Bank of Ireland (NYSE:IRE) Q4 2013 Earnings Conference Call March 3, 2014 4:00 AM ET
Richie Boucher – CEO
Andrew Keating – CFO
Stephen Lyons – Davy
Keiran Callaghan – Marine Capital
David Lock – Deutsche Bank
Andrew Coombs – Citigroup
Good morning everyone and welcome here to our results presentation for the year ended to 31, December, 2013. Thank you to those who are joining us here in Dublin and for those who are joining us by conference call and by webcast. I would give a short presentation, and I’d be followed by Andrew Keating, our Group CFO, who will provide a more detailed review of our financial performance. I will then sum up our priorities as we look forward.
2013 was a year of further substantial progress for Bank of Ireland. Coming into 2013, we had a number of objectives. We delivered against these objectives and substantially enhanced the value of the Group and its franchises. We strengthened the Group’s strategic position by retaining New Ireland.
New Ireland is the number two provider in the pensions, life and investment market in Ireland and it’s part of our very strong bank assurance model. We addressed the step-up feature of the 2009 preference shares through our capital package in December. This is the key focus for both investors and the Group during 2013.
This successful package was agreed with the Central Bank and the Irish State and ensured that we avoided the 460 million redemption penalty which would otherwise have applied. The capital package has also helped us achieve another major objective that of repaying and rewarding the states and the Irish tax payers for their support and investments in Bank of Ireland.
State aid has now been reimbursed. We carefully manage the ELG expiry which has had significant P&L benefit for us and has also materially reduced this risk to the tax payer. We achieved a net interest margin of more than 2% in the second half of the year notwithstanding the very low interest rate environment.
We continued to maintain strong cost discipline, successfully managing major redundancy and change programs whilst continuing to invest in our people, our businesses and our infrastructure. We accessed the funding markets across all levels of our capital structure and the cost of our debt-to-interest continues to fall.
On asset quality, our deported loan volumes are €1.2 billion lower than June 2013. We have seen improvements across all major loan categories. Our loan portfolios continue to perform in line with our expectations. We have carefully addressed the observations from the Central Bank’s balance sheet assessment in 2013 in our 2013 results and in our capital ratios.
We have agreed with relevant stock members a solution to reduce the deficit of the principal Group-sponsored defined benefit pension scheme and the IAS 19 pension deficit has been reduced by approximately €0.4 billion which has had an n immediate Basel 3 capital benefits.
Our capital ratios are meeting our internal planning targets and are above regulatory requirements. Our Basel 3 core equity Tier-1 ratio was 12.3% on a transitional basis as at the 1st of January 2014. Our progress in addressing all these issues is reflected in our financial results.
Our underlying performance has improved by almost €1 billion in 2013. We are profitable and generating capital in 2014. We are rebuilding our underlying earnings power. Our pre-provision operating profit was €685 million in the second half or 2013. This was almost double that recorded in the first half.
We achieved a net interest margin of more than 2% in the second half of 2013. Deported loans are now reducing; they are fallen by €1.2 billion since June 2013, which is the first significant reduction in recent years. I regard this has been very significant. The reduction is across all our major loan categories and is a function of our actions and support for customers who are in financial difficulty.
It also reflects the improved economic climate in our main markets and the recovery in their property markets.
The H2 impairment charge of €885 million reflects the reduction in deported loan volumes since June 2013. The improvements which are evidence in macroeconomic and property markets and our careful consideration of the Central Bank’s observations from the BSA as at the 30th of June 2013.
Looking forward, we expect impairment charges to reduce from current elevated levels to more normalized levels as the Irish and UK economies continue their recovery. Our underlying loss before tax continued to flow materially even after taking into account of our considerations of the AQR, our underlying loss reduced to €186 million in the second half of the year. And like I said earlier, we are now profitable and generating capital.
Over the past four years, our clear objective has been to reduce the risk to the state of any support for Bank of Ireland and to reward and repay the states and the tax payers for their investment – For 2009, and 2011, the states invested €4.8 billion in cash in the Group. We are grateful for the support we received from the tax payers.
At this stage, approximately €6 billion in cash has been returned to the state. It is right and appropriate that tax payers have got back their investment in Bank of Ireland with a cash profit achieved.
In addition, the state continues to earn at its discretion, a valuable 14% equity shareholding in the Group. The Irish State is also an important customer of the Group and we hold significant investment of Circa 6.1 billion in Irish government bonds.
Economic conditions have improved over the past year. Growth in the Irish economy has been improving slowly during 2013 and GDP is projected to have risen by 0.3% during 2013. Importantly, domestic demand has contributed to this growth for the first time since 2007. Growth is projected to increase significantly to over 2% in 2014.
The Irish labor market continues to improve. The unemployment rate, while still high, has improved to 12.1% at the year end, down from over 14% a year earlier. More importantly, there are 60,000 more people working today in Ireland than a year ago.
