I thank the Chairman for his comments. Once again I thank the committee for providing AIB with this platform to give the Oireachtas and, ultimately, the public a detailed update on the bank’s progress. This is my fifth opportunity since I became AIB’s chief executive to meet this committee and, as the committee knows, it is likely to be my final meeting. I am sure the committee will have some support with that, but I have enjoyed these meetings and the dialogue we have had here. The meetings over the past three years have been robust, but always constructive. These engagements allowed my team and me to explain as openly and frankly as possible our strategy to stabilise the bank and ultimately to move to a position of sustainability. Our discussions with the committee informed and helped frame our subsequent decision-making. We did not always necessarily agree but we have held a common goal to rebuild AIB from its distressed state after the crisis into a profitable bank equipped to support the Irish economy, to prioritise professional service for our customers and, over time, to seek to return to the Irish taxpayers the support they provided in such large measure. My colleagues have been introduced by the Chairman so I will not repeat those introductions.
I am prepared to leave AIB in the confidence that the management team will continue to lead the bank towards delivering our strategic objectives, putting our customers at the heart of our business and playing a pivotal role in Ireland’s economic recovery. After a period of transformation over the past three years, the bank’s financial performance has improved, with profits before tax in 2014 of €1.1 billion. The bank’s impaired loan balances have been reduced by 23% to €22.2 billion during the year and lending approvals stand at over €13 billion. Progress has been made in reducing mortgage arrears with a 22% reduction in arrears for private dwelling homes in Ireland in 2014 and the bank is in a position for the first time to make a €280 million cash payment to the State on the preference shares.
AIB’s recovery over the past number of years has had to be a fine balancing act. Most obvious, it had to be done in tandem with implementing solutions for customers in financial difficulties while protecting taxpayers’ capital and, at all times, attempting to return the financial metrics of the bank to sustainable levels both in terms of margin and the bank’s cost base. It is particularly appropriate that AIB has this forum, at this time, to set out its perspective in terms of a number of issues that are currently the subject of widespread public debate. We have already sent the committee detailed responses to its advance queries but I would like to highlight a number of issues.
Let me begin with the mortgage interest rate charges and, in particular, the standard variable rate. First and foremost, let me explain that AIB’s mortgage pricing reflects consideration of a number of points, the first being the cost of risk attached to a loan. The impact of the recession on the mortgage market in Ireland triggered one of the highest loan arrears and default rates in Europe and, unfortunately, as a result, the level of risk in lending to Irish mortgage customers is proportionally higher than the rest of Europe and has to be factored into our pricing decisions. Thankfully this cost of risk is declining as economic conditions improve and arrears levels reduce. The bank remains focused on further reducing the level of arrears and impaired loans on its balance sheet in the coming period.
The operating costs of running AIB were €1.4 billion in 2014. This represents a reduction of €350 million compared to 2012 levels, following a significant reduction in head count, general administrative costs and progress towards a more efficient operating model. The bank remains focused on ensuring the group is run as efficiently as possible from a cost perspective, while ensuring its customer service levels are appropriate and its systems and processes are robust.
Given its credit rating, the cost of funding for AIB is different to the simple average of other banks across Europe. The narrative that AIB is able to fund itself at the ECB base rate is simply not the case and is an overly simplistic assessment of a much broader set of circumstances. It is important to note that only 3% of AIB’s funding is sourced from the ECB. This is an important point to consider in regard to the debate later today. The bank’s funding costs have certainly improved over the past number of years and it remains focused on further reductions, based on market conditions.
On the need to generate sustainable and viable returns for shareholders, AIB as a commercial and systemically important institution must ensure that lending is at sustainable rates to ensure it is able to generate a return for shareholders but also to rebuild its capital in order to insulate against any future adverse shocks. AIB’s net interest margin in 2014 of 1.69%, excluding ELG costs, increased in the year, but was still below average bank levels across Europe. Given AIB is currently 99.8% owned by the State, the majority of any profits generated by the bank are ultimately to the benefit of the State. In incorporating lessons learned from the recent painful past, the bank cannot return to a situation where its lending decisions are being undertaken on any basis other than a medium to long-term view of sustainability and viability.
Over the past number of years, the bank has worked to improve all of these metrics in the context of creating a sustainable business model capable of supporting economic recovery while also seeking to create an investable model so that over time the bank can start to return capital to the State. As a result of the bank’s underlying positive performance and improvements in funding costs and the cost of risk, in December 2014, AIB, EBS and Haven implemented a number of reductions to mortgage rates. For example, the move meant savings of approximately €330 per annum for customers with a mortgage of €200,000 on a 25 year term. If a customer with a similar mortgage chose to move to a two or three year fixed rate option of 3.8%, this would have resulted in savings of €800 per annum. Importantly, the reductions we implemented benefited both new and existing customers.
