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Edited Transcript of AIBG.I earnings conference call or presentation 26-Jul-19 8:00am GMT

Half Year 2019 AIB Group plc Earnings Call

Dublin 2 Jul 31, 2019 (Thomson StreetEvents) -- Edited Transcript of AIB Group plc earnings conference call or presentation Friday, July 26, 2019 at 8:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Colin Hunt

AIB Group plc - CEO & Executive Director

* Donal Galvin

AIB Group plc - Group Treasurer & CFO

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Conference Call Participants

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* Alicia Marianne Chung

Exane BNP Paribas, Research Division - Analyst on the Pan-European Banks Sector

* Christopher Cant

Autonomous Research LLP - Partner, United Kingdom and Irish Banks

* Eamonn Hughes

Goodbody Stockbrokers, Research Division - Financials Analyst

* Owen Callan

Investec Bank plc, Research Division - Head of Financials Research & Banking Analyst

* Pierce Byrne

Cantor Fitzgerald Ireland Ltd., Research Division - Investment Analyst

* Raul Sinha

JP Morgan Chase & Co, Research Division - Analyst

* Stephen Lyons

Davy, Research Division - Financials Analyst

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Presentation

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Colin Hunt, AIB Group plc - CEO & Executive Director [1]

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Good morning, ladies and gentlemen. I'd like to welcome everyone here in the room, the people on the webcast and also those people who have joined us by the telephone, I'd like to all -- wish you all a very, very warm welcome here to you on behalf of myself and all my colleagues in AIB Group to No. 10 Molesworth Street, our new corporate headquarters. This marks the 101st day that I have been fortunate enough to be CEO of AIB Group. And you'll be glad to hear we've had a busy 20 weeks. We've launched a series of initiatives that I'll go through in a few moments, but before I do, first of all, we need to do the necessary and show you the forward-looking statement. We'll give you about 1.5 seconds to fully digest that before we move on.

So the initiatives that we've launched are very much designed to augment the strength of our existing franchise, and we have a very, very, very robust franchise within this country. In response to changes in terms of customer demand, we cut our fixed rates in the mortgage market all the way out to 10-year, and we have now have a very, very compelling proposition, which serves to complement the already market-leading standard variable rates that we present. We announced our proposed acquisition of 75% of Payzone. And that very much is a signal of our ongoing determination to be Ireland's leading fintech, to remain Ireland's leading fintech. We underlined our commitment to cost discipline by introducing a hiring freeze across the group in March. We completed the sale of EUR 1 billion portfolio of nonperforming exposures, and we announced our intention to rebrand our business in Northern Ireland from FTB, and we will have 1 unified brand all the way across the group later on this year. It's been a solid performance in the first half. As -- now we are content with where we stand. We're very much focused on delivering for the full year, and we look forward to sharing with you our plans for the next phase of the bank's development, and we'll do that when we present our full year results for 2019 in March of next year.

The economic backdrop remains very positive in Ireland, although the level of our performance against expectations is going to be lower, we believe, in 2019 than it was in 2018, where growth came in more than double the level expected when we came to the market in June of '17. The growth rate is still robust and healthy, although it will feel significantly less buoyant than we've experienced in recent years across the country, but it still remains at the very upper end of the European league table. And that very strong dynamism in the economy is translating into an ever-tightening labor market, with unemployment rate now down to 4.5%, a level last seen in 2006, well before the financial crisis, while employment levels continue to expand and hit new all-time highs.

The housing market is looking at an ongoing recovery from a very, very depressed position. At the bottom of the last cycle, we saw housing output no higher than 4,000 units, and this year we expect to see housing output of about 20,000 -- 22,000 new units. There still is a considerable gap between what we think is the normalized level of demand, of around of 35,000. And in the absence of the macro potential rules, I do think we would see very basic significant house price inflation. So the rules, while they are impacting on affordability, particularly in the capital city, they are having a desirable impact on the economy in that it's putting a very, very firm lid on house price inflation.

In terms of the business sector, the service sector continues to expand and looks very healthy in terms of forward-looking Purchasing Managers' Indices. The manufacturing sector is showing signs of moderation of pace and is -- it has dipped lower in recent months. We believe that is very much a reflection of the uncertainty created by the decision of our nearest neighbor to leave the European Union.

In terms of the balance sheet, we saw a new lending in the first half of EUR 6 billion as compared with EUR 5.5 billion in the first half of last year, an increase of 8%, with mortgage lending up 8%. We now have market share of 31.3%, by some margin, the strongest market share in Ireland. These numbers, of course, don't reflect the impact of the fixed rate decisions we took earlier this year, but we are noticing a marked improvement in approvals and applications, and we expect that to translate into an improving market share position as we move towards the back end of 2019.