The Irish property markets are also recovering. Nationally, residential property prices rose over 6% in 2013, the first increase since 2007. We’ve also seen improvement in commercial property markets. There continues to be strong appetite from international and more recently domestic investors for Irish property assets.
In our other main markets, the UK, the economy has performed robustly in 2013 with the recoveries strengthening over the course of the year. GDP which grew every quarter in 2013 has expanded by almost 2%. The fastest pace of growth since 2007.
In summary, while there are still challenges, the outlook for the Irish and the UK economies is looking better than for sometime. We have strong franchise positions. In Ireland, we are the leading bank in a consolidating market. During 2013, we provided about four out of every 10 new mortgages and we provided over half of all new non-property SME lending.
We have a strong multi-channel distribution network. We have been investing heavily in our payments, mobile, e-banking and digital delivery infrastructure. Over 600,000 of our Irish customers are already actively using our online services and over 300,000 customers are actively banking via our mobile app.
With improved capability and functionality of these platforms, which has enhanced our customers’ experience and reduced our cost of sales. Another important component of our strategy is having a viable and vibrant branch network in centers of commerce throughout Ireland.
We are rolling out a new branch model which is designed to make it easier for customers to do business with us and is more cost-efficient for us. To-date, we have upgraded over 70 branches with further upgrades and some new branch locations planned for 2014.
Our corporate and treasury business continues to gain market share in Ireland and our New Ireland business continues to perform well.
We also have strong international franchises. The relationship with the UK post office continues to develop well. The range of financial services been offered through the post office’s extensive network continues to grow.
During 2013, we invested in and enhanced our mortgage offering and we are testing a current account proposition with customers. The post office itself is also investing significantly in the partnership by revamping the areas niche network designated for financial services and through the appointment of further specialist financial advisors.
Our foreign exchange joint venture has maintained its leading position in retail foreign currency in the UK and has expanded its product range to reflect change in customer demand. Our Northern Ireland motor finance business continues to deepen its relationship with customers and has delivered a strong financial performance and our full-service bank in Northern Ireland continues to perform in line with our expectations.
Our international leverage acquisition finance business continues to generate healthy returns and capital and a number of new – and transactions new mandates were won and transactions concluded during the year.
We continued to support and benefit from the recovery of the Irish economy. We are receiving more than a 1000 credit applications per week from SMEs in every sector of the economy. We are approving more than 85% of these applications.
In total, we approved €4 billion of credit facilities for new and increased lending in 2013. Bank of Ireland is providing more than 50% of all new property loans to the Irish SME sector.
It is the similar story in mortgages. We are receiving more than 1000 mortgage applications per month. Last year, in total, we approved €2.2 billion in mortgage facilities for our customers. Put it another way, in terms of loan go downs for every 10 new mortgage in the country, Bank of Ireland is providing about four of them.
Our corporate banking business continues to support customers, particularly those seeking a long-term banking partner as the Irish banking market consolidate and as we have continued to strengthen our existing relationships.
Our ambition is to provide over €30 billion of new lending to Irish business as you can see in the periods 2013 to 2017 inclusive. These are the financial targets we set for ourselves at the time of the 2011 capital raise.
At this stage, we have delivered our balance sheet targets, loans and advances at €85 billion are lower than our original target, partly as a result of foreign exchange impacts. Our original target in 2011 was to leverage our loan book from €114 billion to €90 billion net.
We’ve achieved this target ahead of time and below the assumed cost. However repayments have been higher than envisaged and there has been a lag between improved customer sentiment and increased credit appetite.
Notwithstanding this, our strong franchises combined with the improving macroeconomic conditions give us confidence that we can profitably grow our balance sheet in the medium-term. With particularly regard to profitability, we have achieved a net interest margin of greater than our 2% target notwithstanding the low interest rate environment.
We are well on track to achieve our targeted cost income ratio. Cost disciplines are embedded and continue to receive major focus as we invest in our businesses, our people and our infrastructure.
Non-performing loans are reducing. We remain confident that the impairment charges trajectory is moving in the right direction and towards our target.
I’d like to now hand over to Andrew to take you through the financial results in more detail.
Thank you, Richie. Good morning everyone. I am going to begin by reviewing the Group income statements highlighting the substantial progress that we’ve made in our underlying performance during 2013. I’ll then provide an update on our asset quality, on our balance sheets and on our capital ratios.
So starting with the Group’s income statement. In 2013, we improved our underlying performance by €930 million. We increased total income by 42% over 2012. We achieved this by growing our net interest margin by 59 basis points and by increasing our fees and other income and by safely managing the expiry of the ELG fees. We continued to tightly manage all costs and reduced our operating expenses by further €57 million in 2013.
