Bank of Ireland Group plc (BIRG) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. We'll now listen to Bank of Ireland's Results Announcement for 2020, presented by the CEO, Francesca McDonagh; and CFO, Myles O'Grady, followed by Q&A.

Good morning, and you're very welcome to our results presentation. 2020 was an exceptional year with myriad challenges for the people and communities we serve and indeed for all businesses, including banks. This morning, we'll set out our full year performance. We'll also update on a number of strategic areas, including our new cost target, further restructuring of our business model and the tipping point between branch and digital banking that we have reached. At Bank of Ireland from the start of the COVID-19 pandemic, we immediately focused our efforts on protecting and supporting our customers, colleagues and communities. Our previous investment in transforming our culture, systems and our business model meant that we could adapt to the pandemic very quickly. At the same time, we've remained focused on our strategic priorities. Our results reflect this. In summary, they show a return to profitability in the second half of the year with H2 underlying profit of EUR 295 million. We maintained our track record on cost management for a 6 reporting period in a row. We achieved a 2% uplift in our Irish mortgage market share growing to over 25%, whilst maintaining discipline on pricing. In the U.K., we made further progress in repositioning our business, and we concluded our review of our Northern Ireland business. 2020 was also a year of strong delivery on our digital strategy. We've seen a multiyear trend in digital engagement by our customers. In 2020, this was clearly accelerated by COVID-19. We now have reached a tipping point between online and off-line banking. Reflecting this permanent shift in customer behavior, we are today announcing a new branch strategy. We will reduce our branch network by around 1/3, whilst ensuring customers still have a wide range of choices in how they engage with us digitally and off-line. Our asset quality metrics reflects the comprehensive approach we've taken during COVID-19. We took a substantial EUR 1.1 billion impairment charge for the year. Importantly, the experience with customers coming off payment brakes has been more positive than expected. Driven largely by regulatory change, the group's NPE ratio increased to 5.7% in 2020. Myles will provide more information on these items shortly. Despite this large impairment charge, we have maintained our strong capital position. Our regulatory CET1 ratio is 14.9%, down just 10 basis points in the year. On Slide 6, you can see the outcomes from our customer-focused response to COVID-19. Our Net Promoter Score improved by 5 points last year, our highest to date, and customer complaints in Ireland fell by 22%. We played an active role in supporting government-backed lending schemes, both in Ireland and the U.K., and we're making banking simpler and more transparent for our customers. For example, we replaced 26 separate charges for our personal current accounts with a single monthly flat fee. Around 100,000 payment breaks were agreed with customers, the vast majority of which have now concluded. More than 9 in every 10 of these customers have returned to their pre-COVID-19 terms. And we are dealing constructively with the 3% of payment break customers who have required further support. Our approach is based on more than a decade of market-leading experience in finding sustainable solutions for our customers and maintaining credit discipline in our origination of new business. Turning to the next slide. The response of our colleagues to the challenges of the pandemic has been outstanding. This morning, I want to reiterate my pride in them and appreciation for all that they have done. Our agile ways of working have enabled over 75% of colleagues to work from home. We've delivered physical and mental health initiatives to promote colleague well-being during this time. Our colleagues recognize this. Since 2019, engagement has risen by 5 points. Culture Embedding has also climbed by 11 points, 3 points ahead of the global financial services benchmark. As a leading lender to the Irish economy, we're playing a vital role in economic recovery and reboot in the communities that we serve. Across our portfolios, the group's new lending increased by 30% in H2. Bank of Ireland also announced EUR 4 million in a wide range of community support. This included emergency funding for a range of charitable groups working with those most impacted by COVID-19 and funding for some of the hardest-hit sectors. Combined, this hard work is reflected in Bank of Ireland having been recognized as the best bank in Ireland by Euromoney. Turning now to the macroeconomic outlook, we expect to see a strengthening in recovery across Ireland and the U.K. this year. Ireland was one of the small number of countries globally that saw its GDP grow in 2020. This performance reflected strong and ongoing fiscal support by the Irish government. It was also enabled by the presence of multinationals operating in pandemic resilient sectors such as technology and pharmaceuticals. This growth was not enough to prevent a sharp rise in unemployment in Ireland. However, we forecast much improved labor market dynamics after the economy reopened during 2021. In the U.K., the economy is expected to return to growth following a sharp contraction in 2020. We welcome the conclusion of Brexit trade negotiations between the European Union and the U.K. in late December. This has provided greater certainty to support investment on both sides of the Irish Sea. On Slide 9, we highlight the factors that lead us to believe that the current K-shaped economic recovery in Ireland will become more broad-based in the year ahead. We are hopefully coming towards the end of the third lockdown in Ireland. When the economy reopened previously, we saw a rapid fall in recipients of the government's pandemic unemployment payments. As of last week, some 470,000 people were in receipt of this payment. This close to 1/5 of the labor force in Ireland. Of course -- sorry, of those, just over half worked in retail, hospitality or construction before activity in those sectors was restricted. As these sectors reopen, we should see a step-change improvement to the numbers at work, and we expect this to support growth across other segments of the Irish economy. Reopening will provide more opportunities for people to spend and give businesses the confidence to invest. The resources are there to support this. Irish private sector deposits have increased by 15% since 2019. This