Personal lending scored a very impressive rate of growth, up to EUR 0.5 billion in the half. And on the property side, this relates to our large real estate lending division. We saw a fall in new lending. This is in no way reflective of any diminished appetite on our part. The participation is very, very important part of the market. It is merely a reflection of the fact that loans in this space tend to be lumpy, can be very large, and we expect to be on-plan for the full year.

Within the corporate side, we had a very good strong performance in corporate banking here in Ireland and in Britain. That was offset to some extent, to a large extent actually, by more muted activity in our syndicate international finance area. And that is the result of deliberate decisions that we are making. We turned down over 90% of the proposals we review in that space, and we're very happy with the performance of that side of the house, in terms of the corporate side of the house. All that translates into very, very strong market shares, leading market shares, in the key segments of the markets that we target, and they are highlighted here at the end of the chart.

So when we made the case for investment in our company in March of 2019, we set out for our 4 pillars. We set out 4 medium-term targets, CET1, NIM, cost income ratio and the return on tangible equity. We also stated -- set out what was a really, really ambitious target in terms of the reduction of our NPEs. And it is worth recalling that at the end of '16, as recent as the end of '16, we had 22% of our gross loans were nonperforming. And we set out a very ambitious target. We said we're going to reduce that to circa 5% by the end of '19. And then we had the IPO.

And over the period, since we've made great progress against our targets, we've seen a sustainable profit, we've seen growing balance sheet. And we've seen, critically, a strengthening balance sheet because of the ongoing significant reduction in our nonperforming exposures.

They currently stand at 7.5%, and we remain very committed to get them down to circa 5% by the end of this year. When we meet again in this forum in the spring, we'll not only be presenting our results for 2019, but we will be outlining our strategic plans for the bank's next phase of growth and development out to the end of 2022. We'll be setting out a new set of a medium-term targets, we'll be setting out our plan for capital, and we'll also will be setting out and making clear our ambitions for NPEs. And at this juncture, I can tell you, we intend to reduce that amount decisively lower in the next number of years.

So I'm not going to go through, you'll be relieved, every single point on this chart here. It's going to draw your attention to a few of them. On customer first, we were delighted to launch a EUR 5 billion fund, which is earmarked to support the transition of the economies in which we operate to low carbon. Not only are we looking at funding, renewable energy, generation, but we're also looking at promoting ever more energy-efficient transportation and housing. On simple and efficient, we were delighted to welcome our 1 millionth customer to our mobile app, and we're very proud of our -- of the fact that we have the most popular mobile banking app with any Irish bank.

On risking capital, Donal and the team in treasury had a very, very successful period in terms of annual issuance. We got EUR 3.3 billion now issued, and we're very, very confident of where we stand and well positioned to meet the expected requirement. And on talent and culture, we're putting culture and accountability at the center of everything that we do. And we were very pleased at the first time of asking to be 1 of 40 of Gallup's customers globally to be awarded a Great Workplace Award. And that's a very, very neat reflection of the significant improvement in engagement we've seen across the group in the past 5 or 6 years.

These 2 wheels here, very neatly, I hope, summarize all the ways that we engage with our customers. We engage in person, in branch, by phone, by Internet, using kiosks, over the ATM. But the most popular way that our customers choose to interact with us is using our mobile app. We've had incredible growth in its use in the past 5 years. And the total number today, on an average day, we get 1.26 million mobile transactions. That's 8.5x the level that we would have seen in 2013. And in the half that we're just reporting on, we saw an 18% increase in digital transactions across the group, a 7% decline in nondigital transactions, biggest single shift happening in terms of contactless, which is up 49% on a year-on-year basis. So this is improving the efficiency of the organization, but doing it without any detrimental impact on our customer experience. And in fact, if you look at our NPS, they highlight the fact that our customers value the way that the availability of digital, that allows them to interact with us in the way that they choose. We've -- a very, very strong set of NPS scores. Our mortgage express journey is hitting an NPS now of 65, positive NPS of 65, over 1 in 2 of the customers who are new mortgage borrowers, are choosing to go that particular route. And our mobile app, that I referred to earlier, has an NPS score of plus 66.

We've had a very, very heavy lift in terms of investment over the 2016 to 2018 period. We will continue to invest well in the period ahead, but at a level below where we were between 2016 and 2018, in and around and about EUR 225 million per annum. And that investment is very, very much focused on delivering on our strategy and underpinning our resilience, promoting sustainment and making sure that we comply with the requirements imposed on us by the regulator.