Together, these actions increased our operating profit pre-impairments by €841 million, that’s a four-fold increase over 2012. Impairment charges in 2013 reduced by €104 million. Amongst other things, that charge reflects our consideration of the Central Bank’s observations on the AQR.
Non-core items include the gain from the change in pension benefits. The impact of credit spread movements, and some restructuring and redundancy costs. Looking at our momentum, last year at the time of our full year results, and again at the interim results, I highlighted that all items in the P&L and key financial metrics had improved.
In the second half of last year, that momentum continued. We are rebuilding our earnings power. And in 2014, the Group is profitable. That momentum is also evidenced on a divisional basis. Retail Ireland, retail UK, Bank of Ireland Life which incorporates New Ireland and corporate and treasury are all improving their operating performance.
Of particular note, is the performance of our retail franchises in Ireland and the UK. Together, taken together, these two divisions have increased their underlying performance by almost €0.5 billion.
I will now provide more details on the key components of our income statement, starting with our net interest margin. In 2011, we set a medium-term target for the Group to grow our net interest margin to greater than 2%. Despite the low interest rate environment, we have now achieved that target.
We did this by focusing on re-sizing our loan and deposit portfolios by more efficiently managing our balance sheet and by achieving higher lending margins on our new business. Having achieved that milestone, further expansion of our net interest margin will primarily reflect the volume of new lending, where we are achieving higher margins and future official interest rate increases over the medium-term.
Turning to interest earning assets. Over the last three years, in line with our strategy and our commitment to stakeholders, we’ve successfully deleveraged our balance sheet. At the end of 2013, our loan assets were €85 billion. We are actively pursuing opportunities to grow our loan book, leveraging our strong brands, franchise and distribution and by pursuing opportunities from the liquidating and exiting banks here in Ireland, where that's appropriate and effective.
Overall, the pace of declining average loan assets is slowing while loan assets may decline modestly in the near-term, we expect to achieve our medium-term target as our main market continues to recover.
ELG fees were €129 million in 2013. That's a reduction of €259 million or 67% from 2012. There will be further substantial reductions in these fees in 2014 and 2015.
Moving to operating expenses. We remained focused on tight cost control and in 2013, we reduced our cost base by a further €57 million. This improvement reflects our action to reduce staff cost and other costs by €120 million, which is partly offset by an increase in pension cost of €63 million.
Over the past 18 months, we reduced our staff numbers by about 2000 people leading to a reduction of €80 million or 10% in staff cost in 2013. We reduced other costs by €40 million or 5% through the reconfiguration of our premises and other infrastructure and through the renegotiation of our outsourced contracts.
The increase in pension costs primarily reflects the changes in the accounting rules that I signaled last year. We are continuing to invest in our people, our core franchises and our infrastructure.
In the second half of last year, our cost income ratio was 53%. And looking forward, our cost base has significant operating leverage.
Turning to asset quality. Total customer loans before impairment provisions were €93 billion at December. Our assets are broadly balanced by portfolio and by geographies. On asset quality, we reduced the level of deposit loans by €1.2 billion since June. This improvement is occurring across all major asset classes.
The impairment charge in the second half of the year was €885 million and it took a turns of number of factors including the risk profile of a loan, and in particular the reduction in the deposit loans in the second half of the year, the improving macroeconomic environment, the recovery in property markets and collateral values, and a detailed consideration of the observations from the AQR.
Looking forward, we expect the decline in deposit loan volumes to continue and we expect impairment charges to fall from their current elevated levels to more normalized levels as the economies recover.
I’ll now provide an update on the credit quality of each of our portfolios starting with Irish Mortgages. Our owner occupied book was €20 billion at December and nine out of ten mortgage accounts are up-to-date. We’ve reduced the value of defaulted loans by €36 million in the second half of last year. That is the first reduction in five years.
On a relative basis, our level of default arrears is at about half of the level of the industry ex Bank of Ireland. Our provisioning assumptions continue to accommodate a 55% peak to trough reduction in the house prices compared with 46% at December.
On forbearance and restructuring, we are rolling out effective solutions which are working for customers and the Group. Our customers are meeting the terms of our those new arrangements and we are achieving all of our targets in this regard.
Moving to the Buy to Let book. As with the owner occupied book, we are seeing positive signs in the external environment. Private sector rents are increasing marginally developed 7% last year. In terms of performance, eight out of ten of our Buy to Let accounts are up-to-date and the pace of growth in arrears continues to decline.
Moving to the UK; at December, our UK residential mortgage book was £21 billion and that represented about 30% of our total loan book. The UK economy continues to strengthen. House prices and rents are continuing to increase, employment is rising and the overall economic outlook is becoming more favorable.
Our residential mortgage book continues to perform strongly. It’s in line with our expectations and better than the industry average.
