Governor & Company of the Bank of Ireland (IRLBF) CEO Francesca McDonagh on Q2 2019 Results - Earnings Call Transcript

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Governor & Company of the Bank of Ireland (OTCPK:IRLBF) Q2 2019 Earnings Conference Call July 29, 2019 3:30 AM ET

Company Participants

Francesca McDonagh - Group Chief Executive Officer

Andrew Keating - Group Chief Financial Officer

Conference Call Participants

Diarmaid Sheridan - Davy Group

Owen Callan - Investec

Eamonn Hughes - Goodbody

Pierce Byrne - Cantor Fitzgerald Ireland Ltd.

Alastair Ryan - Bank of America Merrill Lynch

Andrew Coombs - Citigroup Inc.

Christopher Cant - Autonomous Research

Charmsol Yoon - UBS Group AG

Stephen Lyons - Davy Group

Alicia Chung - Exane BNP Paribas

Aman Rakkar - Barclays

Martin Leitgeb - Goldman Sachs

Francesca McDonagh

Okay. Good morning, everyone, and welcome to Bank of Ireland’s 2019 Interim Results. I’ll share a number of highlights from our first half performance, and then Andrew will provide a more detailed update on the financials. I’ll also set out of you of the external environment, and one year on from the publication of our strategy, our outlook and actions from now until 2021.

I’m pleased to report a solid financial performance with an underlying profit of €376 million and a 9% increase in our pre-provision operating profit. There are a number of highlights that have contributed to this performance. The first is net lending growth. For the 6 year in a row, Bank of Ireland is the largest lender to the Irish economy with total new lending of €7.7 billion and net lending growth of €1.2 billion.

We’ve seen a strong performance in corporate banking. And we’re the largest lender to Irish SMEs and the agriculture sector. The second highlight is asset quality improvement. Bank of Ireland already has the lowest non-performing exposure, NPE, ratio of any bank in Ireland. But we’re very clear on our ambition to drive NPEs down further. That’s good for our bank and good for the health of the wider Irish economy.

In the first half, we delivered a further reduction in our NPE ratio to 5.3%, down €800 million. We are now within touching distance of our near term target of NPE below 5% by the end of this year.

The third highlight is business transformation. This means transforming our culture, our systems and our business model. We’re investing in our transformation at the pace we set out previously. We’re delivering key milestones and we’re demonstrating cost reduction and other benefits.

I’ll look at each component part within our transformation program. Culture is a commercial imperative. Good culture attracts and retains the talent we need to develop our businesses. And good culture reduces risk and cost, and builds customer loyalty. We’re making good progress and our culture is strengthening.

On systems transformation, we’ve delivered a number of key milestones. We’ve completed the largest customer migration in the history of the bank. We’ve moved 2.1 million customers to a new First Data platform for debit card and ATM transactions. This gives us and our customers more stable systems for hundreds of millions of transactions each year. We’ve also modernized our payments infrastructure and automated over 100 processes to improve customer experience.

On business model transformation, we are creating a leaner, simpler and more agile organization. We are removing management layers, reducing headcount by 4% year-on-year and making changes to our UK business model. We have sold our UK cars business and exited non-profitable current account and ATM operations.

The fourth highlight is cost reduction. We’ve set a clear cost target as part of our strategy. And we’re delivering. We reduced cost by 3% compared with the first half of 2018. That’s after absorbing costs linked to IT investment, various regulatory requirement and wage inflation.

Excluding IT investments, we have reduced our day-to-day operating cost by close to 5%. With revenue up and cost down, we’ve achieved positive draws of 4%. Combined, these actions have contributed to strong capital generation. In the first half, we generated organic capital of 90 basis points. Our CET1 ratio increased by 40 basis points and now stands at a robust 13.6%.

And we have made an accrual of €100 million, in respect of a dividend in 2019, in line with our policy. We’ve delivered a strong performance in the first half. And we are, of course, influenced by the external environment.

In Ireland, the economy is strong. GDP growth is well above the euro area average. The labor market is growing and unemployment is at a historically low rate. While in the UK, we see more moderate growth. We still see a growing labor market with low unemployment. Nonetheless, aspects of the external environment are more challenging than when we set out our strategy a year ago.

In particular, the interest rate outlook has moved significantly and lower-for-longer rates are impacting margins. As an illustration, since the start of the year, there has been a 100 basis points reduction in market expectations for 5-year swap rates in 2021.

In addition, Brexit uncertainty has still not been resolved. This remained a concern, especially to businesses in Ireland and the UK, which is impacting sentiment and also credit demand. Mindful of these challenges, I will shortly deep-dive into our Ireland and UK businesses and our transformation program.

And I will set out the actions that we are taking to offset the uncertainties and to guide our business between now and 2021. I’ll first hand over to Andrew to go through the financials. But before I do, you will know we recently announced that Andrew will be moving on from Bank of Ireland towards the end of the year. So I would like to take this public opportunity to personally thank him for his exceptional commitment to the bank, especially since taking on the role of CFO in 2012.

Andrew has played a key role in the Bank of Ireland story since that time, and on a more personal level since I have been in the role has provided excellent support to me. Thank you.

Andrew Keating

Okay. Well, thank you, Francesca, for those very kind words and as well as for your support to me since you joined. It’s been an enormous privilege for me to have been the CFO and Director of this great bank for the past 7.5 years. I’ll certainly miss everyone and wish you all well.

So on to the financial results for my 16th and final time. So we’ve had a good start to 2019. We have grown our loan book. We’ve reduced our costs and we’ve reduced our NPEs while improving our strong capital position. Over the last 6 months, we generated an underlying profit of €376 million.

Total income increased by 1% and we reduced our costs by 3%. And as a result, we’ve grown our pre-provision operating profit by 9% to €435 million. Our impairment charge was €79 million or 21 basis points.

Included in our non-core items was customer redress charges relating to the conclusion of the Tracker Mortgage Examination. The associated amount of €55 million covers 3 things: compensation payments, additional costs associated with the program, together with an increase in the provision for a potential fine.

Turning now to lending volumes. We grew our loan book by €1.2 billion in the first half of the year. All geographies of Ireland, the UK, and international contributed to this growth. In Ireland, we lent €3.8 billion to Irish customers and businesses. And as Francesca has already said, that makes us the largest lender to the Irish economy.

In our mortgage business, we lent a €1 billion and our market share was 23%. We’ve maintained our track record of commercial discipline on risk and pricing. In addition, we’re investing in developing our product propositions, expanding our distribution network and progressing our re-entry into the broker channel.

The SME market is a very strong element of our franchise. By some distance, we’re the leading bank for SMEs in Ireland. At €1.5 billion of new lending in the last six months, despite Brexit uncertainties, we’ve grown our market share and we’re well positioned to support and benefit from expanding credit demand in this sector.

We’re the number one corporate bank in Ireland. Our business has performed strongly, contributing €400 million of lending growth in the last six months. In the UK, we’re broadening our distribution network. And we’re selectively investing our capital in those sectors that are generating more attractive returns. And that’s enabled us to prudently grow our loan books by €600 million in higher return sectors such as consumer Bespoke mortgages and corporate portfolios.

Finally, our international corporate business grew by €400 million. We have continued our conservative approach to asset selection. Typically, we only underwrite the 1 in 5 loans that meet our strict credit criteria.

Moving to our net interest margin, which was 216 basis points for H1, we continue to maintain our strong commercial discipline on pricing. Over the last 6 months, the yields on our liquid assets have been lower at 17 basis points negative. However, we’ve seen total loan book spreads stable at 284 basis points. We’ve grown the loan book at front book spreads that continue to be higher than the back book. And there has been a stabilization in the level of competition in UK mortgages.

When I spoke to you in February, I expected the tailwinds to our NIM would support its growth into the 220s over the next couple of years. As you all know, since then, there’s been a very significant and a material reduction in the interest rate environment. And that’s a headwind for all retail and commercial banks including Bank of Ireland. As a result of that, lower-for-longer interest rate environment, I now expect our NIM for the full year 2019 will be slightly lower than the 216 basis points for the first half.