So before I hand over to Donal, my last slide. The Irish economy is doing very well, but clouds are gathering on the horizon. Geopolitical environment is very difficult and getting increasingly difficult. Global trade tensions are at levels we haven't seen in decades. Purchasing Managers' Indices the world over are turning downward, monetary policy authorities are pointing to a loosening rather than expected tightening of -- on the policy side. And of course, we have that conundrum of Brexit, which we still don't know what form it'll take 3 years after Britain's decision to leave the European Union. So all of these point to risks to the level of growth in the economy, and it is incumbent upon us within AIB to ensure that we put our balance sheet into the strongest possible position to allow us to weather the storms that may lie ahead, and we will do that in the interests of our customers and our shareholders. So we are focused now on controlling what we can control.

That means ongoing reductions in our NPEs. It means ensuring that the quality of loans we put onto our balance sheet is high. And in the first half of this year, we would have graded 98% of our new loans as strong or satisfactory. And that has seen our total stock of loans that -- the grading there is strong or satisfactory has moved from 83% at the end of '18 to 86% at the end of the first half. And we have a very clear and unremitting focus on managing our cost base well. Taken together, these are going to be the guides, the appropriate guides for us at this juncture. And combined, they will underpin the sustainability and strength of our business through '19 and over the years ahead. Donal?

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Donal Galvin, AIB Group plc - Group Treasurer & CFO [2]

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Good morning, everyone. Thank you very much, Colin. Okay, before I get into the financial highlights, I really just want to run through a couple of points that I want to leave you with. Overall, underlying business performance for AIB in the first half is very strong.

We have a growing balance sheet on a gross and a net basis. Our NPEs are reducing, and we're very well capitalized. They're the big 4 headline messages for me. We'll get into some of the detail now.

PBT, EUR 567 million, pre-exceptionals. Net interest margin, 2.46%, obviously, a very important metric. We'll come onto that one in a bit more detail later, but we are seeing strong discipline on pricing on the asset side. Costs of EUR 744 million for the first half of the year, which is up 6% year-on-year, which really underlines the requirement, and like Colin said, for us to focus on costs. Again, I'll come into that a little bit later.

Nonperforming exposures of EUR 4.7 billion at the -- as of June. So that's a very strong reduction from our FSG unit of EUR 1.4 billion. It puts us very much on target for the circa 5% at the end of the year, which is -- we've always maintained as a very, very important data point for us. CET1 ratio, 17.3%, solid underlying profit generation of approximately 80 basis points. We have got indicative guidance on our AIB mortgage TRIM. I'll try and go into that a little bit later, but that looks like it's going to be a 90 basis points impact to CET1. As Colin mentioned, our MREL issuance program is proceeding very well.

Okay. So on the income statement, like I said, operating income, pretty strong. We're very comfortable with that, very much in line with the environment that we've been in and the market shares that we have. Expenses, I'll come onto a little bit later in a bit more detail. Bank levies and regulatory fees, it looks like a large increase year-on-year, probably distorted by the fact that in 2018 there was in fact a reduction. So actually, probably more in-line year-on-year. Impairments for the half year, there's a charge of EUR 9 million. That's probably the first time since 2013 that we've had an impairment charge. Even last year, we had a significant write back of EUR 142 million charge. And I think this is down to a number of things.

Obviously, as we work through our nonperforming exposures and that quantum reduces, the amount or the ability for our numbers to get written -- or written up or written down reduces. But I'd say more importantly what we're seeing in some of the key indices that we value as collateral, such as HPI, or even commercial real estate indices. Throughout 2019, these indices have probably leveled off quite a bit. Overall business-wise, we probably feel like that's a positive, affordability in the mortgage market and the housing market is very important. It just does have, obviously, an impact when you're looking at your provision levels. So I think EUR 9 million charge for the year, as we look from now to the end of the year, difficult to predict entirely, given the sensitivity around provisioning models, but I mean it's going to be driven really by the macro environment where we go from here. But it certainly does seem that we're coming into an environment of more normalized cost of risk-type discussions.

Overall, the key metrics here you can see, I'll come to those a little bit later.

Net interest margin, quite a bit going on overall. What I've tried to do on the top slide is itemized exactly what is impacting our net interest margin and down below really try to give you a sense of what's happening quarter-on-quarter.

So on the positive side, I mean, last year, we would have spoken about impact on, I'd say, pricing competition, et cetera. We're very pleased to see that overall asset yields and asset pricing and loan pricing is holding up very strongly. So that's actually an improvement of 4 basis points for the first half year -- first half of the year. On the deposit side, we've managed to make some efficiencies there of approximately 1 basis point as well. Then on the headwinds, we would have talked previously about MREL issuance, the requirement to hit all our MREL targets. So as we do that, and as we issue quantums of MREL, that's obviously coming onto the liability side and creating a drag.

