half also reflects additional gains of €140 million.

Turning to the balance sheet. Our customer loans declined by €1.1 billion in the first half, and were €83.4 billion at June 2014. Our business did benefit somewhat from the strength of sterling. Redemptions continued to exceed new lending, however the pace of reduction in our loan book is slowing in both, new lending which has increased significantly to €4.3 billion and redemptions have been broadly in line with our expectations in the period.

Looking forward, the momentum we are seeing in our business gives us confidence that the pace of reduction will continue to slow. Our defaulted loan volumes continue to fall, reducing by a further €0.4 billion since December 2013. This reduction reflects our ability to appropriately and sustainably support viable customers in financial difficulty, the improvement in the economic environment and the recovery in collateral values.

We are generating capital and continue to strengthen our capital ratios. Our Basel III Common Equity Tier 1 ratio increased by 90 basis points during the first half to 13.2% on a transitional basis.

As we have previously stated, we are prioritizing the capital we are generating towards facilitating de-recognition of our preference shares in 2016. The ECB’s Comprehensive Assessment is ongoing and we expect the results will be published in the later part of this year.

We are fully engaged with the ECB. We have a more developed understanding of this process and the methodologies been applied, and we are meeting all the information requirements by the required deadlines.

We continue to expect and maintain a buffer, above our Common Equity Tier 1 ratio of 10% on a transitional basis. As a result of our improving financial performance, our tangible net asset value per share has increased by 5% in the first half of 2014.

The macroeconomic environment and outlook is continuing to improve in our main markets. In Ireland, we forecast GDP to grow by 2.8% for 2014. And this growth is becoming more broadly based.

Employment continues to increase and over 40,000 people are employed now – sorry, 40,000 more people are employed now than what’s the case a year ago. Commercial and residential property prices continue to cover with residential prices now 43% lower than peak values.

In the U.K. where we have 45% of our assets, recovery is further advised. Key indicators such as unemployment and activity levels in the residential property market are continuing to trend positively, as is GDP.

Our Irish businesses performed in line with our expectations in the first six months of 2014 and have improving momentum. We are continuing to innovate our mortgage offering and enhance our customer propositions.

As a result, we’re providing one out of three new mortgage in Ireland. New mortgage lending for the first six months was approximately €440 million, representing an increase of 40% in 2013. It is worth noting that our tracker mortgage book has reduced by €1.4 billion in the past 12 months – sorry, yes, €1.4 billion.

Our retail franchise continues to attract new customers and we also benefited as other banks with challenged business models exit the market. In savings, where we have a market share of 25%, we have simplified our products and enhanced our digital propositions.

Our life business, New Ireland is the clear number two player with a 24% market share. We are the only banc-assurer in Ireland and our integrated distribution creates added value for both our customers and the bank. The strength of our model is demonstrated by the strong performance of the bank channel in the first half, where new business sales were up 14% versus the prior period.

We are the number one bank in Ireland for SMEs. We are providing over 50% of new lending in 2014 across all sectors of economy. We continue to provide more than 50% of new agricultural lending, and we’ve also had equally strong performances in our motor finance and commercial finance businesses.

We are also seeing an increase in opportunities to build new relationships with SMEs who are refinancing from exiting financial institutions, but where customers have questions about existing banks commitment to the Irish market.

Our corporate business had a good start to the year and we have dedicated teams focused on large refinancing opportunities arising as the market consolidates. We continue to have the leading share of foreign and direct investment market, and we have maintained our number one position in the Irish corporate banking sector.

In total, new lending volumes in our Irish businesses were over €2.5 billion in the first half of 2014, which is an excess of redemptions and repayments excluding the tracker books. These new lending volumes make us the largest lender to the Irish economy during this period.

In the U.K. through our partnership with the Post Office, we are one of the largest challenger in consumer banking franchises. A key priority for this business in 2014 is to significantly grow our new mortgage lending. We are well positioned for the introduction of MMR and the dedicated mortgage specialists facing Post Offices are gaining traction.

In June, we launched our distribution partnership with Legal & General under the Post Office brand. This is a material development for our U.K. business which is already delivering encouraging business flows. These developments have allowed us to achieve our new mortgage lending expectation in the first half. They also give us confidence that we can significantly grow new mortgage lending in the second half.

New lending in our core U.K. businesses was over €1.3 billion in the period. Our corporate and business banking activities in Great Britain, which we are required to run-down under our EU-approved restructuring plan have deleveraged more quickly than expected in the first half. However, we expect that pace to slow down.

Our international acquisition finance businesses performed well. While we have adopted a cautious stance to certain segments of this market, overall we have increased our loan volumes with new lending volumes being ahead of redemptions and repayments.

I just want to put our first half performance into context. We continue on our journey from recovery through stabilization to where we are now, the growth phase. During the recovery phase, we successfully restructured our balance sheet. Within that restructured balance sheet, we have significantly increased our pre-provision profitability by; rebuilding our net interest margin to over 2%, exiting the ELG scheme and reducing our operating costs by over 25% with strong momentum towards 50% target to cost income ratio.

Like I noted earlier, our ongoing investment in our franchises means that we have significant operating leverage when our balance sheet starts to grow.

Loan impairment charges are key factor in return to profitability. You could see this in our first half performance where impairment charges have fallen by over 40%. While the charge of 97% basis points is still elevated, we expected to return to normalized levels over time.

While in overall level the loan book is reducing, we expect to see that pace of reduction continue to slow with our loan books demonstrating momentum broadly in line with our expectations.

