Earnings Call: H2 2016

Feb 24, 2017

Okay. Good morning, everyone. Welcome to our annual results for the 12 months to the 31st of December, 2016. Thank you to those of you who are joining us here in Dublin and also who are able to join us by call and on the webcast. I am going to give a short presentation, after which Andrew Keating, our Group CFO, will provide a more detailed review of our financial performance. I will then sum up our priorities going forward before we move on to questions and answers. At our 2015 results presentation last February, I outlined our strategic priorities for the year ahead, focusing on three key areas, customers, profitability, and capital. During 2016, Bank of Ireland has continued to deliver against these strategic objectives. We continue to develop relationships with both existing and new customers as we leverage the strength of our customer franchises. Bank of Ireland has been the largest lender to the Irish economy over the past three years, advancing EUR 6.7 billion to our customers in Ireland during the past 12 months. Our core loan books have continued to grow, up by EUR 1.7 billion over the past year. The significant progress we have made in recent years on non-performing loans has been maintained. Our NPLs have reduced by over EUR 4 billion, with reductions right across our portfolios. We generated an underlying profit before tax of just under EUR 1.1 billion, with all of our trading divisions contributing to this result. We have significantly increased our net interest margin in the second half of the year, and our impairment charges reduced by 40% to 21 basis points. As I have consistently said, our priority is to generate and protect capital. In 2016, we once again delivered strong organic capital generation, and as a result, our capital ratios have increased by 100 basis points to 12.3% on a fully loaded basis, and the transitional ratio has also increased to 14.2%. This time last year, we set out our aim to have a sustainable dividend building up to a 50% payout ratio. Last July, I stated that the timing of the first payment may be impacted by external factors, such as the significant volatility in bond yields and the U.K.'s decision to leave the European Union. As we continue to generate capital and as additional clarity emerges on these external issues, including stability in bond yields, we expect the first payment to be made in the first half of 2018. We generated an underlying profit before tax of EUR 1.1 billion. Total income of EUR 3.1 billion, flat operating expenses, and a EUR 120 million in our impairment charge were the key factors underpinning the strong performance. We have also commenced a major investment to replace our core banking platforms, and I will discuss these in more detail shortly. Looking now at the group balance sheet. Bank of Ireland's core loan books continued to grow. They did so by EUR 1.7 billion during 2016. While on a headline basis, customer loans reduced by EUR 6.2 billion, this was almost entirely due to the FX translation impact arising from a 16% fall in sterling, along with material reductions in non-performing loans and in Irish tracker mortgages. Turning to asset quality, our non-performing loans reduced by EUR 4 billion, that is 34%, and we generated 130 basis points of organic capital during 2016, increasing our capital ratio to 12.3%. The economic backdrop in our core markets has remained supportive for our businesses. Aided by growth in consumer spending and exports, Ireland is set to be the fastest growing economy in the Euro area for the third year running. This reflected increased consumer and business confidence arising from strong job creation and earnings growth. Residential and commercial property prices are increasing, and the unemployment rate is at a multi-year low. Notwithstanding the decision to leave the European Union, the U.K. economy also expanded in 2016, benefiting from growth in consumer spending, employment, and real incomes. Looking ahead, we're expecting some economic expansion in both economies in 2017. We're cognizant of the U.K.'s decision to leave the European Union and will remain vigilant, carefully assessing any impact on our risk profile and potential growth trajectory. Bank of Ireland has developed attractive businesses operating in economies that are growing. As a group, we've made conscious decisions to retain and invest in businesses where we have sustainable competitive advantage. We generated about 70% of our total income from our Irish businesses. We are Ireland's only bank assurer, the leading retail and commercial bank, and our number one or number two market positions in all sectors. Bank of Ireland continues to be the largest lender to the Irish economy while maintaining strong commercial discipline on margins and return. Given the strength of our franchise in Ireland and the sustainability of the market structure, we are well-positioned to continue to play our part in supporting and benefit from ongoing Irish economic growth. We've also developed attractive international businesses. Our international diversification provides additional opportunities to deploy our capital and liquidity in the way that meets our risk and return hurdles and allows us to develop and grow profitable businesses. About 20% of our total income was generated in the U.K., where our U.K. bank is a separately regulated, capitalized, and self-funded business. Bank of Ireland's U.K. businesses are focused on the consumer sector, primarily through a long-established partnership with the Post Office and a more recent partnership with the AA, two of the U.K.'s most trusted brands. Our partnership and commission-based business model in the U.K. provides us with flexibility to adapt quickly to market developments as they arise. About 10% of our total income was generated through our predominantly U.S. and European acquisition finance business. This business has a strong track record over the past 20 years and continues to perform strongly. Like all banks, our customers' preference for the way they chose to interact with us are changing, and their financial requirements are evolving. We too are evolving to meet these changing needs by developing our customer channels, processes, and propositions, so as to meet these needs efficiently and cost effectively. We're investing in our digital and direct offerings and transforming the role of our branches to being business development hubs in their communities. At all times, we're looking at ways to make our customers' engagements with us easier and more efficient. We've developed our infrastructure and processes to respond to changing customer preferences. We've made substantial progress