IFRS 16, putting leases on our balance sheet. No income impact, but obviously grosses up and balance sheet and has an impact. And then obviously, on the investment securities, it's this old legacy investment securities that if our high-yielding coupons mature, it has that downward pressure on our overall net interest margin. So I mean we would have cautioned in Q1 not to think too far above 2.5, and in fact, recognize that there was going to be more downward pressure. And that's, obviously, what we're seeing now. And like I said, it's really is created by the issuing the MREL and also the impact excess liquidity can have of just actually holding that on the liability side. But I think as I look towards the end of the year, this is a similar position where we were last year, where we had a lot of liabilities to consume in the first half of the year, and then it's just onto management to get actions effectively to recycle that and reduce what the impact is going to be for the outturn.

Other income, we're pretty pleased with the outturn here. Year-on-year, you can see business income slightly down, but fees and commissions up 6% year-on-year, which is a pleasing result. The other business income is related to customer-related derivative-type exposures, so CVAs, XVAs, or whatever you want to describe those as. So year-on-year, you can see the change there. I'd say that structural nature -- and links to the interest rate environment. And so business income, we would say is fairly flat. In terms of other items, I think you're seeing more of the available-for-sale investment security gains than there was last year and equally a little bit less on realizations on restructured loans. But overall, that's pretty flat. So other income, year-on-year, is certainly in line with what we would have hoped.

So costs. Colin would have talked about this earlier with our renewed focus on cost discipline. If we look at our exceptional items first, EUR 131 million. This is made up of a number of different items. We have a gain in our portfolio sale of approximately EUR 34 million. We have restitution costs of EUR 102 million. That's made up of 2 things: number one, there is the unit that we had put in place to complete all of the work related to the tracker program, dealing with customers. Now that, that program has effectively -- and that's coming to -- at an end, and we've dealt with all customers. We're in a different phase of the tracker journey, which is an enforcement phase. We're working with the Central Bank. We believe that this will go into 2020, and obviously, there's going to be units and people attached to that. So we think those -- that the cost related to that is around EUR 40 million.

In addition, we have a self-identified restitution cost of EUR 61 million. This is a loan documentation issue, which we self-identified, relating to some SME and some personal customers. We don't think -- we've sized this problem up. We think that a EUR 61 million is adequate for what we have identified. And we're comfortable with that.

The second item is a provision for fines of EUR 43 million. The largest part of that is a provision that management has made for the tracker mortgage examination. So we've made a provision of EUR 35 million, and this is effectively management's best estimate for what we think could be an enforcement fine. Again, we don't think that we're going to have line of sight on that in 2019. It's more likely to move into 2020, but management felt it was prudent to try to take a provision at this stage.

Now if I look at the operating expenses. You can see between Half 1 '18 and Half 1 2019, they're up 6%, approximately EUR 40 million. So I'm going to try and break those out a little bit. Wage inflation running at 3%. I think is what we would've always have talked about is being the normalized level. And that's approximately EUR 10 million.

Increased depreciation from investment programs. Again, this is one of the headwinds we said related to all of the prior year's investment in technology. And that's approximately another EUR 10 million. And the cost of heightened regulatory requirements in oversights. I mean I'm -- and we're not going to put a specific number on that, I mean that's just across all areas of business, it's -- and I'm not really just referring to items related to inspections, et cetera, it's just items such as open banking, or if we look to the future, things as the AIBor project. It's just always a lot of very large regulatory projects coming through that we have to deal with.

And lastly, I would look at the elevated cost of our workout unit. As you can see in the FTE and the employees number here, year-on-year, the amount of staff that we have dedicated to our workout unit has actually remained the same. This is a conscious decision of the management to ensure that we have a -- we were fully invested in our workout unit.

And two reasons for this: number one, we have a very clear target for the end of 2019, a circa 5%. But beyond 2019, recognizing the significant headwinds that may face us with respect to calendar provisioning, et cetera, we also would have said at the year-end results that we saw the circa 5% as a milestone and not a destination. So I'd say as we're fully invested in this area and all the associated support that goes with working through these very complex, difficult environments. And so they're all of the items that we -- that are feeding into the operational expenses. But like Colin said, we've -- we're very focused, overall, on the cost agenda. We've implemented a hiring freeze from March of this year, and so we're really going to get focused and ensure that we work hard in that area.

Balance sheet. I'm going to start firstly on the liability side here and work my way into the asset side. Main moving parts here, I would say, are on customer accounts. The strong macro environment in Ireland overall is just leading to stronger growth in retail deposits. This is a theme that we've seen over the last number of years, and that really just is driven by that environment. So that's a positive.

Debt security is an issue. You can see that, that's increased on the year, and that's really -- down to the MREL issuance that we obviously would have done. So you can see the excess liabilities then actually moves onto the asset side of the balance sheet. When you look at loans to banks, really what you're seeing and the increase there is the additional or the excess liabilities appearing on the asset side of the balance sheet, kind of manifesting itself as a EUR 2 billion to EUR 3 billion of excess liquidity that we hold with the central banks. So when I talk about the NIM drag from excess liquidity, really that's what I'm referring to: excess cash, particularly held with the ECB, given the fact that there's negative interest rates there. On the asset side overall, performing loans, you can see strong, year-on-year. Net loans to customers, net asset growth year-on-year, very much in line with results last year and in line with our projections as well.