In our SME and corporate loan portfolios, asset quality is improving. In Ireland, our SME portfolio was €10 billion at December. While challenges remain, we are seeing emerging signs of improvement across a range of sectors in the Irish economy. The level of defaulted loans has fallen since June. At this stage, we’ve agreed end stage strategies with nine out of ten of our challenged customers.
In the UK, our SME portfolio amounts to £2 billion and the level of defaulted loans has remained stable. Our corporate loan portfolio was £8 billion at December. Through our actions, we’ve reduced defaulted loans in this book by £0.5 billion since June.
Turning to property and construction, our investment property portfolio was €13.6 billion at December. The portfolio is balanced geographically, about half of the assets are in the Republic of Ireland and half are outside ROI. The portfolio is also diversified across sectors albeit with a retail focus.
In Ireland, we continue to see increased liquidity in the commercial property market reflecting the ongoing international and emerging domestic demand for assets. We are also seeing positive trends in rents and in asset values.
In the UK, London and the Southeast continues to perform well and there is growing confidence in real estate markets outside of London. The land and development portfolio amounted to €3.2 billion at December, 89% of that portfolio is impaired and the coverage ratio is 58%.
Before I move on, I will summarize the key aspects of asset quality. We’ve reduced the level of defaulted loans by €1.2 billion since June. The impairment charges in the second half of the year reflect among other things at detailed consideration of the AQR observations.
Going forward, we expect impairment charges to fall from the current elevated levels to more normalized levels as the economies recover.
Turning to funding and capital; we’ve restructured and transformed our balance sheet over the last three years. In 2010, deposits made up less than half of our total funding. We had €70 billion of wholesale funding and half of that came from the ECB. Our loan to deposit ratio was at 175%. Today, it’s very different.
Customer deposits make up the substantial majority, that’s over 70% of our funding base. We’ve reduced our requirements for wholesale funding by over 60%, that’s more than €40 billion and includes the repayment of €25 billion to the ECB. As a consequence, we have improved our loan to deposit ratio to 114% last December.
Stepping back, we have completed the restructuring of our balance sheet and we have the capital, liquidity and infrastructure to profitably grow our loan book. Turning briefly to deposit, Bank of Ireland is substantially a retail deposit funded institution. Over 85% of our loans are funded by our stable pool of customer deposits.
In Ireland, we’ve increased our deposit volumes by €1 billion during 2013. In the UK, we’ve reduced our deposit volumes, in line with our franchisees to manage the liquidity position of the UK subsidiary.
Moving to wholesale funding. Last year, we reduced wholesale funding by €12 billion. The year-end figure of €27 billion includes €8 billion of monetary authority going and half of that relates to the NAMA three year bonds.
Our private market funding was €19 billion at December, 60% of this amount had a residual maturity of greater than one year. As such, the refinancing requirement from one secured maturities is very low and manageable. As you can see, over the past year or so, we have demonstrated consistent assets to the funding market right across the capital structure.
During that time, we raised €3 billion of senior secured debt and one and a quarter billion of senior unsecured debt. The total and 2009 preference shares were sold to private sector and we successfully issued €0.6 billion of common equity. The cost of issuance has also reduced substantially during this time reflecting the progress we’ve made in strengthening the Group
To illustrate this, in November of 2012, we issued a corporate bond, – secured on those mortgages with a three year maturity at a cost of 270 basis points above the drop. A year later, we issued a similar instrument with a same collateral with slightly longer maturity and the cost was 150 basis points lower.
Turning now to capital; in the second half of 2013, the Central Bank conducted its balance sheet assessment or AQR. This is a pointed time exercise at the 30 of June. In our announcement in December, we explained that there was three components of the AQR.
All of these components has now been addressed and reflected in our published capital ratios. The first component related to the treatment of the expected loss adjustment. In line with our previous expectations, we incorporated this updated treatment at the year-end.
The second element related to risk-weighted assets. Following recent engagement with the Central Bank, the adjustment from the AQR have been applied in our year end capital ratios.
The third component related to impairment provision. And as I said already, our full year impairment charge takes accounts of this among other factors. Having addressed the AQR, our capital position remains robust. Our common equity Tier-1 ratio was 12.3% and that’s using the transition rules at 1st of January 2014. On a fully loaded basis, our CET 1 ratio was 9% and that’s an improvement from 8.6% at June.
Going forward, we continue to expect to maintain a buffer above CET 1 ratio of 10% on a transitional basis.
So, to recap, 2013 was a year of substantial progress for Bank of Ireland. We have improved our underlying performance of the Group by almost €1 billion. And as we start 2014, we are now profitable and generating capital.
Richie will now elaborate on our priorities for 2014 and beyond. Thank you very much.
Before I outline our priorities for 2014 and beyond, I think I’ll just quickly go over the progress we’ve delivered. Three years ago, we had a range of strategic objectives. We’ve achieved these objectives. We’ve completed the restructuring of our balance sheet. We’ve transformed the profile availability and cost of money to us.