mirrors the trends in other countries, including the U.K., where household and corporate deposits grew 14% last year. And we see clear pent-up demand from surveys such as our housing polls, which rose to a 20-month high in February. Of course, recovery is conditional on the effective delivery of the COVID-19 vaccine program. We're all aware of the U.K.'s progress in vaccination rollout. In Ireland as of last week, around 7% of the population had received doses, slightly ahead of the European Union average of 6%. COVID-19 has accelerated the multiyear trend towards digital engagement by our customers. In 2019, 6 out of 10 of our everyday banking products, such as current accounts or personal loans, were delivered entirely digitally. In 2020, this increased to 7 out of 10. And in 2021, we expect it to increase to more than 8 out of 10. Another example of our digital progress is the 26% increase in registered users of our new mobile app since its launch in 2020. The app has driven increased customer satisfaction including in the 19 to 30 age group, where we have recorded a remarkable 50-point increase in our customer effort score during 2020. Digital adoption has clearly reached a tipping point. This underlines the importance of our own systems transformation. It also reinforces the need to continue to involve how we serve our customers, and that's why we've taken the decision to close 88 branches or around 1/3 of our physical network in Ireland. Importantly, in taking this step, we've entered into a new partnership with the Irish postal service, An Post. This will allow all of our customers access to banking services at local post offices. With Bank of Ireland and An Post's footprint combined, our customers will have access to more than 1,000 places to bank nationwide. As we set out on Slide 11, our systems transformation is delivering both customer and cost benefits, and we'll continue delivering in 2021. We're making strong progress in digitizing everyday banking. This is enabling tangible commercial benefits, increasing revenue, reducing costs and improving customer satisfaction. For example, our digitization of sales and servicing journeys has delivered more than EUR 21 million of cost savings. We introduced a fully digital mortgage journey for first-time buyers in Ireland, which has supported our increase in market share. 38% of our general insurance sales now come via our digital insurance wallet, reducing our cost to serve. And we launched a new digitized, small business lending proposition in 2020 where 2 out of 3 customers that apply for a loan can now do so digitally in less than 10 minutes. As we look ahead, we feel positive about our digital road map for 2021, which includes a range of new initiatives across payments, wealth, security and customer engagement. As you can see on Slide 12, costs have reduced consistently in the last 6 reporting periods. Since 2017, we've reduced our gross costs by over EUR 300 million, creating capacity to invest in our people and our technology. We've achieved our original target of a EUR 1.7 billion cost base 1 year early. And building on this track record, we plan to do more. Today, we've announced a new EUR 1.5 billion cost target for 2023, and we will deliver this new ambition in 5 ways: by simplifying and automating more of our customer journeys, by concluding the voluntary redundancy scheme, by restructuring our U.K. business, by continuing to reduce our head office property footprint to reflect new ways of working and by changing the scale of our branch network. Turning to Slide 13. We delivered further strategic progress in the U.K. in 2020. We grew our operating profits with JAWS of 12%. Our exit margin of 1.82% was well ahead of the full year average of 1.73%. This was supported by our ongoing pivot to higher margin products. We grew our bespoke mortgage proposition, and we reduced our more expensive deposits. In terms of the outlook for our U.K. business, our financial performance in 2021 will see more evidence of implementing our strategy. In line with our aspiration for a smaller but more profitable business, we expect to see our U.K. loan book contract by around 10% this year. Margins are expected to be in line with the 2020 exit NIM. We expect to deliver a further 3% reduction in costs, and impairment charges should see a material reduction, reflecting the improving economic backdrop. As we look forward, we believe that the building blocks are in place to deliver higher returns for our U.K. business. We have today announced the results of our Northern Ireland strategic review. Acknowledging the dynamics of the local market, we've taken the decision to materially restructure our business there. We will reduce our cost base by over 15% in the medium term, supported by the closure about half of our 28 branches. And in line with our strategy for Britain, we will simplify our product offering in Northern Ireland, leveraging our expertise in mortgages and car finance. Moving now to the next slide, I'd like to focus on our Wealth and Insurance business. We are Ireland's only universal bank assurer. This is a unique competitive position enabling us to capture the full value of a manufacturing and distribution business. This contributes 38% of group business income and has assets under management of around EUR 20 billion, up 3% last year. Wealth & Insurance's contribution to business income rose 14% in H2, and we've made significant progress in recent years. The penetration of our customer base at 35% has grown by 9 percentage points since 2018. With EUR 33 billion of personal deposits in our retail Ireland division we see clear opportunities to do more, supported by the rollout of our digital Wealth and Insurance platforms. On Slide 15, we cover our responsible and sustainable business strategy, which is a focus for the group. Our new strategy, Investing in Tomorrow, has 3 key pillars: enabling all colleagues to thrive, financial well-being for our customers and supporting the green transition. On this slide, you can see some examples of the progress made during 2020. These include our launch of a green bond framework, the expansion of our sustainable finance fund and the integration of climate risk into our frameworks and policies. In terms of our own operations, 100% of our electricity consumption is from renewable sources, and we're committed to making our operations net 0 by 2030. As we come towards the end of our 2018 to 2021 strategic cycle, we will share more detail on our strategy refresh and new medium-term targets as an update later this year. I'll now pass you over to Myles to take you through our financial performance in more detail.