Our leading position in a consolidating Irish market together with the strength and potential of our international businesses supported by the improving economic outlook gives us confidence that we can grow our balance sheet to our target level over time. We have the capital, liquidity and infrastructure to support our growth ambitions.

In summary, we are on track to deliver attractive results and sustainable returns for our shareholders. And my colleagues and I remain totally focused on delivering on our objectives.

I’d like to now hand over to Andrew who will take you through the financial results in much more detail.

Andrew Keating

Okay. Thank you, Richie. Good morning everyone. I’m delighted to see so many people here this morning and look forward to chatting with you over the course of the day. I am going to take you through our financial highlights for the first half, starting with our Group income statement.

As you can see, we have maintained our strong momentum in the first half of this year. Bank of Ireland is now profitable and generating capital. To deliver this result, we increased our total income by 24% to about €1.5 billion. Our net interest income of €1.2 billion reflects an expansion in our net interest margin of 40 basis points, partly offset by a reduction in average interest earning assets.

As expected, ELG fees have reduced from €99 million last year to a charge of €21 million in 2014. And these fees will be eliminated over the next couple of years. While we grew total income by 24%, our operating expenses were broadly flat when compared with the same period last year.

In the first half of this year, impairment charges on customer loans were substantially lower. The charge has reduced by over 40% when compared with the same period last year. Separately, our first half performance includes gains of about €140 million, reflecting the write-back on the NAMA subordinated debt, together with the gains arising on the rebalancing of our liquid asset portfolio.

Overall, we generated an underlying profit of €327 million. That’s an improvement of over €700 million over the prior period.

I’ll now provide more details on the key components of our income statement stating with our net interest income. Our net interest margin increased to 2.05% in the first half. This improvement reflects lower funding costs. As you know, we have consistently led the repricing of the Irish deposit market over the last number of years.

The improvement also reflects the impact of new lending volumes, which I’ll give you more detail on shortly, partly offset by the two rate cuts from the ECB and the expiry of certain capital hedges.

From here, net interest margin expansion will primarily be driven by the impact of lower funding costs, the volume of new lending and over the medium term by any increases in official interest rates.

As you can see, our average interest earning assets were a little over €110 billion in the first half of this year, compared with €112 billion in the second half of last year.

I’ll now give you more detail on our customer loans. While customer loans are declining, the pace of reduction is slowing. And we expect the pace to continue to slow further as new lending increases. Our new lending volumes were €4.3 billion in the first half of 2014. That’s an increase of over 15% compared to the prior corresponding period.

We have strong new lending performances across our portfolios, and a number of our loan books are now growing in absolute terms. Our lending volumes are up over 40% in our Irish mortgage business, and this book is growing when we exclude the low yielding trackers.

We’re also seeing good momentum in our Irish SME business. Overall loan volumes were stable over the period. Our corporate business is growing, benefiting in part from refinancing opportunities as the Irish market consolidates.

New lending in our U.K. mortgage business increased by over 100% compared with the first half of last year. Our U.K. business is benefiting from the positive impact of the mortgage advisors recently appointed by the Post Office. Together with the recent launch of our partnership with Legal & General, these developments give us confidence of further significant growth in U.K. lending in the second half of this year.

Redemptions in the first half were €6.4 billion and are broadly in line with our expectations. I would also note that redemptions include deleveraging in the low yielding Irish tracker portfolio and in the EU-mandated books in Great Britain.

While redemptions in the EU-mandated books were higher than expected in the first half, we expect these redemptions to slow from here.

Stepping back, we’re encouraged by the new lending momentum in our businesses and by the level of economic recovery. We remain confident that with our strong market positions in the consolidating Irish market, together with our attractive overseas franchises, that we will achieve our balance sheet target over time.

Turning to operating expenses. We remain focused on controlling our costs and driving efficiencies, while continuing to invest in our businesses. Staff costs are in line with the second half of last year. Underlying pension costs have reduced by €8 million, reflecting the impact of the benefit restructuring in 2013.

The increase in other costs reflects investments in our digital and other infrastructure, together with the increased cost of regulation. We have significant operating leverage, and our cost income ratio was 55% in the first half of this year. As a result, the increase in our total income flowed straight through to our bottom line.

Moving to asset quality. Defaulted loan volumes continue to fall reducing by €400 million in the first half of this year. These reductions reflect our ongoing work supporting customers who are in financial difficulty, the improving economic environment and the recovery in collateral values.

Our portfolios continue to perform in line with our expectations, and we expect further reductions in the level of defaulted loans in the second half of this year. Our loan impairment charges have fallen by over 40% compared with the second half of last year, and these reductions have occurred across all of our portfolios. However, impairment charges remain elevated at 97 basis points, but we expect that they will continue to reduce to normalized levels over time.

I’ll now give you some highlights in each portfolio starting with our Irish owner occupied mortgages. Nine out of ten of our accounts are up to-date. And our level of default arrears is less than half of the Irish industry. 94% of our loans are on a capital and interest repayment basis. Defaulted loans reduced by a further €140 million over the past six months. They are now down 13% from their peak.

Impairment charges reduced to a €11 million. House prices continue to recover with average values increasing by 12% over the past 12 months. Our provisioning assumptions remain unchanged and continue to accommodate a 55% fall from peak.

Moving to the Irish buy-to-let book. The improvements in the macro economy and in collateral values are also relevant for this portfolio. In addition, private sector rents continue to increase. Nationally, they were up about 9% over the past 12 months. Impairment charges have reduced to €81 million, reflecting the improving economic conditions, the trend in arrears and the actions that we are taking to support our customers.