Looking to 2020 and 2021, the trend will be for a net reduction in our NIM of mid- to high-single digit basis points from that 216 level. Francesca will set out shortly, the actions that have been taken to mitigate these financial impacts, so that our RoTE will continue to grow to target levels.

On to fees and other income, as you know, we’re exiting UK cards and ATMs, and they contributed €21 million of fee income last year. So on a like-for-like basis, our business income of €311 million was $9 million or 3% higher than last year. Retail Ireland was broadly stable; while our Wealth and Insurance business benefited from the investments, we’re making increased activity and economic growth. Valuation and other items gave rise to a net gain of €28 million in the first half.

On to costs, we continue to make good progress and our commitments to reduce our costs with a net 3% reduction in the period. Staff costs reduced by almost 5%, reflecting a decrease in FTEs and a change in mix with fewer management layers.

Taking other costs and depreciation together, they reduced by a net €14 million half-and-half. And this net reduction reflects the benefits from the ongoing transformation of our processes and from strategic sourcing, and partly offset by higher depreciation associated with technology investments.

Exiting the UK cards and ATMs, reduced our costs by €26 million. All of the efficiencies that we’re generating are enabling us to absorb wage inflation, regulatory costs and the ongoing investment in our transformation programme. We are on track to deliver our commitment to reduced cost every year to €1.7 billion in 2021.

Turning now to asset quality. In the first half of the year, we reduced our NPE ratio by 100 basis points to 5.3%. This is the lowest NPE ratio of any Irish bank. The securitisation of an Irish buy-to-let mortgage portfolio unlocked 30 basis points of capital. We expect further reductions in NPEs, and we’re keeping all of our strategies under review. Our impairment charge was 21 basis points in the first half, and absent the change in the economic environment or outlook, we expect that our net impairment charge will be between 20 and 30 basis points in the next couple of years.

On funding and capital, we have strong liquidity and leverage ratios. Our customer deposits are primarily sourced through our retail distribution network, and while our loan to deposit ratio is below 100%, it gives us the funding and capital to support our growth and strategic objectives. We have MREL targets, which are very manageable. We will be issuing €1 billion to €2 billion of holdco securities this year and next.

Moving now to capital. Our position and outlook is very strong, and our guidance is unchanged. We increased our capital ratio by 40 basis points since January, and it’s now 13.6% on a fully loaded basis. We continue to generate strong capital organically, 90 basis points in the first half. And in addition, the NPE securitisation unlocked a further 30 basis points. In terms of our guidance, we continue to expect to maintain a CET1 ration in excess of 13%, so on a regulatory basis and on a fully loaded basis by the end of the O-SII phase-in period.

Over the last 12 months, I’ve set out clearly how we invest and allocate that capital. In the first half of this year, we invested 30 basis points of capital in supporting the growth in our loan book, and we invested 25 basis points in our transformation programme. In terms of future regulatory capital demands, the 80 basis points I guided you to in February is unchanged.

Finally, on dividends and distributions, at the half year we accrued for dividend of €100 million. And that’s equivalent to an annualized dividend of €0.185 per share, an increase from $0.16 last year. There’s no change for dividend guidance, we continue to expect that dividends will build on a prudent and progressive basis towards a payout ratio of 50% of sustainable earnings.

So in summary, we’ve made good progress for strategic objectives and targets, and we expect that to continue in the second half. As we look to the full year outturn, we’ll grow our loan book further, our total costs will be lower than last year, and we’ll reduce our NPEs below 5%, while strengthening our capital position.

We’re committed to increasing our return on tangible equity to the target level of in excess of 10%, and thereby delivering on our commitments to our shareholders.

I’ll now pass you back to Francesca. Thank you all very much.

Francesca McDonagh

Thank you, Andrew. Earlier, I set out our view of the evolving external environment much of that is outside our direct control, but what we can control of the actions that we take to grow and transform Bank of Ireland, and to deliver on the strategic ambition that we set out one-year ago. These actions are especially important for our Irish and UK businesses, and for our systems transformation.

Ireland is one of the fastest growing economies in Europe with increasing population, employment, wealth and construction. We are Ireland’s leading retail and commercial bank with over 2 million customers and strong market shares. This gives us a strong position from which to capitalize on Ireland’s development and grow our business. Our multi-year strategy leans in to this, we are the leading supporter of home building and buying, and are financing the construction of more than 6,000 new homes in Ireland.

We see more potential here, and have a development fund of €750 million to further grow our home building business. We also see upside potential in an expanding mortgage market, we are accelerating the onboarding of new mortgage brokers in what is a growing section of the market and we’re innovating. We recently launched €1 billion sustainable finance fund with a range of home and business loan offerings including a green mortgage discount.

In business lending, domestic demand still lags European peers, but as the leading business bank in Ireland, we are well-placed to benefit from growth in credit formation. And Ireland’s growing population and increasing disposable income brings demand for wealth management. We are Ireland’s only bancassurer, and are uniquely positioned to benefit from this.

When we set out our strategy in June 2018, we spoke about investing, improving and repositioning our UK business to increase returns. In terms of investment, we have launched higher margin Bespoke mortgages in the UK. This pivots us away from mainstream and more into niche. Within 100 days, we have £100 million worth of Bespoke mortgage office.

We’ve also increased new lending and higher margin personal loans and grown our profitable Northridge car finance business. These actions are shifting our product mix and increasing returns. In terms of improvement, we have reduced operating costs in the UK by 19% in the first half. This has delivered a cost income ratio of 60%, down from 66% year-on-year. We completed a transaction to diversify our funding base, which also reduced our cost of funding.

Our focus is on further reducing our costs and optimizing margins in lending and deposits. And in terms of repositioning, we’ve exited our UK cards business as well as non-profitable ATMs and current account operations. Combined these actions are improving the returns of our UK business.

On systems transformation, we’re making progress to achieving several key milestones and all within the budget we set out last year. This includes migrating customers to a new platform for ATM and debit card transactions and modernizing our payments infrastructure.

Our focus is on translating our work and investment to date into tangible customer and efficiency improvements. That includes the release of our new mobile app later this year with customer migration continuing into 2020. This app will expand the services available to our customers on mobile, but it would also give us the platform from which we can enhance services on a rolling basis into the future.

And in Wealth and Insurance, where we’re already generating income growth, we are launching new digital platforms this year. This will transform how our customers access advice, get a quote and purchase the product.

So we set out our progress in the first half and delved into our Irish and UK businesses and our systems transformation. And we’ve also clearly called out the evolving external environment, which is more challenging then when we set out our strategy a year-ago. RoTE in excess of 10% is the key financial target for Bank of Ireland, we are committed to this. And while it will be more difficult to achieve, there are number of actions we are taking to hit the target.

We’re keeping a relentless focus on costs; this is not new. Cost reduction has been a top priority at Bank of Ireland for the past 18 months, and it’s clearly working. Cost will continue to reduce every year from now until 2021. And we’re confident in achieving our cost base target. We are now looking at other efficiencies to reduce operating expenses further. We’re targeting selective growth in key areas. This means growing where we see high quality and attractive returns. For example, in capital-light Wealth and Insurance and by building on our unrivaled SME franchise in Ireland.

We will maintain our pricing discipline across all segments and stay focused on simplifying our business and delivering our systems transformation. These actions will create revenue capacity, reduce risk, improve customer experience and support growth as well as deliver further efficiencies.

And we will continue to manage our capital efficiently. We keep all options on the table to optimize capital and we allocate it prudently to support our growth. We’ll provide updates on key actions in our next reporting cycle.

I’m pleased with our performance for the first half and the highlights that we have shared this morning. We see further opportunity in our Irish business, in home building and buying, business lending and in Wealth and Insurance. The actions we’re taking in the UK are improving returns and our transformation is delivering with more to come.

Looking ahead, our actions respond to the external environment. And they set out how we will develop our business to 2021 to achieve our strategic ambition. Thank you for your attention and we very much look forward to answering your questions.

Okay, so we’ll take questions in the room first and then go on to the line. If you don’t mind giving your name and institution to help everyone in the room; we’ll go with Diarmaid first.