Thank you, Francesca, and good morning, everyone. Today, we report an underlying loss for the year of EUR 374 million, with a return to profitability in H2 of EUR 295 million. This performance represents good underlying momentum in the second half of the year, and it is ahead of expectations for 3 key reasons. First, the credit impairment of EUR 1.1 billion at the lower end of our guidance range. Second, total income reduced by 8%. And third, we continued to deliver on costs, with operating expenses reducing by 4% we also finished the year with a strong capital position, 14.9% on a regulatory basis and 13.4% fully loaded CET 1 capital ratio. Our income is in line with guidance. Net interest income declined 2% and business income fell by 21%. We took our usual comprehensive approach to impairments with 60% of the charge relating to performing assets. Noncore items of EUR 386 million include the voluntary redundancy scheme that we announced in quarter 3 and the impairment of software assets taken in H1. As you can see on Slide 20, we continue to maintain pricing discipline across our lending portfolios as reflected in stable loan asset spreads. Overall, reducing yields on liquid assets and hedging income were the primary drivers of the decline in interest income and margin. Customer deposits increased by EUR 4.6 billion in 2020. Against the backdrop of subdued credit demand, liquid assets increased by EUR 3.6 billion. In addition to pricing discipline, we took action to address the buildup of the liquidity, including the expansion of negative rates to deposits of $8.5 billion with further expansion planned in 2021. Turning to the next slide, net lending growth was stable last year supported by EUR 0.7 billion of revolving credit facilities. Excluding these RCF, new lending declined 19% while impairments in FX were further drags on net loans. However, new lending recovered significantly in the second half of the year, increasing by 30% compared to H1. The primary driver for this was a strong recovery in mortgages in both Ireland and the U.K. COVID-19's impact on economic activity weighed on business income, contracting by 21% for the year. We experienced this contraction in a range of divisions. Wealth and Insurance income fell by 23% from lower sales on existing book experience. Retail Ireland saw an 18% decline in transaction fees and FX revenue. Corporate and Treasury fee income fell by 10% due to lower underwriting income. And in the U.K., travel restrictions impacted our joint venture FX business. But once again, H2 demonstrated a good recovery, up 12% on H1. In addition, recovering financial markets boosted valuation items. As Francesca noted, this was the sixth consecutive period to report lower costs. Last year's 4% net reduction included absorbing unplanned COVID-19-related costs of EUR 25 million and wage inflation of 2.6%. Importantly, we achieved our Investor Day target of a EUR 1.7 billion cost base 1 year early. Today, we're announcing that we're going further with a new EUR 1.5 billion cost target for 2023. This will see us deliver a net reduction of 20% since 2017. A range of actions across all divisions underpin this target. These include EUR 140 million expected reduction in annualized staff costs from the voluntary redundancy scheme, a smaller property footprint and lower third-party costs. And while costs reduce, we will continue to invest in our transformation and business model restructuring. We expect to remain materially within the EUR 1.4 billion transformation budget, and that investment will help us to meet our target of operating expenses to be below EUR 1.65 billion by the end of this year. As you can see on Slide 24, our impairment charge of EUR 1.1 billion has 3 key elements. The first is the update to our IFRS 9 models, incorporating the latest economic conditions and outlook. This accounts of EUR 515 million, an increase of EUR 83 million since H1 from elevated unemployment levels, partly offset by the improved outlook for house price inflation. The second element is a group management adjustment totaling EUR 181 million. On a net basis, this is broadly unchanged compared to H1. Less customers than expected requesting forbearance was offset by increased risk associated with sectors more vulnerable to COVID-19. And the final element is EUR 437 million of actual loan losses. The increase in H2 was EUR 116 million. This is primarily from increased impairments on a number of large legacy property exposures. Based on current macroeconomic indicators, we believe