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Bank of Ireland (NYSE:IRE)

Q2 2012 (Interim) Earnings Call

August 10, 2012 4:00 AM ET

Executives

Richie Boucher – Group Chief Executive

Andrew Keating – CFO

Analysts

Eamonn Hughes – Goodbody

Gérard Moore – Merrion Capital

David Lock – Deutsche Bank

Vincent Hung – Autonomous Research

Richie Boucher

Hi. Good morning, everyone. Welcome to our Interim Results Presentation for the Six Months to June 30, 2012. And we’d like to thank you for joining us here in Dublin and for those who are joining us by way of the conference call and webcast. I’d like to do a short presentation, following which then our CFO, Andrew Keating, will do more a detailed run-through of the numbers, and then we’ll move to a Q&A session.

So, the operating environment in the first half of 2012 has been characterized by considerable uncertainties in the Eurozone and very low official interest rates. While there the Irish economy has return to growth driven by the export sector, demand in the domestic economy has been sluggish. The external environment and interest rate environment remains challenging. However, Ireland is achieving considerable progress in the adjustments in the industry to realign the Irish economy with sustainable economic recovery. Ireland continues to meet its commitments on the EU/IMF Programme of Support. And in July, we turned to international bond market. The regulatory environment is also subject to a broad range of changes from both domestic and international regulators.

Against this backdrop, we continue to make progress in strengthening the group’s balance sheet with robust core Tier 1 capital ratios and improving liquidity ratios. We exceeded our asset disposal target of €10 billion ahead of schedule and well within the discounts assumed as part of the 2011 pre-call. In addition, redemptions and repayments remain in line with the expectations. As a result, our loan-to-deposit ratio has further improved to 136%.

Our deleveraging initiatives have lowered the group’s requirement for wholesale funding, and we have no requirement to raise term funding this year with unsecured term maturity of just €0.4 billion for the remainder of the year. Our unsecured term maturities for 2013 and 2014 are both low and very manageable.

Our operating performance in the first half of 2012 has been impacted by the interest rate environment, exceptional guarantee fees and the economic environment. Operating profits before impairments reduced from €164 million in the first half of 2011 to €58 million for the first half of 2012. This positively reflected a reduction in the level of our average interest earning assets as we deleverage the balance sheet and particularly the sharp reduction in official interest rates, which impacted on our earnings rates. This, together with the continued elevated cost of funding in deposits, impacted our net interest margin which was 1.20% for the half year.

Rebuilding net interest margin is one of our key priorities, and we have taken a range of actions to help rebuild that net interest margin. We have taken a leadership position, endeavoring to bring pricing discipline into an intensely competitive market in Ireland. We have also continued to reduce the quantum of our deposits in wholesale funding on which we are charged ELG fees.

These pricing and ELG actions have not adversely impacted our deposit run charges or volumes we’ve received. In addition, we have taken measured actions to reprice loan assets including in our Irish SME book where we have repriced the loan portfolios to reflect the actual cost of funds and increasing our SVR rate in the UK, 100 basis points in June and a further 50 basis points in September. We expect these and other varied actions we are taking will strengthen our net interest margin.

Our operating costs remain in line with the first half of 2011. Lower staff costs were offset by investments in our core franchises and in processes and systems aimed in improving customer service and bringing cost efficiencies, which will flow through. As we restructure the group to further improve their efficiencies, regrettably, the number of people that we employ will reduce. Revised redundancy terms have been agreed with key stakeholders and our volunteer redundancy programs to facilitate the controlled departure of stock in line with the group’s revised requirements has recommenced.

Impairment charges and loans and advances to customers were €941 million. This was higher than the first half of 2011, but below the level incurred in the second half of 2011. We remain focused on proactively managing the credit quality of our portfolios. Without being complacent, we are becoming more comfortable with the performance of our corporate and unsecured consumer loan books and our UK mortgage book. We are seeing some stabilization in Irish commercial real estate and in the Irish SME sector, albeit the very challenging conditions remain.

The management of arrears in our Irish mortgage book is a critical priority. We have made significant investments in people, processes and systems in order to help us support customers in difficulty through engagements and restructures, where they are sustainable and appropriate. Whilst the number of customers moving into arrears has increased, reflecting both the economic environment and a considerable number of our buy-to-let customers moving from interest-only to full capital and interest-repayment basis. The rate of migration into earlier arrear and to broad categories has begun to reduce.

We still anticipate that impairment charges will reduce from the level recorded at the half year, trending to a more normalized level as the Irish economy recovers. However, the pace of the reduction in impairment charges will be particularly dependent on the future performance of our Irish residential mortgage book and on the commercial property market, as well as, obviously, our own credit management initiatives.

Focusing on our key priorities. As I mentioned earlier, we’ve continued to make significant progress in restructuring the group’s balance sheet, completing the target of €10 billion in asset disposals ahead of schedule and below the cost assumed in the 2011 PCAR. We reaffirm that our loan repayments and redemptions are in the target set for our financial plan. Our deposit franchises have remained very resilient with deposits of €72 billion at the half-year stage, in line with our expectations. Reflecting the foregoing, we have reduced our loan-to-deposit ratio from 144% in December 2011 to 136% at June 2012. We remained – we maintained a robust core Tier 1 ratio at June 2012 of 14.9%.

We’ve continued to focus on enhancing our franchise to benefit our customers. We have become the leading bank in Ireland in a consolidated sector and as we state in our strategic, important and mutually beneficial relationship with the UK Post Office. In this regard, we are pleased to announce a three-year extension of a main contract with the UK to a minimum of 2023.