Question-and-Answer Session

Q - Diarmaid Sheridan

Good morning. It’s Diarmaid Sheridan from Davy. Thank you for the presentation. Firstly, Francesca, maybe starting where you finished off around return on tangible equity and meeting your 10% plus target, it very much feels like that will be a cost based lever that you look to pull. So I just wonder if you could comment a little bit further around when we might get some visibility of when that might be achievable and what specific areas you might be looking at.

Secondly, maybe, Andrew, it’d be remiss on one final time not to ask about margin. So your outlook obviously is lower around the rate impact. I wonder if you could maybe just detail that a little bit further for us please.

And then, finally, on the capital intensity of your loan book growth. Obviously, you’ve set out targets of 200 to 250 basis points of overall capital intensity to reach the €90 billion target, 30 basis points this year, followed by 40 basis points last year.

It feels like it’s still quite heavily capital intense. When should we expect that to be maybe a little bit lower in terms of that? And are you still confident that your guidance around the capital intensity of the growth? Thank you.

Francesca McDonagh

Thanks, Diarmaid. So I’ll start on RoTE and then pass to Andrew. So we’re committed to the target of over 10% RoTE by 2021. We’ve acknowledged it will be more difficult because of lower-for-longer interest rates and some of the uncertainty around Brexit impacting credit formation. But we have options and we have choices and things that we absolutely can control.

And I outlined six of them at the end of the presentation. Cost is one of them. It’s not the only one. But we have demonstrated over the past 18 months our capability and the opportunity to take out cost strategically. And we talked about 3% down. But if you exclude our core banking investment that’s closer to 5% and that’s the same time as investing in our business. So the actual gross savings are €60 million in the first half.

So we feel confident about that and there is potential to do more. Obviously, the interest rate environment has changed relatively recently and we’re not providing a new guidance or target on cost reductions today. And if we do that, it will be on the basis of a really well thought through and grounded plan. But there are other areas that we also see opportunity to further contribute to RoTE. So we talked about the growth in the key areas, Wealth and Insurance. We’re well positioned, capital light. We are unrivaled in our SME proposition.

And it’s a separate question. But even though we’ve seen more of the net loan book growth coming through from corporate banking in the first six months, we would expect more of the growth to be coming from our retail operations in Ireland in the second half and beyond. I’m not going to go through each of those levers, but I would say on the prudent price management, our loan asset spread is slightly up.

We have been consistently disciplined commercially in how we price. Our front book margin is around 300 basis points across the entire bank. And that’s higher than our back book. And the discipline that we have around growth is always about risk than pricing, than volume. And that philosophy hasn’t changed.

Just on simplification, we gave a lot of examples about the UK and what we have done successfully in the first half to simplify and make our UK business model more profitable. When we look to the future, we also see across Ireland [one] [ph] as well, from an end-to-end process perspective, there are opportunities to improve the efficiency of our process.

Not all of that is dependent on core banking technologies. Some of that are just better processes and changing our approach to reengineering. So if you like that sort to buildup, stairway to RoTE, and we feel that we have those levers in our control. And we’ll be providing an update on the combination of those levers that we’re pulling to achieve RoTE in our future reporting cycles.

I’ll pass to Andrew. The only point I would just add on the third around corporate banking is we see more – proportionally more growth in corporate banking in terms of the first six months, but that is high quality RoTE accretive and good risk quality business. And as the National Champion Bank, we have the ambition to be National Champion Bank in Ireland supporting corporate Ireland. And investing in infrastructure has a knock-on impact to SME, credit formation and household incomes, which is obviously part of our strategy.

Andrew?

Andrew Keating

Great, okay. So thank you, Francesca. So, Diarmaid, on the NIM, we have a couple of comments in relation to that. As Francesca has said the commercial discipline that we have in terms of risk and in terms of pricing has long been a feature and a hallmark of Bank of Ireland. And as you’ve heard Francesca say, that philosophy is completely unchanged and is going to continue.

In terms of the first half, we achieved our NIM of 2.16%. Liquid assets were off a little bit. But as we pointed out in the presentation this morning, the loan-asset spread increased by 1 basis point or so. There has been through this very significant change in material downgrade in terms of the interest rate environment and interest rates across the piece have been lower.

And so, in addition to the normal sort of 1% sensitivity that we give, we thought it’s important to set out, how we think our net interest margin is going to perform over the next couple of years in our presentation this morning.

So as I think about the – through the full year 2019, while we’ve done 2.16% in the first half, I think the average for the year is likely to be slightly lower, thinking like maybe 1 basis point, maybe 2, that sort of space.

As we go out into 2020 and 2021, the trend, because of the interest rate environment that trend is going to be for a lower NIM. It’s going to be somewhere in the sort of mid- to high-single-digit basis points from the 2016 level. Okay? And it will be a trend down that level rather than sort of a – for use, Francesca’s stairway comment, it won’t be in that space, it will be more of a trend in that direction.

The growth of the loan book plus the commercial discipline point act as some mitigant to that, but we still think the NIM will lower because of the 100 basis points decline in the interest rate environment in the last couple of months.

Switching then to capital. So when we set out the Investor Day in June of last year, as you say, we allocated between 200 and 250 basis points of capital to support the growth in our loan book. And that 200 and 250 basis points was to cover a 20% growth in retail Ireland, a 10% net growth in our retail UK business, and a €4 billion growth in our corporate business.

And so, what’s happened in the last kind of 18 months has been that the corporate businesses that Tom leads, has been at the front of the peloton. We always would have expected that. They have generated about €3 billion of balance sheet growth over the last 18 months, so very much within our expectation of about €4 billion of balance sheet growth for our corporate. And so, of course, that business is more capital intensive than, for example, mortgages that are in Ireland and UK. But that’s fully accommodated within the 200 to 250 basis points that we set out.

In terms of going forward from here, while corporate has been a very important part of the growth and as Francesca said, I mean, it’s very high quality business from a risk perspective and from a return [REROC] [ph] perspective. But as we think about the next 2.5 years, the proportion of the balance sheet growth is going to come more from the less capital intensive areas, so more from mortgages, more from SME, more from consumer. And so that would mean that over the next couple of years, the capital allocation of between 200 and 250 basis points, it continues to be the appropriate amount of capital to support the growth that we have. We are not going to continue to grow our balance sheet in the same pace over the same mix of capital intensive lending as has been the case over the first 18 months.

Francesca McDonagh

Let me go to Owen next, and I’ll come to Eamonn afterwards.

Owen Callan

Good morning. Owen Callan from Investec. Just three quick questions for me. On the UK, you’ve obviously made three kind of strategic moves or decisions around how to refocus that business this year in terms of the cards business, the ATM network and the current account proposition. Do you feel you have the right kind of model or business mix; they’re now going forward? Or is there other kind of business lines or operations that you’re maybe still looking at whether they should be part of that?

On costs, you’ve had a very consistent kind of 3% annualized reduction over the last couple of years, which is very impressive. Is there still the ability to go with that kind of run rate into the second half of the year and into 2020? Or does it get a bit sticker or more difficult to find that level of cost savings going forward still?

And then just on the RoTE investment, that’s one of the kind of standout areas in terms of amid weak volume and weak margin environment, you’ve been talking about the Wealth and Insurance rather division has been able to kind of really so some strong growth? Is there other opportunities you’re looking at within that broader space as regards M&A? And obviously, I’m sure, you’re always willing to look at something, but is that, let’s say, relatively active consideration? Or is it very much organically focused at the moment?

Francesca McDonagh

Okay. We’ll both do a little bit of all of those three. So just on the UK, you’re right, we’ve been very clear, I think, we’ve made good progress in the first half in terms of the invest, improve reposition. And I – we’ve made a quite deliberate shift in the product mix of new origination, so within mortgages taking step back not entirely, but reducing our emphasis on our waiting on the lower loan to value remortgage space, which is very tight margin, focusing more on the pivot to niche.

We’re seeing high quality and then underserved segment that isn’t necessarily well served or desires to be well served by some of the larger banks. And I’m very pleased with the initial progress we’ve made. I mean, it’s 100 days. It’s early, but high quality, good profile and well received by the broker network that we distribute through.