Further rate reductions for AIB customers, existing and new, are something that my team and I continue to consider. However, it is critical to bear in mind just where this bank has come from. In just over a three year period, AIB has moved from reporting multi-billion euro losses to €1.1 billion in profit in 2014 - into profit for the first time in a number of years. Considering all of the factors outlined, when the appropriate opportunity arose late last year, we moved to cut variable mortgage interest rates for our customers. We must maintain a balance between securing the bank’s present and future financial health, preserving and building capital to fuel the economy and repaying the State the sums invested in the bank, while all the time providing our customers with appropriate and sustainable lending rates in the market.
The bank is carefully monitoring the variable components that influence interest rates and will act accordingly in favour of our customers on mortgage rates. We did so after looking at the facts involving all of the elements I have outlined in this letter. There is no ECB rate. It is just not relevant to AIB and we are not funding at some cheap rate in Europe. That is just 3% of our funding. We have a much higher funding rate and in addition we have the cost of risk and the cost of running the bank. We can only charge a rate above those costs if we are to maintain a margin. If we charge below those costs, we will have a loss making bank. Previous tracker rates are an example of that, where the cost of funding, the risk cost and the management of the bank costs were higher than the rates charged on tracker mortgages. We do not want to go to that place again.
That said, as we looked at the four elements to which I referred earlier, the last variable rate cut we made was when we looked at those elements and asked whether if we made a rate cut we would still maintain a position of sustainable profitability in the bank. If so, we could pass on that rate cut to our customers. Our principles have been to run the bank on a commercially viable basis, with sustainable profitability and yet to be fair and equitable in the treatment of our customers. That is how we arrived at our decision of December 2014. As we look at the variables, we see a continuing positive trend this year. We will consider those four variables and if we see that trend continue over the next couple of months, towards our half year financial year, we will consider making a further rate cut. However, that will be decided on the basis of those variables, cost of funding, our cost to manage the bank and our risk operating costs. If all of those costs reduce, as they have in the past, we will be willing to consider another rate cut in the next couple of months. We will look at our financial performance in that window.
This completes my additional supplement, which I make for the sake of clarity, as our position seems to have been defined in the media. I would rather it be clear today, but we can discuss it further.
I also want to refer to the question of mortgage arrears. Apart from dealing with the commercial impact of distressed loans on the bank’s balance sheet, we absolutely share concerns at the societal consequences of the ongoing difficulties associated with legacy debt. Reflecting this concern, our trained staff deal with customers who continue to experience financial stress and we work tirelessly to arrive at sustainable solutions that will allow them to emerge from arrears. I have said it many times before and reiterate again today that AIB aims to keep people in their homes where possible, if customers engage with us. With that as our primary motive, we have put in place what we believe to be the most comprehensive set of permanent arrears solutions in the market. Where there is no affordability of any form of mortgage repayment, a loss of ownership may be the appropriate solution, but we believe we have a pragmatic approach to residual debt, recognising that one cannot restructure where there is no affordability.
We have engaged with third party channels such as the IMHO for those customers who feel they cannot come directly to the bank. We pause the legal process when customers engage with us and enter a sustainable restructuring arrangement. While we have much more to do, the success of this approach is borne out in our most recent set of results, with overall arrears levels in our mortgage portfolio in the Republic reducing by 18% in 2014 and owner-occupier arrears falling by 22% and buy-to-let arrears down by 7%.
Similarly, as we seek to protect employment and viable businesses, solid progress was achieved for non-mortgage customers who typically have exposures across a number of asset classes, including SME debt, associated properties and buy-to-let mortgages. At the end of last year, a total of €4.7 billion of non-mortgage loans were subject to forbearance and we continue to constructively engage to offer restructures to our customers in 2015. The improving economic climate in Ireland is translating into an increased appetite for credit, with growth in the personal, business and corporate banking segments of the market. In 2014, we approved over €13 billion of lending in Ireland and our lending draw downs to our customers were 42% higher than the previous year, including our mortgage and business customers. We continue to have capacity to lend and we remain focused on supporting our customers, jobs and the broader Irish economy. These figures are reflective not only of the improving economic backdrop in our main markets of Ireland and the UK but also speaks to the underlying ability of the bank to lend prudently to our customers in the future.
While the bank has made enormous progress in recent years, we are planning for the challenges that lie ahead. We continue to focus on rebuilding the trust and confidence of our customers and improving customer service levels. We have previously indicated that we are in discussions with the Department of Finance over the future capital structure of the bank and while I am not in a position to discuss this in any detail, these considerations are continuing.
On behalf of AIB, I want to express thanks to the committee for inviting us here today and for the huge support the State has given this bank. On a personal level, I want to acknowledge the help of the Oireachtas in the course of my work as chief executive of AIB over the past three years. The bank will continue to approach with vigour the challenges ahead. As a public company with a commercial mandate, AIB has to balance the requirement of generating value for our shareholders, most principally the Irish taxpayer, with the requirements of our customers who also need the support of the bank.
In summary, AIB today is a profitable business, generating capital for shareholders. It has received EU approval for its restructuring plan, has passed the ECB stress tests, is reducing arrears levels and overall levels of impaired loans and is well positioned from a funding, capital and liquidity perspective to prudently lend over time and support the country’s economic recovery. We look forward to any questions.
