Moody's Investors Service has today downgraded by two notches Permanent tsb's (PTSB) deposit ratings to B3/NP from B1/NP and senior debt ratings to Caa1 from B3, prompted by the concurrent lowering of the bank's baseline credit assessment (BCA) by three notches to E/caa3 from E+/b3. NP ratings also affirmed. Today's rating action reflects Moody's view of the increase in risks to bondholders arising from (1) sizable asset-quality challenges that may potentially put pressure on PTSB's capital levels beyond the expectations of the Prudential Capital Assessment Review (PCAR) undertaken by the Irish regulator in 2011; (2) the closely-related risk for PTSB'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 the results difficult to anticipate, banks such as PTSB with poor quality lending books and very limited prospects of returning to positive profitability over the rating horizon 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. And (3) the continued dependence on public funding support for its non-performing and non-core businesses increases uncertainty and potential risk for bondholders. In that context, the approval of the restructuring plan submitted to the European Commission (EC) is still outstanding. The bank will potentially have to wait some time to receive approval from the EC and unveil the final details of its reorganisation and funding plans. Given the bank's significant negative funding gap, Moody's notes that the creation of independent business units including a core bank, an asset management unit and a non-core portfolio, would create funding challenges for the businesses outside of the core bank since the deposit base will likely remain within the core business. As a result, these business units will likely have to continue relying on external liquidity provided by monetary authorities; The moderate expectation of support from the Irish government leads to a two-notch uplift for PTSB'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 PTSB's deposits, resulting in three notches of rating uplift from the standalone BCA. RATINGS RATIONALE --- UNCERTAINTY REGARDING APPROVAL OF RESTRUCTURING PROCESS AND ONGOING WHOLESALE FUNDING RELIANCE The restructuring plan submitted to the EC in June 2012 (updated in August 2013) involves the reorganisation of the bank into a number of business units separating the non-core and non strategic assets from the core performing bank so that a viable entity can eventually return to the private sector. Despite significant progress reducing its funding gap, reflected in a decline of its loan to deposit ratio to 157% in June 2013 from 191% in December 2012 , Moody's believes that reliance on funding from monetary authorities will remain high. Furthermore, the potential sources of funding for each independent unit remains unclear and therefore, Moody's considers that monetary authorities would have to continue providing support. In addition, the group will face a funding cliff in 2015 when most of its debt matures ( EUR2.4 billion ). --- ASSET-QUALITY CHALLENGES CONTINUE TO POSE DOWNSIDE RISKS The significant and increasing level of problem loans at 22.3% as of June 2013 continues to pose risks to the bank's performance. Although the bank maintains coverage ratios in line with Irish peers, 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 has not released any details regarding further potential impairment provisions, expected losses on default assets or adjustments on risk weighted assets (RWAs) following the balance sheet assessment BSA performed by the Central Bank of Ireland (CBI). --- ADEQUATE CAPITALISATION UNDER CURRENT RULES, BUT PTSB STILL HAS TO PASS THE ECB STRESS TEST Moody's believes that the 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 PTSB, with vulnerable lending portfolios, and negative 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. 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 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 PTSB to improve its asset quality and profitability, despite the negative effect on profits that lower ECB base rates could have on the bank's tracker mortgages. In Moody's view, PTSB'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 the bank has significantly strengthened its collection processes. --- SUPPORT ASSUMPTIONS The senior unsecured debt rating of PTSB incorporates two notches of uplift, reflecting Moody's assumption of a moderate probability of systemic support coming from the Irish government, if the bank requires additional capital. Moody's believes that PTSB will continue to be considered as a systemically important bank by the Irish authorities. The deposit ratings of PTSB incorporate three 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. --- UPGRADE OF SUBORDINATED AND HYBRID INSTRUMENTS Moody's upgraded the provisional ratings of PTSB's subordinated debt to (P)Ca from (P)C and affirmed the (P)C junior subordinated debt provisional rating in line with the rating agency's guidelines for rating junior bank obligations. WHAT COULD MOVE THE RATINGS UP/DOWN Upward pressure on the bank's BCA is unlikely in the short term given the current negative outlook. However, upward pressure might develop from a successful restructuring plan outlining potential threats to creditors.
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