in simplifying our products and processes during the year, and we are gaining valuable customer insights. As we look forward, we must ensure that we're strategically positioned to underpin our franchise's future generations. To meet this objective, the next step in our business transformation is investing to replace our core banking platforms. This investment is critical to building a customer centric, robust, flexible, and efficient organization. This will be a multi-year investment and business transformation program. With the Bank of Ireland Group in the lead, we are working in conjunction with our implementation partners who have a proven track record globally in delivering best practice core banking systems. We are adopting, integrating, and moving on a phased migration basis to more scalable and modern platforms, which will lead to the decommission of legacy systems and activities and reduce our cost to serve and our costs of change. Once integrated, this infrastructure will provide integrated digital channels, powerful customer analytics, support business growth, and provide strategic optionality. Together with the structural cost efficiencies from the simplification of processes and a materially enhanced IT infrastructure, our investment will be a critical enabler in the achievement of our 50% cost income ratio target over the medium term and will position Bank of Ireland for long-term sustainability and competitiveness. Thank you. I am going to now hand over to Andrew, who will take you through the financial results. Okay. Thank you, Richie, and good morning, everyone. 2016 has been another strong and profitable year for Bank of Ireland, and we are focused on growing our sustainable profits. We increased our net interest margin by 16 basis points in the second half of the year. Operating costs have remained constant in recent reporting periods. We reduced our non-performing loans by 34%, and our capital ratio grew by 100 basis points in 2016. I will now take you through the financial statements in more detail, starting with the group's income statement. We delivered an underlying profit before tax of almost EUR 1.1 billion. A solid income performance, tight control of our costs, and lower impairment charges were the key factors underpinning this result. Our net interest income was EUR 2.3 billion. While that is lower than last year, it is primarily due to the foreign exchange translation impact from the fall in the value of sterling, the impact of the ongoing low interest rate environment, and lower income from our liquid asset portfolios. Other income was EUR 842 million, and this includes business income, which was over EUR 600 million, and additional gains of EUR 171 million. 2016 was the last year when we incurred ELG fees. Following the actions we took during the year, none of our liabilities remain covered by that guarantee. Operating expenses were EUR 1.75 billion, in line with last year, albeit benefiting from the weakness in sterling. Our asset quality continues to improve across our asset classes, and that is reflected in a 40% lower impairment charge of EUR 178 million. Turning now to our trading divisions, all of which continue to be profitable. In Retail Ireland, we continue to be commercially disciplined in the competitive mortgage market. We are the number one bank for Irish businesses, providing 50% of all new lending to the SME sector. We are the only bank assurer in this market, and our subsidiary, New Ireland, is the second largest life assurance company. We continue to be Ireland's number one corporate and treasury bank, and our international acquisition finance business is performing strongly within a disciplined risk appetite. Our Retail UK division is investing in our consumer banking businesses, further developing the exclusive financial services partnerships with the Post Office and more recently, the AA. I will now provide more detail on the key components of our income statement. As I noted previously, our net interest income was EUR 2.3 billion. Two factors here, volume and margin. On volume, while our average interest earning assets fell during the year, that was almost entirely related to the fall in the value of sterling. On the margin side, our net interest margin grew strongly during 2016. From that margin of 211 early in the year, we increased our margin to 227 basis points in the second half. This increase reflects our strong commercial discipline in the price of new lending, lower deposit costs, particularly in the U.K., and the repayment of the CoCo last July. Looking forward to our net interest margin in 2017, we expect further modest growth from that H2 level. Moving now to customer lending. Our core loan books grew by EUR 1.7 billion in 2016. We continue to be the largest lender to the Irish economy. Due primarily to the weakness in sterling, customer loan volumes decreased in reported terms at the end of the year. New lending during 2016 was EUR 13 billion, and that is slightly higher than the previous year on a constant currency basis. New lending volumes in Ireland were EUR 6.7 billion and we are continuing to play our part in supporting and benefiting from Irish economic growth. International new lending reflects FX translation impacts, together with strong pricing and risk discipline. Redemptions amounted to EUR 14 billion across the group, and that is broadly in line with the previous year. Of this, over EUR 2.6 billion relates to cash we received from the reduction in our defaulted loans, redemptions in our low-yielding Irish tracker mortgages, and the rundown of our non-core book in Great Britain. We will continue to maintain an appropriate focus on pricing and risk throughout 2017. Turning to fees and other income, which totaled EUR 842 million. This includes business income of EUR 621 million, and that is consistent with previous reporting periods. Additional gains were EUR 171 million, and they reflect the sale of shares in Visa Europe, the rebalancing of our liquid asset portfolio in the earlier part of the year, and the sale of certain other assets. Turning to operating expenses, which were EUR 1.75 billion last year. We continue to maintain tight control over our costs while investing appropriately in our businesses. For each of the last three half-year reporting periods, we have kept the operating expenses flat, including on a constant currency basis. Staff costs increased last year by 1%, and that was primarily due to our career and reward framework, which is completely aligned with our strategic objectives. Levies and regulatory charges amounted to EUR 109 million for the year, and we expect these charges to be at broadly similar levels in 2017. As Richie