Allied Irish Banks Plc (OTCPK:AIBSF) H1 2016 Financial Results Conference Call July 28, 2016 4:30 AM ET
Bernard Byrne - CEO
Mark Bourke - CFO
Stephen Lyons - J&E Davy
Darren McKinley - Merrion Capital
Eamonn Hughes - Goodbody
Stephen Hall - Cantor Fitzgerald
Good morning. Thank you for attending. We're here to obviously run through the half year results. [Indiscernible] And so in summary, I think these have been the issues we've been talking about for a while. And the important point is that we do get to a stage of talking about it consistently and because that's the demonstration where we believe the business is at this stage, which is it's a normalized business, we have some issues that we're still obviously dealing with in terms of constantly reducing the size of the impaired loans. But the core franchise is in very good shape at this point in time and we think it's delivering what we want. We think we're in a strong operating economy, and that's giving us the opportunity to do what we want to do with the business, which is to grow that sustainable underlying performance and quite also getting the benefit of the reductions in the impaired loans.
So in summary, what you see is a strong financial performance in the period, ongoing sustainable profitability being delivered through, significant capital generation being demonstrated in the period and also demonstrated by the repayment actions that we've been able to undertake over the last eight months in terms of over €3.5 billion of capital back to the state in that period, and honestly, we have significant improvement in asset quality continuing. Our franchise is the market-leading franchise. We have a very clear customer first strategy. We have a significant investment program in terms of the digitization of our offerings in terms of innovation and those offerings and we'll be able to demonstrate some of those today in terms of how it's helping to drive the commercial agenda forward, and ultimately, that's about making it easier for customers and more efficient for the bank to actually do business. There are two strands of this, you can make it easier for customers and you can make it more efficient in terms of the operations so you can get the double benefits.
And we do think we're well positioned, as I've mentioned it, the robust capital generation already, we think we're well-positioned for the future challenges that are there and -- but there's also plenty of opportunities and we're fortunate I think, ultimately, even though we've had a significant sort of markdown in GDP expectations for 2017 and 2018, it's still going to be the fastest growing economy in Europe. So we're in a good position and a good economy and probably accepting that there are real challenges out there. So when you -- when you get to the exciting piece, it's always nice to have a €1 billion of profits to report, it's a good start.
And realistically, of course, when you look at the underlying piece and the underlying piece is about €0.5 billion of profitability coming through, again, a nice consistent message. I think we've been talking about that level of underlying profitability being at their current level that we expect to see in business. Mark will talk about that more. The level is down from last year in overall terms and there's a few factors playing into it, but the major one is obviously the level of write-back associated with the impairments last year. It was a bigger amount in terms of the reduction of impairments last year was bigger, about €540 million.
So that reduction in the impaired credit write-back, €200 million this year, €500 last year, is one of the main drivers of that change. This year, we have had another benefit of the Visa transaction and Mark may touch on that as well. Obviously, it's a one-off benefit, so €0.5 billion of one-offs, €0.5 billion of underlying profitability coming through. Increasingly, the net interest margin is continuing to move in the right direction. That's been one of the things we've talked about for a while, and it is nice now to be -- to be in then target range that we've talked about. We're over 2% at this stage and a 16 basis point improvement in the period. Our momentum behind that is strong and again, we're going to -- we're going to give you a bit more detail on that later on, but the net interest margin moving into that 200, 250 basis points margin range where we've talked about.
Confirming the actions we've taken, we believe in terms of pricing, so we've given some pricing benefit back to customers, but we have the benefit of a very strong franchise, very good funding, which is allowing us to do that and achieve operating model. So we think it's in the right space. Impaired loan is down by €1.8 billion in the period and €11.3 billion gross or €5.9 billion net. Obviously, we're very happy that we're continuing to make significant inroads in that. We have been talking for the last number of periods about when we would hit a sort of a change in the run rate of that, when we would hit a sort of a normalization of that reduction which has been very dramatic over the last number of periods.
And really, what we're saying is, we're in that period now where that restructuring period, the first phase of that is ending, and that's consistent with two-third of the restructuring of €30 billion down towards €10 billion nearly completing. So that message is we have more work to do in this but the momentum is very good. And core equity Tier 1 ratio, on a fully loaded basis, 13.3%, 30 basis points higher than in 2015. And again, we'll talk about the capital generation within the business and our ability to repay significant amounts of capital to the state and maintain a very strong level of our equity. We think it's a key message coming out of these results.
When you look at the economy, that's obviously crucial, we are a very large franchise in the Irish economy. And really, the four charts here are slight update on our normal sort of position to talk in the top left about the old projections and create some sort of Brexit impact effect, 5% for this year, 4.5% for 2017 and 4% for the year after. Really, what we're saying is when you look at -- when you take the estimate of -- from our estimates, it's about 1% in central bank, obviously, the lower starting point, so a lower reduction, 3.5% for next year and 3% for the year after, so very strong underlying growth in the Irish economy even factoring in the Brexit effect. So that's the key point, a good market position in a good growing economy.
Unemployment continuing to fall and the expectation of new job growth, new job creation and coming through from the central bank as well yesterday. So underlying that the -- our economy is obviously improving in jobs which is crucial. Unemployment rates falling but also growth in employment numbers, eligible for employment horizon, so a growing economy. The bottom left hand chart is one we use to talk to the overall position on debt, and really there are a couple of messages here. Firstly, you can see the dramatic reduction in debt, and if you were to project that forward, those numbers aren't out at this point in time. What you see are the further 15% to 20% reduction or in terms of the percentage-side on that net disposal income, so -- I'm sorry debt to net disposal income.