On asset quality, deposit loans are now reducing, they are down more than €1 billion since June. We have successfully implemented a solution to deal with deficits in our sponsor defined benefit pension scheme. We have addressed the step up feature of the 2009 preference shares and strengthened our capital condition in the process.
We’ve safely managed the expiry of ELG schemes and tax payers investment are supported being repaid and rewarded for the cash profit achieved. We’ve confirmed the strategic shape of the group and continue to substantially improve its earnings power. We’ve retained our profitable New Ireland business. We continue to do necessary balance sheet deleveraging ahead of time and below the esteem cost.
We’ve achieved a net interest margin of greater than 2%. And we’ve reduced our costs by over €0.5 billion since 2008 with a cost income ratio of 53% in the second half of 2013. We are now profitable and we are generating capital. Our focus is now on the next stage in the Group’s development. We have a very clear set of priorities.
First and foremost, our focus is on continuing to develop long-term relationships with existing and new customers and leveraging the strength of our brand, our franchises and our distribution. We are simplifying our production processes and enhancing our customer service. Our ongoing investment in infrastructure and distribution platforms is improving our customer’s experience and supporting greater efficiencies.
Our priority is to significantly grow our profitability and to generate strong and sustainable returns for our shareholders building on the significant momentum already underway. A key contributor would be reducing the current elevated level of impairment charges to normalized levels.
Meeting our net interest margin objective and rebuilding the size of our loan book is obviously also very important. With our strong franchise position and with economic conditions s improving, we are confident that we can reach our targeted loan book size in the medium-term.
Continuing to effectively manage the evolving regulatory environment remains an important priority for the Group. We’ve been generating capital since the beginning of 2014. This capital is being prioritized towards the planned de-recognition of the remaining €1.3 billion in 2009 preference shares during 2015.
Thereafter, our ambition would be progress to dividend payment capacity. I am very grateful to all of my colleagues throughout the Group for despite the many challenges we have faced have remained resilient, committed and focused.
My colleagues and I must and will continue to maintain this focus as we strive to reward our shareholders for their confidence in our group. We are confident in the Group’s prospects and in our ability to deliver strong and sustainable returns for our shareholders.
Thank you. Andrew and I will now take some questions.
Stephen Lyons – Davy
Good morning Stephen Lyons here from Davy. Just a couple of questions. First of all, just on your earning assets, you’ve given that target of €33 billion out of €17 billion, might you be able to time weight that for domestic lending and maybe overlay that with some targets or ambitions for your state of Ireland lending?
And then maybe secondly, just on provisions, post the AQR, if I look your provisioning methodologies and your coverage, you seem to have a very conservative hedge price assumption, if I interpret you correctly, your cure rate is possibly some 5% in your collective residential provision models and then your IVNR provisions now been buffered up again.
Is it fair to assume that assuming that the current run rate continues for eight out of ten of your mortgage restructures actually stick that – we might actually see a return to more normalized loan losses next year because you might have a release of provisioning on some on those portfolios. Thank you.
Thanks, Stephen. I’ll take the volumes one and let Andrew take the other. I think on the volume, we’ve set up the target that we have, I think there is a degree of ambition in them, but if we look at the track record that we have had over the last four years, if we look at what we did on the net interest margin, we set that target, interest rates came down much lower the curve, it became lower, we still achieved it.
So we are very, very focused on that. I think on the time waiting, I think we had to see that – a gradual pick up during the period that we are talking about after 2017. We have deliberately put that figure out, we’ve put it out in the beginning of this year and I think that should hopefully give people some comfort that we’ve thought and to be very carefully and the momentum we saw in the 2013 was in line with our expectations.
So I think there will be a – it won’t be a hockey stick, but there will be a gradual improvement as the economy as a whole improves. And, I think on the balance between international and Ireland, I think at the moment, our loan book is about 52% in Ireland and round about 48% outside.
I would see that gradually moving towards kind of a mid-50s, but I think the diversification will remain very important and therefore our new lending targets in our international businesses I think primarily around the post office relationship in the UK and then leverage our finance portfolios and some growth in our Northern Ireland business.
But I think, broadly speaking and broadly speaking we see that the volumes will be across the books and locking in proportion to their current makeup.
Okay, Stephen, your second question related to impairment charges going forward and maybe just to put that in context, I guess, we’ve said again this morning that we expect certain impairment charges are going to fall from here, from the current elevated levels to more normalized levels as the economies recover.
I guess, at each reporting period, we will be taking account of the fundamentals behind the risk profile of our balance sheet and our customers and also taking accounts clearly off the macroeconomic conditions and outlook and the state of the property markets both residential and commercial.