has outlined earlier, we're transforming our business, including a multi-year investment program to replace our core banking platforms. Last year, we invested a total of EUR 105 million in this program, of which EUR 41 million was charged directly to the income statement and about EUR 60 million was capitalized. We expect that the future investments in this program will be split approximately half and half between the income statement and the balance sheet. These investments will enable us to drive efficiencies and will be a critical enabler in the achievement of our cost income ratio target of less than 50% over the medium term. Turning to asset quality. Our asset quality continues to improve. In 2016, we reduced our non-performing loans by EUR 4 billion. That's a reduction of 34% last year. It means that over the last two years, we've reduced our non-performing loans by 50%. Defaulted loans have also reduced significantly. They're down to EUR 6.9 billion at December. Looking forward, we expect to achieve further reductions in 2017 and beyond. Our net loan impairment charge for last year amounted to EUR 178 million, or 21 basis points. That's 40% lower than last year and 65% lower than two years ago. We expect our net impairment charge for 2017 to be at broadly similar levels. We're reducing the NPLs right across our portfolios. Particular highlights are the EUR 0.8 billion reduction in Irish mortgages, where our level of arrears for owner-occupier customers is now just one-third of the industry level. Separately, the EUR 2.1 billion reduction in our property and construction NPLs, and that's down 60% since 2014. Turning to funding and capital. We have the capital and liquidity to support our growth and to achieve our strategic objectives. All of our liquidity ratios continue to be robust. We're primarily a deposit-funded institution, and our customer deposits account for more than 95% of our loans. Our strong liquidity position allowed us to buy back circa EUR 1 billion of relatively expensive debt during 2016. The rating agencies are recognizing the progress that the group is making. For example, last month we received an upgrade from Standard & Poor's. Turning now to capital. The group's transitional CET1 ratio increased by 90 basis points to 14.2% at the end of the year. The group's fully loaded CET1 ratio increased by 100 basis points to 12.3% at December. The increase in our capital ratios is driven by our strong organic capital generation, together with an improvement in our pension deficit. We're investing some of that capital in transforming our business. In 2016, the EUR 105 million investment in our core banking platforms equated to an investment of 20 basis points of capital. Over the next four years, we expect to invest circa 35-45 basis points per annum in this transformation program. Finally, in terms of capital guidance, the group expects to maintain a CET1 ratio in excess of 12%, and that includes an appropriate management buffer above minimum regulatory requirements. Our aim is to have a sustainable dividend. We expect dividends to recommence at a modest level, prudently and progressively building over time towards a payout ratio of around 50% of sustainable earnings. We expect the first payment to be made in the first half of next year. Thank you all very much, and I'll now pass back to Richie. Thanks, Andrew. As we look forward to 2017, I would like to thank my colleagues for their ongoing professionalism, commitment to their businesses and their customers. This has allowed us to once again deliver against our shared strategic objectives during 2016, and will be important as we look towards our priorities for 2017 beyond. Customers continue to be our number one priority, and we are focused on developing relationships with existing customers and with new customers. We are doing more business with more customers than we were a year ago, and we expect this to continue. We will leverage our strong retail and commercial franchise in Ireland, and continue to support and benefit from ongoing Irish economic growth. We will continue to develop our business in the U.K., while closely monitoring the impact of the U.K.'s decision to leave the EU. We will continue to have a strong commercial focus on pricing, risk, and asset management. We will maintain strong cost discipline and invest to deliver operational efficiencies, business growth, and unlock strategic opportunities. We will continue to work with customers in financial difficulty, and to seek to provide them with appropriate and sustainable solutions. We will grow and protect our capital, strengthen our capital position, maintain appropriate buffers over regulatory requirements, and progress towards sustainable dividend payments to our shareholders. We are well-positioned to deliver on our strategic objectives. The economies of our main markets have produced a supportive backdrop for our businesses. We have an experienced, commercially focused management team with a proven track record of strong commercial disciplines and of generating and protecting capital. We have a diversified business model with strong proven retail and commercial franchises. We are investing in our businesses now to ensure we will deliver enduring, sustainable returns for our shareholders. Thank you. Diarmuid. Thank you. Good morning, and thank you. It is Diarmaid Sheridan from Davy. A couple of questions, if I may. Firstly, around dividend. Andrew, you mentioned a kind of a 12%, and a buffer above that in terms of your capital guidance from here. I am just wondering whether you could provide us with some further insight into what your thoughts are around the quantum of that buffer against those uncertainties that you have called out. Secondly, on the core banking program, thank you for the additional detail. I just wonder whether you could provide some further details on the benefits of the program, and when they begin to emerge. Do we need to wait till 2020, 2021 before you see those benefits really beginning to emerge? Then, finally, just a quick question around resolution and the Holdco. Whether you could provide any guidance around the timing for the setup of that entity, and how you expect to meet your MREL target, and your thoughts around capital efficiency as you move to the Holdco. Thank you. Okay, Diarmaid. Well, I'll take the first question and the third question first to deal with those. The guidance we gave this morning, Diarmaid, to maintain our CET1 ratio above, in excess of 12%, that includes a management buffer above minimum regulatory requirements. In relation to Holdco, the resolution authorities have given us their preferred resolution strategy, which includes the