Moving to the U.K. At June, our U.K. residential mortgage portfolio was £20 billion, and represents about a quarter of our total loan book. The book continues to perform well and the arrears levels are less than the industry average.

Moving to our SME and corporate books. While challenges remain in our Irish SME book, we are seeing signs of improvement across a range of sectors. We have agreed resolution strategies with more than nine out of ten of our challenged customers and more than 90% of these restructured customers are meeting the terms of their new arrangement. Impairment charges fell by 50% relative to the second half of last year.

In the U.K. our SME portfolio amounts to £2 billion, and the level of defaulted loans continues to fall. Our impairment charge reduced to £17 million in the first half of this year.

In our corporate loan portfolio, defaulted loans are down by nearly €400 million over the past 12 months. The increase of circa €100 million since December partly reflects a small number of individual case-specific factors. Impairment charges fell to €44 million in the first half of this year.

Turning to property and construction. In terms of our investment book, about half of the loans are in the Republic of Ireland and about half are outside ROI. Our loans are diversified across sectors, albeit with a retail focus. In Ireland, we are seeing the improved investor sentiment in commercial property markets starting to expand from Dublin to the other urban areas, reflecting the ongoing international and domestic demand for assets.

We’re also seeing positive trends in rents, especially in Dublin where vacancy rates are low. U.K. commercial property values are also continuing to rise, including some improvement in regional locations. The land and development portfolio was €3 billion at June and we have a coverage ratio of 73%.

Before I move on, I will summarize the key aspects of asset quality. We reduced the level of defaulted loans by a further €400 million over the past six months, and the loan impairment charges have reduced by over 40%. Looking forward, we expect the defaulted loans to continue to reduce and the impairment charges to continue to fall towards normalized levels.

Turning now to funding and capital. We had a strong and stable balance sheet and with capital and liquidity to support future profitable growth. Customer deposits accounts for more than 75% of the Group’s funding and these predominantly retail oriented. We repaid a further €2 billion to the ECB, and we continue to access wholesale funding markets at reducing costs. All of our liquidity ratios are robust. Our capital ratios are also strong.

Over the past six months, we increased our Common Equity Tier 1 ratio by 90 basis points. At June, it was 13.2%. Our total capital ratio increased to 16.4% reflecting our successful Tier 2 issuance in June.

As you know, we are prioritizing the capital that we are generating towards the de-recognition of the preference shares in 2016. In that regard, on a pro forma basis at the end of June, our CET 1 ratio was 10%. That ratio of 10% takes account of the phase-in adjustments between now and 2016, and it excludes the preference shares. Future profits will further strengthen this capital ratio.

I’ll now summarize the key financial highlights of our first half performance. We increased our total income by 24%. Our impairment charges reduced by over 40%. We increased our capital ratio by 90 basis points. We delivered an underlying profit of €327 million, that’s an improvement over the prior period of over €700 million. We are on track to deliver attractive and sustainable returns for our shareholders.

Thank you all very much. Richie and I are now very happy to take your questions.

Question-and-Answer Session

Richie Boucher

Hi Emer.

Emer Lang – Davy Stockbrokers

Thanks. Emer Lang from Davy. Just wondering, can you shed any more light at all on the Comprehensive Assessment process, maybe where we are in terms of timing, when you expect to be able to make any announcements on it?

Richie Boucher

Yes, I think let’s just look as to where we are and what we know. And what we know is that AQR/BSA was done in the last quarter of last year by the Central Bank [indiscernible]. That didn’t identify any capital requirements. There were certain observations made which we reflected in our year-end accounts at the end of December. And the AQR or exercise has been done on behalf of the SSM by the ECB and the EBA. It’s a different process, but it would be drawing on some of the work done on the AQR/BSA.

But we have got a much more developed understanding of the methodologies, the processes. We have also – there has been very significant information requirements. We’ve been able to meet all of those, meet them on time. And so it’s an ongoing process that’s manageable. It’s after the end of probably October, and there is still lot of work underway, but so far it’s very manageable from our perspective, albeit a lot of work and lot of consideration to the information.

And then again we look at what’s happened. We are generating capital. We’re up 90 basis points. The macroeconomic environment in which we’re operating is continuing to improve. We’re continuing to see ourselves generating capital going forward from here. And we have taken the opportunity today to repeat our capital guidance, which is that we remain above for Core Equity Tier 1 of 10%. And that we were on track to de-recognize the preference shares as core capital in 2016.

So we have a much more developed understanding, but there is a way go, yes, but we’re repeating our capital guidance this morning.

Fiona Hayes – Cantor Fitzgerald

Fiona Hayes from Cantor Fitzgerald. You stuck with the 55% peak to trough house price assumption, and of course I’d like to have moved away from that to just reflect an extra level of prudence ahead of the Comprehensive Assessments and when you’ll be looking at that later in the year. I’m also interested in the tracker book of €1.4 billion of net redemptions over a year is pretty impressive compared to the industry and sub-part of the mortgage restructuring process, or is probably similar you were paying rents there [ph]? And third question, do you expect to participate in the TLTRO?

Richie Boucher

Well, if we go to maybe the trackers first. That’s broadly reflecting repayments you can see it in – when you have look in more detail the slides will show about half in the owner occupied and half in the buy-to-let book and it primarily reflects normal. So we have an amortizing book. If we look at our own occupied book, we got about 94%, 95%. So that is a fully amortizing book. And about two-thirds of the buy-to-let is fully amortizing, so the impacted there. We are also seeing customers using cash to pay down. And so that’s part of what’s happening.