We’ve continued to provide capital funding to the Irish mortgage market and to the SME and corporate sectors. Although demand is muted, we are rolling out new products and services and continuously seeking new business opportunities. Announcements over the past couple of weeks regarding new products for the student market and contactless cards being cases in point.

Driving increased revenues from within our restructured balance sheet and restructured cost base on a basis which supports the provision of liquidity and capital is critical to our strategy and to the delivery of sustainable profitability over the medium term. The management of our Irish mortgage book remains a critical priority. The vast majority of our customers continue to meet their mortgage repayments in full. However, the difficult economic environment has meant that a number of customers have encountered changed circumstances which have negatively impacted on their income.

We have made further significant investments in people, in processes, in systems and in procedures to help us support such customers through engagements, modifications and restructures spread are willing and able to cooperate with the bank. In so doing, we are mindful of our responsibilities to all of our stakeholders in seeking to maximize the repayment of moneys owed.

In terms of efficiencies, we are continuing to centralize and streamline support functions which also contribute to the reduction in our office footprint as we reshape the group. We are investing in technology and, in particular, leveraging low-cost channels to migrate routine transactions from branches and to improve customer service and convenience.

As we restructure and reshape the group and drive the efficiencies, the number of people we will need to employ is regrettably reducing. Our redundancy programs have recommenced to facilitate this and we have taken a €66 million restructuring charge in the half year just ended. Our estimated payback for redundancy programs is 11 months.

The current difficult economic environment and the impact of policy measures does not reflect this from our focus on reducing the cost of money to the group through initiatives that we can take ourselves. This increased deposit re-pricing and disengagement from the ELG scheme which is of critical importance.

We believe that a system-wide approval of the exception of deposit guarantee as supported by the renewed financial stability in Ireland. And we bear in mind that it is government policy.

Loan book re-pricing has taken place and will continue to take place. We have a heavy focus in credit management which continues to require considerable attention. All of these initiatives, in themselves, cannot restore profitability without our generating revenues from the restructured balance sheet in a sensible way. Our attention is very much focused on this.

The Irish state is an important stakeholder and a 15% shareholder in Bank of Ireland. Since the 1st of January 2009, the state has invested €4.8 billion in Bank of Ireland through €3.5 billion in preference shares, of which €1.7 billion converted to equity in 2010; and to a contingent capital instrument of €1 billion; and a net investment in ordinary stock of €0.3 billion in our recapitalization in 2011.

Since September 2008, Bank of Ireland had paid €2.5 billion in cash to the state in respect of: exceptional guarantee fees, transaction fees, repurchasing warrants, and coupons on the contingent capital instrument and on preference shares. In addition, the state continues to hold a €1.8 preference shares in the bank and a €1 billion contingent capital instrument, together with the 15% shareholding.

To reduce the risk to the state, we’ve been implementing target initiatives to reduce the level of liabilities covered by the exceptional state guarantee. The volume of liabilities covered by the exceptional guarantee has reduced from circa €136 billion in September 2008 to €36 billion at the end of June, over €100 billion in reduction.

As an important customer and stakeholder, we were pleased to be able to facilitate the IBRC repo transaction on commercial terms, there with our customer, the state. We believe that Ireland is positioned to benefit from economic recovery, given the progress made in rebalancing the economy. Bank of Ireland is supporting this recovery by investing in our franchises and actively seeking new customers and business opportunities. With the credit we have provided to the Irish market, we are growing our share of mortgage and SME markets.

We remain very focused on the medium-term target. The first half of 2012 has been a very difficult environment in which to operate. Lower official interest rates, which are not reflected in our funding costs, are somewhat offsetting the progress we’ve made to reduce the cost of money to the people. Whilst the Irish economy had begun to stabilize, it remains a challenging environment for which to manage credit cost and selling new products. Nevertheless, we have continued to have a strong focus in the key priorities which are within control and against which we must continue to make progress. We must and will continue to work very hard in delivering against those things we can influence or which we can control.

We have made a lot of progress in balanced restructuring and also in strengthening our core franchises. We expect to continue to make progress in credit management and cost programs. We are placing even more focus on trying to progressively reduce the cost of money to us and increasing our revenue-generating capacity through doing more business with our existing customers and with our new customers, thereby returning to sustainable profitability.

May I now turn to Andrew Keating who will review our preliminary results in more detail.

Andrew Keating

Thank you, Richie. Good morning, everyone. I will cover the group’s financial performance for the first half of 2012 and will also expand on some of the key areas of focus for our stakeholders.

The group made an operating profit on a pre-impairment basis of €58 million for the six months ended 30 June 2012. After taking account of impairment charges of €978 million, the group made an underlying loss before tax of €907 million in the first half of 2012, which compares to €722 million in 2011. The underlying loss affects a range of factors and is impacted by the interest rate environment, government guarantee costs and economic conditions.

Net interest income was €857 million, a reduction of €177 million over 2011, which reflects a reduction of €14 billion in our average interest earning assets due mainly to the progress we have made on balance sheet deleveraging and a 13 basis points reduction in our net interest margin to 1.2%.

ELG fees were €212 million for the first half of 2012, which was €27 million lower than in 2011. A number of one-off items means that other income this year was higher than in 2011. Recurring fee income in 2012 was broadly in line with the first half of 2011. Overall, operating expenses were in line with 2011. Lower staff costs in 2012 were offset by investments in our core franchises and customer service and efficiency initiatives.

Total impairment charges remain elevated and reflects the current economic conditions. They amounted to €978 million in the first six months of 2012, and the increase of €77 million over 2011 is primarily due to ROI mortgages. Non-core charges in 2012 reflect the cost of deleveraging and the impact of tightening of Bank of Ireland credit spreads. In addition, we have set aside a redundancy provision of €66 million, reflecting the range of restructuring initiatives that are under way.

