Fitch hints at upgrade for AIB and Bank of Ireland

International ratings agency Fitch has said it could upgrade AIB and Bank of Ireland if their asset quality and capitalisation continues to improve.

In a note published on Monday that compares the credit metrics of the two banks in the wake of their 2016 financial results, Fitch said asset quality was the main rating weakness for both companies.

However, it noted that this metric was “improving” as the banks manage down their stock of impaired loans, helped by property price growth, investor demand and a low inflow of new impaired loans.

Fitch said Bank of Ireland’s asset quality was better than AIB’s, reflecting its “lower stock of impaired loans and its better-performing UK residential mortgages”.

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Bank of Ireland’s impaired loans ratio fell to 8 per cent at the end of last year, down from 11 per cent in 2015, compared with 14 per cent for AIB, which was down from 19 per cent a year earlier.

“Both banks still have high proportions of forborne loans, low-yielding loans, including tracker mortgages, and defaulted but not impaired loans,” Fitch said. “However, we expect asset quality to continue improving in 2017, underpinned by a supportive operating environment, strong demand from investors for Irish commercial property and the banks’ proactive approach to reducing their legacy assets.”

Outlook

AIB is currently rated BB+ by Fitch while Bank of Ireland is rated BBB-, with both on a positive outlook.

Fitch also said that the contrasting dividend news last week from the two banks highlighted the impact of pension scheme volatility on their capital management.

AIB plans to pay a dividend of €250 million to shareholders this year – its first since 2008 – while Bank of Ireland has deferred its payment until 2018, citing volatility in its pension deficit.

Fitch said the banks’ common equity Tier 1 (CET1) ratios were exposed to differing degrees of volatility in their pension schemes, mostly driven by changes in corporate bond yields used to discount pension liabilities under international financial reporting standards.

Bank of Ireland’s capital position was “more susceptible”, as the bank’s fully loaded CET1 ratio of 12.3 per cent was only slightly higher than its stated long-term target of above 12 per cent. In the first half of last year, an increase in Bank of Ireland’s pension scheme deficit the reduced its CET1 ratio by 80 basis points.

Although its deficit has since narrowed, the bank wants to see a sustained improvement before resuming dividends, Fitch said. In contrast, AIB’s fully loaded CET1 ratio of 15.3 per cent, post a dividend payment, gives it “headroom to absorb volatility and resume dividends”.

Fitch said the credit fundamentals of AIB and Bank of Ireland were on a positive trajectory, with improving capitalisation driven by deleveraging, capital structure simplification and solid internal capital generation.