On the TLTRO, we have a business and a model which ensures that we fund our businesses in the currencies in which we have our assets. We have strong performance in the U.K. and in our core Irish franchises. And we kind of like to think about it in our own heads that our customer loans should be funded by customer deposits and our capital. And then our required liquid assets we fund out of the wholesale markets, and we continue to look at the maturity profile of that.

Even in probably really challenging times, two, three, four years ago, we always tried to say we must resist a dependency on Central Bank funding, like our business model must be a robust one and must be part of our strategy.

At the same when the LTRO came out, we did and we made it very clear to the market. We took about €1.5 billion in carry trade there. And I think you will see us look at the TLTRO, but more kind of carry trade running in each strategic part of our funding. And I am very sorry, I forgot your first question.

Andrew Keating

I mean the net housing price, the impairment provisioning and the 55%. So I mean one of the things that we’ve consistently said is that we were going to continue to maintain our prudent coverage ratios ahead of the regulatory initiatives that are underway over the – right now into the second half of this year, and until we had a better sense of the emerging regulatory regime in terms of the SSM etcetera.

It’s something that we’re going to continue and we will keep under review on an ongoing basis, Fiona, but we felt it was appropriate at the half year to retain our 55% assumption and to retain our coverage ratios at an overall level have increased from 48% last December to 50% at June. So we felt that was an appropriate thing to do in the context of the various regulatory and other factors that are underway.

Richie Boucher

Ciaran?

Ciaran Callaghan – Merrion Capital

Hi, it’s Ciaran Callaghan from Merrion Capital. Two questions please. Firstly, on your income. Should I ask, [Inaudible – Microphone Inaccessible] do you have any guidance over the income gains, so that should we expect – do you want me to repeat that question or do you want…

Richie Boucher

Yes, I’ve got that one, Ciaran. And I’ll repeat it for the rest of the audience.

Ciaran Callaghan – Merrion Capital

Okay, thanks. Yes, just trying to get some color on any guidance on the H2 AFS gains possibly from disposal for your Irish sovereign bonds? The second question is just around defaulted loans. If we look at decline in H1, it was roughly €400 million versus €1.2 billion in H2 last year. How should we think about that going forward? Is the H1 performance this year, was that really impacted adversely by that sort of blip in the corporate book or is there also potentially accounting implications in new EBA guidelines, etcetera. Is that affecting the decline in NPLs? Thank you.

Andrew Keating

Okay. Maybe just to talk about the other income, Ciaran. Certainly I think one of the things that we felt was important was to call out for people, the level of treasury gains as you call them or the gains that we’ve generated from the sale of the bonds in our liquid asset portfolio. The background of that is very much just a normal ongoing rebalancing and restructuring of that portfolio. And you’ll see in terms of the disclosure in the books, the continued reinvestment of those bonds in relevant Irish assets.

In terms of other income, generally in terms of those gains I think we call out very fairly there is a slide in one of the appendix says at 34 for your reference, which sort of sets out the various historical gains and other items that have risen over each of the last three periods. What we’re trying to do is to call out, if you like, the underlying business income in terms of how that has evolved and developed. And then we’re – because other income is impacted by a range of pluses and minuses in each reporting period, we tried to give a lot of disclosure in relation to that.

The management of our liquid asset portfolio and the balance of that liquid asset portfolio will continue on an ongoing basis, Ciaran, I think if you look at that particular side, you’ll see what’s been the typical level of gains that we’ve crystallized over each of the past three reporting periods. This first half, the level of gains was outsized by historical standards and that’s what we felt was important to call that out.

Richie Boucher

On the defaulted loans, I suppose the first point is to make is that there has been no change in accounting policies or any changes in current recognition, but we run quite a conservative basis for concerning with the launch defaulted, by the way its opened the corporate book. And we think that the – well, we know that this slight movement upwards is primarily due to what could be determined as technical defaults which we believe will rectify. And I suppose that’s evidenced by the fact you can see even though we’re keeping prudent coverage ratios at provision stock against the corporate loans has actually come where the provision charge has come down.

And I think you would see, we continue to anticipate that the defaulted loans will reduce. Our philosophy is obviously to maximize and manage cash to ensure that we’re holding strong coverage ratios. We cannot be selling portfolios of loans, and we may, but like that wouldn’t be a call. Our philosophy and strategy is to work these loans out.

And if you look at our buy-to-let book for example, we have 1,800 rent receivers appointed. That’s up 500 on the first half of – position at the end of December. And that’s ensuring that we’re getting the cash and control of the assets and we manage them out. So we continue to anticipate that the defaulted loans will continue to reduce.

Andrew Keating

Was there a question?

Richie Boucher

I think that’s Eamonn.

Eamonn Hughes – Goodbody Stockbrokers

So Eamonn Hughes with Goodbody. Maybe just picking up a little bit on the non-interest income side. Well, I suppose you construed the impairments number, but the NAMA subs right up to €70 million, Andrew. Just we’ve had the Section 227 review of NAMA which come out in July. So I am just wondering taken that on board, whether that may have any implications in terms of the valuation of that bond in H2? And then maybe just moving on to the margin. It was kind of flat Q2 on Q1. So I am just kind of wondering if you can give us a little bit of kind of color in terms of momentum coming into H2, whether we’re seeing any upward momentum or flattish, and maybe you could tell us on that?

Andrew Keating

Okay. So in terms of the NAMA sub-debt, Eamonn, I mean that’s clearly something again that we keep under review on an ongoing basis. We certainly moved up its valuation over the past six months, and again we’ve called that out clearly. It’s still valued at about 72% of its par value. And certainly over time our expectation is that will pull to par.