I guess, it was very notable this morning and I think Richie emphasized this in his own presentation whilst the reduction of €1.2 billion in the level of defaulted loans since last June. We think that going forward, the level of deposits owned will continue to fall from that level and that’s coupled with the improving macroeconomic outlook and the recovery in the property markets will set a better environment and framework for the level of impairment charges as we go forward.
We give very extensive disclosure in the interim or in the preliminary announcement this morning. We’ve stuck with our assumption in our provision, they accommodated 55% peak to trough reduction in house prices. We take account of four sale discounts and cost of recovery on top of that and as we say, our cure rates have been – as setting out the level that we’ve set out reflecting our consideration of the 7% of bank guidelines et cetera from 2013.
So certainly, all of those factors together give us a high degree of confidence that our impairment charges will fall and they will get to a normalized level of 55 to 65 basis points as the economies recover.
Keiran Callaghan – Marine Capital
Hi guys, Keiran Callaghan from Marine Capital. First question please, around that balance sheet assessment, I’m just wondering how should we see consider that note? Is it really a done and – is there any risk of maybe further – and watch it, you didn’t recognize. Relating that also just on the slide 36, there is a chart there on sort of bridge core tier-1, 1.7% reduction in Core Tier-1 ratio relating to the impairment charge, it’s from the AQR.
If I do a rough calculation by some €55 billion of – that compared with €935 million of H2 impairment charge, just wondering, it seems kind of offsetting that or is that an incorrect way to look at that calculation? And then finally, just overall capital ratios can we get – any feel on how you are actually looking at that, is there potential for maybe a lower tier-2 issuance later this year – also a fully loaded Basel 3 ratio is there an internal ratio there that you are already targeting before you would consider paying out? Thank you.
I think you forgot to the capital target first of all Keiran and we said offset – first of all, we did capital package in December 2013. That capital package had four consideration of the AQR BSA. We’ve done our on stress test scenarios into that and that reflected the design of that capital package.
And we maintained our guidance. So the other thing we know I think to your range is that the AQR BSA that’s coming now will be done on a transitional basis recognized the transition arrangements. We’ve continued to guide that our internal target is a buffer over 10% core equity tier-1 on a transitional basis. And, we guided that at the time in December, we guided that our priorities will be to de-recognize the – in 2015 and to move to (Inaudible). So I think that should hopefully demonstrate some of the confidence that we have in there.
Just on your impairment charges question Keiran, certainly the 1.7% is effective and movement to the capital ratio from June to December. It maybe sort of some rounding effects, it certainly isn’t intended to be anything other than the €885 million of impairment charges that we took in the second half of the year in relation to that.
And in terms of the AQR, I think, we set out in December and again this morning that there was three components to the AQR and then all three components of the AQR have been addressed at this stage has been reflected in our balance sheet and that’s been reflected in our year-end capital ratios.
So that, we’ve incorporated the adjustments in respect of – at the last we have applied the risk-weighted asset adjustment from the AQR and our impairment provision and impairment charge involves among a range of deposits but it involves a very detailed consideration of the observation from the Central Bank at the time of the BSA at the time of the AQR.
We are not comparing exactly like-for-like to what our loan books are at the end of December and obviously macroeconomic environment and collateral value. I think one of the things I would note though is that our coverage ratio, so that’s the non-performing to provision ratio is 48% at the end of December and that’s in excess of what the coverage ratio would have been on a pro forma basis at the end of June if all of the AQRs had applied at the end of June.
Maybe if I can just look at the – in terms of growth, maybe kind of turn a little bit to that, you have kind of the medium term target of €90 billion out there, but you mentioned Richie, in your commentary about opportunities that are of exiting Ireland just one could we be seeing a stabilization in the net lending book this year and then two how quickly you think can get to that €90 billion further?
I think on the stabilization thing Amen, what I would note is that the reduction in the loan book slow down considerably in the second half of 2013. It’s hard to call it exactly where it might – that trajectory might move from reductions to an increase both.
Again we set our targets on a basis that where we think it will happen and we would like to see a combination of lending coming from new, new opportunities in the market as customers start to invest, we still have some customers with strong cash flow are deleveraging.
But I think that’s starting to change and with regard to people exiting the market, yes that’s obviously part of our business. Sometimes that exiting of customers considering their banking relationship and we are not sure they are an existing bank – that a capitalistic way they are looking to do something new and they really wandering we should have been partnering with going forward.
And we’ve seen loan book sales and we think that is – we’ve obviously participated in supporting customers who have come out of a liquidating scenario or liquidation scenarios by other entities in the market or with us those people are exiting the market together.
And then we have seen that other private equity et cetera has brought in on book as that private equity is looking to realize their cash from what their budget, that I think that create opportunity for us because the customers would be looking to refy out of those or they would be selling them some amount of leverage. Having looked very carefully at the process, we’ve participated in the process and we have a reasonably good understanding of the dynamics within those loan books.