And in terms of the product mix, we are originating more from our personal lending and Northridge business, and that isn’t because we’ve loosened credit, criteria or changed our risk appetite. That is very reflection of deepening our distribution. So personal loans will be predominately from the AA, but also the Post Office and some from our Northern Ireland franchise, and we’ve improved the processes there. We’ve actually improved our margins, while we’ve been growing. So we’re not just price for volume, we have priced for risk in the appropriate way.

And on Northridge, this is a business that we’ve had many years of experiencing and we’ve broadened the number of partners that we work with and also covered more of the UK geography. So the business mix, we are happy with the changes we are making and always looking for new opportunities and to create more value. But the – I think the model that we are creating now is providing better returns than we had previously.

On costs, I wouldn’t read too much into the 3% every half. We’ve talked about year-on-year reductions, but we’ve not given guidance on half-on-half. And you asked whether it gets more sticky? I think, we’ve made some sticky in difficult decision already to get to the numbers we’ve achieved. So it’s not about low-hanging fruit, we’ve made difficult decisions around reducing our senior management by 7%, we’ve closed 30-odd service centers, and we’ve exited some businesses that we’ve been active in, in the UK for a while. So those were tough decisions, and we’ll continue to make the right decisions to improve the efficiency of our business in the UK, but also across the group.

And in terms of Wealth and Insurance, the backdrop of the Irish economy and the demographic change really support us. So households are becoming wealthier, and job security has increased. We’ve got good demographic trends around aging population that’s probably under protected or under pensions, and then you’ve got more younger people, well-educated entering the workforce who need wealth management need and protection.

And we’ve also have the advantage of a large retail customer base. So the penetration of our customer base, last time we presented our results we would have talked about 26% penetration, which was up from 23%, we now saw in the first half of 29% penetration. So the backdrop is helping us, but our positioning in our customer base is, there’s fantastic opportunity for us to do more from a digital perspective and that’s one of the key milestones we’ve set ourselves as well.

But I’ll pause there and Andrew may want to cover some of the details on cost.

Andrew Keating

Yeah. So just on the costs, Owen, I mean, I think, we set out a year-ago, a very clear target to take our cost on every year, and to hit €1.7 billion in 2021. And clearly, with evidence, the reduction in that cost as we’ve gone through each of the periods, and that continues to be our focus right now. Of course, we said that the external environment has changed in terms of the interest rates and that’s going to be a headwind to top-line revenue. So you’d expect us to see what levers, what self-help options we have to pull in cost is a very obvious one of those.

And so we’re looking at what further opportunity is there for greater efficiencies to bring us below a figure of €1.7 million. We’re not announcing a different number today, but we are going to work, as you’d expect, and as we are doing that work has added what opportunities are there to be more efficient even on that €1.7 billion. What I’d also say is that, when we set out that plan to €1.7 billion, we fully accommodated the inflation around wages, for example, for our colleagues, but also around the higher depreciation charges associated with the investments that we’re making in technology.

And of course the higher cost of complying with some of the expectations and regulations of our regulator. And so we’ve gone beyond, we’ve absorbed all of those costs, and I think that’s important and still brought our overall cost that will down 3% as you saw in the presentation this morning, and that continues to be our focus. This is about reducing the absolute level of costs, as we go through to 2021, and in that this was a mechanic really to help support our overall strategic ambition to increase our RoTE up to that target level of 10%.

Francesca McDonagh

Thank you. Eamonn?

Eamonn Hughes

Eamonn Hughes from Goodbody. Can I just kind of come back to the NIM just in terms of your first question, I wanted to ask about capital and NPEs as well. But just in terms of NIM, you mentioned kind of, Andrew, in terms of capital consumption over the next couple of years. Can we take it that NIM kind of guidance over the medium-term is still kind of a premise to hit the €90 billion loan target? It’s obviously important in terms of recycling and you were talking earlier about the new business being higher than the stock, so just to get a bit of comfort around that.

Secondly, as this was kind of the first time, we’ve been able to chat to you publicly since the SRB discussions that were right there, so maybe thoughts around kind of future capital target whether there’s any offset around P2R and things like that. How are you feeling about that?

And then finally maybe in terms of NPEs, you’ve kind of stuck to that, we’re hitting the 5% number by the end of the year, that’s great, you’re making progress there obviously, which is fantastic. Just maybe thoughts over the next year or two, in terms of future targets around that, because it will be important in relation to the capital number?

Francesca McDonagh

Okay. Thank you, Eamonn. Let me just talk a bit more broadly about the €90 billion total loan book targets, because it’s something that a guidance that we were quite explicit about a year-ago. We’re pleased with the progress in the €1.2 billion net increase and continuing as the largest lender in Ireland. But we recognized that lending growth reflect – it depends on the external environment, and it’s lesser to now than it was a year-ago, but mainly because of Brexit, I think a year-ago we would have assumed that Brexit would have been resolved, and the Brexit uncertainty is creating some reticence particularly in Irish SME growth.

So the issue isn’t if €90 billion is the right number, it’s when, and I’m keen to get through another six months of trading and hopefully the next six months, the other side of Brexit. Just to have a better idea of that that credit formation. And some of those external events will inform our journey to €90 billion. Regardless, we’ve never chased volume at the price of commercial discipline or risk. So our philosophy around, when we look at lending opportunities looking at risk, then price, and then volume is unchanged in that context.

And I’ll leave Andrew to talk about NIM and capital a bit more detail. Just in terms of NPEs, just sort of key message there is, we are 5.3%. We talked about being in touching distance of being sub-5%. We’re about €300 million, €350 million of being 5% based on loan growth outlook by the end of this year that would be important. We are not just doing that as a result of the inorganic actions we’ve taken. So of the €800 million reduction we’ve seen so far this year, a little bit more than half of that is working out solutions with customers and the rest would have been the securitization that we’ve done. Even just through organic working through with customers, we feel comfortable about the 5%.

But we’ve said it before and we’ll reiterate it. All options to reduce NPEs are on the table and that can include the securitization or loan book sales. The trajectory and the go-forward pace of reduction beyond 5% does depend on other factors such as the rollout and the introduction of definition of default, which we expect in 2020.

But when we look at the normalized level of NPE ratios amongst European peers, you’re expecting that to continue to go beyond 5% over time. Andrew?

Andrew Keating

Okay, so, excuse me, if I speak to the capital piece, Eamonn, so I mean the Systemic Risk Buffer, clearly the Central Bank have looked for the authority to look at that. But I suppose as we sit here this morning, we don’t know if or when it’s going to be introduced or whether it applies to Bank of Ireland and you know what the offsets might be in terms of whether it’s the O-SII buffer or whether it’s a P2R or et cetera.

I think there are some developments at the European legislative space as well, which might influence both the timing and the potential quantum of what might come in. I think your point is right, in terms of P2R, Eamonn, we have the same P2R today as we had 5 years ago. Okay. And, obviously, in the last 5 years the risk profile of the bank has changed and strengthened very significantly from the investments that we’ve made in reducing NPEs, sustainable profits, volatility and capital ratios, et cetera.

Are the regulators ever going to adjust to P2R ahead of a Brexit type scenario? I mean, that’s not – that’s very understandable. But certainly, as we think about the progress of the bank has made over that time period and the improved resilience of the balance sheet and the de-risking of the balance sheet, we’d be very optimistic about the opportunity for P2R. But we have to get beyond the Brexit piece.

I think unlocking capital in the balance sheet is something that is important. We’ve emphasized the RoTE as being the very major target. You’ve seen us take some actions in the first half of the year in terms unlocking 30 basis points of capital to do with the buy-to-let securitization.

We are looking at doing further transactions to unlock capital. Clearly, the decision to exit out of UK cards, also unlocks some capital in the second half of the year. And that’s something we’re going to continue to do over the next number of years, Eamonn, to make sure that our capital is optimized and appropriately allocated and support of our overall the targets.

Francesca McDonagh

Thank you. We’ll take one more question in the room. We’ll go to the call and come back to the room.