So what you see there is continuing significant deleverage across the economy. And in looking at that, we tend to try and look at it from the point of view of the cohorts where that's true. So you have a 40-plus cohort who have significant amount of debt and they're paying it off very quickly. That's true for SMEs as well. There are certain types of SMEs out there, they have debt but paying it off very quickly. And then you've got the under 40s who have no debt. And actually, they haven't entered the housing market, they haven't entered the big capital decisions and they are entering this marketplace with very little debt.
So maybe that chart shows significant pay down of debt but actually you need to think of the two characteristics of an under 40 and over 40 grouping and how they play, which feeds in into the next chart which is where housing is because that is the engine of growth that hasn't yet fired. And I think the update and everyone in this room will be very familiar with is the update is obviously to say, we think that there's a series of national initiatives now beginning to take place which should allow that housing completion number to move in the right direction, and that is a really significant issue for us, you know, a very strong mortgage proposition, a very strong share. And of the development side of that activity, we would see that as a real growth engine for us when that fully normalizes over the next 18 to 24 months.
We have a customer first strategy and it is driving our commercial agenda. The key points here are, we have a very strong omnichannel and digital offering in place. So we have very good physical distribution and we have very good online offering. And our customers are using that in seamless fashion in an increasing way at this stage. If I take the physical distribution side, we've refurbished over 50% of the branches at this stage and we started with the larger ones and are working way down, so far more than 50% of customer interactions are taking place in the new environment that we want.
And we have a number of branch openings that have taken place and a number of significant change in format. So we have three new branch openings which took place, Cork, Carrickmines and in the Docks, and that's just meeting customer demand, different service offering, different availability. We have announced the joint venture with SuperValu in terms of a private program like Lucan trying to see if that is a new model that is interesting in the Irish market. That branch is open 76 hours a week and seven days a week, and to see if that works in terms of where the new customers at, where the new market dynamic is going to be.
And our Grafton Street branch is open actually just after re-launching at similar amount of time. So lots of our -- lots of our physical distribution is now open seven days a week and, you know, 8 to 10 to 12 hours a day, so a complete difference in terms of availability up in main locations, trying to see where customer demand is at. But the reality is 95% of our customers -- our customer transactions are now online or in an automated fashion. That was the number we've talked about a few years ago and saying that's the target we think that's where we're going to get to. We were at that, we have over 1 million online customers, with almost 600,000 mobile customers. This is where the action is happening at this point in time, and our ability to provide all of our services, all of the customer support, all of the transactions, all of the products through those channels is what's driving volume across the business and then driving the efficiency of the business model.
When you look in the right hand side, you know, that's our brand position. We have a very strong brand in Ireland. And we have a multi-brand position in the Irish market as well. So on the mortgage side, what's that's allowing us to do is to position our mortgage offering in different ways. There are two types of key demands out there at this stage, and obviously, our core offering is around making sure we provide the best rates to customers that we have as we pass on some of the benefits and there were SVR reductions in the main AIB brand.
What we've also recognized that a number of customers are interested in the cash offer, and so in EBS, we're able to use the EBS brand and significant reduction in SVR rate that's taking place in that brand as well. But more recently, we've given the cash back offer there and that's where the firepower for that brand is. And so positioning ourselves in different products in the market we think gives us the opportunity to position ourselves well and that increased moving forward. I'll just ask you to note one particular number which is personal loans. We have a market share that we didn't have the last time of 21%. We had talked about the fact that our market share in personal loans was 15%. And if you take it, that was 15% and our current market share was 37%, 38%. It was a big opportunity there.
We then talked about how we were improving our proposition and invest and support our proposition for those customers and effectively moving it to an online channel and then moving it into mobile and channel. And what you can see from here is 76% of personal and applications are now through those digital channels, mobile being the easiest personal loan channel that we have at this stage. And customer satisfaction associated with that is very, very high, and it is 88 -- plus 88 net promoter score, so it's an incredibly high score. And volume has risen very dramatically. And we've increased our total market share by 6% as the result of improving the customer proposition; results are far more efficient from our point of view. And it's that type of linking our customer first with efficiency which allows us to deliver the sort of target returns we believe are appropriate for the bank and ultimately, have the strongest franchise in the marketplace. The overall investment program of €870 million is therefore targeted around these initiatives.
So to focus on the customer, make sure you're trying to do things more simply and efficiently -- better of risk and capital management, and obviously, online offerings and automated offerings allow you to have better risk models in place and then make sure you provide people in the organization. Another initiative we could talk to at this stage is down in the bottom left, and digital forecourt finance capability, and we've just piloted at this stage an e-signature offering on forecourt finance, which effectively allows people to walk into a dealer and then in the best case scenario where somebody makes a choice quickly which doesn't always happen when you're making a car purchase, and actually, walk out half an hour later with a financed deal because the e-signature piece and an AIB customer, we can credit approve and actually transact it straight away, effectively taking documentation out of the system, 18% of mortgages now will operate through this system as well.
So what you can see is, the system is moving, customers are adopting and that's making a far more efficient from our point of view and a much better experience from the customers' perspective. All of that leading to the number in the bottom right there which is, we have transformed customer experience, net promoter scores of plus 38. Some of you will remember that that was at around zero, in fact, negative at times. And so we're improving that year on year, customers who are willing to give us a 9 or a 10 for the service have increased radically, so 40% more customers now are giving us that exceptional performance rating which is exactly where you want to be.
It's important to talk about the strength of the Irish franchise but also put into context the rest of the group because Brexit is an issue that clearly is on people's mind and the impact on the UK business. Some stats obviously, roughly speaking, our UK business is about 10% of our group assets, it's about 15% of gross loans and about 10% of operation contribution. So for us, the UK isn't a big strategic question. It's a question of positioning the business appropriately and doing the right things to make sure that the profitability of the business comes through, but we don't have a huge exposure into that business at this stage as AIB group. And it's the only part of the business which we saw a softening in Q3 in terms of lending demand, and that was associated with the uncertainty that existed in the UK marketplace and around the actual vote itself.