And what – it is supportable from a financing quality from us. So, that pace pf reduction in the balance sheet did slow down quite considerably in 2013. Part of it was exactly when it’s going to bottom out, but I would also say that the first couple of months of this year and we have been quite encouraged by a pickup in real demand by moving to people asking for term sheets, to people moving to go down and the some of our business will become our car finance business et cetera, very, very good start of the year.
Oh yes, to your point, maybe we can check if there are any questions from people who are joining us on the line from London.
We have a telephone question from David Lock of Deutsche Bank. Please go ahead. Your line is open.
David Lock – Deutsche Bank
Good morning. I just have a few questions on the UK business and also one on NIM. So on the UK business, I just wondered first of all, could you confirm the proportion of the UK mortgage book, which is in run-off at the end of the full year, and particularly what kind of churn you are seeing in the SVR book in that business there?
And secondly, when I look at the kind of the NIM going forward, I can't help but look at the Post Office website and you are offering quite good pricing for customers on 65% LTV mortgages sort of at 1.6% for two year fixed and yet with a savings rate of – an instant access savings rate of about 1.3%. I just wondered how much volume is really behind those kinds of prices you are putting out there, because that seems quite aggressive pricing?
And then thirdly on the UK, just in terms of risk-weights, the first half of 2013, the EBA data on your UK business suggested you had a 9% risk-weight on mortgages. I wondered if that had changed by the end of the year and whether you have any expectations around where risk weights would land for the UK. And I have one further question on liability pricing in the Ireland.
I think about – as I think we’ve talked about in the past that David, on the UK mortgage book we have had mortgages in what we call the GovCo balance sheet and also has moved into the BOI UK PLC balance sheet which is the regulated subsidiary and which has funded almost entirely by our customer deposits, so exclusively by customer deposits. And we have seen mortgages transferring from the GovCo book into the UK book.
You’ve seen what we had talked about last year was – what we described it as excess liquidity as the deposit book will grew and we were making sure that there was a stable deposit book and then transferred mortgages in. So, I would see that during the course of this year, you will probably see some more mortgages transferring from the GovCo book into the other book.
I think in terms of redemptions, as a payment, they are moving in line with our expectations. We don’t give absolute deficit figures on that, but it’s generally in terms of where the market is. And in terms of the pricing strategies we employ in the UK, clearly we priced across a wide product range and we seek to attract interest from people in our product range and then we identify the appropriate products at the appropriate margin for the customers.
In the UK, the new mortgage lending, the LTV for that is around about 70% 73% I think Andrew and we are – the margin targets we have for the Group for every part of the group to reflect both the capital employed and obviously the franchise value and the accurate amount of money you need to earn. And all of it is – businesses have to achieve their margin targets are designed to ensure we are able to get the return on capital but also and meet the overall Group and contribute the overall Group’s pricing.
So, I think you would expect that our this grade we are getting in our UK business between deposits and new lending through in the round – type of all the products and utilize out some other products altogether. It would be contributing to the net interest margin target for BSA for ourselves. As regard to the risk-weighting, maybe, Andrew, you take that?
Sure, I think, David, you are saying in terms of the risk-weighted percentage was around about 9% at June and I think as part of the AQR and considerations we have applied, the risk-weighted asset adjustment and to our year-end balance sheet and so the consequential risk-weighting for UK market is around about 15% on the IRB basis.
David Lock – Deutsche Bank
Thank you very much and I just had a further question on – in terms of NIM, looking out, going forwards, particularly it’s in the Irish business. Clearly, there was a huge re-pricing of deposits last year. I just wondered if there is any further road to run in terms of re-pricing on deposits and if there are any hedging impacts you'd like to call out over the last year? Thank you.
I think there is a hedging impact which we will come through on the preference shares, Andrew.
Yes, what that relates to David, is, we had an hedging phase for that €1.8 billion of preference shares which were – which were hedged out to March of 2014. That hedge was put in place in 2009, when the capital was invested in the Group. And despite your swap rate at that time was in round numbers, is about 3.5%.
Clearly, with the hedge is going to mature in March and we will now be rehedging that capital for about 2 to 2.5 years in line with the time the recognition of the preference shares, the €1.3 billion preference shares in mid-2016.
Clearly, the 2 to 2.5 year swap rate today is much lower and so in total, the impact of that maturing and reinvesting of the capital will have an impact on the Group’s margin. It will be around by four to five basis points on a full year basis. And, other than that, that’s the main issue that we call out in relation to hedge items. I think on the NIM more generally, the deposit pricing in Ireland.
As I say, we made very substantial progress in reducing our deposit pricing over the last number of years and that’s contributed to the significant fall in the cost – the overall cost component such as the – I think, when I was looking a chart 19, you will see that the cost for the Group across all of our sources of funding it has dropped by – from 1.99% in 2012 to a weighted average cost of 1.26% today. I think, recently in the Irish deposit markets the cost of marginal deposit has been stable over the last number of months and that will be true also in the UK.