Pierce Byrne

Good morning. Pierce Byrne, Cantor Fitzgerald. Just two questions for me, just on mortgage pricing and market share, just as well as how you feel about the moves you made earlier in the year on the mortgage pricing and the impact that might have had on share, and where you see that going forward.

And then just on the credit impairment, what’s kind of – are you happy with that level of credit impairment? Is that a normalized rate we can look at going forward? Thank you.

Francesca McDonagh

Thank you. I’ll do – I’ll answer mortgages and Andrew on credit impairment. So our market share in our Irish mortgages for the first half this year was 23%. We don’t chase volumes and we’ve never set a specific market share target. Again, it’s risk, then price, that volume.

But we have – I’ve previously said we feel most comfortable with the market share – market share range of 25% to 30% in Irish mortgages. So during the first half of this year we would have stepped slightly outside of that. And two key drivers from our perspective, one is the rise in the broker channel. So brokers are now 25%, 1 in 4 mortgages in Ireland are originated through a broker channel, through a broker.

And we have reentered that channel less than one year ago. So it’s still a relatively new channel which we are growing. We’ve expedited our growth within, but in a sensible way. So we would have previously mentioned that we were looking to have 50 broker partners by the end of 2019. And we have that this week. So we’ve got – we developed more relationships to more brokers more quickly, but in an appropriate way.

So as well as the – that market share reflecting, our relative newness in the broker channel. There is also a pricing factor. So we would have increased some of our prices in January, which we believe was the right thing to do at the time, given the interest rate environment and the outlook. Since then the interest rate environment has changed quite significantly. And we’ve reflected that in some of the propositional and pricing changes we’ve made recently.

So we would have changed some of our 5 and 10 year fixed rates to ensure that we remain competitive and we’re not leaving good business on the table. But we also did some innovation. We tested that for some higher value mortgages. Some customers prefer a lower rate and the cash-back offer. Many of our customers, particularly, first time buyers really like the cash back offer.

But we found that some actually just wants a better rate. So for mortgages over €400,000 we are offering a rate of 2.5% at the moment. And we also offer a 20 basis point discount for people buying a new home that is sort of [BER] [ph] rated energy efficient. So those are some of the examples of innovation.

As we look into the second half, feeling comfortable with our pipeline, excited about the opportunity to originate more through the broker channel and I feel confident about our trading. But we’re the largest lender Ireland. I don’t overly exercise myself on week to week or month to month market share numbers on mortgages.

Andrew Keating

So, Pierce, you asked about the impairment. And, yes, I mean, 20 to 30 basis points is the kind of the guidance that we’ve set out a year ago, when we stated this morning. And we think that’s certainly, we’re getting more of that sort of normalized level, clearly with the NPEs coming down to 5.3%, touching distance as Francesca said.

And obviously, we go beyond that as we go forward. One of the things that, if we think about the first half charge, Pierce, there are probably a very small number, 2 or 3 discrete cases in corporate banking, where we had a particular provision that we set up for those cases. And then, we also took an opportunity to increase the coverage ratio in our Irish mortgage portfolio. So you’ll see that the coverage ratio has increased from directionally 20%, 21% to directionally 25%.

And the reason we’re doing that is really is part of preparation to get ahead of our – in advance of the NPE calendar provisioning issue that is upcoming, starting at the back-end of next year. For various technical reasons, it’s much more capital efficient to take some of those charges through the P&L rather than to do it as a sort of a capital deduction.

And therefore, you will see us looking to increase your coverage ratio within the context of 20 to 30 basis points guidance that we’ve set out, Pierce. So if we happen to get some collections, post-write-off or something like that, you’ll see us taking the opportunity to actually up our coverage in advance of and in preparation for the NPE calendar provision, because of the capital efficiency that comes with that, so yeah, confident with 20 to 30.

Francesca McDonagh

Thank you, Pierce. Why don’t we take a few questions on the conference call?

Operator

Thank you very much. The first question we have today on the line comes from Alastair Ryan from Bank of America. Please go ahead.

Alastair Ryan

Thank you. Good morning. One specific and one more general, please. So the €0.185 dividend you’ve accrued for the first half, how good an indication should we think that is the way you end up at the full year. Is that a floor now or that’s where you’re expecting the board to land? Obviously, it’s quite early, I appreciate. But it’s quite an important figure.

The second more general, just a few more pointers on how you’re getting on with the core banking platform, the implementation of the new IT structure. You sound pretty confident. But it’s just very hard from the outside for us to see, where you’ve got to. What are the best pointers for us to look at? Thank you.

Francesca McDonagh

Thank you, Alastair. We go first on – Andrew on the dividend.

Andrew Keating

Okay, Alastair, good morning. So, yeah, we’ve – I suppose the Board. The first thing I’d tell you is the Board has made no decision about dividends for this year, yes. Quite obviously, the timing of that decision will be in sort of the –as part of the year-end preparation in sort of December, January, February time.

The Board’s policy on dividend is very, very clear, which is that it’s going to increase this year over last year. It will increase, of course, prudently and progressively towards our longer term target of 50% of sustainable earnings. At this half year point, we must make an accrual for the dividend in line with the capital rules.

And the Board has gone for around some number of €100 million. That happens to – equates to €0.185, which is obviously an increase on the €0.16. But I don’t think you should take it as being particular guidance either way in relation to that. It is an accrual. It is consistent with the policy. But ultimately, the decision around dividend will be one that the Board will take at a later stage.

You’ve seen over the past couple of years, when we restarted the dividends two years ago, that we’ve been almost at a track record of inconsistency, if you like, in terms of the half year accrual versus the year-end piece. It is a half year accrual piece. And decision for the Board, the Board has not taken that decision. The Board will take our decision in December-January time.

Francesca McDonagh

Thank you. If I answer the question about core banking in two ways. So one is about progress in regard to spend and another one is progress in terms of milestone achievement. So you’ll remember, Alastair, a year-ago, where we talked about our broader transformation strategy, which includes systems change, but also business model change. And we broaden and deepen that to the €1.4 billion between that point and 2021. And we guided that would be equal to 50 to 60 basis points of capital or an average spend of €275 million per annum. And obviously that will help us to improve efficiency competitiveness and reduce expenses over time.

And core banking is an important component of it. But when we look at the overall transformation spend, what we’ve shared today is the first half, we spent €138 million and 25 basis points. So we’re not $0.01 or 1 basis point over where we said it would be, so that the spend is exactly where we indicated. And in terms of milestone, so we’ve talked more broadly, but these are key aspects of our core banking delivery. So the change in our payments infrastructure, the change in our ATM and debit cards infrastructure being the single largest migration of customers in history of the bank. Our big milestone deliveries in the first half, we’ve also done – made some progress in some of the cybersecurity deliverables in the first half and improving our insurance underwriting process.

The second half, the big focus for us is on the mobile banking app, we have the technical functionality now and we are going to be rolling that out to customers during the second half of this year, although, the rollout will continue into the new year, I don’t want to rush roll out. We want to make sure that we’re doing it in a very sensible and appropriate way for our customers. There are other areas, operationalizing the single view of customer. I’ve talked about having that functionality rolling it out, so that we are using it to engage with our customers will be important.

And I mentioned the Wealth and Insurance investments, and how we would change our origination to give competitive advantage there. So the spend is as we said it would and it would be more explicit on milestones that we’ve delivered against and that we will deliver to over the coming months.

Alastair Ryan

Thank you. Thank you Very clear.

Francesca McDonagh

Thank you. Let’s stay on the conference call.

Operator

Thank you very much. The next question comes from the line of Andrew Coombs from Citi. Please go ahead.

Andrew Coombs

Good morning. If I could have some follow-up questions on the interest margin guidance, you talked about mid- to high-single digit down over 2020 to 2021. Firstly, could I ask as a cumulative impact rather than a per annum guidance?

Secondly, can you just provide the trajectory? Is this front-loaded? Is this spread on a linear basis in your view? And the third question relates into that NIM guidance, it would be how does that split out between the UK versus Republic of Ireland? And certainly the NIM question, my broader question just to finish out, you’ve reiterated the greater than 10% return target, despite the lower NIM guidance. Is the same true of your less than 50% cost income target as well? Thank you.