And when we look at the announcements from NAMA, we will continue to assess the impact of those on the timing and receipt of cash flows and also on the discount rates that we apply to those expected cash flows. I mean certainly more generally the fact that NAMA have been making positive announcements is clearly a positive from our business more generally.

On the net interest margin, in terms of the 2.05%, certainly we’re pleased to have to continue to sustain our margin above 2%. I think we start calling to target a little while ago when we talked about it being a milestone. We continue to see positive momentum in terms of that net interest margin. There were a number of items that impacted on that in the first half of the year, and we’ve called at some of those in the past. The capital hedge is a good example of that.

We’ve also issued clearly our Tier 2 in June, and obviously very pleased with the coupon associated with that. And that will have a minor impact on the overall net interest margin. But when you look forward, I guess the key thing – there are a number of factors that will drive that margin going forward into the second half. Certainly the impact of new lending is a positive. Clearly the margins we’re generating on the new lending activity would be above average net interest margin.

Deposit costs have clearly come down very significantly over the past number of years, and they’ve reduced further in the first six months of this year, about 115 basis points is the average cost of money to Bank of Ireland at this point. And that’s the weighted average cost top-to-bottom, the current accounts all the way down to the Tier 2.

I think there maybe some little bit more to go there. Again that’s certainly something we’re keeping close watch on in terms of both the competitive environment, and clearly we’ve got very strong liquidity position in relation to that. But the funding cost impact together with the impact of new lending are likely to be the key drivers of our margin in the short term. Clearly over the near or medium or longer term any changes in the official interest rates will also have a positive impact on our net interest margin.

Richie Boucher

Sorry, we might just see if there is anyone joining us on the line and come back to Dublin in a second. So, Karen?

Operator

We have a telephone question from David Lock of Deutsche Bank. Please go ahead.

David Lock – Deutsche Bank

Good morning, everyone, and thank you for the clear presentation. I just wanted to ask three questions please. Firstly on the loan book. I appreciate it’s very difficult to really forecast where the different elements will move given the FX impact, but I just wonder what your current view on where the loan book is going to trough, and is it going to be the end of this year, beginning of next year? That would be really useful to get some color on that. Secondly, and it’s just a follow-up on the 55% peak to trough assumption, the question that we had earlier. I just wondered if you could confirm what the size of the buffer is between the 55%, and what we’re seeing in the market at the moment. My numbers is between €300 million and €350 million. I just wondered what actually triggers the re-recognition of this. Is it an auditing – would it be your auditors who would force you to re-recognize that or would it be a regulation that would need to sign off on that? And then thirdly, just on the U.K. business. I just wonder if you could give a little bit of color on what you’re seeing in terms of churn of the SVR book? Clearly, you’ve got quite a higher SVR rate there. Yesterday Santander were saying they haven’t decided whether they would actually put up the SVR rate if interest rates went up in the U.K. I just wondered if you could give a little color on what you’re seeing in terms of churn and how you think about official interest rates impacting that book? Thank you very much.

Richie Boucher

Thanks David. What we are trying to do as much as possible in the presentation is to show the dynamics of what we think is happening in the loan book. I think if we look at it – if we’re starting with the Irish business, we’ve called out which is important because we look at the relative yield on them, called out the reduction in the tracker book. And we’ve seen the growth in new lending in Ireland that’s 2.5 premium [ph], that’s up considering the first – since the first half of last year. And I think it’s reflective of the fact in particular of momentum which took place in the second quarter, which we have seen carrying through, like a small example is like we’ve bought 50% of the motor finance and vehicle finance market in Ireland.

You have the registrations changed in January and July. And July was even stronger month for us than January. So we’re seeing relatively good momentum, and ex the tracker book, where new lending is in excess of redemptions or repayments in our Irish businesses.

On our leverage finance business, we’ve been relatively cautious on that market. We see some features like [indiscernible] which we’re cautious of, particularly in the high end of the market. It hasn’t been as much of the feature in the mid market we operate. And obviously we’re relatively diversified in terms of geographies. We can originate our assets from – and that book has grown slightly as well.

And coming back to the U.K., there are two features in our U.K. business. Like in Northern Ireland is – most probably three. Northern Ireland is progressing okay from our perspective. It was mainly a restructuring play in the first half of during 2013 and we’re starting to see some momentum picking up in Northern Ireland, but the bulk of our U.K. business is in England we’re having some question [ph].

We were mandated by – effectively we negotiated with the European Union that we kept our New Ireland business in Ireland. That’s strong performance in the first half and is a good income stream, it runs with low capital. But in order to do that we had to agree to run-down our Great Britain business banking and corporate book. That’s running now at around about €2.4 billion, €2.5 billion.

And when you have a book and run-down, it’s probably – sometimes you don’t have the dynamic of new lending, etcetera, it’s more difficult I think sometimes to predict the pace of run-down, and certainly you revise etcetera that we saw in that book in the first half of this year, we’re a little bit ahead of our expectations.

And it’s hard to make a real call, albeit I’d note that the absolute quantum and size of that book is obviously reducing and the pace of reduction we expect to come down. Then we turn to the principal book that we have in the U.K., which is our U.K. mortgage book. And we have seen – our churn is probably broadly in line with the market. The mix we have between base rate, between buy-to-let with also self-cert. So our churn is broader in line with the market that we don’t see any particular features. And our pricing I don’t think is you’ve got align with the market either.

What we have seen now is very good momentum in our – in the origination side. We put a lot of effort and work into being ready for MMR. There was a lot of process change, a lot of the trading etcetera had to take place for MMR until we were positioned ourselves well. We had been indicating to the market in the second half of last year and during the first half of last year that the Post Office channel was opening up. There was a lot of training and recruitment of people and mortgage advisors in that channel and the product design etcetera. And that has grown well, and we’re seeing momentum has picked up in the second quarter there.