Turning to the net interest margin. Before taking account of the cost of the ELG, our net interest margin for the first half of 2012 was 1.20% compared with 1.33% for 2011. We now operate in a historically low interest rate environment and the outlook for official rate is to remain lower for longer.

In the last nine months, in particular, official rates have fallen sharply. In that time, the ECB rate has fallen by 75 basis points and the three-month Euribor rate has fallen by 120 basis points to a rate of less than 40 basis points today. This reduction impact on the income that we earned on certain of our loans and consequently on our margin, particularly as the price that we pay for deposits, which is not linked to official rate, has not fallen quickly. Rebuilding our net interest margin is a key priority for the group. And we have already executed a range of actions in this regard.

Bank of Ireland continues to lead the market in reducing the pricing for deposits in Ireland. For example, in the highly competitive market for one-year term deposits, we have reduced our rate by 120 basis points since last December with other reductions across our range of product. We would expect to make further reductions in the second half of the year.

As the overall cost of funds to Bank of Ireland is expected to remain at an elevated level, we must recover the cost of this in the rates we charge in our loans. As a result, we have had to reset the price on our SME loans with reference to the bank’s actual cost of funds.

In the UK, we increased the standard variable rate on our mortgages by 100 basis points on the 1st of June last. And a further increase of 50 basis points is scheduled for September. We have also increased the rates on our new loans. But as demand is currently muted, it will take time for this to flow through to the group’s net interest margin. Together with the benefits of some structural transactions, we expect that these actions will strengthen the group’s net interest margin in the second half of 2012.

The cost to the group of the ELG guarantee was €0.2 billion in the first six months of 2012, which emphasizes the commercial necessity to safely disengage from it. We have already made significant progress in reducing liabilities covered by the guarantee from €136 billion in September 2008.

In the first half of 2012, we reduced the level of liabilities guaranteed by €6 billion to €36 billion at June. This was achieved through a range of initiatives including withdrawing our UK subsidiary from the scheme last April; our line of non-deposits are no longer guarantees to take effect from today, both those funding has been repaid as maturity from the proceeds of the deleveraging initiatives; and we have also generated non-ELG deposits from our corporate and business customers.

But all of the progress that we have made, less than 30% of all our funding is now covered by the ELG. Very substantial progress has been made in stabilizing the wider Irish banking system, and these achievements should support the system-wide withdrawal of the ELG scheme.

For the first half of 2012, operating expenses were €0.8 billion, which is broadly in line with 2011. Our cost base is tightly managed, and we are taking ongoing actions to reduce costs further. Bounty parting terms have recently been agreed with all stakeholders, and we have recommenced a range of redundancy programs that are expected to lead to a further reduction in head count in the second half of this year.

The government introduced a levy on Irish pension funds in 2011, and the cost of this levy was actually borne by the members of the bank’s pension schemes. The cost savings expected from the renegotiation of our outsourced contracts are also being realized. At the same time, we are making investments in our branch, mobile and online channel, in our UK post office relationship, and in efficiency and customer service initiatives.

Turning to asset quality and related matters. Since September of 2008, we have already reduced our loan portfolios by €46 billion or 32%. We have, at this stage, completed our target of €10 billion of loan sales. And our repayments and redemptions continue to be in line with our expectations. We are on track to meet our target of €90 billion by December 2014. Total loans at June were €105 billion before taking account of impairment provisions of €7 billion. 54% of loans are mortgages spread evenly between Ireland and UK. 50% of loans are in the Republic of Ireland with 50% outside of Ireland, predominantly in the UK.

Impairment charges and loans and advances to customers were €0.9 billion for the first half of 2012, which compares to a charge of €0.8 billion for the same period last year and a charge of €1.1 billion in the second half of 2011. We continue to expect impairment charges to reduce from the current elevated levels, trending over time to a more normalized impairment charge as the economy recovers. The pace of reduction will depend on the future performance of Irish mortgages and commercial property markets.

The analysis of the ROI mortgage book is presented separately for each of the owner-occupied book and the buy-to-let book. Our owner-occupied residential mortgage book was €21 billion at June. The repayment basis of this book is substantially full capital interest and 57% of the loans are ECB tracker products.

The vast majority of our customers continue to meet their mortgage repayments. 93% of the group’s owner-occupied mortgage loans where neither 90 days past due nor impaired. The arrear level of 7% at June represent an increase of 143 basis points since December and compares favorably to the industry statistics published by the Central Bank of Ireland. On employment and affordability issues are the principal drivers of arrears.

We have fully implemented the code of conduct in mortgage arrears and continue to work proactively with those customers in financial difficulty on a case-by-case basis. We are enhancing the solutions available to support those customers and have recently introduced new products such as stick mortgages, trade-off and trade-down mortgages.

At June 12, we have restructuring arrangements in place for loans of €1.8 billion. Longer term arrangements will continue to be rolled out during the second half of 2012. The impairment charge on owner-occupied mortgages amounted to €0.2 billion or 174 basis point for the first half of 2012. We had a stock of impairment provisions of €0.7 billion at June with a coverage ratio of 35%.

In terms of residential property prices, the CSO index at June indicated that values had fallen by an average of 50% from the peak level. The average fall in the Dublin area was 57%, while the average fall outside of Dublin was 47%. Recent data is suggesting a stabilization of values for our traditional family-type properties in the main cities, particularly Dublin.

