Moody’s downgraded BoI’s deposit ratings to Ba2/NP (from Ba1/NP) and senior debt ratings to Ba3 (from Ba2) yesterday, following the lowering of the bank’s baseline credit assessment (BCA) by two notches to b1 (from ba2). The group’s outlook remains negative. The downgrade of BoI’s BCA reflects increased risks to bondholders relating to ongoing asset quality challenges and the ECB stress tests next year. According to the rating agency “banks such as BoI with poor quality lending books, relatively low levels of provisions and poor profitability are at relatively greater risk of failing the test”. Consequently, any material capital shortfall that can’t be remedied by BoI or its shareholders “directly raises the risks for BoI’s bondholders”. At the same time, Moody’s believes that the bank’s increasingly visible return path to sustainable profitability should help it to offset some of these challenges. <p>
While Moody’s is of the view that BoI will remain adequately capitalised under the Basel III transitional rules even after reflecting BSA related provision and RWA adjustments, the starting capital position at the time of the stress tests is likely to be eroded. The phased DTA deductions under CRD IV also represent another headwind to capital levels. While BoI’s proven ability to raise equity from private investors is positive for bondholders, “access to private capital following the stress test cannot be taken for granted”. <p>
While we think Moody’s may be taking an overly conservative view of the risks facing BoI at the time of the ECB stress test, we continue to see merit in the bank raising additional equity in Q1/Q2 next year to assuage lingering concerns over solvency level. We believe a rights issue would be fully supported in the market and help to enhance the bank’s low fully-loaded Basel III ratio (c. 5.5% at 2013 year-end based on our numbers assuming BSA related impairment charges/RWA adjustments). While BoI’s underlying profitability dynamics are continuing to improve with impressive margin expansion coupled with cost reduction, average interest earning assets have been under pressure. However we note the potential for BoI to benefit from the demise of other Irish peers, and expect significant one-off re-financings deals to be a feature over the coming months especially relating to the IBRC liquidation. With an imminent peak in arrears expected, we are bullish on BoI’s long-term prospects as the group reasserts its dominance in Ireland but would be more comfortable with the bank navigating the stress tests of a higher equity base.
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