Holdco. That's something that we will be talking to shareholders about in due course. Setting up a Holdco requires shareholder approval. In terms of MREL and thinking about MREL, when we look at our total capital ratio, which is at about 18.5% at December, we believe that leaves us very well positioned in terms of dealing with the MREL requirements, which, as you know, haven't been clarified until towards the end of this year, and it's expected that there will be a phase-in period. On the investment in the IT program, Diarmaid, it's obviously a very substantial investment. It is our shareholders' money, so we've thought very carefully about how we will do this. We've been really doing it for. We thought for about 9 to 10 months beforehand, decided the route we go. As you know, most banks have similar issues in terms of the cost of their systems, the inflexibility of the systems, the fact that a lot of them are coming to the end of their useful lives or indeed gone beyond their useful lives. So in Bank of Ireland, what we do is when we see those kind of issues, we make a plan, think very carefully about their implementation, and we're in the implementation phase. The first phase has gone very well for us. The design and architecture will deliver. We've got enhanced confidence that it will deliver what we need to do. A lot of the last 12 months has also not just been looking at the new systems and putting them into a test, standing them up and potentially putting them into test environment, has been the selection of the partners who will help us going forward, and also improving the capabilities of our internal team. So a lot of what we've done also was go and visit with people who have had success in very large change programs like this, banks and other fund, but also people who've had problems. We've brought in. We've been very gratified that we've been able to recruit people who have huge experience in this area. With the selection of partners, that process we've been going through over the last four to five months has been very detailed, and contracts being developed with them. A lot of those contracts, both for the delivery of infrastructure and the services that they will help to help us integrate and migrate, are on a fixed cost basis. Again, we've nailed down that and also that process, when you move to a fixed cost basis, it helps ensure that everyone really understands their accountabilities and responsibilities. We would anticipate that over the next two years we'll have done the real core platforms, the core processing engines, and the core payments engines will be done. We will also, by this time, 2019, we'll be in the phase of the migrating of a very substantial part of our customer base. The costs we've given you also incorporate the cost of migration, and they incorporate contingencies held at the center. The programs don't have an access to contingency. As to the business benefits, I think we'll see them in a range of areas. We are very significantly transforming the way that the people who work in the company think about themselves and think about the kind of roles they'll have going forward. In my CEO statement in the letter to shareholders, I point out that 3,000 of our colleagues last year engaged in third-level accredited programs, which are very much generated for them educating themselves, us supporting that education for the Bank of Ireland of the future. We've got 1,750 people at the moment doing those kind of courses. This is ensuring that we can redeploy people to revenue-generating roles. That'll be a significant part of that. Secondly, we spend about EUR 400 million a year in cash, which impacts capital on running the systems and changing the systems. Running the systems costs about EUR 200 million a year. Changing them in 2015 and 2016 is going to cost EUR 200 million a year. A lot of that cost of management and change has to do with the complexities of the systems and the test environments we have to run when we want to do anything new, and the long, long tails to get to market. Clearly, as we will have got our new platforms, our new channels up, those costs will be substantially reduced. I would expect that would start to happen in around 2019. We'll start to see some of those benefits flow through. Another significant cost we have is fulfillment. Because of whereas we are moving and we've made a lot of progress, like say in our retail bank, 50% of consumer product sales are done through our direct channels now. But there's a lot of background fulfillment because a lot of our systems aren't straight through processing. A lot of that background fulfillment is done by partners very often offshore. As we move through straight through processing, through customers doing what they want to do, which is serve themselves and to see it done immediately and flow through our systems immediately, clearly, we won't need that level of support and fulfillment. The other thing is obviously on the revenue side. We have strong market positions here. We have very good routes to market in the U.K. We've worked very hard on the channels that we have, making it better for our customers, improving our analytics and our insights. But we have a very, very significant way to go. Obviously, if we can improve our customer satisfaction and in particular improve our analytics capabilities and insights, then we would anticipate we'll be able to generate further revenue. The other thing that the systems will give to us is strategic optionality. If we look at where the world is going in retail and commercial banking, if you look at It's a negative example. But the issues with, say, for example, Williams & Glyn. One of your absolute requirements going forward as a retail and commercial bank is to have IT systems that you're very, very comfortable with, you know inside out. That gives you scalability to be able to, if you were to make acquisitions, to be able to migrate the customer seamlessly, take out cost that way, and engage with your customers, the newly acquired customers, in the way that you're comfortable and that you know is right. I think the investment is a very, very large investment. We thought about it very carefully. We believe that we must take the steps now for the bank, not just for tomorrow, but for future generations. And we think that this will do that for us. Eamonn Hughes and Goodbody. Maybe just two questions, one on NIM and one on NPLs. Just in relation to the guidance for NIM, Andrew, for this year, and maybe kind of thinking a little bit further out as well, what's your kind of thought process in terms of the headwinds from MREL issuance in terms of how it impacts on NIM? Secondly, your view on kind of