While we anticipate regional variations, it is our expectation that the ultimate peak-to-trough fall in residential property values will average 55%. We estimate that negative equity in our owner-occupied book at June was €2.9 billion. 15% or €0.4 billion of this negative equity relates to the default book.

At June 12, our buy-to-let mortgages amounted to €7 billion, of which ECB tracker loans account for 81%. A significant majority of our buy-to-let customers continue to meet their mortgage repayments. At June 12, 86% of the buy-to-let accounts were neither 90 days past due nor impaired.

The arrears level of 14% represent an increase of 3 percentage points over December 11. Arrears are partially due to economic conditions and affordability issues but also reflect the impact of rising repayments when interest-only period come to an end and customers move to capital and interest repayments.

At June 12, we had restructured 3,700 accounts, our loans with a value of €0.75 billion. The group’s impairment charge on its buy-to-let portfolio for the six months to June was €0.1 billion or 3.2%. The stock of impairment provisions at June 12 was €0.7 billion, equating to a coverage ratio of 46%. We have appointed rent receivers to over 500 properties. And the group had 85 buy-to-let properties in possession at June. This number is expected to increase during the second half of 2012. We estimate that there is €1.4 billion of negative equity in our buy-to-let portfolio at June 2012. 26% or €0.4 billion of this negative equity relates to the deposit book.

The UK mortgage portfolio at June was £23 billion. During the six months to June, the book reduced by £1.4 billion due to the sale of a portfolio of loans and due to ongoing repayments and redemptions, which continued to be in line with our expectations. This portfolio continues to perform very well. At June 2012, the number of loans that were greater than three months in arrears equated to 151 basis points, which was a reduction of 27 basis points since December 2011. The impairment charge for the first six months of 2012 was £15 million and the stock of impairment provisions was £110 million. Negative equity is not a significant feature of this book.

Turning to non-property corporate and SME loans. This loan book has reduced by 7% from €27 billion at December to €25 billion at June 2012, reflecting the divestment are project finance and other international corporate loans. This book is diversified across geographies with 55% of loans in the Republic of Ireland and 45% of loans outside of ROI.

Regarding corporate banking portfolio, the level of impaired loans at June was €1.1 billion, which was in line with December 2011. The impairment charge for the six months ended June 2012 was €0.1 billion, which was in line with the first six months of 2011. In relation to SME loans in the Republic of Ireland, ongoing pressure remains due to the current economic environment, subdued consumer spending and the current level of business insolvencies. Those sectors that are correlated with consumer spending, other property markets remain particularly impacted. As a consequence, the level of impaired loans increased from €2.3 billion at December 2011 to €2.5 billion at June 2012. However, the pace of formation of impaired loans appears to have slowed during 2012. The impairment charge of €0.1 billion in 2012 was lower than in the first half of 2011.

Turning finally to the SME loans in the UK, economic conditions remain subdued and the level of impaired loans remains stable at €0.6 billion. The impairment charge for the first six months of June of 2012 was €16 million and the reduction from the second half of 2011 primarily reflects the non-recurrence of impairment charges on a smaller number of individual cases.

The investment property loan book was €16 billion at June 2012 which is a reduction of 3% from December 2011. Our portfolio is well-diversified geographically with 45% of exposures in the Republic of Ireland and 55% outside of Ireland. The portfolio is also diversified across sectors albeit with a bias towards the retail sector. Ongoing difficult economic conditions have led to an increase in the level of impaired loans from €4.5 billion at December 2011 to €5.3 billion at June 2012. The impairment charge for the first half of 2012 was €0.2 billion. At June 2012, the group stock as impairment provisions was €1.7 billion equating to a coverage ratio of 32%.

Our land and development portfolio continues to reduce. 88% of this portfolio is impaired with a coverage ratio of 58% at June 12. The portfolio of consumer loans was €3.2 billion at June 12. This portfolio is diversified geographically and by product type. Our consumer loan portfolio continues to perform within our expectations. 10% of the portfolio is impaired with a coverage ratio of 82%.

Our available-for-sale financial assets, including sovereign exposures at June, were €11.3 billion compared to €10.3 billion at December 2011. The increase substantially reflects the net incremental investments in Irish sovereign, an ELG covered bank bond of €1.5 billion funded by the three-year LTRO facility. Our exposures to Spain and Portugal are substantially covered bonds, all of which are investment grades. We have a small Italian exposure of €0.3 billion and no exposure to Greek bonds. Our AFS reserve improved by €0.3 billion to €0.4 billion at June 12 primarily due to the strong performance of Irish sovereign bonds. Separately, our portfolio of NAMA senior bonds amounted to €4.7 billion at June and the IBRC repo transaction with €2.8 billion.

Turning to funding and capital. At June 12, totally liabilities, excluding BOI Life funds held on behalf of policy holders, were €145 billion. Our funding strategy envisages that we will fund our loans substantially through cost through deposits and term funding. In this regard, our key objectives are to attract stable deposits at an appropriate price. To reduce the quantum of deposits that are covered by the ELG and to maintain prudent capital and liquidity ratios. Our funding strategy is being achieved by driving deposit growth through the strength of our franchises and the scale of our distribution. And by deleveraging international loan books we’d reduce our reliance on wholesale funding.

At June 12, customer deposits were €72 billion. And the increase of €1 billion since December partly reflects the positive impact from foreign exchange rates. The profile of our deposit books is highly granular and retail oriented, which enhances its stability. Despite the continuing competition in our whole market, we have taken a leadership position on deposit pricing and we have implemented a range of significant re-pricing initiatives during the first six months of 2012. Our deposit volumes remain in line with our expectations.

