Moody's Investors Service has today downgraded by one notch Allied Irish Banks' (AIB) deposit ratings to Ba3 from Ba2 and senior debt ratings to B1 from Ba3. In line with the downgrade of AIB, Moody's has also downgraded the deposit and senior debt ratings of AIB's subsidiary EBS Ltd to Ba3/NP and B1, respectively. In both cases, the rating actions follow the lowering of the entities' baseline credit assessments (BCAs) by two notches to b2 from ba3. The outlook on all ratings has been changed to stable, NP ratings also affirmed. 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 AIB's capital levels beyond the expectations of the Prudential Capital Assessment Review (PCAR) undertaken by the Irish regulator in 2011. As of June 2013 , above one third of the bank's loan portfolio was non-performing . (2) the closely-related risk for AIB'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 AIB with poor quality lending books and poor profitability are at relatively greater risk of 'failing' the test. Any resulting material capital shortfall following the ECB's Comprehensive Assessment, will raise the risks for its bondholders. The moderate expectation of support from the Irish government leads to a one-notch uplift for AIB'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 AIB's deposits, resulting in two notches of rating uplift from the standalone BCA. The outlook on all ratings has been changed to stable, reflecting the balance between the continuing downside risks that underpinned the downgrade, as well as the positive signals stemming from the broader economic stabilisation. RATINGS RATIONALE --- ASSET-QUALITY CHALLENGES CONTINUE TO POSE DOWNSIDE RISKS The still sizable level of impaired loans at 34.3% as of June 2013 poses risks to the bank's performance. Although the bank maintains relatively high coverage ratios, the need to address the ongoing asset quality problems may increase regulatory pressure on banks since the adequacy of current provisions could be questioned once more. The bank announced that it believes it continues to be well capitalised and in excess of minimum regulatory requirements following the BSA results, incorporating those results in the preparation of its year-end financial statements. However, AIB did not provide a detailed breakdown about further potential impairment provisions, expected losses on default assets or adjustments on risk weighted assets (RWAs). Moody's has incorporated these challenges in its analysis for AIB. --- ADEQUATE CAPITALISATION UNDER CURRENT RULES, BUT AIB STILL HAS TO PASS THE ECB STRESS TEST AND REPLACE NON-QUALIFYING CAPITAL INSTRUMENTS UNDER CRD IV Moody's believes that these underlying asset quality problems, reflected in a very high level of NPLs could leave the bank in a more vulnerable position to face the European Central Bank's (ECB) stress test later 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 AIB, with vulnerable lending portfolios, 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 the bank 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 AIB's CET1 ratio will be deemed adequately capitalised on a stressed basis following completion of the ECB exercise. In addition, the bank's stressed ratio would face additional pressure since it should include a phased-in deduction for deferred tax assets. These remain sizable for AIB and 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. However, 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 senior creditors). --- SOME POSITIVE SIGNS STEMMING FROM THE RETURN TO GROWTH IN THE IRISH ECONOMY Today's action (including the stabilisation of the outlook) 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 AIB to improve its asset quality and profitability metrics. In Moody's opinion, the bank's leading retail and commercial banking franchise in Ireland will contribute to its 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 Moody's view, AIB's mortgage portfolio credit quality will likely show some improvement 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. Moody's notes that AIB reported a 56.4% coverage ratio at the end of June 2013 , which is relatively high compared to 51.7% for rated banks in Ireland . --- SUPPORT ASSUMPTIONS The senior unsecured debt rating of AIB incorporates one notch of uplift, reflecting Moody's assumption of a moderate probability of systemic support coming from the Irish government, if the bank requires additional capital. AIB is systemically important to the financial stability and economic prospects for the now stabilising Irish economy. The deposit ratings of AIB 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. This is based 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.
Most Popular Stories
- Koch Brothers Step up Anti-Obamacare Campaign
- FDIC Sues Big Banks Over Rate Manipulation
- Vybz Kartel Convicted of Murder
- Stocks Close Lower Ahead of Crimea Vote
- Is Malaysian Airlines Flight 370 in Andaman Sea?
- SoCalGas Reaches Record Spend on Diversity Suppliers
- Ulta Shares Look Good on Strong Q4
- Jittery Investors Dumping Russian Stocks
- FDIC Accuses Big Banks of Fraud, Conspiracy
- U.S. Consumer Sentiment Falls in Early March