Francesca McDonagh

Thank you. Andrew?

Andrew Keating

Yeah. Let me talk about the NIM, Andrew, first. So just to clarify, yes, the mid- to high-single digit is cumulative, and is not per annum. Okay. So by the end of 2021 my expectation is that the NIM in 2021 will be mid- to high-single digits lower than 216 basis points not per annum. Okay. So just be very clear on that piece. And I think the trend is for it to trend down to that level, is it going to be precisely linear or kind of slightly in that space. I mean, I think it’s – the expectation is going to trend in that sort of space. I can’t confirm, it’s exactly going to be a dead straight line in relation to that. But it will be trending down to that point.

And I think in terms of UK and RoI, clearly, our Irish NIM and UK NIM are very different. There are different drivers behind those, but the interest rate environment in both geographies has been pretty equal. UK probably has come down on a similar measure by sort of 75 basis points, the euro by about 100 basis points. So there’ll be some impact from those. Both interest rate and environment updates have been factored into the NIM guidance that I’ve shared with you this morning. So I, Francesca, you can talk with RoTE and cost income.

Francesca McDonagh

Yeah. I’ll talk, I mean, the cost income, obviously – let me talk about costs, we gave three very clear piece of guidance. One, €1.7 billion cost base by end of 2021, we’re saying today that we’re confident about that and looking out if there are opportunities to go beyond. We talked about reduction year-on-year; we’re achieving that. That’s still stand. And we’ve talked about cost income ratio, so you’ll see the cost side of that is progressing well. The cost income ratio does depend on revenue. But if you look our cost income ratio in the group, it’s gone down from 66 to 65, so there’ll be still more to go. You look at parts of our business, where we really focused on improving profitability to the UK, the cost income ratio there has gone from 66 to 60. So it just shows you the opportunity for us to cost takeout, while growing as we have in the UK.

We’ve talked about positive draw today, and that’s not a substitute for our cost income ratio target, but it does show you the positive trajectory that we are on with revenue at 1% and cost down 3%. And it is challenging, but it is still part of our cost guidance, when we just take a step back and look beyond ourselves, and we look at our UK or European peers. Banks like ours are getting closer to the 50%, so it feels like absolutely the right thing to do to be driving our efficiency over the coming strategic period.

Andrew Coombs

Thank you.

Francesca McDonagh

Thank you, Andrew. We’ll take another couple on the line, maybe come out of the room.

Operator

Thank you very much. The next question on the phone today comes from the line of Chris Cant from Autonomous. Please go ahead.

Christopher Cant

Good morning. Thank you for taking my question. I just wanted to come back on NIM, and understand exactly what’s driving the pressure here. You referenced to front book NIM of around 300 bps that hasn’t changed, and you stated lower swap rate expectations in your presentation? So is it a structural hedge that is weighing on your NIM guidance? And could you provide some detail on your structural hedge program for us, so we could understand this? What’s the current contribution to NII, how big is the hedge in terms of the notional what’s the tenure of the swaps you’re using that?

And just as one further minor point of detail, you referenced capital efficiency with regards to taking provisions in the P&L rather than waiting for a capital production? Is that just the tax that you’re referring to that, you get a tax yield on the provisioning charge? Thank you.

Andrew Keating

Okay, Chris, good morning. Maybe I’ll take those questions. Let me start of the capital side, so obviously from the tax isn’t what I’m thinking about, while of course we get a tax deduction, you’ll be familiar with the fact, we have a large deferred tax assets. And so from that perspective it’s not in that space. Really, I suppose from a technical perspective, Chris, I’m thinking about the interplay between provisions and the regulatory expected losses. And so we have a – if we like our capital ratio of 13.6% today this morning, it’s after taking the deduction for the IFRS 9 provisions. But in addition, it’s after taking a further €400 million or 80 basis points deduction for the higher level of regulatory expected losses.

And so as the IFRS 9 provisions were to increase the level of regulatory expected losses wouldn’t automatically increase by similar level. And so there’s an opportunity there in terms of that €400 million to deal with that from a capital efficiency perspective.

Just on the net interest margin, I mean again, we’ve given in terms of the sensitivity you’ll have seen that kind of instantaneous impact of the – of a 100 basis points up or down, we’ve given that usual disclosure that others give on sort of Slide 39. But I think, like the – that’s obviously kind of instantaneous static balance sheet, no changes, et cetera. But – so what we have factored into the guidance of the mid- to high-single digit reduction in margin over the next couple of years cumulatively to Andrew’s point earlier is the fact that we have the benefits from the tailwinds from the higher front book spreads and a growing balance sheet.

But certainly in terms of the yield, you’ve seen on our liquid assets, of course, is coming down, because that very much reflects the interest rate environment. In terms of our structural hedge, we have continued with our usual approach there, which is effectively we hedge the free funds at an average of 3.5 years. So we essentially have a portfolio of swaps that get roll over, and so every year in broad terms, 15% of the swaps mature, and then we reinvest a new swap and effectively the new seven year swap.

And so as that caterpillar hedge sometimes people refer to it us, as a caterpillar hedge continues to progress, you’ll see that’s where you get the impact from the 100 basis points reduction in the, for example, the market’s expectation for five year that we highlighted this morning. So there are the dynamics that are happening, Chris, in relation to the net interest margin. So the tailwinds that we’ve seen in the first half that are continuing, which are driven by our commercial discipline on pricing, which are driven by growing the balance sheet – which is driven by growing the balance sheet with better front books raised than the back book for factors like rolling off of, et cetera. Our positives, but they are being impacted then by the impact of the interest rate environment on liquid assets on that caterpillar hedge. Thank you very much.

Christopher Cant

In terms of the hedge, you were able to share a number on the contribution if I think about some of the large UK banks, it’s about 10% to 12% of NII is generated from the structural hedges. Is that about the right level, higher or lower? Any guidance that will be useful? Thank you.

Andrew Keating

Sure. I’m sorry, because I don’t have that number with me this morning, if I – if we decide to disclose that, I’ll come back and tell everybody in relation to that. We’ll look at that certainly between now and the year-end in terms of disclosure, but if there’s an opportunity to disclose it in advance of that, we’ll look to do that. Thank you.

Christopher Cant

Okay. Thank you.

Francesca McDonagh

Thank you, Chris. Another question on the line.

Operator

Thank you very much. The next question today comes from the line of Charmsol Yoon from UBS. Please go ahead.

Charmsol Yoon

Hello. I’ve got two questions, one on NIM and one on RoTE again. So can I just follow-up the Andrew’s question regarding the split between euro and sterling in a slightly different way. Can you split the rate sensitivity, you’re disclosing to Slide 39 into sterling and euro, if that’s possible, please?

And secondly, on RoTE, so when I see consensus 2021 number, it has RoTE of 9%, 9.1% for underlying PBT of €1.1 billion, slightly below €1.1 billion, suggesting that you will need probably €1.2 billion underlying PBT to hit 10% RoTE target. But given the timeline pressure, you flagged it, it looks like reasonable to me that €1.1 billion consensus will probably come down to a touch below €1 billion. So effectively, you require about €200 million of cost savings plus fee income growth to hit 10% RoTE. So, firstly, can I please check if this math is broadly reasonable? And if not, where you see consensus is wrong maybe a loan book growth or fee income or even capital base, please? Thank you.

Andrew Keating

Good morning, Charmsol. I probably won’t get into kind of auditing your spreadsheet this morning, Charmsol, if that’s all right. And in terms of the euro and sterling interest rate sensitivity, I mean, we don’t give that disclosure, so that’s not something that I can help you with in relation to that. In terms of the RoTE, I mean, I think, certainly there is top-line revenue pressure as we’ve called out this morning.

We are, as Francesca said, looking at self-help options, Francesca set out on the Slide in her presentation, six levers that we’re looking at, cost clearly is a – you’d have noticed was the first one of those six, that’s not an accident as you’d expect. And we are looking at opportunities to be more efficient than is implied by the €1.7 billion, but not announcing an update on that number this morning. But we’re continuing to look as you’d expect and as we are doing looking at further opportunities there.

