Irish banks' asset quality denting rating, says Fitch
AIB and Bank of Ireland's weak asset quality is hindering their chances of getting a ratings upgrade, Fitch has warned.
The ratings giant said the "volatility" of Ireland's economic cycles and high private sector indebtedness are likely to constrain their ultimate rating levels.
And it also warned about that both banks could end up vulnerable to a shock on the commercial property front.
"Weak asset quality is the key vulnerability for Irish banks, in our view, and this constrains their fundamental credit worthiness," Fitch stated.
Fitch said its assessment of asset weaknesses included a high proportion of troubled loans in the system, very low yielding loans, defaulted but not impaired loans, and restructured loans.
But there were some positives. The ratings agency said both banks had made progress in reducing problem assets.
It pointed to data released by the European Banking authority in November which showed that Irish banks have been among the most active in cutting the stock of bad loans.
But it warned that more work was required, stating asset quality was fragile and saying working through the back log of impaired loans at Bank of Ireland and AIB would take time.
"We estimate that net impaired loans as a percentage of Fitch core capital has fallen to just below 100pc for Bank of Ireland for the first time in seven years.
"For AIB, this ratio was significantly above 100pc but once end-2015 figures are published, there will be an improvement because the bank will have converted some of its government-held preference shares into common equity. At their worst, the banks' net impaired loans represented 555pc (BOI) and 400pc (AIB) of Fitch core capital."
"While capital ratios at BOI and AIB strengthened significantly over the past six months, we believe the banks could still be vulnerable to severe shocks. In particular, we are monitoring developments in Ireland's commercial real estate market (CRE).
"Irish banks are not expanding aggressively into this type of financing but the market is particularly cyclical and investment levels currently exceed pre-crisis levels."
The agency said international and domestic investors are driving the expansion, but added that the expanding commercial property sector could be vulnerable to changes in investor sentiment, so significant expansion in commercial property financing at Bank of Ireland and AIB would therefore increase risks.
Fitch said economic growth in Ireland was strong last year, with growth rates well above the average reported by other Eurozone countries. "Fitch forecasts GDP growth of 2.4pc in 2016 and this provides a supportive operating environment for the banks," it said.
"Private sector indebtedness at 150pc of GDP is similar to the UK, but the Irish central bank highlighted in its 2Q15 quarterly bulletin that debt overhang is still a problem for many households in Ireland."