We have also significantly reduced the rates paid on corporate deposits, with volumes remaining stable. Our joint venture with the UK Post Office continues to perform ahead of expectation, with deposit of €1 billion since December. The growth in group’s deposits together with the significant progress made in reducing our asset side of our balance sheet has resulted in an 8 percentage points improvement in the loan-to-deposit ratio, from 144% at December to 136% at June. Further improvements are expected in this ratio.

Wholesale funding has increased by €2 billion, from €51 billion at December to €53 billion at June. However, this increase primarily reflects the funding for the IBRC repo transaction. We also made a net incremental investment in Irish sovereign ELG-covered bank bonds of €1.5 billion, funded by the three-year LTRO. Our wholesale refinancing requirements is both low and manageable, with just €0.4 billion in unsecured term maturities for the remainder of 2012 and €2.6 billion in 2013.

Turning finally to capital. Our risk-weighted assets reduced by €5 billion to €62 billion at June primarily due to the reduction in our loans and advances customers. The impact of a higher level of impaired loans partly offset by the impact of movements in foreign exchange rates. Our core Tier 1 ratio at June was 14% compared with the regulatory requirements of 10.5%.

To wrap up, I will summarize our position as follows: the operating performance in the current period has been impacted by the interest rate environment, the cost of the government guarantee and the current economic conditions. Against this background, we continue to deliver on each of our strategic objectives. We are leading a significant reduction in deposit pricing. We’ve completed our asset disposal target of €10 billion ahead of schedule and below the assumed cost. We’ve further reduced the liabilities covered by the ELG. Less than 30% of our funding is now covered by this guarantee. We are continuing to invest in our core franchises in enhancing customer service and in further efficiencies. Our businesses are strong and very well-positioned to benefit from economic recovery.

Thank you. We are now happy to take your questions.

Question-and-Answer Session

Eamonn Hughes – Goodbody

Hi. Eamonn Hughes, Goodbody. I thought it was going to be there for a second, so I just jump in. Maybe just a couple of points. So, I’ll kind of open it to both of you maybe, but maybe more so Andrew. You just gave some figures there, Andrew, in terms of RWA progression, maybe some thoughts on where you think that might trough now given the balance sheet is going to probably continue deleveraging into next year as well.

Also, just in terms of the margin, you gave some of kind of punchy pickup in terms of SVR rates in the UK, is it possible to give kind of an estimate of what that might do in terms of the group margin into the second half? And also, just in terms of ELG, the number came in a little bit higher than I kind of pencil in for the first half, maybe any sort of theory you can give us on where you think that number might be for the full year. Thank you.

Andrew Keating

Okay. So, in terms of RWA progression, Eamonn, we believe the RWAs will continue to reduce in line broadly with the same percentage reductions in our loans and advances customers. In terms of the net interest margin, the SVR rate increase of 100 basis points applies to that book in the UK mortgage book. The SVR book in UK is approximately 60% of our UK book and there is a further 50 basis points scheduled for September for that book. On the ELG, do you want take that, Richie?

Richie Boucher

Yes. Thank you, Andrew. I think on the ELG, Eamonn, we have a number of initiatives under way. There’s a couple of factors that I’d just bear in mind, if you look at the liquid asset portfolio and money on deposits with the monetary authorities, within our UK subsidiary, the model is that we gathered deposits. We ensure that those are very granular deposits, very sticky deposits. We confirm that to ourselves. The subsidiary confirms it. And we then discuss with the monetary authorities in the UK and the regulatory authorities in the UK. Since the period end, we have had – approximately €2 billion of mortgages would have transferred. And what we do with the cash we received at group level is that we are repaying guaranteed wholesale funding. So, that’s obviously a factor.

We’ve continued to get more and more of our deposits of below the exceptional guarantee in Ireland. And obviously in the UK, we’ve come completely off that. And we had – we came off in April. Deposits actually grew but also we would have had deposits which would have had term – a return mix of three months, six months and longer, which as they mature, they’ll come off the ELG as well.

We have a range of further initiatives which we think are appropriate for ourselves and for the system as a whole. And we are conscious that it is government policy to reduce their liability to the tax there. And obviously, it’s considered as a contingent liability by the bond markets, and Ireland has a very clear objective to become a more regulatory issuer in the bond markets. So, we have further plans under way. Some of those are our plans alone, and some of those are systemic suggestions.

We also have – as I should’ve mentioned, we also are seeing increasing levels of customers, of corporate customers who are availing of some pricing arbitrage opportunity for themselves, which is commercially sensible for the bank and taking deposits which are not ELG covered, noting our short-term deposit ratings are very equivalent to the state. I think we’ve got about 120 corporate customers.

Andrew Keating

About 120 corporate customers, yes.

Richie Boucher

Yes. And we’re seeing something I watch closely and we’ve got some better ones last night.

Gérard Moore – Merrion Capital

Gérard Moore from Merrion Capital. Could you just talk a little bit more about the net interest margin again and how you see that in the second half of the year? How do you see that playing out?

Richie Boucher

Well, obviously, the fact that it’s outside of our control is official interest rates, Gerard. And as we – as Eamonn had mentioned, we discussed with Eamonn as we reduced the quantum of wholesale funding which is expensive, that has a positive impact to the deleveraging side of the balance sheet. We see the flow-through of the initiatives from the some of the asset re-pricing and we have continued to take down deposit pricing in the Irish market. We have seen some belated actions by some of our competitors to bring that down.

So, I think there’s a range of initiatives that will – that are in our own control and the weakening influence which are starting to have some positive impacts. But obviously, there’s vulnerability to official interest rates there.

