S&P Global Inc. (SPGI) Earnings Call Transcript & Summary

Good afternoon, good morning, everybody, and thank you for joining us on what is that another very sunny day here in Dublin for this S&P Global Ratings webinar. My name is Patrick Drury Byrne, I'm the Global Head of Credit Market Research, and I'll be moderating this session today. So today's short 30-minute webinar, which will focus on recent rating activity, and specifically, on the upgrade during May of the Irish sovereign, and obviously, the upgrade of 3 main Irish domestic banks, probably about a week ago. I'm delighted that today I'll be joined by Anastasia Turdyeva. She's a Director and our Financial Institution ratings group to talk about the upgrade to the Irish banks and also by Johanna Melinder, Associate director in our sovereign rating group to talk about the upgrade to the Irish stuff. We have a lot to cover. So we will have plenty of time to answer your questions as well. But before we make a start, let me just briefly go through a few housekeeping notes in terms of this console which you see in front of you today. So first and foremost, we want this to be interactive. So you can submit questions at any time during the webinar via the Q&A box. You can download a copy of the presentation slides today, actually a short deck together with research in relation to the sovereign finance, the bank upgrades and insights published by us via the relation content back, which you can also see on your screen. To know more about speakers, you can view their bios via speaker bio widget. And as of we say at the bottom of the page, like your opinion mannered. So at the end of the day, if you don't mind completion to survey at the end of webinar to help us basically facilitate our future webinars that would be appreciated. Okay. Let's get started. Before we kind of focus specifically on the sovereign and the banks, I just want to paint a very quick picture about basically the overall Irish portfolio. And as you can kind of see on the left-hand side, that's the overall composition of the Irish portfolio. So we raise in Ireland, approximately about 120 issuances, which were incorporated or headquartered in Ireland. Larger sector, as you can see, is structured finance. So -- but obviously, you can split that into a number of subsectors. The largest loss would be RMBS , so residential mortgage-backed securities, secured is backed by residential mortgages, and collateralized loan obligations. So these are collateralized loans, which are backed by leverage loans. Corporate is obviously the second biggest sector. The 2 probably largest subsectors in our for corporates in Ireland are health care and transportation. We have financial institutions and sought of them which we will come on to discuss. Now just on the right-hand side, I just wanted to give a very quick view of upgrades. But just if we kind of step back a little bit, first and foremost, like in global terms, when we look across the globe at the moment, what we're actually seeing is probably just growing divergence with kind of stability at the investment-grade level, but kind of growing rating pressure at the lower end. But this pressure is kind of uneven across sectors. So clearly, what we are seeing is that most economies are kind of proven to be quite resilient. And in certain sectors, particularly certain corporate sectors, they're still kind of a recovery story in the pandemic, which is kind of playing through. However, on the flip side of that, we're also seeing this impact of higher input costs, as a result of precision inflation, and we're also starting to see the impact of like higher for longer rates, which will likely increase in impact as obviously, the monetary policy lags play through. And as a level of refinancing risk increases in the years to come. But specifically, just in relation to Ireland, what you can see, if you look at the very right of the chart is that we had a significant increase in upgrades in the first half of the year. And I think just looking at them briefly, basically, first, when we look at the corporates, like the themes I just spoke about there, they literally hold true in terms of when we apply that to the Irish portfolio. So the upgrades were due to kind of improved operating performance, sometimes due to basically the continuation of the pandemic recovery. And then downgrades, which I haven't shown here, but which we also had in the first half of the year are due to like high impact across pressure on margins, and therefore, operating pressures overall. Structured finance, you can see there is a significant basically 5 upgrades. Once again, that's largely across residential mortgage backed security. So they're backed by mortgages and there, those upgrades were driven by essentially stable performance in the underlying portfolios. And obviously, financial institutions and sovereign. We won't -- I won't talk about them now. I'll leave that to obviously to Johanna and to Anastasia in particular. And clearly, the number here in financial institution includes other financial institutions other than the Irish banks, and obviously, while the sovereign looks like it's 2, that obviously relates to both the Irish sovereign and NAMA, which we wish. Okay. So what we might do is now let's jump into the actual what we wanted to discuss today. So what I'm going to do is turn it over to Johanna Melinda. So she's our associate Director Sovereign Ratings. And she will take us through the upgrade to the Irish sovereign in mid-May and kind of the reasons behind it.

Johanna, actually, like just as the questions are coming in, I might just ask and pass it on to you in advance, which I'm sure you will cover off because obviously, it's a key component. So a question coming in, is the increase in corporate tax more permanent than the government is suggesting? So Johanna, over to you.

