The main Irish banks have been upgraded by ratings agency Standard & Poor’s, with Bank of Ireland being raised to investment grade, the first Irish bank to achieve such a rating since the financial crisis.

Increased net interest margins was the key factor causing the agency to up its support for the sector, which it now believes is set for a period of lower risk appetite in an enduring, stable, competitive landscape.

The increased optimism about the banks is backed by increased optimism about the economy generally, with the agency expecting Ireland to outperform most of its European peers in terms of economic growth in the coming two years. It expects unemployment to drop to 8 per cent by the end of next year.

One notch

Bank of Ireland was upgraded one notch to BBB-/A-3, the lowest of the so-called investment grades, in a development that is likely to boost to its stock market performance.

AIB and Permanent TSB saw their long-term ratings increased one step to BB+ and BB- respectively, with the outlooks on both being stable.

Standard & Poor’s revised its outlook to stable from negative on KBC Bank Ireland and affirmed the ‘BBB/A-2’ ratings on Ulster Bank Ireland Ltd.

Last month, the agency raised its rating for Ireland to A+, so there is still a significant gap between its attitude towards the sovereign and the banking sector, reflecting the enduring legacy issues facing the banks arising from the sector’s recent collapse.

“We believe that improvements in banking system profitability and lower risk appetite will prove enduring,” the agency said. “In addition, we believe that the structure of the industry will remain broadly stable, with relatively few players and a primary focus on domestic retail and business banking. As a result, we expect the industry’s existing competitive landscape to remain supportive of a more rational risk- return profile than before the crisis.”

While the gap between what the banks are paying out in interest and charging in interest has grown over the past number of reporting periods, the agency does not expect this to continue at the same pace. This is partly because deposit “repricing” has largely run its course for now, with the possible exception of a few banks.

It said tracker mortgages will continue to weigh as long as low interest rates persist and also that banks are coming under pressure to cut standard variable rate mortgages. It expects net loan growth to remain muted in the next few years.

Improving

The agency’s views on the economy generally and on the individual banks are such that it has advised that it may be improving its ratings on the banks over the coming period.

“The Irish macroeconomic recovery has provided an increasingly supportive backdrop for the banking system,” it said, adding that it expected GDP growth of 4.2 per cent this year and 3.8 per cent next year.

With house prices expected to continue to rise, the agency expects this to feed into positive trends for banks, with credit losses expected to remain “exceptionally low” due to provision releases and declining inflows into new defaults.

The agency also noted the continuing trend in deleveraging by households. Defining private sector credit as household debt plus domestic corporate debt, it said it believed it was approximately 15 per cent lower at the end of 2014 compared with the end of 2013.

However, the banking system’s large stock of non-performing loans and high level of mortgages in arrears remain significant challenges.