base rate expectations, given it's a lot more topical over the last while, maybe a little bit further out, but just kind of what your own house view is in terms of what you're building in for your guidance. Then secondly, in relation to NPLs, there was quite a significant reduction last year. So we're kind of getting down probably now to a kind of a core rump. How should we think about that in terms of further reductions, sales, further workouts, that sort of stuff? I'll do the NPL. Yeah. Okay. Maybe if I start with the NIM, Eamonn. Clearly, in terms of giving the guidance, we expect further modest growth in our NIM from the H2 level of 227 basis points. Clearly, that takes account of our anticipated MREL issuance in relation to that. As I was saying to Diarmaid earlier, we think the MREL is a very manageable issue for us given our total capital ratio is at that 18.5% level. The key drivers of our NIM going forward from here tend to be the same three drivers that we've had over the last couple of years, two positive and one negative. The negative is clearly the very low interest rate environment. Clearly, there might be some expectation of base rate increases in the U.K. We tend to be pretty conservative. We've probably had a number of years where the rates have tended to be lower than we might have expected at the start of any particular year, and so we tend to be quite conservative in terms of an expectation for base rate increases in the U.K. In the Eurozone, that certainly feels to us to be a good bit further away. So we're not anticipating increases in Eurozone rates for some time to come. So that's the negative headwind on the NIM, Eamonn. In terms of the positive side, reduction in our cost of money and the fact that our front book margins are higher on average than our back book spreads. On the reductions in the cost of money, we've obviously had good progress over the past 12 months in relation to that. The repayment of CoCo is an obvious example. But on the deposit side, we've continued to make progress on reducing the cost of deposits, particularly in the U.K., and we see further opportunity for further reductions in the cost of U.K. deposits through 2017 and beyond. In terms of our front book margins and front book spreads, they continue to be higher on average than the average spread in the back book. As the new lending and redemptions work through that dynamic will actually add a further tailwind to the progress that we're making. So putting all that together, it means that we expect further modest growth in our NIM from the 227 level in 2017 and beyond. On the NPLs, Eamonn, I think obviously, EUR 4 billion was coming off. I'd like the laws of math start to apply. We anticipate further strong progress this year. I think as we look at our NPLs, they are right across a range of asset classes. I would say a lot of the substantial heavy lifting, in particular, the exposure to potential volatility in economies has been materially reduced. For example, area one we always think about is property and construction. The defaulted loans in property construction reduced by EUR 2.1 billion last year, and our coverage is 61%. If we look at Irish mortgages, they came down by about, defaulted, came down by about EUR 800 million this year. I think the feature that we are seeing, and again, the gratifying thing is that our restructures for our customers are working. The customers who have gone into forbearance, about 92%, 93% are sticking with their full forbearance arrangements, and then those customers move to cure. I think one of the features, as you get an opportunity to look in the book in a bit more detail, you will see these probationary mortgages, which we were calling out last year. You see those coming down, and that is customers curing after a 12-month probationary period. Then, as you know, we release the specifics or the attributed IBNR over about a four-year period. On the Irish business loans, again, very significant reduction in the year just ended. Again, a lot of that now is where customers are in forbearance. About 90%, 95% of our defaulted customers are in a forbearance or a resolution strategy. Of those customers in forbearance, again, about 90% of them are meeting that forbearance. Again, we should see those defaults coming down. I think you will see continued good progress, and mathematically EUR 4 billion would be almost impossible to achieve, but we will see good progress on that. I do not think that loan sales will be a feature. We might or might not in a corporate book or say some, maybe not anymore, but in a property and construction, you could see some individual sales, and that has always been a feature. We did do some large portfolio sales in 2014 and 2015. Sorry, yeah, 2015 and 2016. Part of that, in particular, the two big Irish mortgage books we sold, the buy-to-let book in Ireland and in Northern Ireland, was because there was not a lot of liquidity at that time in the market. We had to test our assumptions. Our assumptions on provision coverage and our assumptions on resolution. The asset sales were as much to test our assumptions, and we achieved those. I am not sure big book sales would be a feature of our NPL reduction strategy going forward. Clearly, what we have done on the other side is we work with people who bought asset classes over the last few years, and as they move their own customers to a restructured basis, that restructure becomes sustainable. We are in a position to buy performing loans on an ongoing basis. We are acquiring portfolios, and we are in due diligence for a couple of portfolios at the moment. Good morning. Stephen Hall from Cantor Fitzgerald. Could you just comment on your position in the U.K.? Has your strategy changed or risk appetite changed following Brexit? Also, a brief update on how the partnership with the U.K. Post Office and the AA is developing. Secondly, just on your outlook for new lending growth in 2017, do you expect to see a shift in the new lending mix? Do you expect to see an inflection point in the size of your balance sheet on a constant currency basis? I think if I go to the other one first, we do expect to see, if we assume a constant currency, obviously one of the again, positives in our management of our NPLs and defaulted loans. The defaulted loans were coming down last year, and that obviously had an impact on the gross book. As the defaulted loans get smaller, then you will not have the same mathematical impact. We did about EUR 13 billion of new lending last year. That is excluding book acquisitions of about EUR 200 million. I would expect we would beat that this year. In the U.K., our route to market, as you correctly identify, Stephen, in