But there are other levers in terms of that will help bridge the gap caused by that revenue headwind and across the very six lever self-help options, so what is capital efficiency or capital-light Wealth and Insurance, et cetera. So there is a range of things we can look at there, not exclusively on the cost side. Okay. Thanks, Charmsol.

Francesca McDonagh

Thank you. I just want to check how many questions there are in the room still? Any more questions in the room? Yeah, please. Stephen?

Stephen Lyons

Thanks very much. Good morning. Stephen Lyons from Davy. Just if I could probe two areas of particular book growth in the period and your comfort around risk appetite, which you’ve already commented on, but maybe just to get a little bit more. The first, just on Leveraged Acquisition Finance, we’ve seen particularly the central bank flag that is an area of possible concern for the two Irish banks, and I noticed in the period. In addition to growth, you opened up a further office in Madrid. So maybe you can just highlight that added comfort through historic loss experience maybe diversification of particular sectors?

And secondly just in the UK, I think, you mentioned in the deck that part of the personal loan volume growth was improved, credit risk process in the period driving increased applications. Could you elaborate a bit more on that? And then that comment around Northridge below industry arrears and losses et cetera. Could you maybe just elaborate a bit more give us some comfort on those numbers? Thanks very much.

Francesca McDonagh

Yeah. Thank you, Stephen. So on Leveraged Acquisition Finance business, this is a profitable part of the Bank of Ireland franchise, €170 million of PBT last year. We’ve been doing this since 1997, we’ve had a low loan loss track record during that period, so an average of 70 basis points per annum from 2002 to 2018. This is a high margin business that is appropriately risk priced, so high margin of around 4.3% plus fee income and it’s also relatively low cost or not high dependent on the infrastructure of the rest of the organization. So the cost income ratio not part of our business would be in the sort of sub-20% space. It does provide material diversification in terms of product, but also geography for us, which we feel comfortable about.

We’ve also got a diversified client base, we’ve have actually broadened our client base by 9% in the first half of this year, but we continue to work with repeat business and in partnership with well-established and large sponsors, who got a good track record. And our average deal size would be around €20 million.

So – and again that diversification within a diversified portfolio is important to the top 10 deals would represent about 8%. So we feel comfortable in – obviously, we’re very cognizant of risk, 80%, 85% of the deals we reject. We’re nearly 80% covenanted on the total book. So it’s something that we keep close to, but it does provide profitable diversification for us.

In terms of the UK, so we would have been quite explicit in our strategy year ago about the investing part of our strategy to grow and diversified and we talked about targeting growth in our personal lending and Northridge businesses, and we’re doing exactly what we said. These are prime mass lending only, so in personal lending we do that predominantly, not exclusively through the AA. It’s about half – a bit more than half of the business, but also the Post Office, so two very trusted brands plus our Northern Ireland franchise. Yeah, we’ve got – we’ve demonstrated very good growth half-on-half, so year-on-year. But just in terms of market share were 2.6% of the market, and we operate exclusively in the prime area. So even if as we grow, we would still be in the up to sort of 3% market share range that we feel comfortable with.

Net lending credit quality is up. Margin is up. We have invested in prescreening tools. We’ve also invested in our processes. So we are getting customers quicker than we did in the past, we would rank very positively and compared to other prime players in the UK. We don’t want to be the slowest process, because you get adverse selection. We’re opposite of that. And we’ve also to give ourselves assurance, we’ve done some external benchmarking on the quality of our origination versus peers. We would see that we are more conservative than many of our peers. Our minimum income is higher. And the minimum age of applications is higher, and we have higher bureau score. So we feel comfortable in terms of that origination.

And on Northridge. Again, it isn’t about loosening credit scores or risk appetite, it is about broadening distribution. So we have about 2% market share and we have broadened our dealer relationship, all 99% plus of our new business is dealer- or broker-led. And the dealership in particular in the southeast of the UK, and we’ve broadened. We’ve been conservative in terms of sort of residual value assumptions as well. We’re very cost conscious as we broaden the distribution of that consumer lending portfolio. Thank you.

Yeah. We got three callers on the line. So let’s go through the pending questions.

Operator

Thank you very much. The next question today comes from the line of Alicia Chung from Exane. Please go ahead.

Alicia Chung

Good morning. Just wanted to turn back to NPEs and some of the future regulatory headwind, if that’s okay, that’s my first question. So obviously, you previously guided to 80 bps negative impact from trend Definition of Default and NPE coverage ratio, which is very useful to get that forward looking view. I understand now that TRIM is broadly complete, and you’re not expecting a material impact on the corporate loan portfolio? So as such is there any reason that we couldn’t expect you to lower the guidance of negative 80 bps impact? And secondly, as you increase your coverage ratios, can we expect that capital impact to fall even further from there? That’s the first question.

And then the second one is just looking at the – your corporate loan spreads, which you give on Slide – it’s on Slide 40. What is driving the increase in corporate loan spreads over the last half year, despite the fact that swap rates have fallen. Is this reflective of market trends? Or is this specific to Bank of Ireland? And has your change in the mix of corporate lending – has the mix in corporate lending changed for Bank of Ireland? Thank you.

Francesca McDonagh

Okay. I’ll pass to, Andrew on both. Just on that the capital guidance, we’ve been very clear in previous reporting cycles about our view of regulatory capital requirements. And we’ve been explicit it reflects our desire to be prudent and transparent in our approach to capital guidance. The only change is just in terms of timing of that 80 basis points headwinds that we would have communicated before, we would have been conservative in thinking that was more 2019, 2020, realistically that’s probably more like between 2020 2021, but Andrew can expand a bit more.

Andrew Keating

Sure. Yeah. So, hi, Alicia, good morning. So look at the 80 basis points, it was obviously the net impact of a range of different regulatory programs that are underway. You mentioned TRIM, Definition of Default, NPE, also things like [RRB] [ph] repair et cetera. And so, what we thought was useful in February, and again, we’re stating the number today, is to basically put all that together, and you don’t need us to break it down kind of program by program. And say, look, the net impact from those programs is a headwind to our capital of 80 basis points.

And clearly, you’ve seen this morning there were effectively pre-funding for some of those headwinds, by unlocking for example, the 30 basis points out of the NPE securitization that we did.

TRIM is done for mortgages, Ireland and UK at this stage. And so, that’s in the balance sheet this morning. Definition of default, that’s something that’s more likely to come in 2020. And, obviously, that will impact on the amount of capital we need to put against the regulatory defaulted assets and will impact the pace of NPE reduction next year.

On the NPE provisioning, that obviously kicks in at the backend of 2020, Alicia. And as I was explaining to Chris earlier, it is capital efficient for us to – where that’s possible, but in the 20 to 30 basis points guidance, to start doing some proprietary work in relation to that, because we’re able to get some advantage and offset in relation to the level of regulatory provisions that are already set up and that are already a deduction from our capital ratio.

We think 80 basis points continues to be the right level. Clearly, that’s not a – we’re not targeting to use 80 basis points. But we think that’s a reasonable estimate of what the net impact of those various regulatory programs are. And clearly, as we go through those and to the extent, we see some upside associated with that, of course, we will keep you up to date.

And the key thing for us is that, when we look at our capital position, I mean our capital position is very strong. And the outlook is clear, certain and positive. I mean, ultimately, we’ve done – our operations have generated 90 basis points of organic capital in the first half. We unlocked the 30 basis points by doing the first transaction on NPEs.

We’re looking at a second transaction at this stage and very much going to prefund the impact of that. So about 13.6% today, that’s an increase of 40 basis points since January. And obviously, continuing to generate capital on a daily basis. And that’s above our long-term guidance of excess 13%.

Sorry, on the corporate loan space, you had a question there. That’s really just a mix issue, Alicia. Within the corporate portfolio, it’s clearly – we think about it that there are 4 portfolios between corporate Ireland and corporate UK property and Life. And you would have seen the numbers over the – in the deck this morning.

