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Rating Action:

Moody's downgrades Bank of Ireland's deposit ratings to Ba2, senior debt ratings to Ba3; outlook remains negative

Global Credit Research - 17 Dec 2013

Actions follow lowering of the bank's BCA

London, 17 December 2013 -- Moody's Investors Service has today downgraded by one notch Bank of Ireland's (BOI) deposit ratings to Ba2/NP from Ba1/NP and senior debt ratings to Ba3 from Ba2, prompted by the concurrent lowering of the bank's baseline credit assessment (BCA) by two notches to b1 from ba2. In line with the downgrade of BOI, Moody's has also downgraded the deposit ratings of BOI's subsidiary ICS Building Society to Ba2/NP and lowered its BCA to b1.

The lowering of the BCA reflects Moody's view of the increase in risks to bondholders arising from

(1) ongoing asset-quality challenges that have the potential to put pressure on BOI's capital levels beyond the expectations of the Prudential Capital Assessment Review (PCAR) undertaken by the Irish regulator in 2011. These pressures are at least partially reflected in the adjustments required by the Central Bank of Ireland (CBI), following its Balance Sheet Assessment (BSA) of BOI; and

(2) the closely-related risk for BOI's bondholders stemming from the prospect of the stress test that will be undertaken by the European Central Bank (ECB) in 2014. While the design of the stress test remains unclear and its result difficult to anticipate, banks such as BOI with poor quality lending books, relatively low levels of provisions and poor profitability are at relatively greater risk of 'failing' the test. Any resulting material capital shortfall, if it cannot be remedied by BOI or its shareholders within a certain (still undefined) period, directly raises the risks for BOI's bondholders.

At the same time, Moody's believes that BOI's increasingly visible return path to sustainable profitability should help it to offset some of these asset quality and capital pressures, while the potential for the bank to tap the private capital markets -- to which it currently has some access -- for equity injections should also be a further protection for bondholders.

The moderate expectation of support from the Irish government leads to a one-notch uplift for BOI's senior unsecured debt ratings. In line with previous government actions to support depositors, Moody's continues to incorporate a higher degree of support likelihood for BOI's deposits, resulting in two notches of rating uplift from the standalone BCA.

RATINGS RATIONALE

--- ONGOING ASSET-QUALITY CHALLENGES POSE DOWNSIDE RISKS

The continued rise and high level of non-performing loans illustrates the extent of BOI's asset quality problems in its Irish lending book and the ongoing downside risk this poses for BOI's capitalisation. The data as of June 2013 suggest that over 14% of mortgage loans in Ireland, about 23% of the Irish non-property SME and corporate book and, overall, 19% of the lending book (including the UK) is non-performing. Moody's takes some comfort from tentative signs that the build up of new NPLs is weakening. However, even if these positive signs were to persist, the expected loss in BOI's balance sheet could still increase in view of regulatory pressure to increase still further the provisions, which remain low by comparison with BOI's peers in Ireland and some other countries facing similar challenges such as Spain. The results of the BSA reflect this risk because under the terms of the BSA published by BOI, but which it currently contests, BOI would have to set aside EUR360 million of additional impairment provisions for its Irish mortgage portfolio and EUR486 million for its property & construction, small and medium enterprises (SMEs) and corporate portfolios respectively. The bank would also have to take 547 million of additional provision to cover the additional potential updated treatment of expected loss on defaulted assets. The sum of all potential provisions would increase its coverage ratio above 50%, in line with the current system average. In addition, the bank might have to increase its RWAs by approximately EUR6.8 billion.

--- ADEQUATE CAPITALISATION UNDER CURRENT RULES, HOWEVER BOI STILL HAS TO PASS THE ECB STRESS TEST AND REPLACE NON-QUALIFYING CAPITAL INSTRUMENTS UNDER CRD IV

Moody's is concerned that these underlying asset quality problems, reflected in the continued rise in NPLs and the low level of provisions, leave the bank in a more vulnerable position to face the stress test the ECB will conduct in 2014 as part of its comprehensive assessment of European banks. There remains considerable uncertainty surrounding the stress testing process and the key parameters it will incorporate -- for example loss rates, target capital levels, corrective windows -- which make the outcome difficult to anticipate. However, in Moody's opinion, banks such as BOI, with vulnerable lending books, relatively low provisions and poor profitability, are at relatively greater risk of 'failing' the stress test.