the majority of the credit impairment risk associated with COVID-19 has been captured. And while the 2021 charge is likely to be higher than pre-COVID-19 levels, it is expected to be materially lower than 2020. Slide 25 provides an overview of coverage across our loan book. Taking account of the charge for the year, balance sheet stock increased by 71% to EUR 2.2 billion. In percentage terms, coverage increasing from 1.6% to 2.9%. The biggest increases in coverage are property and construction from 2.8% to 6.9% and SME and corporate, nearly doubling from 2.4% to 4.7%. There were minimal movements on mortgage coverage because of less-than-expected payment break forbearance and a positive outlook on property prices beyond this year. Moving to the next slide, we set out stage migration detail. 2020 resulted in a significant deterioration in credit quality, driven by the economic environment, actual loan loss experience and outlook. Stage 2 loans increased by EUR 10.2 billion. EUR 6 billion of this increase relates to SME and corporate, including sectors more vulnerable to COVID-19, while the balance primarily relating to property and construction. Stage 3 loans increased by EUR 1.3 billion, of which EUR 0.9 billion is from regulatory -- from the regulatory implementation of the new definition of default. 74% of the loan portfolio remains within Stage 1 where credit risk has not increased significantly. Turning to NPEs. The ratio increased from 4.4% to 5.7%. Again, performance in the second half of the year was materially better with the ratio flat for H2. The EUR 1 billion increase includes EUR 0.6 billion from the definition of default referred to previously. We expect NPEs to increase in 2021. We will recommence the NPE transactions this year starting with an Irish mortgage portfolio. Meanwhile, we continue to have active and early interaction with customers in difficulty to ensure organic NPE reductions. As you can see from Slide 28, our capital ratios have remained resilient throughout 2020. The fully loaded CET1 ratio declined by 40 basis points to 13.4%, with much of the capital shielded from a combination of regulatory interventions, including the SME support factor and software relief, while the expected loss offset absorbed some of the credit impairment charge. On a regulatory basis, the CET1 ratio was 14.9% providing significant headroom to regulatory requirements. Risk weights reduced by EUR 1.9 billion while density also reduced by 2%, reflecting an ongoing reduction in mortgage risk weights and the impact of the SME support factor. I'd like to call out in this slide that the previously guided 80 basis points impact of regulatory capital demand is now materially complete. And so to finish on 2021 outlook. COVID-19 will impact H1 with some form of lockdown or restrictions to continue into quarter 2 at least, followed, we hope, by a return to more normalized activity in H2. With this as a backdrop, we expect total income this year to remain broadly in line with 2020. Our assessment is informed by the following considerations: While we continue to take actions to minimize the impact of the rate environment, net interest income and margin are expected to fall due to reduced lending volumes, surplus liquidity and negative yields on liquid assets. Offsetting that, business income is expected to improve in 2021, with Wealth and Insurance a significant contributor. At the same time, recovering financial markets support a lower charge for valuation items. As previously set out, costs are expected to be sub EUR 1.65 billion while we anticipate the credit impairment charge to be materially lower than 2020. Taking account of our organic capital generation, credit impairment, transformation and other items, capital levels are expected to remain stable. We recognize the importance of distributions to shareholders. Our policy of improving distributions on a prudent and progressive basis remains unchanged. Our focus is on the return to profitability in 2021 and our intention is for distributions to recommence based on performance and capital position. It is also likely that future distributions will include share buybacks. We will refresh our medium-term targets at our strategy update later this year. In conclusion, while 2020 was clearly a challenging year, good momentum and profitability in H2 last year provides comfort that 2021 is expected to be a year of recovery and a return to sustainable profitability. Thank you, and I will now pass you over to Francesca for concluding remarks.

