Irish banks: Are they fit for purpose? Presentation to DEW Annual Economic Policy Conference
Dermot O’Leary
Chief Economist
Wexford, 24 September 2016 Some context
• While there were other vulnerabilities, the state of the Irish banks was the key reason
for Irish bailout in December 2010. Here’s what the IMF said on December 4th 2010:
“At the root of its problems is a critically-weakened banking sector that has yet to be
restored to health and stands at the center of a dynamic that dampens economic recovery
while creating pressures on an already serious fiscal challenge.”
• Here was the plan to sort the problem:
• Downsize and reorganise – close non-core operations, transfer troubled assets, provisioning,
deleveraging, reduce dependence on non-deposit funding
• Recapitalise (€35bn set aside, not all used) – increase capital buffers (immediate 12% CT1
target), stress-testing (PCAR)
• Stronger supervision & special resolution regime for banks – increased resources, new
resolution framework, new personal insolvency regime
• What position is the Irish banking system now in?
2 Before and after
Summary balance sheet position of Irish banks (Consolidated data) Dec-10 Mar-16 Change 2010-2016 % change Total Assets 446,953 240,439 -206,513 -46% Loans and receivables - debt instruments* 50,572 12,681 -37,892 -75% Loans and receivables - loans to customers 276,022 166,386 -109,636 -40% Loans and receivables - loans to credit institutions^ 15,316 5,703 -9,613 -63% Available-for-sale financial assets 46,163 28,097 -18,067 -39% Cash & cash balances with central banks 6,673 12,995 6,322 95% Other Financial assets 8,085 3,603 -4,483 -55% Other Assets 44,120 10,976 -33,144 -75% Total Liabilities 428,124 216,749 -211,375 -49% Deposits other than from Credit Institutions 155,449 153,012 -2,437 -2% Deposits from Credit Institutions and Central Banks 170,812 22,068 -148,744 -87% Debt Certificates 56,818 26,454 -30,364 -53% Subordinated Liabilities 9,809 5,503 -4,306 -44% Other liabilities 35,236 9,712 -25,524 -72% Equity & Minority Interest 18,829 23,690 4,861 26% Total Liabilities, Minority Interest and Equity 446,953 240,439 -206,514 -46% Equity/Assets 4.2% 9.9% Loan/Deposit ratio 178% 109% Source: Central Bank
3 LDR targets were met quickly
Loan/Deposit ratio
200% Original 2010 target of 122.5% LDR 180% created perverse incentives for the 160% banks 140% 120% 100% 80% 60%
Loans/Deposits 40% 20% 0%
Source: Central Bank
4 A deposit-funded banking system once again
ECB borrowing at lowest level since August 2007
250
Non-resident deposits 200 Private sector deposits
150 bn
€ 100
50 ECB Borrowing
0
Source: Central Bank
5 Significantly smaller banks
Loan to deposit ratio by bank
300 273
250
200 175 165 150 131 99 103
100 Loans/deposits 50
0 AIB BoI ptsb
End-2010 H1 16 Source: Company accounts
6 Bank profitability
Irish bank profitability to plateau in 2016 8 8 6 6 4 4 2 2
0 0
bn €
bn -2 -2 € -4 -4 -6 -6 -8 -8 -10 -10 -12 -12 2012 2013 2014 2015 2016 Net interest income Non-interest income Operating costs Bad debts Pretax profits
Source: Bank reports & Goodbody estimates
• Irish banks returned to profitability in H1 2014
• Large hits in crisis period due to bad debts, but provisions are now slowly being written back
• Net Interest Income makes up the large majority (c.75-80% excl. bond gains) of Irish banks’ income
• Net interest margins have expanded significantly
• Majority of this has been due to liability repricing; in a ZIRP world this is coming close to an end
• Rolling off of trackers helps NIMs, but asset growth will be key for future revenue growth 7 Profitability at average levels internationally, but poor in historical context
Return on equity (retail banks)
16% 14% 12% 10%
8% RoE 6% 4% 2% 0%
Source: Factset, Goodbody
8 NIMs – Reaching a plateau
Tailwind still at AIB & PTSB, looking more for loan book growth from here at BOI
AIB Margins progression - some AIB specifics (NAMA & cocos) BOI Margins - Starting to flatline
2.5 2.5 2.25 2.21 2.16 2.17 2.17 2.15 2.17 2.11 2.12 2.14 2.17 2.08 2.08 2.03 2.05 1.97 2.01 2.0 1.92 2.0 1.82 1.78 1.65 1.67 1.6 1.5 1.45 1.34 1.5 1.42 1.20 1.27 1.28
NIM NIM % 1.2 1.0 1.0 0.5
0.5 H2 H1 H2 H1 H2 H1 H2 H1 FY FY 0.0 H1 H2 H1 H2 H1 H2 H1 H2 H1 FY FY FY 2012 2013 2013 2014 2014 2015 2015 2016 2016 2017 12 12 13 13 14 14 15 15 16 16 17 18
