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Strong internal capital generation is a key strength of our business model and this will result in growth of the Bank’s core equity in excess of 20%, whilst continuing a progressive dividend policy. This inherent capital strength positions the Bank well in the current testing environment for the sector, where we expect credit impairment to rise and the higher cost of funding to remain.
The Bank’s performance in 2008 demonstrates the resilience and strength of our business model. Expected highlights for the year will include:
• Growth in earnings per share of c.15%
• Strong asset quality with a lending impairment charge of between 0.13% and 0.18%
• Net interest margins broadly stable year on year as increasing lending margins partially offset higher funding costs
• Continued active management of the cost base
• Controlled loan growth of c.15% for the year equating to approximately 5% in the second six month period reflecting our cautious and selective approach to new lending
• Strong balance sheet with a significant high quality liquidity portfolio
• Customer deposits representing approximately 60% of total funding
• Immaterial net residual exposure to assets impacted by market dislocation
• Significant equity capital generation in the year with an expected Basel II core equity ratio of close to 6%.
Business performance
Business lending
We anticipate net lending growth of approximately 15% for the full year. We continue to control loan growth in the second half of the year and have adopted a very cautious and selective approach to new lending opportunities. This strict lending policy will be maintained in 2009 with loan growth moderating further, predicated on sustaining our strong balance sheet. Lending is currently attracting increased margins and we expect this re-pricing to continue.
Lending asset quality
Notwithstanding the difficult environment, lending asset quality continues to be robust. We expect a lending impairment charge for the year of between 0.13% and 0.18%. Looking forward, impairment will continue to increase from historically low levels but we expect this will be maintained at a rate that reflects our strong underwriting standards and the focused and specialist nature of our business model.
Key aspects of our underwriting model that will mitigate against losses include:
• Professional, experienced and well capitalised client base;
• Strict focus on cash flow loan serviceability;
• Experienced and focused lending underwriting teams, specialists in their sectors;
• Centralised risk and underwriting model ensuring consistent decision making with early identification and proactive management of issues;
• True relationship lending with a high proportion of personal recourse;
• Senior debt lending protected by client equity and secured by a first legal charge on tangible assets. Further cross collateralisation with legal security over clients’ wider asset portfolios;
• Traditional on-balance sheet lender - no transactional or ‘bought’ loans;
• Independent assessment by Group Risk of each and every loan several times a year.
The majority of the Bank’s loan book in Ireland, the UK and North America is secured investment or owner occupier business lending supported by contractual rental or operating income. This lending is performing well, as cash flows derived from diverse sectors of the service economy remain strong. We continue to monitor both client and underlying tenant performance closely given the current economic environment.
The Bank’s commercial and residential development lending is to experienced, well capitalised and proven clients, often supported by existing cash flows from their investment portfolios through cross collateralisation. The commercial portfolio, which has limited speculative exposure, continues to perform satisfactorily and there has been no significant increase in impaired loans within this area.
The Irish residential development sector has continued to deteriorate due to more restricted mortgage availability, particularly in the last quarter. This sector accounts for some 7% of the Bank’s total loans and the majority of clients are well established and sufficiently strong to service their facilities through a protracted downturn. However, this sector represents the principal risk to future impairment and is a key focus for management as we work to proactively mitigate against any potential losses.
Assets impacted by the current credit market dislocation
The Bank has no direct exposure to US or other subprime sectors and does not sponsor any off balance sheet vehicles. Similarly, the Bank has very limited indirect exposure to assets impacted by market dislocation and has no residual exposure to Structured Investment Vehicles. In estimating full year profits we have allowed for additional write-downs in respect of our holdings in assets indirectly linked to US subprime. Accordingly, we do not anticipate material write-downs of treasury assets in 2009.
Funding
Against a background of sustained wholesale market dislocation, the Group continues to benefit from our strong customer funding franchise where we source c. 60% of total funding. This core franchise, which has been built over the last 30 years and now spans 16 international markets, provides an attractive source of durable and granular funding. The heightened level of competition across the sector has resulted in increased funding costs for all participants. We expect funding costs to remain at a premium for the foreseeable future.
In the global wholesale markets we continue to have good access out to one year duration. In addition, we have sourced longer term funding through structured instruments, private placings and bilateral repo transactions. The Bank’s liquidity position remains strong with a significant surplus to operating and regulatory requirements.
Capital strength
The Bank consistently generates significant internal equity capital given the annuity and low volatility nature of our earnings stream, combined with our highly efficient cost structure. With controlled risk asset growth, and profit retentions of c. €1 billion in the current year, the Bank’s Basel II core capital ratio will rise close to 6% at 30 September 2008. The ratio is expected to strengthen further to in excess of 6.5% in the subsequent period without recourse to additional external equity capital. With close to 100% of our lending secured, and insignificant trading exposures, this level of capital is conservative relative to the Bank’s risk profile, but we consider it appropriate in the context of the prevailing environment.
The Bank operates under the Basel II Standardised method and therefore has not benefited from reduced risk weightings on lending assets. Accordingly, the pro-cyclical effects of Basel II should not result in any material impact on our capital requirements.
Outlook
We are confident our strong underwriting standards, centralised structure and ownership culture will serve the Bank well during this down-cycle. As virtually all lending is secured by tangible collateral, our total provisions comfortably exceed our net exposure to impaired loans. Furthermore, even allowing for a lending impairment charge in line with the 2009 market consensus of 0.7%, some four to five times the anticipated current year level and above management expectations, the Bank would remain highly profitable and capital accretive in 2009.
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