Thank you, Myles. So in summary, before we open for Q&A, we expect to see recovery this year. Our capital position is strong. We're working with our customers in need of support to find sustainable solutions. We're continuing to transform. We are laser-focused on costs. And the continued implementation of our U.K. strategy remains a priority. Thank you, and we'll now go to questions.

[Operator Instructions] We have the first question from the line of Diarmaid Sheridan from Davy.

A couple of questions, if I may. Firstly, if we start on your income guidance for 2021. I think if we look at the second half of the year, it would indicate perhaps a higher run rate into 2021 versus flat, and appreciate your comments around the interest rate environment. Just curious as to what other factors you're thinking about there. Secondly, if we take the distribution guidance that you provided this morning and, in particular, if we take it within the context of flat capital guidance, should we think of that as being the residual once your investment and your loan growth are factored in for 2021? And thirdly, on Ulster Bank, just firstly, perhaps your thoughts on -- you're not participating in the back book acquisition. So just interested in your thoughts on that process? And then secondly, just would be very interested in any thoughts that you have in terms of what the exit might mean more generally in the market.

Sure, thank you very much, Diarmaid. Maybe I will go straight to sort of the second and third on distribution and consolidation in the sector, and then I'll invite Myles to comment on income and capital more broadly. So obviously, we recognize the importance of distribution to our shareholders. And our policy of improving distributions on a prudent and progressive basis is unchanged. And as a team, we're absolutely focused on our return to profitability and also returning to capital distribution as soon as possible. And based on the guidance that we are providing today on 2021 performance, that would support the restart of distribution in relation to 2021 full year performance. And of course, the eventual actual decision depends on seeking by the Board, depends on actual performance and obviously, our capital position at the year-end. And I think just flagging that, our reference to distribution rather than dividend is designed to give more flexibility in how excess capital is returned. So I think very similar to what Myles said in his presentation, given the bank's share price, it's likely that future distributions will include share buybacks. Just to answer the other question on consolidation and NatWest news the other week. Obviously, it's not appropriate for us to comment on an ongoing transaction. But maybe let me share how we think more broadly about M&A. So we look at all opportunities, and it's interesting to note that Bank of Ireland was the only bank that has done a high level of portfolio deals. We've done 8 in the past 5 years, but we won't do a deal that doesn't create value for our shareholders, and our thinking around M&A is as simple and clear as that. In terms of what it means, the announced exit of Ulster Bank means for the market, so the Ulster Bank would be a corporate banking SME lender and active in mortgages, but simply fixed rates. And in comparison, Bank of Ireland is the largest domestic lender to corporate Ireland with the #1 lender to SMEs. And our market share of new business in SMEs has been over 50% for each of the past 7 years. In our results today, we've shown that we're increasing our market share in mortgages. And an important component of that is our strength around fixed rate mortgages. So that puts us in a podium position, and I feel good about our ability to win new business organically and the opportunity to compete for new business flows that we're already seeing now given Ulster Bank's news. And separately, we are just keeping an approach on negative interest rates under regular review, given that there is a potential for more surplus liquidity in the market, we keep our negative interest rate approach under constant review. But I'll go to Myles on maybe anything else from sale capital and also income guidance.

Sure. Thank you, Francesca. Diarmaid , I hope you're well. When it comes on income guidance, first of all, so as an overarching point, when I look at consensus, the market is broadly in line with my expectations on income for 2021. In a very challenging rate environment that we're all unaware of, we are taking actions to minimize the impact on bottom line. And so overall, at the highest level, I expect interest income to reduce from lower average loans while the rate of environment continues to impact margin. So some of the moving parts. So with the buildup of liquidity and that negative yields continues to impact, our decision to expand the application of negative rates from EUR 8.5 billion last year, getting closer to EUR 15 billion this year. That's expected to improve income. It benefited last year by EUR 31 million, and we'll get closer to EUR 80 million this year. So essentially, applying negative rates to large deposits is offsetting the impact of negative yields on liquid assets and structural hedges. So we're successfully managing the rate environment. However, average loans will be lower in 2021. We entered the year with lower loan assets. In 2020 H2 last year, balances were EUR 2 billion lower than H1. That flows into 2021. And additionally, in line with strategy, while we protect margin, U.K. mortgages are forecast to reduce 10% over the year, which will pull down interest income a little bit. Moving to business income, which I expect to grow this year and essentially offsetting the impact on interest income, that growth is primarily from Wealth and Insurance business lines. While banking fees are expected to remain broadly stable, supported by the introduction of flat fees for current accounts that were introduced last year. So again, in summary, a stable total income, broadly in line with consensus. And just a follow-on comment on capital, just to put the guidance for '21 into context, '21 being the year of recovery with a return to profitability, we're generating sufficient organic capital to support elevator's credit impairment, transformation, business restructuring to meet cost targets. And I suggest as I said, the recommencement of distributions. I should also say that in any year, items such as expected loss, pension volatility and NPE transactions can impact capital. And overall, this will result in capital levels remaining stable and in line with December 20 levels. I hope that's clear, Diarmaid.

We have the next question from the line of Eamonn Hughes from Goodbody.

Maybe one on cost, one on impairments and one just in relation to maybe valuation items. And maybe a smaller one. Just in relation to the cost side, you talked, obviously, the target in relation of EUR 1.5 billion for FY '23. There's quite a significant decline in the number of staff at year-on-year at the end. So that's kind of clearly hopeful in terms of debt trajectory for 2021. But just maybe wanted to get your thoughts about the cost trajectory into '22 and '23. Should we think about it more linearly or kind of back-end loaded into '23? And will there be associated costs involved with that? I mean, you've talked about certainly the existing program within the EUR 1.4 billion for 2021, but will there be more in '22 and '23? So that's the first one. Secondly, just in relation to the impairment charge, just noticed in your disclosures you have in terms of your central case, kind of declines in HPI in Ireland and the U.K. So I mean, directionally, the trend seems to be a little bit firmer than that. Just wondering what was the thought process on it and could that auger for the impairment number and maybe being a little bit better than the guidance if it was to pass. And then finally, just in relation to valuation items, maybe Myles. You broke down, and thankfully, in terms of the revenue guidance, but just want to get my head around what you were saying in relation to why there would still be -- it looks like a deduction in relation to valuation items for 2021. That's it.