Source: Company Data NIM excl. ELG NIM excl. ELG & NAMA bonds
PTSB Margins progression - strong momentum continues
1.7
1.47 1.5 1.43 1.38
1.3 1.24
NIM % NIM 1.1 1.00 0.94 0.88 0.9 0.82 0.82 0.76 0.68 0.7
0.5 H1 H2 H1 H2 H1 H2 H1 H2 H1 FY FY 12 12 13 13 14 14 15 15 16 2016 2017 NIM excl. ELG
9 How low can it go?
10 Profitability drivers
Tailwinds of recent years coming to an end
AA corporate bond yield – Increases pension deficit Sovereign holdings - little more scope for revulation gains 4% 5.5% 12%
3% 4.5% 8% 2% 3.5%
1% 2.5% 4%
0% 1.5% 2010 2011 2012 2013 2014 2015 2016 0% 2010 2011 2012 2013 2014 2015 2016 FTSE Euro Corp. Bond AA Avg Yield (LHS) 3 Year Avg. (RHS) Irish 10 Year Sovereign Yield (LHS) 3 Year Avg (RHS)
Rates paid on 12 month deposits in Ireland Market expectations for interest rates in the euro area
4.4% 6.0 Market expectation 3.9%
3.4% 5.0
2.9% 4.0
2.4% 3.0 % 1.9% 2.0 Oct-15 Deposit Rate Deposit 1.4% 1.0 0.9% 0.0 0.4% Current -0.1% -1.0 Jul 12 Jan 13 Jul 13 Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Jul 16 Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug AIB Ulster BOI PTSB 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 Source: Company Data Source: Bloomberg
11 Can costs be reduced further?
AIB & BOI C/I ratio significantly below Ulster & PTSB
90% 84% 78% 77% 75% 69% 68% 64% 60% 58% 58% 51% 54% 49% 46% 45%
30% Cost /income ratio 15%
0% Ulster PTSB AIB BOI 2008 2015 2017F Source: Company accounts 2015,Goodbody Estimate
12 NPLs still high but constantly improving
• Improvement in the economy, asset sales and
write-off is reducing the level of NPLs, but they
still remain high at c.15% overall – substantially
above European levels
• Banks appear to be well provisioned for these
NPLs, with the coverage remaining stable at
c.50% over recent quarters; this is in line with
European peers
Provisions as % of impaired loans in line • Further write-backs are likely as the economy
120% continues to improve and asset prices rise 100%
80% • 50% of NPLs are mortgages - restructuring is 60%
40% picking up pace but has been exceptionally slow 20%
Provisions as % % ofimpairedProvisionsloansas 0%
Irish Banks UK Banks Nordic Banks Iberian Banks Source: Company accounts 13 Slow progress on mortgage arrears
Summary of Mortgage arrears & restructures (% of total value) Dec/13 Mar/14 Jun/14 Sep/14 Dec/14 Mar/15 Jun/15 Sep/15 Dec/15 Mar/16 Jun/16 Owner Occupiers (€bn) 10 7 .4 10 6 .5 10 6 .2 10 5 .5 10 4 .9 10 4 .3 10 3 .5 10 2 .5 10 1.6 10 0 .9 10 0 .3 Arrears <90 days 5.8% 5.6% 5.1% 4.6% 4.5% 4.2% 4.0% 3.8% 3.8% 3.7% 3.5% Arrears 91 days+ 16.9% 16.6% 16.5% 15.7% 14.8% 14.1% 13.4% 12.7% 12.1% 11.8% 11.5% Arrears 180 days+ 14.6% 14.5% 14.5% 14.0% 13.4% 12.9% 12.3% 11.7% 11.1% 10.8% 10.5% Restructured 6.5% 7.4% 8.3% 9.5% 10.4% 11.1% 11.6% 12.2% 12.2% 12.4% 12.6% Total 90 days + restructured 23.4% 24.0% 24.8% 25.2% 25.2% 25.2% 24.9% 24.8% 24.3% 24.2% 24.1%
Buy- to- let (€bn) 2 9 .7 2 9 .4 2 9 .2 2 8 .8 2 8 .0 2 7 .0 2 6 .7 2 6 .5 2 6 .0 2 5 .6 2 5 .2 Arrears <90 days 6.6% 6.3% 6.0% 5.1% 4.9% 4.7% 4.4% 4.5% 4.5% 4.5% 4.2% Arrears 91 days+ 29.2% 29.9% 30.7% 30.8% 29.4% 28.5% 27.1% 26.2% 24.6% 24.2% 24.1% Arrears 180 days+ 25.6% 26.6% 27.7% 28.2% 27.2% 26.6% 25.3% 24.5% 23.1% 22.8% 22.6% Restructured 11.2% 12.1% 12.4% 13.3% 14.3% 15.5% 16.2% 16.7% 17.9% 18.3% 18.6% Total 90 days + restructured 40.4% 42.0% 43.0% 44.1% 43.7% 44.0% 43.3% 42.9% 42.5% 42.5% 42.7%