Thank you very much for that, Patrick. I can go to the next slide. Yes. So as Patrick mentioned, we raised the rating on Ireland to AA with stable outlook from AA- with positive outlook. This happened in May. And this upgrade primarily comes on the back of strong public finances that we have seen improving over the past year at least with an increasing budgetary surplus, and we believe that this will help the government to pay down on this debt and especially as we share of Modified GNI revenues. We expect both the debt in nominal terms as of the share of revenues and GNI to reduce and this is faster than we previously did and hence that grade. At this stage, we believe that the risk to the ratings are balanced. So therefore, the rating have a stable outlook. We can go to the next slide for the more specifics. Yes. So the government finances, they recovered very softly from the pandemic and reached a surplus last year, as you can see on the first chart here. And thanks to the resilience of the economy despite the external shocks too it in the past year. Tax revenues have continued to grow very rapidly this year. And although we expect them to slow down, we believe that the government public finances would remain strong and post surplus in the coming years. And this strong performance is not only on the revenue side, but also to some extent, on the expenditure side because some of the temporary support measures that were implemented first and foremost, under the pandemic, but then also to combat the cost of living crisis will gradually reduce. But at the same time, there are large expenditures, for example, housing infrastructure and social policy that mean that overall expenditures will still increase overall. So we don't expect major reduction, but that the growth rate will come down now. But that said, sort of partly relating to the question Patrick asked, this risk in -- the increase in the revenues that we observed is not sort of full without risk. And as you probably all know, a large share and an increasing share of the government revenues are related to corporate tax receipts, which are highly concentrated with more than 50% coming from only 10 companies and slightly even more concentrated at the very top, and this makes corporate tax receipts and government revenues in general, quite vulnerable to a specific company and industry trends. This is, to some extent, already incorporated in our ratings on Ireland. So for example, we have -- we see this as structural sort of weakness in the fiscal position overall filing compared to peers with some similar budgetary trends. Yes, because of this vulnerability as I mentioned. And given expect a slowdown in economic activity and primarily in the ICT sector, we also expect that there could be a slowdown in growth this year and then more. So in the medium term, we also have the OCD agreement that has a component of it that will include relocation of profit taxation that will likely mean that some -- They will likely be some reduction in the revenues going to the Irish government. Maybe more sort of specifically on the question on corporate tax revenues and if it's permanent. But I think it's quite fair to assume that part of the increase that we have seen are more organic and there to stay. But given the nature of it, as I mentioned, with the concentration and the volatility there's probably still a large area of this that it's more vulnerable to specific company trend and industry set trends. That doesn't mean that it won't remain for a longer period. It's rather that the risk to a portion of it is higher. But I've seen in at least latest 18 months, this can also lead to a surprise on the upside, but I think there's some volatility and risk inherited to it. And considering sort of all this maybe volatility in the -- potential volatility in the corporate tax revenues. We view it positively does the government quite recently launched plans to create a longer-term savings fund to channel some of these higher revenues to specific funds and accumulate assets rather than increase spending in your [ Chart map ] . And this sort of potential higher assets that accumulate in this fiscal surplus will help the government debt to continue on this quite clear downward trend that we are expecting, especially when looking at that as net of liquid assets. So we can go to the next slide for just a comment on the economy as well. And there's a where it is also supported by the macroeconomic performance of Ireland and especially considering the uncertain external environment. I mean, similar to other peers, we still expect the Irish economy to slow down this year, but we expect it to perform better than most of its peers and still post a relatively solid growth rate. In similar to the region as a whole, the pressure primarily comes from higher interest rates and inflation, but also generally to global demand. But what's supporting the Irish economy is, for example, that the labor market is still faring pretty well, and the households have accumulated large savings buffers that still out there and to support consumption in the near to medium term. And then there's quite high investment needs in the economy, and especially housing and infrastructure. And I think this could likely mean that although interest rates like you mean that some construction investments goes down, there will be demand for it there so that it will uphold higher than you might see in other countries that don't have sort of potential deficits in some key infrastructure sector. And then we have on the external side, Irish exports are quite noncyclical in nature and especially ICT and pharma could probably withstand some of this sort of general decline in demand globally. And then going forward, we expect that Ireland in line with most years on economies will have some pickup in growth as primarily inflation comes down and potentially even interest rates go down and at the same time, see stabilization or increase in external demand. Things on a medium term, what I mentioned on the housing market that this is a key risk to the potential growth of the Irish economy. There's government measure aim to address this. But it's still quite large deficit. So it's unsure if this will be enough to dampen the demand, in medium term, this could had the ability to maintain and attract talent in Ireland, and therefore, impact the potential growth. And with that, I like to hand over to Anastasia.