Eamonn, I'll cover of costs and then pass to Myles on impairment and valuation. So obviously, we've now demonstrated a really consistent track record in our delivery today, and that reinforces our confidence in going beyond the target that we had previously set. So we achieved EUR 1.7 billion 1 year early. We're guiding to 1 point -- or less than EUR 1.65 billion to 2021. We're doing that in a number of ways. It's very broad-based around simplification, organization, sourcing strategically, the sort of dividends, the cost benefits of our IT digitization, also ways of working. And you mentioned the reduction in headcount. So we would have concluded our -- we closed the voluntary redundancy scheme in September 20. That's going to result in 1,450 FTE leaving the organization. The majority of that will happen during 2021. So the full year benefit of that will -- is more like -- we'll see more of that in 2022. And obviously, we're staggering those exits from an operational perspective. In terms of the 2021 to 2023 kind of glide path to EUR 1.5 billion, and because it is broad-based and it's across a number of areas, you could expect that to be sort of broadly linear as opposed to particularly front or backloaded. And yes, we feel confident about the progress we've made and the strategic decisions we're making to execute beyond this year. I'll hand over to Myles, and over to you.

Sure. So let me just deal with the impairment guidance, and then I'll come on to the valuation items. And so just in broad terms, there is a central scenario, quite correct. And we do apply 5 scenarios overall, which capture essentially upside, base case and downside as well. And as an overarching point in relation to impairments, I have previously set our objective for the 2020 impairment provision, aligned to IFRS 9 was to capture the majority of the risks associated with this pandemic and arriving at a charge of EUR 1.1 billion. I think we've done that. And I'm also encouraged that we've increased our coverage of performing loans. Having done that, we've actually experienced minimal deterioration in credit arrears in H2 are indeed an increase in NPEs in the second half of the year. So that's a positive point. However, given the continued lockdown this year and the continuation of government support, we can't expect the impairment charge to be elevated this year, but materially below last year but above our pre-COVID medium-term guidance of 30 basis points. And yes, we will update our macro forecast throughout the year. And property prices are holding up quite well. I'd say that plus unemployment are probably 2 of the larger macro factors, which impact credit impairment provisioning. On valuation items, there's a couple of subtleties here. Overall, what I'm saying is that I expect 2021 to benefit from a lower valuation charge, having taken an overall charge of EUR 56 million last year. And I say that because I think we can expect to see a level of stability in the financial markets, both on the equity side and indeed on credit spreads. As we begin to come out of COVID, that underpins that guidance. But there's a particular point that, in the second half of the year, valuations had a positive of EUR 67 million because we recovered from the half year. My only point is don't extrapolate that as a number for the full year. But the broader point is that valuations should be a positive factor for 2021.

Just actually, if you don't mind if there's a follow-up. Just the loan book looks like -- in terms of certainly gross loans, you were stable into Q4 and certainly, H1, I suspect, probably close enough in terms of Q3 as well. And just in terms of momentum improving, and I'm conscious you kind of flagged earlier on in terms of maybe some NPE disposals, but could we see the loan book actually grow this year?

Yes. I think our objective -- I mean, when I think about that in a H1 that is -- for the most of it, will be in lockdown and also mindful the part of the economy, such as construction and housebuilding essentially closed for 1/3 of the year to April. That's going to have an impact. But equally, we believe that the second half of the year is going to be more normalized, and there will be a level of recovery there. The other point to make -- anyway, just to remind you, that is part of our strategy. We do expect the U.K. book to decline by about 10% over the course of the year. Whilst margins remain strong, that planned reduction will also play out. So I think in terms of new lending, I expect overall for it to be stable, but you've got those overall factors played out on the total loan book.

The next question came from the line of Chris Cant from Autonomous.

Two, if I can. One on capital generation, one on accounting. So in respect to your stable capital guidance, am I correct in thinking that, that is after any distributions or foreseeable dividends that might be in the mix of the year-end? Obviously, you're talking about buybacks as a potential option as part of your distributions and they would not be considered foreseeable at the year-end. So the guidance is a little bit -- I mean, it really depends on what assumption you're making in respect to the mix of dividends and buybacks. If I could ask for sort of a related color. Your organic capital generation, are you expecting that to be up presumably on the 2020 performance? And could you give us some guidance on some of the below-the-line charges? I'm just wondering whether there's anything in there that is sort of in the capital back down again. And then on accounting, just in terms of your comments around the strength of the Insurance and Wealth business as a contributor to other income, could you give us any color on how you expect IFRS 17 to impact that element of your business income from 2023, please?