I think our focus is not just on the asset side re-pricing which is, as Andrew mentioned, I mentioned, we’re increasingly changing the structure of products we provide as we move from products which our raw material cost and based on official rates to the – to actual cost of money to the bank plus the margin for credit.

Gérard Moore – Merrion Capital

And maybe a follow-up question, if I may. Could you give us a few words on the Personal Insolvency Bill and how you see that progressing?

Richie Boucher

What we’ve seen is – as we mentioned, we have seen that our arrears and our own mortgage portfolios have increased, the pace of increase slowed in the first half of the year. And we did see somewhat of a spike, and we thought there was a spike related to all the media speculation. In the second half of last year, we think that has abated. There are certain parts of the personal insolvency scheme that we prefer not to see, but there are some other parts, which we feel are very important. As we restructure our mortgages, if we look at our owned or occupied mortgages we have restructured, as with medium-term or short-term solutions, 12,000, and 80% of those customers are performing in accordance with the revised terms.

But we could restructure a lot more mortgages if there was some form of arrangement with the unsecured credit providers, credit clients, et cetera. And we think the personal insolvency will achieve that. We could see a very significant improvement in our ability to restructure on the base that it works for the customers, commercially sensible for us if there is some haircut on the unsecured. We’re not suggesting that’s a – we think it’s unrealistic to expect that the unsecured will take a 100% haircut, but we think a sensible haircut would make us be able to modify it a lot more. And certainly, the insolvency and DSA will assess that from a customer’s point of view and from our point of view.

Eamonn? Please keep going

Eamonn Hughes – Goodbody

Okay. Just on the impaired mortgage loans in Ireland, the number was up about 100 basis points in H2 last year, and it’s up 3.4 percentage points in H1 this year. Now, the pace of mortgage arrears you’ve indicated is slowing. Is it more on the buy to let just when you look at the component that’s providing a bigger element of the impaired loans increase in the first half of the year, maybe just give some sense on that?

Andrew Keating

Yeah. Certainly if you look at the various levels in our buy-to-let mortgage accounts, they’re clearly significantly higher than the various levels in our own occupancy book, and that will shoot in to the classification as to whether they’re 90 days past due or impaired.

Eamonn Hughes – Goodbody

Where did you had various levels to be?

Richie Boucher

I think we got the other question. Obviously, we’re just a little bit careful of calling something in advance of seeing how the insolvency legislation would call that. I mean, based on our own assessment of our loan losses, we don’t think it will be a major negative impact on what we think. But we just have to be careful of calling that in advance of how we see that pan out.

But the pace has slowed, and I think as we are – as we’ve been enabled to work more progressively on restructuring and modifications. And as I mentioned, our cure rate from restructuring and modification is high. So, the arrears level is a function of those two factors, obviously, the pace of customers moving into early arrears. And if that slows down, the more quickly we can restructure and modify but on the basis that our policy is maximize the recovery of money. And our modifications and restructures are working on that basis to-date, but it’s on two sides of the cylinder, as we call it.

I think we have from the conference call. We have two questions and we’ll be happy to take those.

Operator

Thank you. (Operator Instructions) And we take our first question from David Lock with Deutsche Bank. Please go ahead, sir.

David Lock – Deutsche Bank

Good morning, everyone. Thanks for clear presentation. Can you hear me okay?

Richie Boucher

We can, David. Thank you.

David Lock – Deutsche Bank

Excellent. Okay. So, just the first question again on the margin, the cut in the ECB rate which happened obviously a few – just quite recently. When did that begin to impact your tracker books? So, when does that lead through into the 65% as your average mortgages?

Andrew Keating

Through immediately, David.

David Lock – Deutsche Bank

Immediately. So, that’s – or that’s already in the number we’ve got for the first half?

Andrew Keating

Yes. Obviously from the days of the rate cost.

David Lock – Deutsche Bank

Okay. Secondly, if you would still leave ELG at December, how long do you expect this to continue the impact to that going forward and what kind of profile could we expect from that?

Richie Boucher

I beg your pardon, David. It broke up slightly. So, if I could ask you to repeat the question.

David Lock – Deutsche Bank

Certainly. ELG, if you were to leave the ELG scheme at the end of this year when it expires under the current EU agreement, how long would the fees remain a feature of your income statement going forward and what kind of profile would we expect going forward?

Andrew Keating

Maturity profile of the deposits is very short-term in nature. And therefore, the – once we come away from the ELG scheme, the volume of deposits that are covered and consequently the fees related to that ELG scheme will fall away very quickly. The only – we will continue to have some fees related to deposits and wholesale funding that has more of term nature than with issues before the day of exit that continues to be covered and consequently we can just pay a fee on that until its maturity. But our expectation would be that a very significant proportion of the fee would start to fall away very quickly after any exit.

Richie Boucher

I think the other factor to bear in mind, David, is that I think, as we have previously mentioned, the fee is structured so that you pay a higher fee on shorter-term deposits. So, clearly, we have also been looking to manage the guarantee deposits to move them towards categories of that, but the impact on fees might be disproportionate by the volume reductions given that the way that the fee is structured. We could pay up to about 160 basis points.

Andrew Keating

Yeah.

Richie Boucher

On a guarantee deposit of less than three months. And then it graduates after the...

David Lock – Deutsche Bank

Okay.

Richie Boucher

It’s a very, very important thing for us to focus on, and we believe for the Irish system as a whole to focus on.

David Lock – Deutsche Bank

Okay. Thanks very much. That’s very clear. Just another couple of questions, if I may, very quickly. In your report, you mentioned on page 12 that there was an emerging urban/rural divide with the residential property. Could I – could you give a split of your urban/rural divide of residential property in Ireland?