At this stage, all the actions we're taking in respect to the business are the right ones in terms of making more efficient and confirming our overall proposition in the GB business. And we will see how events unfold at this stage in terms of overtime and what sort of clarity has evolved to the UK operating environment. But we're very comfortable with the position we have. It's a modest position in terms of our overall balance sheet and one that allows us to have exposure to that marketplace, but on a net basis, given that the rate that business is hedged, a real exposure in any reporting period is simply a translation effect on the net profitability of that business, so an FX impact which obviously is very modest, and Mark will talk a bit more, but that's in overall terms, to put us in context.
And you can see that here, I've mentioned the lending piece before, overall drawdown, a modest increase in the period. That's the chart on the left which is the total number, and that's a €o number, so it includes the negative effect of FX. And the Irish propositions which are the sort of the top boxes there, mortgage lending up modestly, the 2% to 3% in the period, which isn't bad given how constrained and tight the market has been. Personal lending up 28%, business and corporate lending up 12%, and then UK down 8%, and that is just for -- in case you haven't gifted eyesight. And it is a sterling number that's there to show on a comparable basis, lending activity in one period versus lending activity in another period whereas the chart on the left is a translation effect sort of as an FX adjustment as well.
And so you can see that modest reduction of 8% taking place in underlying volumes in the UK that Q2 effect coming through. But in overall terms, €6.1 billion of lending approvals, and drawdowns to approval rate of 64%. Important to say, that is an increasing number, which is where you want to be. It's a sign of a normalizing economy again, so people actually drawing down the facilities that they put in place which is where you wanted to be. And when it comes to the legacy issues, impaired loans is obviously the biggest one, that €30 billion down to €11 billion at this point in time and continue to make progress on that. The case by case restructuring element of that is the key point which is, as you get to the volume, you get smaller cases, so you're still doing an awful lot of value, but the individual cases are actually just much more difficult to get through the volume in order to give you the value effect, so there's huge activity but the size of the cases are obviously reduced.
And 37,000 forbearance solutions provided to mortgage customers at this stage, and there is €0.8 billion of impaired mortgages in that probationary -- that 12-month probationary period as well. And the second point we've talked about is the primary restructuring period is concluding. So it is two-third of the way through at this stage and we are -- we are moving into a more difficult phase but we're very comfortable about the book as well provided and the evidence of the write-back is supporting that and what we know is going to take us a while to get through this so we will maintain the infrastructure associated with FSG to work through this. And on the positive side then what you would expect to see is the benefit of that coming through in terms of the credit position numbers as you have more and more of these cases coming through, all be it in a much more reduced rate coming in. So we have a cost associated with maintaining FSG but we also have the benefit of seeing that impairment reduction in terms of the credit side coming through.
The second issue, which we thought is an appropriate update on, was we made a provision for the tracker mortgage redress scheme last year in €190 million. We're not changing that number and we're not changing any of the costs associated with that. We've completed a significant amount of work. We said we would take it on, commit a significant bank resource to it and trying to get this moving as quickly as we could to get the right resolution for customers. And we've made a lot of progress. And in the next month or so, we will start to communicate with a significant portion of customers that we've made progress on that far enough through the overall program. It is a significant program with 300 people working on it. It's about 630,000 contracts you need to be tracking but going through to figure out exactly where you're at in this, and it is subject to significant third-party review and then the Central Bank's finding out.
So we would hope by the end of the year to be substantially complete on this and all we're doing now is giving you an update given that it's the half year as to where we are on that particular program. And ultimately, and the good news position here from the point of view of the majority shareholders at this stage is the amount of capital we may be able to distribute to the state over the past while. And you can see it's quite significant and we've been able to do that because of the performance of the business, because of the reduction of the impaired loans and how that's feeding through in terms of one-off credits and we still maintain pretty strong capital ratios.
Today, it was obviously a very important day because it's the normalization of the capital structure with the effectively, the repayment of the CoCo and which puts us in a position where all of the elements -- the legacy elements of the capital structure around 2010, 2011 are now resolved, so we have a normalized capital structure which is great. In this stage, it has received at this point €6.5 billion of capital back, about €3.5 billion over the last eight months. And so we think we're well-positioned to repay further amounts of capital to the state when that private ownership debate moves one and I'm sure we're going to talk about that later on. But obviously, the business is in very good shape from that point of view.
And so in summary, we're sustainably profitable with good capital base and delivering that back to the owner. And the continued reduction in impaired loans and improvement in asset quality, very strong market shares, growing new lending, very clear focus on the customer and that is delivering an improved and more efficient operating model. We're executing that strategy well, and ultimately, it's about these four pillars that we've talked about before which is we have a targeted net interest margin of somewhere between 2% and 2.5%, 2.5% in the upper range.
We don't expect our anticipation -- or say we are going to operate beyond that. We will share benefits with customers when our net interest margin gets into that range which is -- which is what we know we're at, at this stage. We think we need to operate with the cost to income ratio that starts with a four and to make this business model work and that's exactly where we're at in terms of our overall objectives. And if you assume a capital level of about 12% in core equity Tier 1 then that's going to deliver your return on equity of about 12%. If your capital levels are higher than the return on equity is lower. And we're very comfortable that the business model we have at this stage is showing that we were able to deliver that and we obviously have risks and challenges out there in terms of the market but the core franchise is in good shape, the investment program is working, the customers are responding well to us and we're seeing it coming through in terms of the operation performance.