Thank you very much, Chris. Before I hand over to Myles, both actually, probably talk about Wealth and Insurance more broadly, but I'll leave the IFRS 17 to Myles. But what I would say is that on distribution, I mean, we're not being -- it's too early to be definitive on the combination, but we are -- our reference distribution is to maximize the flexibility in how we return excess capital. So that's well understood. Myles?

Sure. So just first of all, to be clear, the capital guidance to be flat in 2021 is after setting aside an assumption on distributions. And your point on the below-the-line impact, so a couple of points to make. Firstly, we expect to remain materially within the EUR 1.4 billion transformation budget to get to our cost base of below EUR 1.65 billion. But in the context of setting a new cost target of EUR 1.5 billion by 2023, we kind of expect a level of investment required over the next number of years. And we'll give you more detail on that as part of the strategy update later this year, but there is an assumption in that when we call out capital levels being flat. On IFRS 17, I mean, it is an interesting accounting standard, as you say, to be brought in by 2023. And it's interesting in the context that it is truly an accounting standard, meaning that it doesn't actually change the underlying economics of an insurance business or indeed our Wealth and Insurance. It does impact the timing of when income gets recognized. And so when I think about IFRS 17, not just for Bank of Ireland, but generally for banks that have a bancassurance model or indeed stand-alone insurance companies, there's going to be a communications exercise to explain the underlying economic value that's created aside from the accounting impact in a given year. And also, particularly from a bancassurance point, like what is the value that has been created for the group, whether that's the embedded value of the entity, ours is overall contribution. So I think it doesn't impact business model or economics of our business, but it does require better explanation of how those numbers are arrived at and somehow I guess, reconciling between economics and accounting outcomes.

Next question from the line of Aman Rakkar from Barclays.

I had a couple of questions on income and then capital, if I could. So just around the 2021 guidance on NII, could you help us understand just a couple of things? Have you made any assumptions around TLTRO? Or could you help us think about your appetite for drawing on that? And is that a potential positive that you might want to call out? Also on the U.K. business, kind of could you help us understand the pace of reduction there and when you would expect the loans to fall away? Basically, I'm thinking -- I think you're calling out something like EUR 40 million, EUR 50 million of less NII from that business. Should we straight-line that through the course of next year? Or can you help us kind of understand the shape? That would be really helpful. I guess second one on capital. I was just thinking about how you guys were thinking about your medium-term capital ratio. I mean, you've had a pretty material reduction in your Pillar 2R through the course of the year. Presumably, you've got some issuance to do to kind of fill your buckets, et cetera. But the kind of 13.5% CET1 target level that you guys were hovering around before or at least targeting probably seems a bit too high now. And I guess the reason why that's relevant is if we're now starting to think about possibility of buybacks and sweeping away additional capital, I guess, that's something that could kind of help us in the medium term. I'd be really interested to hear your views on both of those, please.

Sure, happy to. So let me take the TLTRO question, first of all. So we haven't drawn down TLTRO to date. And just important to highlight that this is probably very obvious, we don't need TLTRO for liquidity purposes. We have plenty of liquidity. And I think in the context of COVID and its impact on overall balance sheet progression over the course, particularly of this year, it's too early to conclude whether we will draw down or not. The next decision point actually is in March this month, and we will give a careful consideration. But it does, if we were to, it would represent a level of upside. But I would caution a little bit on that just given the progression of the balance sheet this year. On the U.K., directionally, you're right, but I'd say to you just that 10% reduction in lending in the U.K. will be graduated over the course of the year and actually probably a bit more biased towards the second half of the year. So I wouldn't have the hit quite a severe amount as you have called out. And actually, just as a broad point, how to think about the U.K. dynamics of the financials. If you think about a balance sheet falling by 10% this year, margin improving by 5%, operating costs down by 3%, you're beginning to get a sense of what the model looks like. And that general shape -- we're not that perfectly, but that general shape will continue out beyond 2021. And on capital, you're right, 13.5%, the pre-COVID-19 capital target. And just to put that into context, that was against, at that point in time, a capital requirement of just under 12% when everything -- all of those buffers came in. So the buffer of about 150 basis points, including P2G. Now we are in an evolving environment where 1.2% of regulatory buffers were removed because of COVID, and just under 1% of P2R requirements are now filled from non-CET1 capital. Mindful, we did EUR 975 million of our AT1 transactions last year. So our capital planning assumptions, we assume that the eventual reintroduction of the 1.2% will happen over time, which will take the regulatory requirements to about 11% based on what we know today. And so I think post-COVID, it's appropriate to maintain a management buffer in the region of about 200 basis points, including P2G. So taking all of that into the mix, I think your view or your approach is about right.