I think a couple of features there also David is, we obviously focus not just on the loan to deposit ratio, but on the niche type of funding ratio and one of the things that has been a component of our deposit strategy is also being reducing features like access which obviously, call against you been looking at a net type of funding ratio. I think we’ve achieved most of our objectives there.
I think the other thing probably to bear in mind is, the improvement in the Irish economy. We have started to see that come through in the volumes of a non-interest bearing current account and that’s reflecting – I think what’s going in the economy and that’s gaining market share.
We don’t just focus back on trying to win customers who have lending requirements, but also customers who have other requirements. And so we’ve seen that the mix of the Irish deposit book between interest-bearing and non-interest bearing has started to change towards more a non-interest bearing.
David Lock – Deutsche Bank
Thank you very much.
Our next question comes from Andrew Coombs of Citigroup. Please go ahead.
Andrew Coombs – Citigroup
Yes, good morning. A couple of questions from me please. Just firstly, apologies if I missed this. But perhaps you could just explain what the impairment charge for the second half of 2013 would have been ex the AQR top-up?
And then my second question was just regards to the Central Bank of Ireland BSA. If I look at the announcement that was published in December, there is the expected loss deduction of €550 billion that they flagged. There was also the impairment charges of, I think, of another about €750 billion and then the RWA inflation of €6.7 billion.
I notice in your Annual Report you talk about incorporating the expected loss treatments, but I just wanted to clarify the language around the impairments in the RWAs. You talk about taking the impairment into consideration and applying certain adjustments to the RWA. So, of the issues identified in the BSA with regards to impairments and RWAs, I just wanted to get a feel for how much of that you have factored in with these numbers and how much is left unaccounted for? Thank you.
Well, I think like we said Andrew, and maybe, if you missed it earlier on. apologies for that and we’ve addressed the AQR and BSA observations. We have the EL where something was always going to happen anyway on the Basel 3 that was anticipated that’s been taken – the RWAs have been taken.
With regards to the provisions obviously you are looking at a point in time exercise in June, where we are in December and what we have taken into consideration is the AQR observations, also the absolute and actual performance of our loan books with the non-performing loans got reducing number of customers in all of our main portfolios who are defaulting reducing and the economic environment and updated views on collateral values.
I think the most important features the one that I touched on earlier which is our stock and our coverage ratio. We could provision stock against non-performing loans at the end of December it was 48% if all the AQR observations have been taken into account at June at that point in time in June, then it would have been less than 48%. So, we feel that that's been comprehensively addressed. The June figure and the December figure is likely an apple with an orange, but I hope the call out there on the coverage will give you some view of how we’ve addressed that.
Andrew Coombs – Citigroup
So, as far as you are concerned, you've discussed these figures with the Central Bank of Ireland post their analysis and they are comfortable with what you've now taken?
Well, those are figures that we have taken very full view of the observations of the Central Bank. It’s obviously very important to the Group that we have a professional relationship with the Central Bank and that was obviously a very important consideration from our perspective.
Andrew Coombs – Citigroup
Okay, and then on the provision charge ex the AQR top-up?
I’ve just answered your question.
Andrew Coombs – Citigroup
Okay, and just one final one I guess, with regards to the forbearance. I mean if I look at page 72 and the add-on you've taken there, you've taken €364 million extra – let's just say 364 forborne loans have now been classified as non-performing. I just want to get clarity on exactly what the terms and conditions were there, as to why they were restated if you could just provide a bit more detail? Thank you.
Yes, so, Andrew, if I just know that, I mean, for the purpose of the Central Bank they have a different classification in terms of performing and non-performing. And so, we’ve set that out on page 74 and reconciled it back to our own classification of the risk profile of our loan books.
The €300 odd millions of items that you are referencing are mortgage loans which have been restructured. They are mortgage loans where the customers fully up-to-date with the terms of the new arrangement and after the customer maintaining that for a particular period of time, we – in our classification we will reclassify them out of the default category back into the performing category.
The Central Bank in terms of their risk-weighted assets et cetera. They insist on a 12 months’ probation period before those loans are to be classified. So they are effectively – these are loans which are somewhere between our provision period and the Central Bank provision period, it would typically be a period of about six to nine months before we would reclassify them out of the default book into the performing book.
Andrew Coombs – Citigroup
Okay. Thank you.
Okay, do we have any more questions in Dublin? Okay, on behalf of my colleagues and myself, thank you very much for your interest in the Group and we’ve made a lot of progress, but that was last season. We are very focused on what we have to do now going forward and that’s I think worked very hard, got a lot of support from a lot of people and there are opportunities and we are going to avail them. Okay, thanks very much.
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