Gross performing loans, Colin would have broken down the specifics for the year -- for the first half of the year. I'm really just trying to give an overall look at the balance sheet totals. So mortgage growth, up year-on-year by 8%, but the mortgage portfolio, flattish for the year, which obviously the difference there being some redemptions. If we look at the business mix, I would say that this is very much in line with what we would have seen in 2018 as well, more activity in the wholesale type of business area. So Colin would have mentioned strong performance in corporate Ireland and corporate U.K. and property as well. And in the SME business and the SME market, we're still seeing muted credit demand. I mean that was something that we had seen in '18, and that we had -- we thought we would continue to see this year. And that overall, I think is a to enter -- that's a Brexit effect, okay? So the larger corporates are putting in place plans to ready themselves for all kinds of Brexit outcomes. Property and construction is driven by more and more firms moving here in commercial real estate, et cetera, and supporting that. But the SME growth, I would say, is still a little bit muted. So what it really means, business mix-wise, is we've got a little bit more wholesale than we do of retail, which in and of itself is absolutely fine, but it probably talks a little bit to a mortgage market, which is to-date, slightly underwhelming.

Momentum in NPE's. Again, we know we think this is good news story. We've moved from EUR 6.1 billion of NPEs to EUR 4.7 billion as of June. Coverage ratios remain the same. The levers we use within the FSG unit -- there's a large team there, really trying to engage with customers on a case-by-case basis. You can see that really coming through the BAU-type activity. So there's cash redemptions there, there's restructurings, there's new to impaired and there's outflow. So there's a lot going on in that box there for EUR 400 million.

And then there's a obviously portfolio sale executed earlier this year -- what had a material impact on the NPEs. So finishing the year at EUR 4.7 billion, and very much on target for the year-end circa 5%, which has been one of the key targets that we've outlined since the IPO days in 2017.

What I'm trying to do here is just really unpack the underlying nonperforming exposures by asset class. I think what you can see between December and June, notwithstanding the top line reduction, is a large reduction in what we would consider to be stickier or more difficult part of the portfolio, which is the primary dwelling home area. So that's reduced in the 6 months from EUR 3.3 billion to EUR 2.8 billion, and that's really on the back of a lot of case-by-case restructuring on behalf of the FSG area. And that's very tough, granular work because you're talking -- and there are a lot of numbers in there. What I really try to do with the mortgage breakout is try in the middle slides to show what the gross and the net exposures are, pre- and post-provisions. And also really try to separate out, within that mortgage area, what's buy-to-let and what's PDH. Over on the right-hand side, again, this is to give an idea of the type of nonperforming exposures we have in this mortgage area. I think the easiest way to think of it is 50% is deep arrears and 50% is either restructured in a probationary period, which is the 36%, not past due, or recently moved into arrears, which is an additional 11%. So it's really, I would say, split the portfolio, it's split in 2. The part of the book that's recently in arrears, obviously, has lower coverage rates. The part of the portfolio that's in deep arrears, obviously, has higher coverage rates. But that's an important distinction to try and look into these asset classes, and that'll give you an idea of the areas of difficulty in managing the nonperforming exposures. It is more granular exposures, so it does require a lot of heavy oversight from that FSG team to get to the 5% ratio.

Funding structure. I think the easiest way to summarize the funding picture is actually just to look at the loan-to-deposit ratio, 90% to 88% as at the end of June. So our balance sheet is now 75% funded by customer accounts, very strong position to be in. And obviously, from a wholesale perspective, the additional liabilities are really all driven by MREL. Our MREL ratio is 28.22%, so that's fairly linear calculation for you to do. What's changed in the last couple -- or what's changed in the last quarter, I would say, is given the updated that we've got on TRIM of 90 basis points, it has an associated RWA impact. That RWA impact is going to end up increasing our MREL requirements. Historically, we would have talked about an MREL quantum requirement of approximately EUR 4 billion. I think what we're seeing now is that's approximately EUR 5 billion. And that's really just on the back of that TRIM update. But overall, we had positioned ourselves well, and so far as we transacted a number of large deals earlier in the year. So we think we're in a fairly strong position now over the next 1.5 years to just tactically ensure we can get optimized pricing, et cetera.