So I'll hand over to Mark and then we'll continue with the Q&A. Thank you.
Good morning. I was just saying that as Bernard was giving his presentation there that you would have no doubt given how grounded it was in the numbers that there's an FCA after his name. For a CEO presentation, it was very heavily grounded. So just to move on and sort of talk about what that means in numbers at a more prosaic level, all right, the business is, we would say, very much -- you know, it is very much demonstrating a sustainable underlying profitability and at the same time has a positive trajectory in terms of NIM.
We have also a stable performing loan book. We continue, as Bernard said, to reduce our impaired loans balance, and that's coming from €29 billion at the start of 2014 to €11.2 billion now, and €1.8 billion in this period. We are highly capital-generative, we have actually that final kind of legacy instrument being repaid today and Ronald [ph] has just told me that the money has left the bank, so €1.6 billion is now in the draft. And with the accompanying €160 million of dividend and that means we now have re-org capital base and we have very strong ratios. So when you look at our transitional and our fully loaded at 16% and 13.3%, that puts us in a very strong position.
And then I will just trip quickly through this in income statement terms. When you look at the income statement, you see first of all net interest income of €945 million, and that's demonstrating, you know, that continued trajectory in NIM, it is off a smaller asset base and that means it has stabilized over the year. Our other income down, but when you look at it on an underlying level and you look at our fee and commission base that continues to be robust. It rebates a little bit for that loss of interchange fees but it is actually -- that's not a trend, that's just a rebate thing.
Costs were up, and we'll talk a little bit more about that. And they're up really as a function of purely staff or wage increases, for the first time in seven years occurred between 2015 and 2016. But also, our choices as to where we're investing, we're investing in, you know, continuing to focus on restructuring and we're investing, as Bernard said, in that proposition, the efficiency of the proposition and the delivery to the customer. The provisioned number, yes, we have write-backs of €214 million. It's lower than the prior year, but it is kind of in line and linear when you look at the amount of restructuring we have got through and it demonstrates that comfortable level of provision that we have in the book overall.
And we have the final, I supposed, gift, which is in the exceptional item, and that's the Visa transaction so €272 million, which would have been, you know, not recognizing our balance sheet over a year ago which is now converted to cash which we have in our AFS portfolio at the yearend.
So moving to the slide, and for those -- for those in IR and in Finance who are into the aesthetics of slide where they absolutely hate the slide because it's just crowded and cluttered with numbers, but what it does, I would say, it tells you exactly what the performance of the bank is, it tells you essentially what the trajectory and allows you to predict what the drivers and trajectory of the business is. So NIM has come to 2.08%. It was -- it ended the year at 1.97%. It was 1.92% at the half year last year. And what we're doing here is we are maintaining that spread between our loans and receivables and our customer deposits.
And if you look back over the last four or five periods, you will see our yields bouncing between 3.30's, 3.40's consistently, so we managed to maintain that and at the same time, taken the advantage as one liability is re-priced but also as the profile has been changed and we get increased current accounts and we got to shift more to demand deposits and shift away from more expensive corporate deposits. While all of that is happening, and that is our ultimate aim as we look at the average balance sheets, you get the impact of more efficiency emerging as the NAMA bonds are redeemed and as that CoCo is now -- is now actually repaid, and I mean that was 18.63% I think in terms of total cost. So you automatically get a NIM moving up into the 3.30s.
One counter current to that being AFS, our AFS portfolio will lose, you know, 50, 60 basis points over a three, four-year period. And that is the counter current but, you know, we are targeted and aimed right in the middle of that range that Bernard talked about. On the average earning asset side, we have two things, we have a reduction of €8 billion -- and that's two things, that's obviously the low yielding assets of the NAMA bonds being redeemed, but also, we are still -- we still haven't reached that kind of stability of net lending level and that's the challenge of the bank, not a surprising challenge when a 50% mortgage bank is working in mortgage markets, which continues to work at about 50% in normal levels.
On other income, as I said, it's €295 million versus €409 million in total last -- in the half of last year. Underlying fees and commissions at €193 million being stable when rebates for the loss of interchange fees which came in, in mid-2015. All of the other items essentially are a function of two things, one, we hold some pretty long-term customer derivative positions on sterling PPP loans, so they, in mark-to-market terms, move around a fair bit of volatility but obviously neutral if we hold to redemption. And the remaining other items are one-off AFS disposals and gains from -- gains from restructuring. So you're starting to see a normalized other income profile developed over the last couple of periods.
On cost, this is what I'm talking about for a couple of minutes because, yes, our costs are increased, not surprisingly and clearly flagged in previous -- in previous periods. Staff cost first increases in -- for seven years in 2015 and 2016, but also, as we say, you know, we continue to invest in the proposition and also invest in driving efficiency we continue to focus on, ultimately, that cost to income ratio, a sustainable cost to income ratio which begins with a four. As well as that, we will maintain a fairly intense focus on our nonperforming loans. So while this has gone up, and it will be up in the second half, it will continue to up, it is over a medium term, and I'm talking two to three years. We're looking to get to that sustainable number or cost to income ratio that begins with four, so all of that in the context of taking €400 million as of the cost base in the last four years even at our current ratio.
P&L, other items, the things just to draw your attention to here are just, what is the makeup of the provision write-back, and that's new to impaired of €103 million, so that really is your sort of proxy cost of risk, 32 basis points. That, accompanied by specific write-backs in relation to those restructurings that we've worked through of €214 million in IBNR release of €100 million. And the other big items being clearly that Visa disposal, so having been held in our AFS portfolio, it's now converted to €188 million of cash, some deferred consideration and some preferred stock, which we have valued reasonably conservatively on the balance sheet.