Richie Boucher

I think you could anticipate that our – it really is – we are a universal bank across Ireland. And our mortgage book would reflect where the population is. I mean, I don’t have those figures on top of my head but Ireland is becoming an increasingly urban society. Just in terms of asset quality, we would have been a little bit more careful of certain types of property in the rural areas which are probably likely to still face more pressure in terms of where your pricing margin stabilize.

David Lock – Deutsche Bank

Okay. Thank you.

Richie Boucher

We would have avoided certain types of asset class in certain of the rural areas.

Andrew Keating

I think at the high level, David, you can take a step to geographic profile of our book is not materially dissimilar to the geographic profile of the entire country’s mortgage loans.

David Lock – Deutsche Bank

Okay. Thanks very much. And then very finally, if I may, Basel III, there was a comment by regulator earlier in the year about the potential impact that this could have on Irish banks here over the longer term. At the moment, you’ve got quite a sizable deferred tax asset. You’ve obviously got the preference share, you’ve got an AFS with – what is your senses of the current pro forma Basel III reduction to your core Tier 1 ratio that Basel III has?

Andrew Keating

I think the first thing we’d note, David, is that some of the material elements of the Basel III regulations are not yet finalized. And consequently, it’s difficult to give a single pro forma impact. And so, what we would say is that the impact, similar to other institutions, is going to be significant. And you noted a number of the important impacts from Basel III in your question, the deferred tax office is an important one for us.

We have €1.6 billion at June, and of that, about €1.3 billion related to trading losses, approximately €1 billion in Ireland and €300 million in the UK. We know, of course, that the recovery period for the Irish asset is elongated by the current NAMA tax legislation. And that asset will reduce in a base – with future profits. And clearly, the Basel III transition rules mean that the deferred tax asset is disallowed over a five-year period starting next year.

David Lock – Deutsche Bank

Okay. Thank you very much. Very clear.

Operator

Thank you. And the next question comes from Vincent Hung with Autonomous Research. Please go ahead.

Vincent Hung – Autonomous Research

Hi. Good morning. I’ve got quite a few questions. So, the first one is based on slide nine, on your actions to rebuild the margin, I was just wondering if you could give us a basis-point impact of all of those because I’m still unclear to which one has the higher impact.

And just on the NIM guidance for the full year. At the full year results last year, you were guiding to flat NIM. I’m just wondering if you should think about around 125 or something for the full year given the re-pricing.

And then, on the post office deposits, I noticed that the growth rate slowed quite a bit compared to last year. I was just wondering if that was something related to reduced efforts on your behalf. I’ve got a few other questions back and follow later.

Richie Boucher

For the post office deposits and then I – will refer that the NIM to Andrew, Vincent. Clearly, from our point of view, we have proved to ourselves that we can raise good retail deposits of a sticky nature without being in best-buy tables and through the branch network and the Post Office.

However, when we generate the deposits, we must ensure that we can generate the assets that give us a return. And I think I’ve mentioned earlier that the model we have in the UK generate deposits, good assets in – I think banks used to do but the other way around for a while. And we think this is a more sensible way to approach it.

So, we know that we can turn on and turn up the volume, turn it down as a two-tier requirements. We’ve proved that to ourselves and proved it to the regulators in the UK. And so, it is part of our strategy of making sure we have a fully appropriately funded balance sheet. It doesn’t make sense for us to continue to gather deposits and put them back on deposits with the Bank of England. And so, that’s our strategy there. But we are comfortable that we can increase deposit volumes in the UK as it suits our business needs and as deposit volumes been of a sticky, granular basis and not at best-buy table rates.

Andrew Keating

Good morning, Vincent. On the margins, just a couple of comments. Firstly, as I’ve said, rebuilding the margin is a key focus and priority for the group. And we have taken a range of actions which we’ve set out, and we believe that those actions together with the further plans that are under way are now being implemented, will strengthen the net interest margin in the second half of the year.

Clearly, we’ve spoken a lot about the reduction in pricing in ROI and in our corporate and treasury deposits products. ROI deposits are approximately €35 billion in round numbers, of which €10 billion are effectively interest-free balances on current accounts. And our corporate and treasury deposit book is approximately €8 billion.

On our SME – on the asset side, we’ve taken a range of actions. On the SME loan pricing, last November, we reassessed the price of our SME loans to take account of the bank’s actual cost of funds rather than to reference a Euribor. And that initiative has continued to be rolled out throughout 2012. And in overall terms, in round numbers, that loan book is approximately €7 billion.

On our UK mortgages, as we said, that was increased on the SDR book which is about 50% of the UK book, 100-basis-point increase from the 1st of June, with a further 50 basis points from September this year.

To the extent that we’re doing new lending, all of that new lending has been re-priced, albeit we would note that demand is muted. We also know the number of structured transactions which will also support the margin, being the IBRC repo transaction and being the €1.5 billion net increment investments in Irish sovereign and ELG-covered bank bonds.

And we’ll also note, I think Richie referenced it earlier, the transfer of – I think in the book, we set out €2.2 billion of assets to our UK subsidiary in the middle of July. And that will also help in terms of the margin side. So, we try to set out a quite a bit of detail in relation to each of the individual initiatives which would help you in determining what the impacts might be in the second half of the year, which are, let’s say, we do expect the margin strengthening that period.

Vincent Hung – Autonomous Research

Okay. So, assuming those are successful could you get to 130?

Richie Boucher

You have to do your own numbers, Vincent.

