Bank of Ireland revealed on Friday that it has taken a more cautious view of the riskiness of its mortgage book in a pre-emptive move before the European Central Bank carries out a review of euro zone banks next year as new standards are adopted.
The move has served to lower the bank’s capital ratios, which is likely to weigh on the board’s deliberations on whether it can return to paying a dividend next year for the first time since 2008, as planned.
To partly offset the capital impact, however, the lender said in a statement it has taken out a complex insurance contract against potential bad loan losses on €3 billion of business banking and corporate loans with a “small group of international investors.”
Banks must assess the riskiness of various assets as they calculate how much capital they must hold against unforeseen losses. Bank of Ireland, led by chief executive Richie Boucher, said in the statement it has revised its calculation of capital requirements on its non-defaulted mortgage loans in the Republic in advance of the ECB’s “targeted review of internal models due to commence early next year”.
As a result, this has increased the bank’s so-called pro-forma average credit risk weight on mortgages in the Republic to 34 per cent. A spokesman for the bank said that the ratio was previously 26 per cent.
The overall impact of the mortgage book reassessment will see 0.6 percentage points being shaved off its common Tier 1 capital ratio, a key measure of a bank’s financial strength. At the end of September, the bank had a ratio of 10.5 per cent.
However, the bank has moved to ease capital requirements elsewhere by agreeing a deal where a group of international investors will share loan loss risks on a €3 billion business banking and corporate loans portfolio. The unidentified investors have effectively agreed to take the risk of €185 million of loan losses on the portfolio in exchange for an annual interest payment of €21 million, equivalent to a 11.4 per cent rate.
The contract was carried out by way of an insurance contract, known as a credit default swap.
“The transaction reduces the group’s credit risk exposure, and consequently, the risk weighted assets of the reference portfolio of loans, through a risk-shareing structure,” the bank said.
Davy analyst Diarmaid Sheridan said that the contract is the first of its kind among Irish retail lenders.
Crucially, the assets remain on the bank’s balance sheet and the bank’s relationship with business and corporate customers is unaffected.
The contract boosts the bank’s key capital ratio by 0.4 percentage points. Taken together with the mortgage book development, the overall reduction in the ratio is 0.2 percentage points, or 20 basis points.
Mr Sheridan said that an expected narrowing in the final quarter of the year of Bank of Ireland’s pension deficit, which doubled to €1.45 billion in the first nine months, will come as a welcome help to the bank as it considers whether to return to paying dividends to shareholders when full-year results are reported early next year.
The pension has benefitted from a rebound in bond yields globally as investors expect an acceleration of US interest rate increases following the election of Donald Trump as the country’s next president. Mr Trump has promised to push through a massive stimulus plan when he takes up office.
“Net-net, a 20 basis point impact to capital is unlikely to materially alter dividend considerations,” Mr Sheridan said.
Shares in Bank of Ireland fell as much as 2.1 per cent in early trading on Friday. However, a market index for the wider European banking sector rose 1.2 per cent as investors cheered news that Deutsche Bank and Credit Suisse had settled US mortgage securities probes, while a bailout of Italy’s oldest bank, Monte dei Paschi, was approved as the country’s government seeks to end a protracted banking crisis that has hit the economy.