Thanks for that. Just very quickly, I think that it's very interesting to hear as we kind of run through it and I think it's no great surprise in terms of where to use amount of volatility with regards to corporate tax. And then we talk about the Irish economy, you can really apply some of the points regarding higher interest rates, basically strong labor markets and high savings rates to other developed economies. Okay. So now let's turn it to talk specifically about the Irish banks and to Anastasia Turdyeva, who is the Director in our financial institutions group. And obviously, Anastasia, we updated -- or we upgraded, excuse me, 3 Irish domestic banks, I think, on about 14th of June. So maybe you can kind of take us through the reasons behind those upgrades? And in doing so, Anastasia, if you don't mind to deal with a question, which is common in here, which is any concerns on asset quality issues on as loan interest rates reset to higher levels? So commenting, Anastasia over to you.

Thank you, Patrick, and hello, everyone. It's good to present after Johanna, actually set the theme and as she explained upgrades that the sovereign ratings were linked to sort of fiscal performance and anticipated reduction in government debt. But as you can imagine, there is no direct impact of this action on bank's credit worthiness, what is like the most important in sovereign assessment from bank's perspective and what could impact bank's performance is actually economic growth, where Ireland continuously outperform peers and quite tight labor market with forecasted low level of employment going forward as well. So therefore, we see the rating environment are supportive for bank's asset quality that was actually improving over the past decade and landed at around 3.4% on average as a band March this year. The decline was happening due to the nonperforming assets sales previously, but lately, actually, the reduction in NPE ratio is driven by pure nonperforming loans that were back to repayment. And additionally, by consolidation in the banking sector and completion of the deals on the loan portfolio acquisition from exiting the market [ both bank ] and KBC in Ireland. And if you look at the chart on the left, you see that the NPE level in Ireland, it is dotted blue line improved significantly and actually now sits between 2 groups of countries, upper one with a bit higher economic risk and those below the total line is those with the lower economic risk. So Ireland is moving towards the lower risk countries. And -- but following the question that, Patrick, you just asked on the rising interest rates, we don't want to be like rosy here and mindful of both rising interest rates and inflation that would pressure the private sector that service capacity. But actually, like first, let me talk about the largest portion of the loan exposures in Irish bank's books, which is mortgages. And we actually do expect good performance to hold thanks to high employment, as I mentioned, lower average loan to value ratio, which is, on average, 51% on stock in the system. And increase over 2022 share of fixed rate mortgages in new lending and the mortgage refinancing because borrowers obviously thought to lock in their mortgages -- mortgage payments in anticipation of further interest rate increases. So the loan stock with fixed rates actually increased 60% from 40% a year ago, which also helps reduce credit risk in the mortgage portfolio as interest rates still continue to rise. However, if we look at evolution of mortgage interest rates in Ireland, it's right chart on this slide, you see that pass-through of monetary policy rates into mortgages have been quite slow. Fixed rates in Ireland back in times even a year ago were like the second highest in EU. But started to rise not in July last year, but only in beginning this year. And the increase on average rate, as you see was much less in Ireland than in EU on average. And that, in our view, also will be putting like less pressure on work in Ireland as well. This situation is explained by excess of funding banks to get from customers and banks do small increase for deposit rate and therefore, allowing just gradually in full increase rates on the asset price for lending. We also think that households entered the period of rising interest rates in quite good shape with, as I mentioned, a high level of rate succession , substantial savings accumulation and good housing equity position on the back of housing price growth. [ Needless ] to mention that the market potential rules set by Central Bank of Ireland are in place and that's quite strict in Ireland, but also helpful for this particular portfolio. Next slide, please. However, we obviously anticipate that additional problem loans will emerge, but mostly among the SMEs. So if you look at the chart on the left, the SME portfolio with higher level of problem loans, and here, we see that the problem will appear. However, the proportion of the portfolio is not that huge. The other positive risk is the property sector that has been an important driver of imbalances in the past and remains the rest to monitor. But we don't see actually immediate track to the banking sector. As I mentioned, like mortgage side recovered, and we think that it's quite a resilient portfolio, but we are also mindful of commercial real estate that has always been vulnerable, especially during economic shocks. And we see that exposure to CRE has reduced over the past decade in Ireland and the risk for Irish banking system seems manageable, given that we estimate only about 5% of loans are real commercial real estate versus like 9% on average for European banking system. Therefore, we expect that the effect on asset quality duration to be manageable overall with the NPE level to stabilize around 3% of total loans. And we do expect the inflow of new problem loans to be largely offset by the outflow of queued NPEs as well as limited NPE portfolio sales. The management overlays that bank holds -- and the earning capacity -- improved earning capacity of Irish banks will additionally support the banks to manage any credit losses that they could experience. But our expectation that the credit cost will be around 30, 40 basis points for the next 2 years. Next slide, please. The evolution of asset quality and the economic fundamentals actually led us to revise our economic risk for the Irish banking sector that actually sets the anchor for our ratings, and we moved our Ireland in to the group 3 from 4, and actually the peers now for Ireland, Czech Republic, Israel, Netherlands, U.K., Korea and Australia. The industry risk assessment remained unchanged, but still, again, as I mentioned, starting point has moved up to BBB+ from previously BBB, and that was incorporated into our ratings on 3 Irish banking groups. If you look at the left chart, you see the comparison of Ireland, how we assess like each factor for Ireland versus peers? And actually, like on economic risk that are like [ 3% ] factors we see Ireland quite on par on economic analysis and credit risk in the economy. But in terms of economic resilience, reflecting the sovereign fundamentals we see Ireland a bit better positioned versus peers. On industry risk assessment, the Ireland is -- was so faster in terms of competitive dynamics. And here, this reflects the profitability issues that the system had over the past number of years. Next slide, please. But however, high interest rates alongside with the bank's focus on cost discipline and actually like current business momentum, thanks to consolidation within the banking sector will improve Irish Bank's operating profitability. Also, like the gradual repricing of loans, so low funding costs given large share of deposits that are not interest bearing and larger scale that brings the market consolidation to outstanding banks all these put Irish banks in equal position to benefit from increasing interest rates. So we do expect everything just to improve and this right chart actually shows the evolution of Irish banks from 2022 to how we see them in 2025. And actually, all other banks those are showing data forecasted for 2025. So it's like clearly the improvement story for the banks. The only thing that is not worrying, but we should be mindful of is that the largest portion of upside is coming from net interest income. And this is like the largest share of the revenue for Irish banks. So this is like a bit of a concentration and being a prone to interest risk cyclicality, right? So we do see that banks diversify revenue versus an increased top line results by expanding product offering to insurance and wealth management, but again in so far and over the next years. NII will be dominating in revenues for Irish banks. So in our view, like current business momentum and significant growth in revenue over the next couple of years should actually underpin also banks talked about the cost and digital agendas and potentially could bring structural improvements into sustaining a bank's cost efficiencies in the longer run, notwithstanding of interest rate environment. So yes, that's it from my side, and ready to answer questions, if any.