And in June, we entered into the partnership with Legal & General. That’s also under the Post Office brand. And the volumes that we’ve seen in June in line with our credit criteria have probably been slightly ahead of our expectations and our ambitions.

So we’re seeing good momentum to exactly call when we see the loan book to have started to stabilize and move back to growth. I think it’s a little bit determined by what’s going to happen in the run-down book which is obviously non-core from our point of view.

Andrew Keating

Okay. David, good morning. Just in relation to your question on the peak to trough house price assumption. Just to give you the sense, at every first – I think at the full year stage we set out in a document that the sensitivity of the changes in that assumption for every 1 percentage point change in that assumption, the impact on our provision stock would be between €35 million and €40 million. And that sensitivity will continue at the end of June at the same level.

In terms of the overall markets, the most recent CSO index which was published up to the end of June, would suggest that the peak to-date for house prices at a national level has been about 43% since 2007.

The decision around the retention of the 55% is very much a decision for the company and for the board. And that’s something that we do keep under review on an ongoing basis. Clearly it’s an issue that, if we were doing something that was maybe inappropriate, then I am sure our auditors, our regulators will have a perspective on that, but primarily the decision to change that assumption or to retain that assumption, that’s a very much a decision that the board takes at each – on an ongoing basis, and then clearly in particular at each external reporting period.

So it’s something that we will continue to keep under review over the next six months keeping an eye to what’s happening in the external market, keeping an eye to the credit performance of our own portfolio and our success in continuing to support our customers and restructure the underlying loans.

Richie Boucher

And just on the trends on that book. We continue to see in owner occupier, we’re at 50% of the industry average; buy-to-let, we’re about 75% of the industry average. In terms of the arrears, they are falling, but in customer numbers and volumes, the restructures have gone up somewhat, but also I think a key feature in the restructures is sustained and we’ve got a nine in ten of the customers are meeting with new terms.

So all that we are doing is working. Negative equity in the book has come down. So the quantum of negative equity was €3 billion in December, €2.6 billion at the end of the June. And the negative equity, which relates to defaulted book, is around about €700 million, and obviously we have €1.9 billion in provisions against defaulted loans of €3.7 billion or had no obviously against the NIB [ph] and are against the book as a whole.

So the book is in good shape, but I think like Andrew said, we’ve gone through an AQR/BSA. We’ll continue to keep this under our review.

David Lock – Deutsche Bank

Thank you very much.

Operator

And our next question comes from Chris Canns [ph] of Autonomous. Please go ahead.

Chris Canns [ph] – Autonomous Research

Hi, good morning. I had a couple, if I may. I was thinking more generally about your longer-term target of €90 billion loans and advances to customers. Obviously the book is still shrinking, and I understand your reluctance to kind of call the bottom in it. But when you do expect to achieve your €90 billion, would be the first question. And then secondly, just sort of might attack on through this, but the run-down of the tracker book you highlight and someone did mention that that’s faster than the industry. Presumably that schedule principal being repaid rather than refinancing, and so should we assume that that should assist going forward? And then also your SVR book in the U.K. some of your competitors in the U.K. have mentioned, if I understand that [indiscernible] expect to not increase the 3.99% SVR rate for the first say 50 bps of base rate price in the U.K. I was just wondering what you’re expecting to do there. Thank you.

Richie Boucher

Andrew, you take this.

Andrew Keating

Interest rate?

Richie Boucher

Yes.

Andrew Keating

Okay. So just in terms of – Chris [ph], good morning. Just in terms of the tracker reduction. As Richie said in his presentation, that’s reduced by about €1.4 billion over the past 12 months. And in the past six months, the rate of reduction is at about €700 million level.

About half of that reduction is in the owner occupied book and about half of that reduction is in the buy-to-let portfolio. I think, Richie, was making the point earlier that the majority of that reduction is very much the capital repayment from customers as part of the underlying contractual terms. In our owner occupied book, the vast majority of the owner occupied book, 94% at June, is on a capital and interest repayment basis. And in our buy-to-let book, the equivalent percent is about 68%.

So as we look at that tracker portfolio, we would expect that that level of redemptions and reduction €700 million for half year, that that level of reduction should continue. We see nothing other than that that trend will continue.

Richie Boucher

On the U.K., yes we are – again I think it’s important just to reflect on the mix of our book, the proportion that’s base rate and also the mix in terms of the asset classes we have between buy-to-let and self-cert, and obviously standard. I think we’ve – probably just, we’ll keep an eye on what’s happening in the market generally and what would happen in interest rates before we make a definitive decisions towards our pricing strategy will be there.

On the €90 billion, we’ve thought very carefully as to whether or not we would hold that number. And we think it is appropriate, but our most important jobs is to assist the market in forming a view of the medium term performance of the company. And we think it is still an achievable target, but it is a medium term target

We look at the diversification of the books we have, the diversification of the asset classes in Ireland, the opportunities we have that we are benefiting from in the U.K. and obviously our leverage book. And we still believe that it’s an achievable target to get there with that mix we have. But I am sorry I can’t help you by giving you the exact date under which that is there.

Chris Canns [ph] – Autonomous Research

Sure, okay. Thank you.

Richie Boucher

Maybe we can move to Dublin and try to get into...

Emmet Gaffney – Investec

Thanks guys. Emmet Gaffney in Investec. Just one question for myself is on the yield on the AFS portfolio, and how you expect that to progress over the coming year or so, and whether you expect it to create much of a headwind or do you think it could be sustained around current levels for the next year or two?