Total (€bn) 13 7 .0 13 5 .9 13 5 .4 13 4 .3 13 3 .0 13 1.3 13 0 .1 12 9 .0 12 7 .7 12 6 .5 12 5 .5 Arrears <90 days 6.0% 5.8% 5.3% 4.7% 4.5% 4.3% 4.0% 4.0% 3.9% 3.9% 3.7% Arrears 91 days+ 19.6% 19.5% 19.6% 19.0% 17.9% 17.1% 16.2% 15.4% 14.7% 14.3% 14.0% Arrears 180 days+ 17.0% 17.1% 17.4% 17.1% 16.3% 15.7% 14.9% 14.3% 13.6% 13.2% 13.0% Restructured 7.5% 8.4% 9.2% 10.3% 11.2% 12.0% 12.5% 13.1% 13.4% 13.6% 13.8% Total 90 days + restructured 27.1% 27.9% 28.7% 29.3% 29.1% 29.1% 28.7% 28.5% 28.0% 27.9% 27.8% Source: Central Bank
14 European bank stress test
Bottom of the pile, but assumptions look harsh
Fully Loaded CET1 in Adverse Scenario – Irish banks are two of the bottom four banks
Delta Adverse Country Bank Starting 2015 Adverse 2018 2018 (bps)
IT Banca Monte dei Paschi di Siena S.p.A. 12.07% -2.44% ‐1451
IE Allied Irish Banks 13.11% 4.31% ‐880
AT Raiffeisen‐Landesbanken‐Holding GmbH 10.20% 6.12% ‐408
IE Bank of Ireland 11.28% 6.15% ‐513
ES Banco Popular Español S.A. 10.20% 6.62% ‐358
IT Unicredit S.p.A. 10.38% 7.10% ‐329
UK Barclays Plc 11.35% 7.30% ‐405
DE Commerzbank AG 12.13% 7.42% ‐471
FR Société Générale S.A. 10.91% 7.50% ‐341
DE Deutsche Bank AG 11.11% 7.80% ‐332 Source: EBA
GDP growth forecasts in Adverse Scenario – Ireland 30% worse than last time, others in line Baseline growth rates Deviations Adverse growth rates Level deviation 2016 2017 2018 2016 2017 2018 2016 2017 2018 2018 Ireland 4.50% 3.50% 3.60% -4.60% -4.60% -1.90% -0.10% -1.20% 1.70% -10.40% UK 2.40% 2.20% 1.20% -4.60% -2.90% 0.40% -2.20% -0.70% 1.70% -6.80% Euro Area 1.80% 1.90% 1.70% -2.80% -3.20% -1.10% -1.00% -1.30% -0.60% -6.80%
2014 Test Ireland 1.80% 2.90% 2.40% -3.00% -3.60% -1.90% -1.30% -0.70% 0.50% -8.10% UK 2.50% 2.40% 1.60% -3.30% -3.70% -1.00% -0.80% -1.30% 0.60% -7.60% Euro Area 1.20% 1.80% 1.70% -1.90% -3.20% -1.80% -0.70% -1.40% 0.00% -6.60%
Source: EBA, European Commission
15 Irish vs European Capital Ratios
In the middle of the pack
Fully loaded European CET1 ratio 25% 21.2% 20% 18.8% 15.0% 16.5% 16.1% 15.5% 14.9% 15% 13.0% 12.8% 11.3% 11.4%11.6% 11.6% 10.2%10.1%10.3% 10%
5% CET CET 1 Ratio(2015)
0%
Irish Banks UK Banks Nordic Banks Iberian Banks Source: Company accounts Risk-weighted analysis is important too
European RWA density • Irish banks risk-weighted assets are high
100% 92% 90% as a percentage of total assets 80% 70% 58% 60% 53% • This stems from legacy loss issues on 50% 44% 41% 43% 42% 40% 35% 32% 28% 30% 30% 23% Irish bank loans 21% 19% 20%
RWAs to TotalAssetsRWAsto 10% 0% 0% • As a result, Irish banks have to hold
higher levels of capital for every euro Irish Banks UK Banks Nordic Banks Iberian Banks Source: Company accounts & Pillar III Documents worth of assets Mortgage RWA under IRB 50% • This has implications for the Returns that 43% 40% 39% 40% the banks are able to generate and rates
30% 27% that have to be charged 20% 17% 17% 15% 16% 16%
10% 9% 10% 7% 7% 5%
0%
Irish Banks UK Banks Nordic Banks Iberian Banks
17 A concentrated banking sector…
Share of lending by top three institutions (2013) • Irish banking sector is now significantly