Last point is fees, I supposed, which are, I supposed an ongoing tax but €48 million in the first half, and that's a combination of single reservation -- resolution from DGS and some minor amount of the FCS. We will have clearly a levy of around €60 million coming through in the second half, so that all brings you down to that €1 billion. And as Bernard said, you can see the underlying profitability by simply taking the operating profit which is normalizing, taking a sort of normalized cost of risk which I would say that new to impaired represents and you're in €900 million to €1 billion in terms of underlying profitability in the bank.
Turning briefly just to the balance sheet, so on the asset side, gross loans to customers at €61.1 billion from €63.2 billion at December 31st. A big chunk of that is FX, so €1.3 billion just pure translation effect. And we've had strong new lending, as he spoke about. It has been outpaced by restructuring. So we still are €0.8 billion of that stability level, not surprising as we say in a market where we're at 50% mortgage bank and we need -- we need to see that last engine fire in terms of the mortgage market. As well on the asset side, you see the NAMA bond redemptions of €2.4 billion, giving us increased NIM but obviously shrinking the asset base by the same amount.
On the customer account side, it's uniformly good news. Yes, we have -- we have an FX effect, but what you're really seeing there is us losing expensive corporate deposits, a change of profile from term to deposit to demand deposits and the build of €1 billion, even in the half another €1 billion in terms of zero cost current accounts. So all of that has been really the story of that maintaining and even building the spread between loans and deposits and allowing us as we have done in the past to share the benefits with customers. We do see that though as effectively the bottom of the curve in terms of liability pricing and it's just about maintaining that margin at this stage.
On customer loans, again, a pretty -- I supposed, a complicated slide, but it does show you all of the -- all the various aspects of the net loan variables. So you see a performing loan book going from €57 billion to €55.7 billion, take out the Forex effect and you've got a stable performing book. €3.9 billion of new lending, that shows us increasing in all areas by the UK which has clearly [ph] into the second quarter. You see also our impaired loans, the €1.8 billion coming off the impaired loan balance and matching off against the specific provisions falling from €6.2 billion to €5.3 billion. So in terms of messages, strong in new lending, not quite of stability and again, just how it works through in terms of the restructuring against our provision stock.
This slide is simple and that it just starkly demonstrates the difference between the profile of new lending and what we're looking at our backed book, and it starkly kind of demonstrates the point about the mortgage markets, so you have 55% mortgage-backed book, 20% new lending. And we are nearly reaching stability even with that new lending at sort of that depressed level. Across all of the other books, as I say, we are holding or building our market share. On asset quality, this is just working through from €13 billion, as I say, across all of the books. We're making progress across our mortgage book, other personal property and construction and non-property business lending.
In each system, we're actually working through, so there's no particular bias and we're maintaining the coverage which in actual fact is flattering because you are -- you do have an effect -- a denominator effect. As you work through these, you would expect that coverage to drop even while you're maintaining this quality, so 47%, higher level in the mortgage book, lower level in other personal book, which where we're working through higher provided individual portfolios. The provision stock, on the other hand, the work through of that at the start of year, €6.8 billion, €200 million in write-back, €700 of internal and contracted combination write-offs, bringing you down to a combined €6 billion or €5.9 billion, of which, €567 million is IBNR at the half year.
On AFS, only a couple of points to make, one, over a three or four-year period, we will bring an €18.4 billion total AFS and holds maturity portfolio down to €14 billion to €15 billion. Yes, we will have that counter current on our NIM of 50, 60 basis points in that period. There is -- most of our drop off will be in the 2020s in terms of the higher yielding bonds, but in the year 2020, 2021 period. And on the equity side, you're seeing the transfer out of the Visa -- of the Visa transaction, and we're still holding the NAMA debt as approximate, almost par at this stage.
On funding and capital, last, the message is simply, you know, we are effectively balanced in terms of deposits and loans. We've had a successful issuance in terms of ACS in January of this year, and like everybody else, we have done a huge amount since. Our LCR, NSFR -- LCR is slightly higher than you would expect, but that -- and then we would design, but that's really a function of building liquidity into the Brexit vote and also building liquidity for further redemption today. And that would be sort of at 114%, 115% in terms of normalized expectation.
And the last point I would make there is, you know, we started the MREL discussions. The MREL discussions don't give us -- they're kind of in the range of expected and kind of worked with our plan. There will be some increased issuance but it doesn't -- it doesn't overall affect the -- you know, the economics of the bank and at a significant and material level. And it's over a reasonably long period of time that we would ultimately reach our MREL targets.
Last slide before concluding, on capital, you know, we have €0.8 billion of profit feeding into this. Yes, we've had volatility in pension deficit as others have had. But, you know, the ongoing one is the €0.8 billion and the volatility is just -- is just part of the period in terms of increase. We still have managed to grow our transitional ratio from 15.9% to 16.5% and our fully loaded from 13% to 13.3%, which is relevant clearly when we look in a stress test or when we look in next steps as we go to government decisions on selling the business. Reorganized capital stack, last -- I would say the last legacy instrument gone today, our RWAs have come down primarily due to effectively normal activities and restructuring activities. We have a little bit of an increase on up risk, which is -- which is clearly just an arithmetic function defined by our average income over a number of years.
And the last point I think to address here is we have stress test results tomorrow. You know, we're under pain of debt, we can't talk about them at all, but -- so I'm going to talk about them but I'm not going to say the number. And I think that the main context to the stress test results we would give is looking at those capital ratios is primarily a transitional exercise but both are taken into account at 16.5% and 13.3% at very high levels. It is also in the context of us having given back €1.7 billion at the end of the year , giving back another €1.6 today, clearly with a regulator standing at your shoulder. It is in the context, however, of having, you know, a significant DTA and the reasonably large -- reasonably large sort of percentage of MPLs and the impact of that means that we will have a greater more proportion of the impact than others.