And so, the couple of basis points increase in the Corporate and Treasury spread – well, it’s not even the spread. It’s the gross rate that the customers pay us. So it’s before taking off the cost of money. That’s increased by a high-single-digit basis points and that really reflects, I suppose, our commercial discipline in terms of the pricing that we are doing for new origination in that sector, together with just the evolving mix in relation to that.

Francesca McDonagh

Thank you, Alicia.

Alicia Chung

Lovely, thank you very much.

Francesca McDonagh

Thank you. Let’s stay on the lines.

Operator

Thank you very much. The question today comes from the line of Aman Rakkar from Barclays. Please go ahead.

Aman Rakkar

Good morning, team. Yeah, it’s Aman Rakkar from Barclays. First of all, Andrew, congratulations on your time with Bank of Ireland, I wish you the best of luck in your new role.

I just had three quick questions. First of all, regarding your NIM guidance, it looks like it reflects the movement along with interest rate environment in Europe. I was wondering, does affect any movement in policy rates? So, if we had a cut in the depo rates or any movement in the refi rates. I mean, on the depo rate, it looks like you’ve quite significantly reduced your balances at Central Bank, so presumably not a big impact there.

But any kind of color you can give would be helpful. Secondly, on mortgage pricing, Andrew, I was wondering if I could kind of invite you to update your comments that you gave at full year. Regarding mortgage pricing, you suggested that perhaps mortgage pricing could rise in Ireland. I wonder if you still kind of thought that was a relevant comment, particularly in light of fairly substantial mortgage risk-weight rate increase to AIB, as they signaled on Friday. It’s a bit bigger than perhaps the market is expecting.

And then, I guess, the third one on cost, perhaps for Francesca is – I think you’ve indicated a few times now, the potential cost savings that you got to pull. I was wondering kind of what exactly would cause you to kind of reappraise your cost target? Is it a significant deterioration in the operating environment from here?

So is that the interest rate environment softening even further than the forward curve imply? Is that bigger moves on policy rates? Is that pricing pressure in Ireland, the UK? Or is it actually just a matter of timing and it’s just you kind of really want to fully prepare that cost plan that is probably quite inevitably going to come back to the market? Thank you.

Francesca McDonagh

Thank you. We’ll take them in the order.

Andrew Keating

Okay. Great, well – and good morning. And thank you very much for your kind comments. In terms of the NIM, I mean, certainly if I think about the ECB rates, surely, we factor that into our thinking. Obviously, the ECB are considering what their policy is around the depo rates, et cetera.

I think we’re not really expecting a change in our – in the refi rate from the ECB. I think there are reasons that you don’t understand where that feels less likely to us. But we have factored in adjustments to the depo rate that the ECB are currently reflecting on. In terms of pricing generally, clearly, we – my comments earlier about maintaining our very commercial approach to risk and to pricing, are the kind of appropriate comments. And that’s something we keep under review at all stages. Francesca?

Francesca McDonagh

Sure. Yeah, on cost, so it reflects the opportunity we see to be more efficient. I said this before. It’s very easy to take cost out badly. So we obviously don’t want to do that. We haven’t been doing it. We’ve been very strategic in what we’ve done, which is why I’m not giving more guidance or targets today, because we want to make sure that any plans, if we were to go beyond the guidance to reset are well thought through.

You may recall me talked about our cost reduction. There were sort five areas. One was simplifying our organization. And that’s where we’ve seen a lot of the cost reduction so far. So in the €60 million gross saves that we achieved in the first six months of this year, about €24 million of that would have been from simplifying our organization from some headcount reduction year-on-year, but also the changes we’ve made in the structures and the spans and layers within the bank.

Another area we’re sourcing strategically, so this is about how we use externals, suppliers, key strategic contracts. And about €10 million of the €60 million so far this year is from strategic sourcing. And we would see opportunity to do more there. And a third area is delivering the digital bank. And that isn’t an area that necessarily some of the costs that we’ve shared so far reflects.

And a big enabler of that will be, as we roll out our new mobile banking app, and other digital innovation. And that will enable us to be more efficient. So we see potential there and also in terms of enabling brilliant customer journeys. I touched on our sort of end-to-end journeys and some of the opportunities just to be slicker. And that doesn’t require heavy tech investments.

Some of that can be done as a precursor to some of our core banking milestones. And it takes out costs that often trips up our customers in terms of call-backs or some paper-based or manual processes. And the last point is actually a really good cost to be taking out. And that is about enabling a more agile way of working, because in a competitive labor market in Ireland, the demand for more agility is incredibly high.

And we’ve reduced our physical Dublin office space. So it is not about branches, but our head-office space by about 24% over the last 18 months. And that isn’t because we’ve reduced necessarily headcount, it’s because we’ve allowed more agility. We have more agile-enabled there.

So those sorts of opportunities tell us that there is scope to be more efficient. But also, we need to right-size our cost base to revenue. And the interest rate environment is impacting many European banks and is impacting margin. So it’s a natural place to look at, but it isn’t the only lever or option that is open to us. Thank you.

We have one more caller on the line with a question. Then we’ll finish up in the room.

Operator

Thank you very much. The last caller on the phone at the moment is the line of Martin Leitgeb from Goldman Sachs. Please go ahead.

Martin Leitgeb

Yes. Good morning. Just two questions from my side. And the first one is a follow up on earlier comments on mortgages in Ireland. And I just wanted to understand whether you expect to increase your market share in Ireland from here. And this just follows some comments by one of your competitor or who decrease pricing, and as a consequence, expects its share to increase from here.

So I was just wondering whether you still expect your share via the broker channel and so forth overall to increase in Ireland.

And the second question is just broader on ECB monetary policy and the impact. And I’m just trying to understand, just looking at where your deposit costs in Ireland are at the moment, I think around 7 basis points, do you expect to be able to pass on some of the adverse pressure or headwinds which are coming from monetary policy to customers? So would we expect to pass on something to retail customers, whether that’s current account pricing, interest rates? Or if you’re thinking here that, that given the pricing there’s little you can do on the liability side to offset it? Thank you.

Francesca McDonagh

Okay. Thank you. I’ll answer first on mortgage market share, so at 23%, we previously talked about a range of 25% to 30%. I feel our proposition and our distribution and our pricing is more competitive as we go into the second half than where we were in the first half. But we don’t chase market share. I don’t have – if you look at our internal targets and score cards, market share isn’t top of the list.

We will price appropriately. We won’t trade shareholder value for pure volumetric achievement. And I think – I believe we’re competitive. I know our pipeline for the second half has some seasonality in there. We are looking forward to a good trading next period.

Andrew Keating

Great, Martin. Your second question was just in relation to ECB policy and that was really, I think you addressed it here in terms of kind of negative rates. So we already do apply negative interest rates to our institution and large corporate and top end of SME customers. So with certain various thresholds around volume of deposits and negative rates that are – that vary between sort of minus 40 basis points and minus 100 basis points depending on the size and nature of the counterparty.

Your particular question was around whether we will start looking to apply negative rates to personal customers. That’s not something we’ve done to date. Some – the other feature, I suppose, that’s in that space is around Central Bank regulation around fees, et cetera, for personal customers and for small business customers. So that’s a – that will be an issue that we have to reflect on as well. So as well as in simple terms, I think currently our position is that we haven’t yet or we haven’t to-date charge negative rates.

That’s not something that we’re planning to do. But I can’t give a guarantee that, that won’t be something we may have to revisit at some moment. But it’s not a focus for now, Martin.

Okay. Thank you very much.

Martin Leitgeb

Thank you very much.

Francesca McDonagh

Thank you. We finished all calls in the line, anything else in the room? If not, I’d say few words. So thank you for your time this morning and for some really good questions, both in the room and on the line. Just to recap, we’ve reported a solid performance for the first half. We’ve reported good progress versus the strategy we set out a year ago.

We’re cognizant of the evolution and the external environment, particularly around interest rates and Brexit uncertainty. But we’ve reiterated this morning our commitment to the 10% RoTE. It’s very much our financial North Star. And we have options open to us and within our control to achieve that target. Thank you very much for your attention. Thank you.

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