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March 10 (Reuters) - (The following statement was released by the rating agency)
Non-performing loans are likely to have plateaued at the two large Irish banks at end-2013 ahead of the ECB's comprehensive review, Fitch Ratings says. Their latest annual results incorporate some of the observations from the recent Central Bank of Ireland's balance sheet assessment on loan impairment provisions and risk-weighted assets (RWA), leaving them better positioned for the ECB review and well placed to return to sustainable profitability.
Impaired loans had been increasing steadily since 2008, but fell 3% and 2% yoy at end-2013 at Bank of Ireland (BoI) and AIB, respectively. Although NPL ratios rose slightly by 1pp to 17% at BoI and by 2pp to 35% at AIB, this was due to the overall reduction in loan exposures as part of deleveraging plans. We expect NPL ratios to peak in 2014 and begin to gradually reduce.
The central bank assessed credit risk classifications, loan provisions and the appropriateness of RWAs as at end-1H13. Both banks had adequate capital to meet the 10.5% core Tier 1 requirement after the central bank's adjustments. They also incorporated some of the findings into their 2013 results, so these should be more conservative.
AIB's EUR1.9bn of loan provisions were 24% lower than the previous year, but largely consistent with the central bank's suggestion for EUR1.1bn of additional loan impairment charges. It also made some of the EUR1.6bn RWA increases identified in the central bank's assessment. BoI incorporated part of the additional EUR846m loan provisions suggested by the central bank into its EUR1.7bn impairment charge, which was down 3% yoy. It also updated its expected loss treatment and applied some of the EUR6.8bn RWA adjustments.
But there is still downside risk from the ECB's comprehensive assessment. The recovery in asset quality is fragile even though it is stabilising. Forbearance levels are still high even after the Central Bank of Ireland's review. BoI's forborne loans were around 12% of gross loans with a large 88% not classified as impaired. Forbearance at AIB's residential mortgages was also at 12%, although over half were impaired. Performing forborne loans are vulnerable to changes in affordability and could still feed through to NPLs.
Resolution of impaired loans is still a risk for Irish banks. The central bank published mortgage arrears data last week highlighting that the improving economy and loan restructurings are helping to reduce mortgage arrears, but extremely long-term delinquencies continue to rise. The proportion of owner-occupier loan balances in 90+ day arrears fell 40bp to 17% in the fourth quarter, the first qoq decline since the data series began in 2009. However, the proportion of balances in 720+ day arrears rose by 30bp to 6.5%.
Following the Irish central bank's assessment, BoI and AIB are more resilient and unlikely to need more capital. However, we still see weaknesses in capital composition because BoI's Basel III common equity Tier 1 ratio of 9% and AIB's ratio of 10.5% under 2017 rules include perpetual preference shares issued as part of the 2009 bank capitalisation that will be derecognised after 2017.
Stripping these out, we estimate the ratios would be around 5% in BoI and 4% in AIB, which is weak in light of the high levels of net impaired loans relative to equity. Generating capital by returning to profitability is an important part of the banks' recovery.