Andrew Keating

Thanks Emmet and good morning. Yes, the yield on the AFS portfolio was clearly a function of the underlying assets and where we acquire those assets. I think we said a lot of disclosure in our portfolio in terms of that and in terms of the level of the AFS reserve, which I suppose is reflected here and mark-to-market of that piece.

We have done some rebalancing of the portfolio in the course of the first six months of this year and that obviously is what gave rise to the additional gains that we’ve been highlighting, but there is still a very significant AFS gain – our AFS reserve on our balance sheet of about €600 billion. And therefore that will unwind in line with the maturity of that portfolio.

It’s really in the sort of six to 12 months period that you’ve been asking about, I think that the yield in that book will continue at current levels.

Richie Boucher

David?

Diarmaid Sheridan – Davy Research

Good morning. Diarmaid Sheridan from Davy Research. Just I have one question for myself as well. On total capital levels, I appreciate your awaiting guidance from regulators. Just wonder whether you have any thoughts yourself as to where that might ultimately lie?

Richie Boucher

Well, we’re talking about a buffer over 10%, Diarmaid. That’s the best position we can take at the moment. We don’t have any greater insights than yourself or other market participants would have. We think that’s a reasonable guideline, but obviously we also talk about a buffer, and within that buffer we should be able to accommodate.

We also look at – I think one of the other points is the total capital. So we have taken that, we issued the Tier 2, €750 million in June, that’s up 4.25% [ph], like a cost of 10% or did cost of 10% 18 months ago. So we look at the growth in the total capital. And that’s up 16.4% and that’s – so we consider the capital stack as a whole, with the total capital mix with the Core Equity Tier 1 as well.

Andrew Keating

Clearly, Diarmaid, the total capital will continue to increase in line with the future profits, and certainly I think when we look at our total capital ratio, we had an eye to the emerging regulatory and also the market comprised in the relation to that. And we felt that that sort of level is very much appropriate given our mix of business.

Dermot O’Leary – Goodbody Stockbrokers

Thanks. Dermot O’Leary from Goodbody. Just in relation to the asset quality on the Irish mortgages, and the another mortgages under formal forbearance rose €2.9 billion at the half year. Can you just talk about performance of those mortgages after they go into forbearance measures, in terms of what is the retail rate default experience on those mortgages?

Richie Boucher

We got 86% of the restructured book is meeting the revised terms, so we have some level of re-default. That 86% is probably moved up slightly from about 85% at the end of December, and probably a little below that maybe 83% or 84% at June of last year.

So the restructure – I mean we take – for us clearly, a restructure must be sustainable from the bank’s point of view, the customers’ point of view, but I think that’s something from the markets point of view. So it’s a very important that we have just restructures, and we also have tried to ensure that the market has a very clear understanding, and given lot of detail in the back of the book that the types of restructures we have.

We won’t restructure and we can’t restructure mortgage, where for example the customer can’t at least at a very, very least meet the full interest repayments. And so that kind of restructure that we have are set out, and then there are the element that there are not in the restructure book and we identify and I talked about the buy-to-let book where the rent receivers means we control by the asset and the income and then we decide our strategies going forward.

But our experience to-date has been letting pretty high and pretty good in terms of the re-default rate. And we will continue to keep that under very close review. I mean one of the things that those happen, the number of customers we have without an SFS, that’s the standard financial statement, which they must provide for us to be able to review with a repayment option. We’re still able to provide one of our restructures which are prudent restructures, sustainable restructures, provide nine out of the ten customers who complete those.

We have just over 2,000 customers who are default. We’re having providers with an SFS. We think about 500, there always are people that continued engagement strategy will yield some benefits, and the balance of about 1,700 are in the legal process as non-cooperating customers.

Operator

Question comes from Scott Sheridan of Nomura. Please go ahead.

Scott Sheridan – Nomura

Hi Richie and Andrew, it’s Scott Sheridan. Just a couple of quick questions for me here. On commercial real estates, you still got about 18% of your total growth loan book there, and it’s most severely impaired book. I just wanted to know what your thoughts were going forward with that book. We’re seeing a lot of your U.K. peers start to kind of offload some of their portfolios, so there is increased liquidity. What were your expectations there?

Richie Boucher

Well I think probably just to revise ourselves, Scott, that just over 45% of the book is not in Ireland, it’s primarily a U.K. based. And that’s – so our strategies are informed by obviously the allocation of the assets where we are in the provision marks we have against. And in Ireland what we’ve seen is the improvement in collateral values, reduction in defaults, but I think our strategy generally is to work – is to mark the provision, and then to work when a customer has default, mark when everybody is inappropriate and prudent provision, and then work it out ourselves and we’ve had a quite a lot of success with that.

You may see us in so small portfolios and that will be more opportunistic and also to keep testing the market, but I think our general strategy will be workout strategy which reflects the mix of the book we have, the provisions we’ve marked and there are focus for our shareholders is in recovery of cash, because ultimately it’s the cash that matters the most to shareholders provided we took him [ph] off the book.

I don’t know if anything you want to add to that Andrew?

Andrew Keating

No, I mean I think certainly looking at the market generally, Scott, in Ireland, we’re certainly seeing the continued investor demand for assets, that’s both international investors and domestic investors. We’re seeing the liquidity and transaction levels spread out from Dublin to the other urban areas. And clearly that enhanced liquidity and appetite for us, it’s clearly positive from an environmental perspective.

In the U.K. similarly we’re seeing recovery – continued recovery in commercial property values, including some improvement in the regional locations. And again that’s supportive in terms of where we have marks to the book and we’re very comfortable with that.