100 90 concentrated following the exit of foreign 80 70 60 % players over recent years 50 40 30 • Arrival of “niche” players has failed to work 20 10 0 thus far; distribution has been an issue IT FR UK DK AU GE BE EA PO FI NO SP NE IRE GR Source: World Bank • Opportunity for credit unions?
Mortgage market is significantly concentrated...... and the SME market even more so
0.50 0.50 0.45 0.45 0.40 0.40 0.35 HH Index on new 0.35 0.30 mortgage lending 0.30 0.25 0.25 0.20 0.20 0.15 HH Index 0.15 0.10
0.10 Herfindahl Index
(mortgage stock) 0.05 0.05 0.00 0.00 Q4 10 Q3 11 Q2 12 Q1 13 Q4 13 Q3 14 Q2 15
HHI - FLOW HHI - STOCK Source: Central Bank, Goodbody Source: Central Bank 18 …contributing to high lending rates
Lending rates for mortgages in the euro area • Lending rates for both households & 12.0 10.0 businesses remain at one of the highest rates 8.0 in the euro area % 6.0
4.0 • Most political focus has been on mortgage 2.0 0.0 rates but the spread on SME lending rates is
even higher – significant gap has opened up Source: ECB Max Min Median Ireland Ireland - Principal dwelling
Lending rate for loans <€1m since 2010, coinciding with lower competition
8 7 • Particularly acute for micro loans (<€250k) @ 6 5 5.7%. Av. SME loan is €58K % 4 3 2 • Recent proposals to cap mortgage interest 1 0 rates will reduce the incentive for increased -1 Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep 04 05 06 07 08 09 10 11 12 13 14 15 competition to erode these differentials Source: ECB Ireland Euro area (changing composition) Spread • High NPLS are an issue but getting access to
underlying collateral is very difficult 19 Demand or supply issues?
SME demand & credit standards • Demand for business loans has been on 4.5 4.0 the increase for two years due to higher 3.5 3.0 fixed investment and working capital
2.5 Index 2.0 needs; this has been reflected in an 1.5 1.0 increase in lending flows
• Credit standards have been left unchanged SME Demand Credit standards to SMEs No change Source: Central Bank despite the economic improvement Mortgage credit standards & Demand
5.0 Higher demand, looser credit • Mortgage demand and credit standards 4.5 Lower demand, tighter credit 4.0 have been greatly affected by the 3.5 3.0 introduction of the macro prudential rules, 2.5 2.0 with LTV considered to be the main 1.5 inhibitor
Demand Credit Standards No change Source: Central Bank of Ireland
20 Conclusions
• External oversight (Troika, SSM) has been crucial in restructuring of the banking system; SSM to take
over the baton from here
• Capital levels look adequate after significant capital-raising
• Concentration of the banking system is a major reason for high lending rates, as are high NPLs
• Arrival of foreign competition inhibited by size of the home market, but may be an opportunity for
niche players and the credit unions
• Profitability of banks may be constrained over the coming years due to negative rates – particular
problem for ptsb (65% of loan book is trackers)
• Asset growth is needed to increase profits, given that NIM improvements have largely played out
• Work-out of NPLs has been a slow process
• Banks are leaner, safer and better capitalised
• Increased state involvement is a risk to increased competition and best value for the taxpayer from
stake sales – profitable banking systems are in a better position to provide credit to economy
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