Okay, here's the capital ratios. I think the capital walk down below is probably the most important one to look at. Day 1, IFRS 16 hit 20 basis points. So really our starting point was 17.3%. Strong underlying profitability, giving 80 basis points to the bottom line. RWA growth of 20 basis points. That's really driven, I'd say, by the larger wholesale corporate business mix, vis-à-vis, a mortgage type of mix, but that's to be expected. And then there's a number of items around 30 basis points that are impacting CET1, and there's a number of them, so I'm actually not going to itemize them. That's a pre-dividend CET1 ratio of 17.6%, which overall, is clearly very, very strong. The headwinds are now coming to fruition. We've always talked about TRIM potential impact. We now have the answer to our AIB mortgage TRIM, okay? That's going to be 90 basis points, EUR 2 billion of RWA. If we look through the details of the findings, and there are still drafts, okay? So I'm giving you estimations for what these are. Effectively, what's happened is that our mortgage density will move from approximately 29% up to 41%. So that's a reasonably large readjustment. As you know, we have -- we're in discussions with regulator as well on our corporate model, but we have no update on that. I would say that we expect to have some of line of sight on that though before the end of the year. And lastly, calendar provisioning. Clearly, a very large theme in the market. There's a huge -- there's a lot of complexity in this calculation. We're not giving forward guidance on our future NPE ratio given that that's something that we are still working through. But I would say is that there's a reasonably diverse range of estimates in the market for the calendar provisioning impact in 2020, between 50 basis points or 150 basis points. And I'll be comfortable enough to say that we would see it at the very bottom end of that range, so around 50 basis points.

Okay. So to conclude, net interest margin, 2.46%, strong, very, very comfortable with the year-end target of 2.40%. Cost income ratio outturn, 54%. Colin said, we have a very, very strong focus on cost discipline, and we're going to work towards that 50% cost income ratio. Not only is there a -- the hiring freeze that we had in place since March, but I think in Q1 of next year, you can expect to see a very comprehensive overview on how we look at costs, what structural changes we may want to make and -- as we continue to address that. Fully loaded CET1 ratio, 17.3%. Obviously, very strong, well in excess of all regulatory targets. And return on tangible equity of 17 -- 7.9%, obviously, down versus our target, driven really by that movement around exceptionals. So I'll say to conclude that it's a solid operational performance with normalizing NPEs, and now we really need to move our focus to returning excess capital.

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Colin Hunt, AIB Group plc - CEO & Executive Director [3]

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Thanks, Donal. Donal's going to join me up here now and we're going to open the floor to questions. [Pat Clark] can vogue for me because I forgot to tell you earlier to turn off your mobile phones, so if you do that, that will be greatly appreciated and get me out of trouble.

We're going to take questions from the floor first of all, and then we're going to go to the telephone line and then come back to the floor for any other final questions. So we'll take questions now from the floor. You raise your hand, wait for mic and then speak. We'll go to Eamonn first.

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Questions and Answers

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Eamonn Hughes, Goodbody Stockbrokers, Research Division - Financials Analyst [1]

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Eamonn Hughes from Goodbody. Maybe if I can just touch on costs, a little bit on NPEs and then capital if that's okay. Just in terms of the cost side, it looks like the depreciation number was up about EUR 50 million or so year-on-year in the half year. So you'd implied, Donal, about the kind of pickup or maybe it was you, Colin, just in terms of the investment spend over the last couple of years. So can we take it that probably 2019 should be the peak in terms of the depreciation number or how that should profile into possibly next year?

Secondly, just in relation to the NPE side, you were kind of in line where we're looking for 7%, but the organic run rate is slowing down a little bit. You've got that target circa 5% by the end of the year. So to get to there presumably, you're a little bit more open around transaction activity possibly or kind of metrics like that.

And then finally in relation to capital, maybe a little bit of an unfair question in one sense, but the P2R, very elevated at 3.15%. Particularly against the peer group and given specifically what you've done in that balance sheet, should we be hopeful that the regulatory engagement is hopefully a little bit more on the positive fact just given that we've suffered a little bit on TRIM?

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Colin Hunt, AIB Group plc - CEO & Executive Director [2]

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Thanks, Eamonn. I'll address the NPE question, and then I'll refer the cost and capital questions to Donal. On the NPE side, we have any number of options available to us. We continue to work on new options. So we've restructured over 100,000 loans, including over 40,000 PDHs. We have the clear preference to retain these banking relationships. We have a clear preference to work with our customers to put in place sustainable restructured arrangements. However, we have a number of options available to us, including portfolio sales. We have executed a number of portfolio sales successfully, and we will use every lever at our disposal for clear preferences, as I said, for going down the restructuring route, but we will have portfolio sales if we need to because that circa 5% target is an overriding priority for us. We need to do it not only because of capital impacts. We need to do it because we need to get our balance sheet into the strongest possible position given the economic uncertainty the lies ahead.

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Donal Galvin, AIB Group plc - Group Treasurer & CFO [3]

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Eamonn, sorry, question from you was with respect to CET1?