Overall, I think they are -- they are comforting rather than anything else comes, is what we were saying in relation to the stress test. We do not expect it to be a significant issue tomorrow.
Normalized and then finally, the points we make just to reiterate, simplified, strengthened capital structure, and today being a red-letter day, sustainable profitability absolutely demonstrated over the last number of quarters and you're starting to see that actually in the P&L balance sheet that there aren't unusual pieces and they're starting to emerge at this point. Path to a normalized balance sheet, we're getting down to what we said at the half -- first half of 2014. We expected to get to that €9 billion to €10 billion and €4 billion to €5 billion net, and we've maintained our coverage in doing so. We've demonstrated normalized kind of access to markets a number of times. It's normalized as anybody has over the last two years. And we're delivering a clear and focused strategy in terms of building our core franchise.
So there, I think they are really the opening remarks. I'll go back now. We'll go to Q&A.
A - Bernard Byrne
Thanks, Mark. And we have a few mics in the room for people who have questions. So what we're going to do is -- we have a number of people on the phone as well, so what we'll do in the first instance is see if there's questions in the room and then after then, we will move to the phone and see if there are any questions that wished to be asked from overseas. So firstly into the room, anyone got a question? Stephen?
Good morning. Stephen Lyons from Davy, just a couple of questions from me please. First of all, just on the mortgage market, in light of your moves lower in the SVR rate, I'm just curious of your thoughts as to possible further cuts and the timelines, and maybe flows applications you've seen on the back of those recent cut that you've made, any changes in prospective market share there? And secondly, just going back to paying off debt coming to your end, stress tests and, sorry, Mark, but just anything else you can maybe flush out or flag to us in terms of negatives that might hit yourselves with regards to the static balance sheet nature etcetera? Thanks so much.
Okay, I'll lead in with the second question. In respect to the mortgage market, I mean I think the first point to make is in terms of seeing things differently. The reductions are really from the 1st of July, so too early to say anything particular about rates actually out of that. On the longer term perspective, obviously, we have been pursuing this strategy for a period of time around passing on some of the benefits associated with the refunding costs to our customers, so that 1% reduction at this stage is the main piece of the pricing discussion that we've had. Obviously, there are others with different competitive offerings in the market up until now, so the cash-back offer in particular was a significant feature for a number of institutions. So it has been a very competitive market. There have been reductions taking place in terms of people moving on the fixed side as opposed to an SVR.
So I'd say, there's an awful lot of -- as you know, there has been quite a dynamic position in terms of different people have positioned themselves. When we look at the impact from our point of view, how we see that going forward as well, I think the rate piece has been an important element of where we've been and it has helped support our position in the market. And I think it's a more and more clearly understood position from a customer point of view. The fact that it was passed that benefit onto the back book, each time we've done that, it has given us a higher degree of comfort and stability of that back book. And from a customer point of view, giving them the comfort that they have that rate that is out there because it's the rate we have in the front of the back book.
Switching activity is one that we have focused on in this recent activity as well because effectively, we've put in -- on the AIB side, we put in the €2,000 and the contribution to cover the cost associated with switching because there was some feedback that people were nervous of looking at switching because there was a one-off cost associated, so we've tried to take that off the table with the contribution towards switching costs does not give them the benefit but it's taking any friction away. So the AIB offer is very much a very competitive price at lowest price in the market and we will continue to be good on SVR and in terms of keeping an underview and seeing what we can do. That's helping our market share maintain itself very positively through this, so our market share by 34% overall and -- which is where we would target our positions, seeing ourselves as a logic conclusion.
The piece about using the multi-brand strategy and using EBS has been to make sure that we have dual offerings in the marketplace because customer demand has been coming from both sides which is the upfront in cash offer has an attraction for certain people so we want to make sure we have an offer that's there. And very early to call activity on switching at this stage as both of those are new and -- but we are very clearly focused on trying to make sure that we have the best proposition in the market for existing customers and for switching customers, and we think that's going to accelerate. So you're asking for a look-forward piece, I think you'll see a bit more in the switching activity and -- because a good rate and frictionless from a cost point of view and a better proposition we think will be attractive in the market.
In terms of future SVR cuts, we haven't said anything at all about that although we're going to keep these rates under active review. And I think our position has always been to the extent that we see funding benefits coming through that allow us to make benefits passed onto customers, we will do that. But obviously, the funding benefit side has significantly improved already so we're not indicating that there's a significant piece out there that we would need to do, so no statement in that at all, no position on that. We're just after implementing a cost of 1% down over the last 18 months.
And talk about the market, just the flow…
Yes, the buildup -- a lot of what we've been talking about has been the new housing side, I think is the key element in terms of where the market is at this point in time. I think it's normalizing and adjusting to the macro potential growth. But that had a bigger impact at the beginning and that's sort of normalizing at this stage. There has been obviously some modest growth in the market, very modest and significant amount of cash buyers still out there depending on whose statistic you follow its somewhere between 40% and 60%. And so I think the key to everything is the new hour build taking place and actually creating the space in the market for a movement to take place. So it could actually be quite dramatic over two to five-year periods.
And if there has been a pent-up demand developing every year, 25,000 is the requirement, 12,000 is what's delivered, so whether you're 30,000 to 50,000 shortage at the moment in the system, somebody to guess, but you would expect there for new house builds when the machines starts to work and I think the initiatives are developing to move towards that 30,000, 35,000, 40,000 level in order to start addressing that back book -- that demand. And that would obviously speak to the mortgage market more than doubling. And I think that's where we would say, we could see the mortgage market more than doubling from its current level. We've always talked about €8 billion to €10 billion being a normalized level. We could overshoot for a period of time depending on how that activity is there.
