DUBLIN/LONDON (Reuters) - Bank of Ireland BKIR.I on Tuesday raised 1 billion euros ($1.27 billion) in its most significant bond issue in over three years, a move the country's finance minister described as a milestone for Ireland's battered banking sector.
Hammered by the bursting of a gigantic property bubble, Ireland and its banks were locked out of capital markets two years ago, forcing the state into an international bailout and lenders to turn to the European Central Bank (ECB) for funding.
After the government began its gradual market return in July, Bank of Ireland followed suit with a 3-year, non-state backed covered bond, raising the fresh funds against an order book of 2.5 billion euros.
"Today is an important milestone on the path to full independence for our banks," finance minister Michael Noonan said in a statement, adding that he understood 98 pct of interest in the bond issue came from foreign investors.
"This issuance is further evidence of the strengthening and normalization of our banking system."
The bank, which also said in a trading update on Tuesday that it was starting to benefit from lower funding costs and a steadier economy, called the issue a key step in its strategy to return to a more sustainable and normalized funding position.
The bank will use the funds to reduce its borrowings from the ECB which stand at 21 billion euros, a source with knowledge of the bank's plans told Reuters. ECB borrowings are secured against a range of collateral, including between 5 and 6 billion euros of the kind of mortgages used in Tuesday's transaction.
A source with knowledge of the situation said the bank could in time eliminate more of its ECB borrowings by funding those mortgages in the market instead of at the ECB. He declined to be drawn on the timing of any future issues.
Swapping ECB funding for private investors will hurt the bank's net interest margin - since ECB funding is far cheaper - but will help the bank in its goal to return to a sustainable funding base, one source said.
The bond, priced at mid swaps + 270bps, was the first public covered issuance of its type without the help of a government guarantee since September 2009.
"BOI's return to non-guaranteed public market funding is a further sign of balance sheet recovery and investor confidence in the bank," said Stephen Lyons of Davy Stockbrokers.
At 1530 GMT, Bank of Ireland shares were up 1 percent at 0.094 euros.
After becoming the first Irish lender to meet a deleveraging target set under the country's EU/IMF bailout, Bank of Ireland is focusing on restoring profitability and said in a trading update on Tuesday that it was also making progress on that front by cutting costs, reducing deposit rates and increasing margins.
"As expected, and despite the ongoing pressure arising from exceptionally low official interest rates, the group's net interest margin has started to be positively impacted by the actions taken," it said, without giving further details.
The only Irish lender to avoid full state control after the property crash, Bank of Ireland has nevertheless seen its margins squeezed, particularly due to the cost of taking in deposits by having to offer high interest rates to attract them and by paying a fee to the state to guarantee them.
Even when guarantee costs were excluded, the bank's net interest margin - the gap between what it charges for loans and what it pays to borrow - fell 13 basis points to 1.2 percent in the first half of the year, raising a question mark over its goal to reach 2 percent by 2014.
The 15 percent state-owned lender said on Tuesday it was starting to benefit from lower funding costs, including paying less to attract a rising number of deposits.
"Although the Irish economy has begun to stabilize, challenging conditions remain," it added.
Those include the number of homeowners struggling to pay their mortgages, although Bank of Ireland said the pace in growth of mortgage arrears had continued to reduce, making it confident that impairment charges would also fall.
It added that its customer deposits had risen 3 percent to 74 billion euros, helping further trim its loan to deposit ratio to less than 130 percent from 136 percent in June.
($1 = 0.7867 euros)
Editing by David Cowell and Louise Heavens