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Eamonn Hughes, Goodbody Stockbrokers, Research Division - Financials Analyst [4]

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No, the cost depreciation balance and P2R.

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Donal Galvin, AIB Group plc - Group Treasurer & CFO [5]

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Okay. P2R, 3.15%, I think we would conclude that, that is at a fairly elevated level. We are due to receive our SREP letter later this year. We have no forward look at what that would be. But we've made a huge amount of effort in restructuring large parts of our balance sheet, so we will remain to see if we get a reward for that.

With respect to depreciation, I think the comment that I said for the year-on-year growth was approximately EUR 10 million was the impact. You need to strip out some IFRS 16 impacts as well from that, but really EUR 10 million, I think, year-on-year is the number to look at.

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Colin Hunt, AIB Group plc - CEO & Executive Director [6]

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Okay. Thank you. Stephen?

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Stephen Lyons, Davy, Research Division - Financials Analyst [7]

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Stephen Lyons from Davy. Just a couple of questions for me. Firstly just on NPLs, obviously, you had a gain on sale in period recorded and a capital benefit. Just trying to get a sense of the continued strength in the NPL buyer market in Ireland. I mean to the extent that NPL sales are pursued over the coming period, particularly into year-end, to achieve that 5%, what should we be thinking in terms of CET1 impact? The same type of positive gain again? Or has there been a softening? And what factors maybe caused that softening? And then separately just around the syndicated finance market that you mentioned you pulled back a little, just there's been greater scrutiny on that particularly from the coverage from the Irish Central Bank comments particularly. Could you maybe just elaborate on the particular markets that you do participate in within that and how confident you are on the resilience of the asset quality within that, please?

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Colin Hunt, AIB Group plc - CEO & Executive Director [8]

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On the syndicated international finance team, this is a market we've been active in for 20 years. We have a very, very disciplined approach to it. We've got a tremendous team working on supporting the European market out of Dublin and the U.S. market out of the United States. They have a superb record in terms of the credit decisions that they have made it. During the crisis, we were forced to significantly reduce our presence in that marketplace, and we did that very, very successfully and very, very efficiently.

We are very comfortable with the assets that we currently have on the balance sheet. And I think it's important to highlight that this is a part of our activities that we can really choose to take to the sidelines whenever it is in the overall interest of the institution. There are no customer elements here. This is -- we're not managing relationships here. This is a portfolio management tool. It allows us to diversify geographically. It allows us to diversify in terms of sector exposures. But it is a credit management tool, and it's a tool that we use to great effect. I'm really comfortable with the decisions the team have made not only in the last 6 months but over the course of the past 20 years.

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Donal Galvin, AIB Group plc - Group Treasurer & CFO [9]

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With respect to the NPE market, what we've seen over the last number of years with respect to portfolios transacted by AIB is that there has been a gain on sales. We would always guide that we aim to reduce NPEs on a capital neutral basis, and that will remain to be the situation as it's always difficult to try to predict liquidity in different markets at different times. But we'd be confident in hitting our NPE ratio on a capital neutral basis. Overall, within the market environment, I think there's been quite a bit of activity this year, and it doesn't look like there's a market slowdown in appetite for Irish assets.

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Owen Callan, Investec Bank plc, Research Division - Head of Financials Research & Banking Analyst [10]

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Owen Callan from Investec. Just 2 quick questions, if I may. On the credit impairment, I think as Donal noted, the first net negative credit impairment in a number of years. Going forward, assuming, as you said, maybe the NPE workout has no significant impact on P&L going forward, what do you assume or what do you look for as the normalized credit impairment cost that we should expect from AIB going forward given the current market as Colin maybe hinted at the start as well given the fact that some of the growth metrics may be turning down slightly, albeit still relatively healthy levels? So what should we build in for that normalized credit environment?

And then on excess liquidity, as you've noted, you're not alone in this. Banks across Europe are struggling with the excess liquidity cost, and further emollitions would only make that more of a challenge. Is there any strategies you've looked at as regards limiting that excess liquidity as regards maybe looking at either how to be less -- having current account balances maybe either more beneficial for you in terms of being able to charge for them? I know that's difficult from a regulatory perspective. Or seeking to dissuade people from putting retail deposits into AIB to limit the cost of that?

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Colin Hunt, AIB Group plc - CEO & Executive Director [11]

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I'll take the second question, and then I'll hand over to Donal for your first. But we are very, very actively managing our liquidity. In the second half of last year towards the back end of the year, we -- for our very largest corporate customers, we introduced negative interest rates on current accounts, on deposits. And that has had a desired effect in relation to discouraging the larger corporates from placing funds with us, but we'll continue to look at all options in this space. It is a priority for us.