Richie Boucher

And the purchases that we’re looking at high-teen, mid 20s IRR, so we’ll feel if we can do our job properly we can preserve some of that gain and benefit for our shareholders.

Scott Sheridan – Nomura

Okay. Thank you very much.

Operator

And the next question comes from Alastair Ryan of Bank of America. Please go ahead.

Alastair Ryan – Bank of America

Hi, thank you. Good morning. It’s a liabilities pricing question, so you dent to 115 basis points in the first half, but looking at your deposit rates, sort of they’ve continued to improve from yield perspective, not necessarily from the deposits perspective. So is there sort of spot average from the [indiscernible] spot an average that’s not right, but did I mean that blended funding cost relative to that 115 basis points you could give us, because it feels like the funding, notwithstanding the Tier 2 issue, but it felt like the funding cost would still be coming down given what’s happened in the market interest rates over recent months.

Andrew Keating

Alastair, good morning. Yes, I mean as was already – I suppose we work hard to try and give you as much as help as we possibly can in terms of the trajectory and pace of the cost of funds. And you’ll see that there has been further reduction in our average cost of funds over the past six months down to 115 basis points which you say. Certainly within the different components of that, and clearly the cost of wholesale funding has come down very significantly. Obviously the quantum of wholesale funding has reduced, but also the cost. I think Richie hopefully referenced the Tier 2 issuance as an example 4.25% was the coupon in June. That’s down from 10% on the previous Tier 2 issuance we did, just about 18, 19 months ago.

I think in terms of the deposit pricing. Again that’s something that we keep under a constant review. Clearly here in Ireland, we’ve led the market in terms of deposit repricing over the past couple of years and that’s something that we will continue to maintain a very close eye on in terms of the – what’s happening from an interest rate perspective, what’s happening in terms of competitor pricing, what the competitors are likely to be trying to achieve in terms of their own financial targets.

And again I suppose when we look at that, we also look at our own liquidity position. We’ve given you some disclosure on the liquidity metrics, both the loan-to-deposit ratios and the emerging Basel ratios. And you will see that those ratios are very robust. So that’s around liquidity position. And it gives us a strong position from which to address the cost of those liabilities. It certainly, it has continued to come down and we will be kind of keeping an eye on it.

Richie Boucher

So just to help you maybe, the 115 basis points is the average.

Andrew Keating

Yes, the 115 basis points is the average.

Richie Boucher

It probably wouldn’t be the spot rate.

Andrew Keating

Yes, the spot would be lower than 115 basis points.

Alastair Ryan – Bank of America

Got it. Thank you.

Operator

The next question comes from Robin Down of HSBC. Please go ahead.

Robin Down – HSBC

Good morning. One quick sort of numbers question and then perhaps a slight broader question. The numbers question, that’s the JV and associates line picked up nicely in the first half. And there some mention in the commentary about international property. Is there another one-off there? Is that something that we could sort of carry forward in our paired investment? And then the broader question just on the U.K. margins and really coming back to sort of David’s original question about the SVR book. I can see that the Post Office is now featuring quite a lot of best-buy tables in the mortgage market. I can also see from looking at website that you’re getting much more active in terms of offering retention products on existing Bank of Ireland mortgage customers. So I was just wondering, how you feel about the direction of margins within the U.K.? Clearly the ground optimism on the IRR side, but are you a little bit more nervous about U.K. margins? Could we expect to see those coming down as asset yields decline? Thanks.

Andrew Keating

The JVs line question first. I mean as lot of thing [ph] that goes into that. They key business activity that fills into that line is the first rated joint venture that we have with the U.K. Post Office, and that particular business has been very successful business for both ourselves and the Post Office. And we provide about a third of the over-the-counter foreign exchange and volume in the U.K.

That business has continued to perform well and we have positive expectations for that business as we look forward into the second half of this year.

We do have a joint venture structure in relation to a particular investment property in the U.K. And pardon?

Richie Boucher

In the U.S.

Andrew Keating

Sorry in the U.S. and that is with the trends in the property market. There has clearly been uplift in that in the first half. We take a prudent approach to the valuation of those assets, and we’ll continue to keep an eye on the further progress that’s happening in terms of that particular market and its impact on that particular asset.

Richie Boucher

Turning back to the U.K. margin question, clearly what we were trying to do is have a strategy of different pricing points and different pricing features. And we are careful on the volumes that we originated today at different pricings. So we will have product on the best-buy tables, but we’ll be careful about the volumes that we originate and where we are there.

We have retention strategies, but like again I’d note, like where our margins are on our SVR book and we have retention strategies there. And bear in mind also that our retention can save other cost that we would have elsewhere.

As far as, again to remind people like there is an element of our book, which is base rate. So in a rising interest rate environment we will – we’d anticipate that the base rate impact would flow through. And change in the base rate is unlikely to have a change in the underlying cost of money to the Group. And like I said already, I think it’s useful to just look at the mix of our book between the buy-to-let and self-cert and the standard book as well.

And the mix of the book that’s also interest [indiscernible] by the mix that’s amortizing. So between all of those, I mean we anticipate that the margin is a margin we can protect.

Robin Down – HSBC

Great. Thank you.

Andrew Keating

So I think we’re finished in the U.K. Are there any other questions in Dublin?

Richie Boucher

Well, again thanks very much everyone. Very much appreciate your interest in the company – your support for the company. And we’ve got a good momentum underway in the business. These are obviously a good set of numbers, but we have a lot more progress to make and we are confident where the business can go from here. So thanks very much.

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