Thank you very much, Anastasia. I think we're coming up in time, but where I will try and to squeeze in a couple of quick questions. And then other questions if you don't get time to answer, we will address them back post webinar and clearly, you are welcome to download slides. Johanna, I'm going to going to come back to you very quickly try and get a quick answer out of you. What are the key risks for the sovereign relating to the OECD agreement on Pillar Two in particular?

Yes. So Pillar Two refers to the increase in minimum tax to 15%, and this is up from Ireland's current 12.5%. And I mean, there's, of course, a risk that we will see behavioral changes at the company level given that it is a change in policy that will impact some of the larger companies. But our base case is that we don't expect any major companies to move. And this is based on the fact that it's still a very low tax rate in a global perspective. So they can't really move anywhere else in order to get a lower corporate tax rate. And then Ireland has some very key comparative advantages given that it's an EU country with English-speaking populations and a very educated workforce. But still, as I said, there is, of course, a risk that some companies leaving and given what we mentioned on the concentrated revenue source it would be a risk in [ something ] that we monitor, but our expectation is not to see any major changes.

Great. Thank you very much, Johanna. So I think what we'll do is we will probably end it here. So let me just close by -- session by saying thank you very much for our speakers and to all of you our audience for your time and attention. As a reminder, today's webinar was recorded and will be available for you on demand via our website. You should receive an e-mail later today with a link so you can access it at your leisure. And obviously, we will address the questions we haven't got to today post the call. We also invite you to visit our website, spglobalratings.com/ratings where you can find all the latest research events and insight. And do please watch out for any upcoming webinars and events. Finally, if you wouldn't mind, take the survey if you have a minute, your feedback is important to us. And with that, I'll say thank you again, and goodbye from Sunny Dublin.