Great Britain, is primarily working with our partners. That gives us flexibility. Obviously, we take the credit risk of the assets that originated. We have considerable financial flexibility because these are commission-based arrangements. We have not an invested heavy infrastructure in the U.K. We do fulfillment, we take the credit risk, but it is commission-based, so we can move depending on where we believe the economic cycle is. The asset quality in our U.K. businesses has held up very well. We did probably, as we saw how the decision to leave the European Union, we probably were a little bit more cautious in the third quarter of last year just to see how this is going to turn out. Credit quality continued to hold up. But one particular feature in our U.K. mortgage book is that we were working to continue to make sure margin is obviously very important to us, the margin on the asset yield of the mortgages we are underwriting, but also the cost of money. We would have taken some steps in the third and fourth quarter, which would help us manage margin better. I think now that we are more confident on where we have driven the cost of money to and on the asset yields we can get, I think we could see probably a pickup in mortgage lending in the U.K. The average LTV we have in the U.K. is in the mid-60s, and our exposure to markets that could be vulnerable, say, for example, Central London, is modest, and we do not do jumbo mortgages. So we do not do mortgages above 500,000. So it is quite a balanced risk appetite there. The partnerships are going well. Partnership with the Post Office is a very long-standing partnership. I suppose sometimes that component of that partnership is not called out as much because it comes in the associated income line, is the foreign exchange business we have with the Post Office. That continues to go very well. We are the number one in the market for retail foreign exchange with about a 24%, 25% market share. The ATM fleet continues to go very well with the Post Office. With the AA, some of the impact on our profits, our sterling profit in the U.K., has been the cost investment in building the AA partnership, and that is achieving our goals. It is relatively early stages, but we have got about 100,000 customers now through our AA partnership. Overall, in the U.K., we have got well over 3 million customers. We have got more customers in the U.K. than the adult population of Ireland. I think we will always try to keep an appropriate mix in our asset classes in mind. I would expect in 2 to 3 years' time, you will still see our Irish books about 50%, U.K. about 40%, and U.S. and Continental Europe about 10%. Maybe we will take one more question, and then we might go to London. Good morning, Owen Callan from Investec. On the CET1, obviously you have had a very significant rebound in Q4, mainly on the back of that defined benefit pension. I am just wondering, given the volatility that we had last year in both directions, has there been any consideration given to smoothing out that volatility via some hedging tools? Are you happy to take part in maybe a further upward move in the yield curve environment and a reflationary world? Secondly, on costs, obviously we have a bit more clarity and certainty on what the cost trajectory will be for the bank over the coming years. How does that place maybe long-term aspirations for a 50% cost-income ratio? Where would the target for management be on that at the moment? Then just finally, just on that NIM expansion, which has obviously been very impressive in the second half of the year, how much of that has come from the ability to reprice the U.K. deposit book? I know previously you'd mentioned that you pay about 50 basis point premium, I think, over market rates. So how much of it has been your own ability to reprice, versus just the market itself repricing to a lower rate and the sector in the U.K. in general expanding NIM overall? Thank you. Maybe I'll take the ones I can remember, Owen. That's my privilege. I think on the price, yeah, we worked, and probably when I was answering Stephen's question earlier. We've got to know the U.K. deposit market better. We've got to know the mortgage market better, and we're constantly working at identifying how we can manage margin while getting our volume targets. I believe we made some reasonable step changes in things that we can control in deposit pricing and mortgage pricing. But I think the market as a whole, as you correctly identified, was obviously a contributing factor. So I think there's a combination of the two, but certainly, I would anticipate that our U.K. funding costs should continue to be lower while we get our volume targets. So we're constantly learning in that market, and I think we're applying the learnings that we're getting there. In terms of our pension schemes, again, in the book, and when you have an opportunity, you get an obviously look in the book. Our underlying schemes are performing exactly as they should. Their economic performance, they are at or close to surplus, and these are long-dated schemes. Bearing in mind, we closed the DB schemes to new members in 2006. We've done significant work with the existing members of the schemes to reduce their benefit expectations. They've made voluntary contributions to give up benefit expectations for the future of the company and for the future of the schemes themselves. And those have all contributed to that. So as the benefit expectations have reduced, then the kind of asset classes that are in those schemes have changed. And therefore, there's been quite a significant transformation in the asset classes the schemes themselves are invested in. We cannot take out a hedge against the accounting convention, which is that we are required, because of the long dated life of the schemes, to effectively use the AA European corporate bond with an average life of 20 years. I know there's not that many of them, so we do experience volatility. However, we did do some structuring within the schemes, the asset classes, et cetera, which will reduce our exposure to interest rate volatility. We did some work which would've reduced where we were last year to where we are now and reduced that by about EUR 150 million for every 25 basis points move. We expect that the bond yields will be broadly stable over the next. We're not expecting an uplift in the guidance we've given. We expect them to be broadly stable. There'll be some volatility in and out. But we expect that they will be broadly stable, and that gives us confidence to talk about the dividend. Okay. The one you forgot, Richie, was the 50% cost-income ratio target. That is certainly a target that we are