Negative outlook for Irish banking system

The fundamental credit outlook for the Irish banking system is negative, reflecting the increased potential for a further weakening in asset quality, loan volumes and profitability in a domestic economy that is now in recession, Moody's Investors Service said in its new outlook for Ireland.
"The Irish economy is now in recession, primarily due to a more pronounced weakening of the real estate market. This is likely to result in a substantial increase in bad debts for lenders, especially in the residential development sector, as well as lower lending volumes and weaker profitability," explained Ross Abercromby, a Moody's Vice-President/Senior Analyst and author of the report.
"At the same time, the dislocation in the global markets has continued to weigh on the Irish banks' ability to raise funding — one result of which was the recently announced two-year guarantee from the Irish government for banks' deposits, senior debt, covered bonds and dated subordinated debt," the analyst added.
Moody's views the guarantee positively, and has assigned backed-Aaa/Prime-1 ratings to securities maturing within the guarantee period, as it should restore market confidence into the institutions' liquidity.
However, as such support had been already factored into the current ratings and given the temporary nature of the two-year guarantee, this will not impact the long-term bank deposit ratings or debt maturing after the end of the guarantee period of the six institutions.
Moody's also noted that some of the Irish banks display relatively lower levels of capital that have left them less well prepared as they have entered a more challenging operating environment. However, Abercromby explained that "the six institutions covered by the guarantee have all been required to deliver revised business plans to the regulator in the last week and Moody's expects capital adequacy to be a key factor in these, therefore given the capital injections seen at other banks across Europe and the USA Moody's would not rule out a similar process in Ireland. As part of this process Moody's would also expect to see some consolidation in the Irish market."
Overall, however, Moody's continues to believe that the financial strength of the Irish banking sector is relatively solid. The two largest banks — Allied Irish Banks and Bank of Ireland — have strong franchises supported by diversification of earnings and relatively good liquidity underpinned by a broad range of funding sources and stable, and indeed growing, deposit bases. These strengths mitigate the large exposure that the banks have to the country's residential and commercial real estate markets.
The smaller institutions tend to be more focused on certain markets — e.g. in commercial property or residential mortgages — or are subsidiaries of foreign banks. The less diversified institutions tend to be rated at lower levels and, given their concentration on the Irish property market, Moody's views them less positively in the current environment.
Moody's has taken rating actions on ten entities within the Irish banking sector since the start of the credit crisis, for a variety of reasons, including downgrades of parent banks, deteriorating asset quality and the expectation of higher provisioning. Given the rapid deterioration in the economic outlook, further downward adjustments of ratings are possible in 2008 and 2009.