Vincent Hung – Autonomous Research

Okay. Fine. Just some follow-up questions actually. I’m just wondering what the absolute cost guidance is given the actions of redundancies. And then I wonder if it’s possible to quantify the benefit of haircut of the unsecured from the insolvency law. I just wonder how significant this really could be. And then lastly, just a comment on the pension deficit, because it’s gone up quite a bit from €400 million to about €1 billion.

Richie Boucher

If you want to take the pension benefit?

Andrew Keating

Sure. So, as you say, the pension deficit increased from approximately €400 million to approximately €1 billion. That’s the net increase due in part to an increase in asset value, but the particular items that has impacted that deficit has been the low interest rate environment. So, with – over the last six months and particularly over the last three months, the long-term interest rates that we used as an input into our pension deficit to discount the liabilities have fallen very significantly. I think we note in the book that we’re using a discount rate of some 4.7% – sorry, 4.2% and that is a significant reduction from what we used at December. And that is what has really driven the widening of the deficit and – from December to June.

Richie Boucher

I think from the impact of the redundancy programs, Vincent, I bear in mind the accounting regulations that we are obliged to follow. Part for us has been able to take a restructuring charge by definitive plans which are capable of execution and which have commenced. We have – each of those have happened, therefore, and I think I volunteered earlier that we’ll see an 11-month payback. However, the redundancy program is a rolling program, and it’s been executed on a graduated basis across the business over a period of time which was likely to go into the next calendar year. Hopefully, we can give you as much help as we can there.

With regard to the insolvency legislation, that is still going through the Irish Houses of Parliament. And that is more likely to be a future, I think towards the back end of the year than during the summer months. However, we are seeing an increase of use by customers of MABS which is a Mortgage Advice Bureau Service in Ireland and their strong recommendations to citizens coming to them is that the mortgage should have the priority. But until we see the legislation, until we see how it starts to flow through, we can’t give you a firm metric on that. But it is our clear view that it will have a positive impact. I did mention their aspects of the insolvency legislation but we prefer not to be there. But in its slowness it is something we can work with, and we have taken into consideration a range of potential parameters that could happen from the insolvency legislation in terms of how we would look at our impairment provisions over the next couple of years.

Vincent Hung – Autonomous Research

Okay.

Andrew Keating

I might just add, Richie, to that. Pardon me. Just in relation to that last piece. Just to note whether that the size of our own secured consumer loan book has reduced very significantly over the last number of years. And our Irish unsecured loan book at this stage is just €1.8 billion, about 1.5% of our total loan book, just to bear that in mind.

Richie Boucher

And that’s a book that is different. We have seen in that book that it’s a relatively short-life book and we have seen the impaired volumes of new business we have written since January 2009, significantly different than a cohort that was we impaired prior to that. And we have seen that lump of provision moving through that book.

Vincent Hung – Autonomous Research

Okay. Great. Just one more question, sorry. Could you comment on the Q rate of restructuring, because I think you made reference to it before? And I was just wondering what the typical and timeframe of restructuring is. So, how long someone is in restructured terms?

Richie Boucher

Continuing to review our policies in that regard, Vincent, which I think the most important metric to us is that if we look at our owner occupier, we had 12,000 customers who are currently in some point of modification or restructure. A material proportion of those were not in an early category but we came to discuss them. There’s a mix between short-term and long-term modifications. A short-term modification is about two-thirds of that, I think, Andrew.

Andrew Keating

Yeah.

Richie Boucher

And bearing in mind that our modification restructures 98% of those. I think 98% plus is on a full interest only – is on a full interest payment with some element of capital, very significant proportion. The Q rate or customers who have continued to conform to the modification of restructure is roughly around 80%. And if we look at the customers we’ll move to the longer-term modifications, which is in particular term extensions, 85% of those customers are fully performing.

Our policy is that we do not recapitalize arrears until there is a significant peered upward performance by the customer. So, we have an element of customers in our arrears categories who are meeting – fully conforming with their restructure arrangements but they remain in the arrears category.

I mentioned earlier on the buy-to-let or Andrew, sorry, mentioned earlier on the buy-to-let that we have a mix of customers who are moving from interest-only periods to amortization. We have given disclosure that about 50% of the buy-to-let book is on currently on each area and move into amortization.

Within the buy-to-let book, those customers will fall into arrears because they move into amortization. We differentiate between those customers who don’t feel like paying the increased repayments and those customers who can’t. And we take different steps in accordance with our views and our assessment of the customers with repayment capacity.

Vincent Hung – Autonomous Research

Okay. How many move on to the original terms or back on to the original terms?

Richie Boucher

It’s not a figure I have in mind at the moment. And obviously, it moves as we move to a restructure. Bear in mind, if we go to our owner occupier book in Ireland, I think the other charge that we give is 88%, and that includes people that are on temporary – that includes people on temporary modification. 88% of the mortgage book is a fully amortizing book. And so, that gives us flexibility to adjust terms.

Andrew Keating

We’d also just make a point to invest. In that owner occupier book, 93% of accounts are neither in arrears nor impaired. However, that is still 7% by account number and, I think, 9% by volume.

Vincent Hung – Autonomous Research

Yeah.

Richie Boucher

It’s a very serious issue for us and they’re putting a lot of work into, but trying to restructure customers and obviously whenever restructure is not possible to take other steps.

Vincent Hung – Autonomous Research

Okay. Great. Thanks so much.

Operator

Thank you. (Operator Instructions)

Richie Boucher

Well, again, I very much appreciate people joining on the call and people who have attended here in Dublin today. Clearly, if you have any follow-up questions, we’ll be delighted to try and deal with those. And I think the more appropriate contact point is initially through our colleagues in the Investor Relations team. So, thanks again.

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