Perfect. Can I just ask one additional question? Actually, it's a bit tangential. But on associate income, I mean, that's a bit softer in H2 than perhaps we're hoping for. I mean, I guess, what are your expectations for that revenue line next year? I mean, on first class, it looks like that's probably a touch below where the Street is. And then secondly, your income guidance flat year-on-year in '21. Can I just be clear, does that include associate income because you typically do include that in business income? Or is that a separate line?

No, it is included. And that's -- yes, it is included, to answer that question. And I mean that associate income essentially is our U.K. joint venture in retail FX, of people going on holidays, that type of consumer activity. Now that was clearly heavily impacted because no one was traveling, and we do think it's an area that could take longer to recover. But if you presume that eventually people will begin traveling again, will go on holidays, we can expect to see a recovery in that line. The timing, of course, will be dependent on lockdowns and getting people back onto airplanes again.

We have the next question from the line of Andrew Coombs from Citi.

Three questions for me, please. Firstly, the cost guidance, the outlook statement on Slide 29. Can you just confirm the basis of the cost guidance, the sub EUR 1.65 billion for 2021 and the EUR 1.5 billion to 2023? Is that all in costs? Or is that excluding regulatory charges and levy? Just best if you could clarify that, please. Second question will then be on that point or I guess extension of the first question. I think it was EUR 125 million for regulatory charges in levy for 2020. Can you just confirm what consensus has in, in future years because you don't put that in consensus you provide to us? That's the first question. Second question, non-core charges elevated this half, driven by the voluntary redundancies, the software impairment. Given you're guiding to further cost saves going out, presuming that non-core charge below the line is also going to remain elevated. So any guidance you can give on that, please. And then the final one, just coming back to TLTRO. Appreciate your comment about group-wide lending and the trigger points and why it might not be attractive. Obviously, that's impacted by your decision and what you're doing on the U.K. So is there any way you can structure TLTRO to be based purely on the Irish business and on the Irish loan growth? Or is that an impossibility given the way the legal structure works?

Before I pass to Myles, our cost guidance consistently excludes regulatory charges and levies, just for clarity. But over to Myles on maybe more.

Yes. Sure. So the levies, I think about that as it's a pretty consistent number within the EUR 115 million to EUR 120 million range being driven by essentially the shape of the balance sheet at a point in time when the charge was calculated with the different elements. But the EUR 115 million to EUR 120 million is about right. There will be -- if I understood the related question, we talked about remaining within the EUR 1.4 billion transformation spend to deliver on the cost base of below EUR 1.65 billion to get to EUR 1.5 billion. Within that is a level of ongoing investment, which we would expect us to have. When we cut costs, we continue to invest. But also, I would expect it to be some element of non-core out over the next number of years as we invest in essentially one-off costs to deliver on that cost target. But again, we will be in a position to give more detail on that as part of our strategy update. On the TLTRO, it is pretty formula-driven, and it really comes down to the level of the U.K. It's not a major impact on it because the rules relate to business lending, not to consumer loans. And so we'll be looking at that in the context of our business portfolio evolution over the course of this year.

[Operator Instructions] The next question is coming from the line of Diarmaid Sheridan from Davy.

Just a follow-up question, if I can, around asset quality, please. So accepting the bookers of charges that you've taken for the kind of the legacy loans and excluding those, over what time period do you think that we should start to see the other 2 buckets of the charge for 2020 kind of transferring from kind of Stage 1, Stage 2 and Stage 3? Or how should we think about the development of that buildup in charge that has happened? And maybe just in terms of your guidance of a materially lower charge for 2021, just in terms of what you have assumed there vis-à-vis the economy and reopening for this year, please?

Okay. So the -- if you think about the -- where we've got to our EUR 1.1 billion, which is underpinned by the macroeconomic forecast that we've set out in the presentation, now essentially, well, what happened this year in 2021 is that as some of those portfolios go from performing where we've put aside a provision and impairment to be an actual loan loss at the risk of getting technical here, essentially, your probability of default on those loans goes from being less than 1:1. So essentially, you assume a stable macroeconomic outcome, some of those loans that we put aside risk for turns into actual loan losses, driving the [ PDF1 ]. So that's kind of the math behind it. And again, I have said that I expect the charge to be elevated relative to a medium-term normalized credit charge of about 30 basis points, but well below -- materially below the 143 bps that we had last year. Maybe just to give you a little bit more color on that based on the macroeconomic outlook. And when I look at the low to high range that was within consensus, and clearly, there's a level of uncertainty given the current lockdown. But I don't feel the need to move off consensus materially. And just to link that back to capital, clearly, we've captured that risk when we say our capital levels remain stable in 2021.

That concludes our Q&A session.

Okay. Thank you very much, everyone. Appreciate your time, and have a good day.

Thank you very much. Have a good day. Thank you.

Thank you.

That concludes the conference for today. Thank you for participating. You may all disconnect.