In Moody's view the ECB's Asset Quality Review (AQR) poses a lower threat than the stress test since the ECB will likely use the data from the BSA for its comprehensive assessment in line with CBI's expectations. As a result, the rating agency believes that BOI will remain adequately capitalised under the Basel III transitional rules even after meeting all the potential requirements outlined as a result of the ECB's AQR. However, the starting point CRDIV transitional CET1 ratio will be eroded, increasing the uncertainty as to whether BOI's CET1 ratio will be deemed adequately capitalised on a stressed basis. The bank's stressed ratio would face additional pressure from the phased-in deduction for deferred tax assets that remain sizable for BOI, the deduction which will continue to have a negative impact on its fully loaded CET1 ratio.

The implications of 'failing' the stress test are difficult to predict and the offsetting actions management could take correspondingly uncertain. Moody's believes that BOI's proven ability to raise equity from private investors is positive for bondholders. The bank recently placed EUR580 million of ordinary stocks to redeem preference shares held by the Irish government and the government sold its remaining stake in the banks represented in EUR1.3 billion of preference shares to private investors. Nevertheless access to private capital following the stress test cannot be taken for granted, in which case additional capital would need to be sourced elsewhere. Moody's believes that the slightly heightened risks to bondholders need to be reflected in both lower baseline credit assessment (to signal the potential for some sort of support event) and lower debt ratings (to signal the heightened risk to creditors).

--- SOME POSITIVE SIGNS STEMMING FROM THE RETURN TO GROWTH IN THE IRISH ECONOMY

Today's action reflects a balance of factors, including some positive signs. Despite the significant challenges that the Irish economy still faces, signs of stabilisation -- reduced unemployment levels and increased asset prices -- could help BOI to improve its asset quality and profitability metrics. In Moody's opinion, the bank's solid retail and commercial banking franchise will facilitate BOI's expected return to stable profitability. Improved net interest margins will also increase profitability, despite the negative effect on profits that lower ECB base rates could have on the bank's tracker mortgages.

In line with these views, the rating agency says that the quality of BOI's mortgage portfolio could improve in line with the system, after the CBI reported a decline in the number of mortgage accounts for principal dwelling houses in arrears during Q3 2013. BOI has traditionally reported lower levels of problem loans than its peers, at 19.3% compared with an average of 30.3% for rated banks in Ireland. BOI's lower level of problem loans reflects its traditionally more conservative underwriting standards and added geographic diversification from its lending in the UK.

--- SUPPORT ASSUMPTIONS

BOI's senior unsecured debt ratings incorporate one notch of uplift. The uplift reflects Moody's assumption of a moderate probability for systemic support likely to be forthcoming from the Irish government, if an increase in capital is required, given BOI's systemic importance to the financial stability and economic prospects for the now stabilising Irish economy.

BOI's deposit ratings incorporate two notches of rating uplift from the BCA, reflecting Moody's expectation that support for deposits would likely be forthcoming in the event of need. The rating agency bases its view on the supportive stance of the Irish government towards depositors as witnessed by the 2011 transfer orders to sell the deposits of Anglo Irish Bank and Irish Nationwide Building Society to AIB and IL&P.

--- UPGRADE OF SUBORDINATED AND HYBRID INSTRUMENTS

Moody's upgraded the subordinated debt ratings to B2 from C and the preference share ratings to Caa2 (hyb) from C (hyb), in line with the rating agency's guidelines for junior bank obligations.

WHAT COULD MOVE THE RATINGS UP/DOWN

The current negative outlook implies that upward pressure on the BCA is unlikely in the short term. However, upward pressure on the BCA could develop if the bank's management took steps to improve the bank's capital position ahead of the ECB stress test in 2014.

Other elements that could exert upward pressure on the bank's BCA in the medium term are (1) a sustainable recovery of asset-quality indicators; (2) further improvements in profitability and efficiency; and (3) an improved liquidity position, with lower reliance on funding from monetary authorities.

An upgrade of the bank's debt and deposit ratings could be triggered by an improvement in the bank's standalone financial strength.

The bank's BCA could be adversely affected by (1) a greater-than-expected deterioration in the bank's existing capital buffers; (2) an additional capital requirement resulting from the ECB stress test exercise that could not be met organically or through available management actions; (3) an unexpected deterioration in the bank's profitability metrics; and (4) a material deterioration in its liquidity or funding position.

Negative pressure on the bank's long-term debt and deposit ratings could result from a lowering of the bank's BCA.

The principal methodology used in these ratings was Global Banks published in May 2013. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Ferenc Csoke
Analyst
Financial Institutions Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Johannes Felix Wassenberg
MD - Banking
Financial Institutions Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's downgrades Bank of Ireland's deposit ratings to Ba2, senior debt ratings to Ba3; outlook remains negative
No Related Data.
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