continuing to focus on, Eoghan. It is something that we think is the appropriate target for us as a bank in terms of our business, that we would be able to achieve that over the medium term. A key in terms of over the last number of years, we have obviously continued to focus on efficiencies, and that supported the fact that over the last three 6-month periods, essentially the operating costs have been held flat, including on a constant currency basis. As you said earlier, we are investing in our businesses. Richie referenced the AA partnership. We are clearly making a very major investment in transforming our business, including the replacement of the core banking. We have called those costs out very separately and tried to give some good guidance for people in terms of what the capital impact will be and how much of it will flow through the P&L. Those investments will be a critical enabler of our progress towards that 50% cost-income ratio target over time. I think there were a couple of calls in London. Maybe if we take those calls, please. We will now take the next question from Vivek Gautam of JP Morgan. Hello. Morning, Richie. Morning, Andrew. A few questions from me, please. First one on loan growth. I was wondering how you think about the overall group loan balances evolving in 2017. Are we at a point when we should start expecting stabilization in the group loan book on a constant currency basis, and if not, then how long do you think we are from that point? The second one is, on slide 51, you indicate that you have done some interest rate and inflation hedging in February 2017 on the pension. Was there any capital cost to put on those hedges, or am I reading too much into that? And the third one, the U.K. deposit costs were 107 basis points in H2. Can you tell us what was the exit run rate on that? Sure. Let me take the second two questions, Vivek, and then maybe Richard will take the first one. No, in terms of the pension and the additional hedging that we put in place, we did some hedging in 2016 and then some further hedging with the trustees in February of 2017, as you point out. There was no capital cost associated with that. On the U.K. deposits, the average cost of the U.K. deposits in the slide deck, as you say, is 107 basis points. Bear in mind that a lot of our U.K. deposit book is typically a 12 or 15 month maturity, and consequently, the exit cost of those deposits will be lower. Essentially, when Mr. Carney cut the U.K. base rates by 25 points in August, we took the opportunity to adjust down our deposit pricing by between 35 and 40 basis points. We would expect to see continued progress on that 107 rate through 2017. On the loan book itself, again, obviously, we take cognizance of the growth thing, but the book that we are most interested in is the core loan growth. We had core loan growth of EUR 1.7 billion last year. We have a continued reduction in defaulted and NPLs. They have come down quite considerably. We considered that will happen further, but it will not have the same mathematical impact on the gross volumes. Irish trackers, we continue to see them amortizing at about EUR 1 billion a year, EUR 1.1 billion a year, from a straight line amortization. Obviously they are quite low yielding. The customers repaying us is a good thing in that light. I think we will see loan growth, so new lending. We did about EUR 13 billion this year. On a constant currency basis, I think we will do a bit more than that. I think the mix will stay broadly what we did last year. We try and make sure that we will have a balance over the next If I looked out to two to three years, I would still anticipate that we would have around about 50% of our assets in Ireland, around 40% in the U.K., and around 10% in Europe. That diversification of asset classes is very important to us. It helps us mitigate risk, but it also helps us ensure that we can pursue our policy of having a very commercially disciplined approach to pricing and to asset management. Thank you. Okay. Thanks, Vivek. We'll take a second call, a question from London. We'll now take our next question from Nick Baker of Goldman Sachs. Thanks, Jen. Just three from me quickly. I wanted to check on your IT spend, on the core banking investment that you're calling out. I'm assuming that the capital impact is in addition to your existing change envelope of around EUR 200 million a year. The second one really is on the cost income ratio as well. You're just saying that the core banking transformation is a critical enabler to reaching that 50% cost income over the medium term. Just curious, do you think that you'll be able to get there by 2020, or will that be further out in the future? And then the final one is just on your mortgage market share. I think you're calling out that you took about a 25% share this year. Do you think that's your new run rate, or would you expect to increase that gradually over time? I know there was some commentary in the press around potentially reentering the broker channel, which could boost volumes, but any commentary around where you see your share going would be helpful. Thank you. On the core banking platform, I think we will start to see the benefits coming through. Clearly, one of the issues is we have some other change programs, which is part of an integrated plan. We see that as preparing for IFRS 9, preparing for payment directives, all that kind of thing. That's a normal part of business, but it is change that we have to make. We'll be spending some money on that. But I would say, over the four-year life of the program, as we have our new systems in place and standing up, we'll be spending less than EUR 200 million on change, and significantly less when we've completed that. I think you'll see a gradual progression towards that. Maybe I'll take the mortgage market and you come back to the cost. We've got about a fifth of the market in the existing book. We got about a quarter of the market in our flow this year. We anticipate that the market as a whole will grow. The market has been constrained by a lack of supply. The supply is coming on board, and obviously we're supporting the people there. We've got a lot of our builder customers obviously producing that supply. Then that supply will come to the market and is creating a bigger volume. We're never complacent. Our market share of around 25%, we'd like to see if we can do a little bit better than that. But I think you'd probably always see us doing somewhere around 25%, maybe going into late 20s. We have no current plans to go into the broker market. We work in the broker market in the U.K. It's a highly regulated market. We understand it, and the MMR has been an important part