Pricing is holding up pretty well, obviously not dramatically moving ahead, so we wouldn't expect a price effect on mortgages to be dramatic but it's going to be positive in terms of overall house valuation. And our market share, as we've talked about, is in that 33% to 35% range with 34% where we are currently at being very comfortable.
Stephen, I wrote down all of Bernard's question, but I think the first part of yours was static balance sheet. The second part was?
Yes, and that's exactly just looking at the stress test, would there be any other features that you can really flesh out in terms of how the European alliance and a notably static balance sheet nature and features of that?
Yes. I mean clearly, a static balance sheet does a number of things, one, you don't -- it's end of 2015, and two, you're not getting the benefit of the performance since that period. But there are kind of two or three ways we would break this down, so there's going to be a 300-plus basis point impact purely on the methodology, and that comes from the fact that, for instance, our CoCo is considered to roll forward through the entire period. And any income from MPLs is restricted, and there's a benchmark system whereby if, for instance, your BD experience is worse than benchmark, you live with that, but the asymmetry is, if you BD experience is actually better than benchmark, you'll grow up the benchmark.
So if you look at us, as we would see it as, our business and its actual performance in stress which if you look at an ICAP context and you look at a stress test methodology, the methodology itself cast straight off the bat 300 plus basis points. And the other -- as I've mentioned the other things, at a transitional level, clearly, DTAs are a high level of MPLs where you have taken on your restructuring, they will -- you will actually have a more significant depletion or be more impacted as a result. I'm not calling this as a significant issue; I'm just saying that when you look at the results tomorrow and you will be able to see that impact.
That will be 9 o'clock tomorrow night.
Give me a call.
Bernard, Darren McKinley at Merrion. Just a question on the lending volumes and obviously being led by SME and corporate lending, I mean post the Brexit and some concerns that SMEs are most exposed to that risk, will you have a strategy change in terms of lending practices to the SME sector?
Well, any time there is an event like the one that just occurred, you clearly look at the sectors at the most effective [bias], and so clearly, those [insignificant] export businesses into the UK, they're the ones who are making their own decisions about their business as well. So I think what we have is, right now, we just have this period of uncertainty. And I think we saw it in the UK in Q2, I mean we're seeing it a little bit for those who are very exposed and into the UK market place a little bit, people going: You know, I need to think about exactly what this means. So we have this uncertainty effect, and that's the piece that's going to play to the GDP and it will play too a little bit in terms of businesses look at it and therefore we look at our cash flows. So it's not a big callout at this point in time and I think it just an issue to be aware of and we would obviously monitor those sectors more carefully and be more engaged with the customers around that. And you would expect there to be an investment effect over time as people think about the impact of FX in particular on those businesses.
On the other hand, you know, there's a very, very significant portion in the book which will find relatively modest impact associated with that and they will be much more just impacted by a GDP effect, which is where I'd go back to the fact that we still have a very fast-growing economy in European terms, so we wouldn't expect to see at this stage something coming through. So right now, we would call it as it's an uncertainty effect at the moment, and those that are most affected by it will be the ones to think about it hardest. And we all need to think and see how it plays out over time as to what the longer term effect is. And so we're not calling it as a major effect but identifying it, for some it would be more significant. Eamonn?
Eamonn Hughes from Goodbody. Maybe just two specific questions on [you] on general. Just in terms of the specifics, I know you kind of mentioned, Mark, kind of the asset yields but there was a fairly big number there in terms of the net swaps, so maybe just any kind of guidance in terms of that as it progresses over the next couple of years. And secondly, just going to take that the regulatory cost, that's an annualized charge that was taken in H1, maybe just to confirm that. And maybe -- sorry to come back in terms of the balance sheet, but just to kind of recap or kind of elaborate on the target of kind of cost to income ratio starting to four and the aspiration to get to there, kind of how -- would you be able to give us any specific guidance in terms of your thought process around where the net lending book get to because as you look at kind of the macro backdrop at the moment, it's very hard to see it grow materially to get the income number up to get to something starting with a four. So maybe you have a thought process on that, Bernard?
Sure. Well, you want to answer the specifics and then we can…
Yes, on the AFS, net of swaps and embedded value that would actually be just -- that would follow the profile of the maturity of the bonds, just to say, and we're looking at a significant proportion of that maturing over the five years but it is backend towards post-2020. So that's why you see only 60 basis points move in the three-year period to say that in the planning period, there after it falls off quicker just in the early 2020 years. And the second was rig cost as in levies. Our €48 million is actually the specific charges for SRF or the FSCS and/or Deposit Guarantee Scheme. So they go into the first half and then there is a levy which would be a single point, €60 million expected in the second half. Was that -- they were the two specifics.
Yes, and we can chop and change the other one. I mean I think it's -- I think you have to think of the numerator and the denominator with respect to that. And so, you know, for simple sense, it is all going to be growth, don't worry about it, it would be great. And I don't think that's the story. I think -- I think what you're dealing with is, at the moment, we have, on the cost side; I'd call it two pieces which are worth considering. One is the big strategic investment piece at the moment. So we are investing and establishing capability which over time will give us more resilience which is good, but also gives more flexibility in terms of what you can call cost down or not. So the outsourcing side at the moment, we're using a significant amount of that outsourcing capacity, so you're not seeing the cost benefit coming through from having something that was in-house, that's now outsourced. But as you get through a number of these programs, that cost becomes more variable entities, so that's one point.
