Bad loans send AIB pre-tax profits down 62% to €1bn

Allied Irish Banks (AIB) has recorded an annual loss from its core retail business for the first time in the bank's history.

AIB said 2008 pre-tax profit fell 62 per cent to €1 billion after it set aside €1.8 billion to cover loan losses and almost doubled its charge for bad loans to 137 basis points. Earnings per share fell 68 per cent to 66.5 cent.

"We expect the operating environment to remain extremely difficult through 2009 with deteriorating economic conditions in the markets in which we operate," AIB said in a statement.

AIB chief executive Eugene Sheehy described the results as “disappointing” and said he now regretted some of the bank’s lending decisions “particularly in relation to our exposure to the property and construction sectors, negatively impacted on our business.”

"Our loan losses are much higher than we would have anticipated, €1.8 billion, which is 1.73 per cent so the good work that we did in many areas was eroded by our bad debt charge," he told RTE's Morning Ireland.

“The building cycle went on for a long time and the bad loans you make are the ones you make at the end of the cycle and I regret the loans we made towards the very end,” he said.

The bad debt write-offs include specific losses and provisions for anticipated future losses. “We are going into this year with €1.14 billion of IBNR (incurred but not reported), ie reserves for the future.”

“We saw the opportunity with the deterioration of the economy in the last couple of months to increase our IBNR charge significantly for future losses.”

Loans to customers were up 5 per cent, with mortgages up 10 per cent while non-mortgage lending grew by 2 per cent.

Mr Sheehy said the decline in lending to companies was a reflection of lower demand as confidence in the business community declined.

He said for investors the crucial indicator was the level of capital at a bank. “In that respect we would stand up very well compared to international banks. We have a strong capital base and after the Government investment we will have a proforma balance sheet total capital ratio of 13 per cent, which is very strong.”

Despite a weak outlook he said the bank would generate “very strong pre-provision profits and that keeps on replenishing capital that you lose writing off bad debts”.

“We have a franchise business, retail commercial banking in 13 different countries which generates revenues year-in, year-out, and that gives you a lot more resilience in the cycle.”

Asked for his reaction to comments by Minister for Transport Noel Dempsey over the weekend – who compared the damage to the country caused by the banking crisis to that wrought by Oliver Cromwell - Mr Sheehy said the Minister was reflecting public anger.

He also refuted any suggested that he should step down, saying there was a “big job to be done” at the bank. “I want to lead the bank over the next few years to make sure that we can recover”.

In relation to pay Mr Sheehy said he had reduced his salary by 10 per cent last October and by a further 25 per cent last month and would waive all bonuses or pay increases for the remainder of his career.

He said the bank’s board members have also waived 25 per cent of their fees. “I believe we have a good board and a very committed management team here. We built up this bank over generations. We know how the business is run.”

The bank is not paying a final dividend. The bank’s operating profit was €2.7 billion, up 18 per cent, helped by cost-cutting measures.

Sebastian Orsi, an analyst with Merrion Capital, said while last year's cost control and revenue growth were strong the overall trends for this year were concerning."Certainly it's not going to be a set of results that drive a lot of conviction in the stock in the short-term," he said.

AIB’s finance director John O'Donnell said the bank has seen an outflow of institutional deposits but said the withdrawals were not significant

"There have been some outflows but nothing of any significance," O'Donnell told Reuters in an interview, adding that AIB's deposit bases in Ireland, the UK and in its corporate banking and capital markets divisions were very stable.

Mr O'Donnell declined to give an estimate for bad debt provisions or for underlying earnings for 2009 saying the markets were too volatile. "It's just impossible," he said.

AIB said it expected loan growth to be very modest this year and its net interest margin to be down on the 2008 level. "We think loan growth will be very modest, if any," Mr O'Donnell told analysts.

"I would say the margin ... underlying business, excluding any treasury effect, I think it will probably be down slightly."

Mr O'Donnell said that AIB's Treasury division had a strong start to the year as it was well-positioned in relation to declining interest rates. Other divisions, he said, were "doing well."

The bank said it has €15.5 billion of "criticised" loans, a term used to describe

loans that require closer management. This accounts for 11.7 per cent of its loan book and 80 per of these loans are from its operations in the Republic with a further 14 per cent from the UK. This compares to AIB’s exposure to criticised loans of €6.8 billion or 5.3 per cent of loans in 2007.

Under a “stress scenario” loan provisions could rise to €4 billion in 2009 and €2.65 billion in 2010, the bank said in a presentation.

That estimate is based on the Irish and UK economies remaining in recession this year and next and house prices falling as much as 50 per cent from peak values.

The Government is injecting €3.5 billion into AIB and the same amount to Bank of Ireland to bolster their capital position and revive the flow of credit to a rapidly shrinking economy.

But AIB's shares have fallen by nearly two thirds since the recapitalisation scheme was announced in mid-February reflecting the market's view that it is not enough.

The core Tier 1 ratio, a measure of financial strength, fell to 5.8 per cent from 6 per cent last year. Following the Government recapitalisation the bank said its core tier one capital ratio should rise to 8.4 per cent.

Broken down by sector, AIB's retail banking business in the Republic of Ireland incurred an impairment charge of €1.3 billion, or 174 basis points with property and construction accounting for 81 per cent of the bad debt provision.

Overall loan growth was 8 per cent, lower than previous years, due to lower demand and an increased focus on maintaining a strong funding position.

As a result the loan-to-deposit ratio fell to 140 per cent, from 157 per cent a year earlier. Net interest income was €1.7 billion, down 4 per cent compared with 2007.

Pre-tax profits at AIB Capital Markets were 13 per cent up at €585 million while profits at its investment banking operation fell 72 per cent due to market turmoil over the last year.

Profits from AIB’s UK operations were 61 per cent lower at €190 million.

At 9.35am shares in AIB were over 14 per cent higher at 44 cent. The shares have lost over 96 per cent over the last year and have fallen from record highs of €23.95 in February 2007.

Additional reporting Reuters