of that regulation. We also have a very extensive branch network, so we originate the mortgages ourselves. Our experience, particularly in Ireland, where you don't have proper credit registers, et cetera, yet, our historic experience was credit quality was less good, and it certainly is less easy to work with a customer and restructure a customer if you don't have their core account relationship. The other benefit, because we originate the mortgages ourselves, is that we have an ability to In Ireland, you have to have a life policy when you take out a mortgage, and about 70% of our customers take a life policy from us. And actually, we've worked a lot on a new online platform, which is very popular with customers. They can get a life quote fulfilled within an hour, and that's a big advantage for customers. Then we have an arrangement with general insurance partners, where about 50% of our new mortgage customers take out a general insurance product through us. We get paid a commission on that, but we don't take the underwriting risk. Overall, brokers are about 20% in the Irish market. We don't have a current plan to go in that market. We think that market will face some change over the next couple of years, and particularly as it comes under a mature regulatory umbrella. We could look at it at that time, but at the moment, we're quite satisfied with the mortgages we're originating, particularly in quality, in price, and ability to engage with the customers on other products. Switching, Nick, to the cost income ratio question. I think as we've said in the slide, the sequence of events for the core banking replacement platform is very much to stand up the new platforms, this year and into next year to launch it towards the back end of the year, and then start the migration, which will happen during 2019. That will then allow us to start the structural reduction in our cost base during 2019, as we decommission the legacy systems, and as we move to more customer self-service and other forms of fulfillment. Obviously, between now and then, we'll be continuing to work on our efficiency programs more generally. The other aspect, of course, is that it is a cost-income ratio, and so we do expect our income will continue to grow over that time period, including from continued progress on our net interest margin that we spoke about earlier, continued development of our loan book, and growth in our loan book over that time period. Of course, these systems do have a revenue ambition to them also. In terms of a specific time as to when we'll get to 50% cost-income ratio, it's hard for us to be absolutely definitive with a particular year on that. But safe to say, it's something that we're very conscious of and something that we're working extraordinarily hard to try and achieve as quickly as possible. Great. Thanks very much. Take a further question from London, please. We will now take our next question from David Wong of Credit Suisse. Oh, good morning. It's David Wong, Credit Suisse here. I just have one quick question to ask, really, on the new lending figures. I think you quote EUR 13 billion for 2016. That's up 1% year-on-year in constant FX terms. I just wanted to check, I think at the nine-month 2016 stage you quoted, I think it was EUR 10 billion, and that was up 10% year-on-year. Am I comparing the like for like figure? I'm just wondering if that implied Q4 is a bit slower, or if there's anything in there that we should know really. Thank you so much. I think the key feature in the second half of last year was some adjustments we made, in particular to the mortgage volumes we were looking to originate and some of the activities we were taking to work better on enhancing our margin on mortgage yield in the U.K. and cost of money in the U.K. As Andrew's pointed out, we've made good steps on the cost of money, and I think we are much more comfortable on the yield on our mortgages that we're getting. So we'd anticipate we will, in terms of yield and risk quality we want, I think we will do better in 2017 than 2016. In 2016, the figure was 2.8 billion sterling. I think we'll improve on that at a price and asset quality that we're comfortable with. Okay. Thanks, David. We have a further question in London. The next question comes from Chris Cant of Autonomous. Hi. Good morning. Thanks for the call, and I apologize if you've already touched on these issues. It's been a slightly hectic morning here with RBS at the same time. Your interest-earning assets were down quite a lot into the second half, and I think came in quite a long way below consensus, which explains most of the margin beat. I'm just trying to think what the trend there is into 2017. You've said a few times you expect core loan growth. Should we expect interest-earning assets to start trending higher next year than the 2H level? That's the first question. Secondly, looking through the segmental disclosures, you flag a EUR 41 million investment during 2016 in the core platforms as part of your cost base. I'm just wondering what the timing of that was during the year, trying to think about your 2H underlying costs, X levies, X investment, going into next year. Thanks. Okay. Maybe just to cover those off, Chris. On the investment in the core banking, most of that would have been phased in the second half of 2016 because we were effectively acquiring various software licenses, hardware, et cetera, as part of that. What we've tried to do in the slides, and in the book, is to actually strip out the operating expenses, the investment in the core banking, and the regulatory levy separately so that you see the three components of that. On the interest-earning asset reduction, the absolute predominant factor, substantially all of that reduction, Chris, in the interest-earning assets related to the impact of the foreign exchange rate. Clearly, the FX rate in H2 was very different from the FX rate in H1, principally around sterling. If you look at the spot balance sheet at the end of the year, you'll see it's very close to the average interest-earning assets at this point. That will give you a sense of our starting position into 2017. Richie's comments earlier about the development and progress in the loan book will clearly translate into the interest-earning assets through 2017 as well. On loan growth, we've had good momentum coming into the first couple of months of this year in all of our businesses. You'd expect that interest-earning asset number to be higher then than the exit. Everything being equal, yes. Yes. As we go through 2017, yes. Thank you. Okay. Is there any further questions here in Dublin? Thanks again, everyone. Thanks for your interest in the company and your support.