The second point is, when you look at the impaired loan side, we obviously have one of the biggest volumes of impaired loans than any bank and therefore we build the FSG, Financial Solutions Group structure to being a bigger level than anyone else. I think what we're talking about today is we do see the need and the benefit of keeping that going for a period of time. There have been 1,000 people in that part of the organization. The benefit of that at some level comes through in the non-operating income side because you see that coming through in terms of net credit provision write-backs, but the cost obviously sits in your operating performance. So as you move out over two to three years, I think what you'd expect to see is those costs are starting to come down. You'll have a normalization of the impaired side taking place as well, but you have a cost benefit that will come through, so we're investing in that infrastructure now. We don't see the income coming through in your P&L -- sorry, the operating side of the P&L, you see it coming through effectively through management of credit provision issues.
And then on the other side, you have the income effects associated with balance sheet growth. I think we haven't called a number and I'm not trying to guide on a number but we've given you the indications that we think our market share particularly on the mortgage side is going to be a crucial piece. We think we can hold that sort of 30-ish percentage points and we think the market doubles in that three to four-year period. So that gets you an income effect. So it's -- when you take all those together, they're the characteristics that allow you to say we think we can get to those sorts of numbers as the program is complete. As the huge workload which we're still solving some legacy stuff completes then you get to a more normalized position. We're not saying it's a walk in the park, but we can see the pieces that allow us to do that.
Good morning. Stephen Hall from Cantor Fitzgerald; just firstly, you've now returned to sustainable profitability even more normalized funding structure and strong capital base. Would reinstatement of the dividends by 2017 be a realistic target? And secondly, we've obviously seen a low yield environment which has impacted the pension deficit. Are you likely to take some steps to correct them in the near term? And then finally, could you just give us an update on the potential timing for an IPO next year?
I can give you a fairly short answer on the dividend. And that our -- we were saying today, we paid back to CoCo and we paid the dividend of €160 million. So other than that, we do not have as a bank has not worked through a dividend policy and that's a conversation effectively to be had between our shareholder, our regulator and ourselves. But we are clearly building capital on an ongoing basis and ultimately, we recognize that a strong and growing dividend is a significant part of the investment story, but not determined yet. And the second one was the pension volatility. I mean to an extent, it is very technical and they moved in and moved out and the volatility is something we see as we would really like to control. But there are only limited ways into that equation. We have already -- we have already closed it to new entrants. We have taken most of the measures that you can take in terms of limiting it. But we would be in constant dialog with the trustees and pensioners to attempt to take some steps to limit more, but there's nothing imminent to that.
The IPO question, I think let's stay with the overall IPO question and since the question has arisen at this stage. There is really four things that have always been relevant to consideration of the IPO question. The first is to make sure that we can establish a very strong underlying franchise, to demonstrate our strong position with customers and our ability to grow that franchise over time. And I think the results demonstrate that in terms of where we are in lending, where we are in customer satisfaction, where we are in market shares. The second piece is then, can you do that profitably and can you establish it to generate capital and that you are in a position to actually repay capital to whoever is the owner and grow your overall business.
And I think again, the results speak well that the net interest margin growth taking place and the amount of underlying profitability that's taking place -- that's there and the capital coming out with strong CET1 ratio to support that. The third piece has been the strength of the market that we operate. We are effectively in very strong franchise in one marketplace, so the strength of that underlying market is a key issue. When you look at that even with a Brexit effect, the people are adjusting for it at this stage preliminarily. And I've made the point I think earlier that Ireland would still be the fast-growing economy in Europe, so we have a very strong position in a very good marketplace.
The final piece is the market itself, and I'd say, we're comfortable that investor appetite in the AIB franchise in the Irish market is good, but obviously, there's huge market volatility at this point in time. So this wouldn't be the time that anyone would look to do something, but the minister's statement has been quite clear which is, it's an H1 event, so we're many, many, many, many months away from the point of time which everyone needs to make a decision on that. So you hold off, you look at the market and you make a decision at that point in time. The first three questions are the important ones to get right.
So I think we've answered those and we're in good shape on those and then the market timing issue, well when we get close to decision point then the minister will think about that and make whatever decision he makes. But our job was to try and make sure we're operating well from the first three points of view. So no real update on timing other than the minister, I think, has made this comment himself, H1 is where he's targeting plus you look at the market share.
Yes, I think the -- our comments in relation to the capital base and the prep that we would have done through 2015 and through 2016. I mean we are ready whenever that decision is taken to move straight into that.
I suppose -- I think most of the questions I had were already asked, but just two that are outstanding. Do you feel you have any gaps in your product portfolio here in Ireland and separately then on the funding side; do you have any plans for any further dilutions in the second half of the year please?
I think that the two comments we generally make about the strength of our proposition in the market in Ireland, one of which is kind of touched on in the personal lending piece as an example, which is our market share in certain areas is below sort of about 35%, 40% which we can see is natural in most territories. And in our target, we're making sure we deliver the propositions around that. Personal lending was one example, finance and leasing was another one in terms of we were in a very low position, we're growing that, we're not the number one in that market. And so we still see opportunities around those areas to grow market share in the traditional space and the other area where we would say is going to be an opportunity over the next 5 to 10 years is on the wealth management space.
And clearly, we have a very strong franchise and we think we can develop a better offering and a more complete offering over time. Now, just if I go to the phones if I could, I don't know if there's any questions that may have come in over the phones.
There are no audio questions.
Perfect. We've been very clear obviously. Okay, any last questions in the room?
Philip [ph], you had one -- you had a second one?
I'm sure the answer is no. I mean specifically, I think the question of tier 2 issuance has arisen. Our expectation is that there is no significant -- that we would not be doing in the second half.
Okay. Thank you very much. Thank you for the time.
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