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Donal Galvin, AIB Group plc - Group Treasurer & CFO [12]

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With respect to the cost of risk question, I mean, for years, this has been a little bit of a nonevent type of debate with AIB because we've always had such significant write-backs. Definitely seems to be an inflection point this year and that is being driven by the normalization of the key collateral indices, okay, such as HPI and in the core -- the CRE type space.

I think between now and the end of the year, the outturn is going to be driven by some macro factors. Brexit obviously is one. But if you probably look to the future and try to get an underlying cost of risk number, I think between 20 and 30 basis points is what you should be thinking of.

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Colin Hunt, AIB Group plc - CEO & Executive Director [13]

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We'll go to one more question in the room before we go to the line.

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Pierce Byrne, Cantor Fitzgerald Ireland Ltd., Research Division - Investment Analyst [14]

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Pierce Byrne, Cantor Fitzgerald. Two quick questions. Just firstly on the NPEs. So we've seen the quarterly resolution rate down to about EUR 200 million from about EUR 400 million in the previous year. Is that something we can expect to continue into year-end?

And then secondly, just on the additional MREL issuance, so I think you called out in your announcement this morning about a EUR 2 billion increase in RWAs. How are you getting to a EUR 1 billion increase in MREL on the back of that, if you could give us some more color on that?

And then actually one final one then just on new lending. We saw new lending growth rates of about 11% in Q1, down to 8% for H1. How do you see that for the -- into year-end?

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Colin Hunt, AIB Group plc - CEO & Executive Director [15]

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On the new lending rates, we're very, very happy that we are expanding the balance sheet at a sustainable rate of growth. We are looking for steady, sustainable growth rates. We're not in the business of chasing spectacular growth in balance sheet. Our focus is very much on the long-term health and viability of this organization because that is a necessary precursor to allowing us to deliver on our purpose. We cannot deliver for our customers or our shareholders in the absence of having strong balance sheet. And I'm not going to make any apology for not having triple-digit growth rates in balance sheet. I'm very, very content with where we are at this point in time. The second question I want to give to Donal. I'm going to try to remember what your first one was.

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Donal Galvin, AIB Group plc - Group Treasurer & CFO [16]

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I think you were referencing the slowdown in quarter-on-quarter NPE reductions, whether this is -- that's a new guide for the future. Yes. I mean what I've seen from the last number of years, as you know, is that we've been dealing with larger types of asset classes and underlines, which does mean quarter-on-quarter that we're able to reduce on a larger quantum. Where we are today, and like I would have mentioned earlier, is we are dealing with asset classes now that are of the most granular nature. So these are individuals, PDH type owners, okay? So engagement in this area, it's very tough. It's very time-consuming. It takes a lot of resources, and it takes quite a while to get these restructures in place. So you will see a slowdown quarter-on-quarter from that BAU restructuring because of the fact that what we're dealing with is so granular in nature.

And with respect to the MREL, again, I think what I said was we'd always said circa EUR 4 billion and now I'm saying circa EUR 5 billion. If you multiply out the 90 basis points, that's probably around EUR 2.2 billion of RWAs. Multiply it out by the ratio, and that gives you [650]. So we're just moving some -- circa EUR 4 billion to circa EUR 5 billion.

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Colin Hunt, AIB Group plc - CEO & Executive Director [17]

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And notwithstanding the fact that we have had a moderation of pace in Q2 in relation to NPEs, we are very much focused. #1 priority for the entirety of the group is getting that NPE total down to circa 5% by the end of this year by whatever means necessary.

We'll go to the line now. You might open up by identifying yourself by name and institution, please.

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Operator [18]

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Our first question is from a Raul Sinha from JPMorgan.

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Raul Sinha, JP Morgan Chase & Co, Research Division - Analyst [19]

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If I can have a couple please. Just firstly on NPEs and going back to what you said on the calendar provisioning impact, how should we think about this from the outside? You said it's quite complicated and probably quite difficult to work out, but when we look at your NPE coverage, obviously it's quite low relative to the new calendar provisioning guidance that's coming in. And obviously, the coverage ratio also ticked down slightly. So could you elaborate a little bit on how you get to this 50 basis points at the bottom end of the range in terms of calendar provisioning? That will be helpful. And then the second one is on Basel IV. We don't really talk much about that. But have you still thought about how this TRIM impact is going to overlap, if at all, with what impact you might be calculating from the input flow?

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Donal Galvin, AIB Group plc - Group Treasurer & CFO [20]

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Okay. I'll certainly take those ones. On -- calendar provisioning is obviously difficult to calculate because it's asset by asset and it depends on the time in arrears, and we're projecting out to 2024. We don't want to give and we're not going to give any guidance today on what the future NPE ratio is going to be because that's going to be packaged up in a much larger overview that we want to come back and describe in the first quarter of next year. But just to help you model out the impact, what I've tried to do is look at our existing planned run rate, et cetera, without giving you our end state, which I'm not going to. I'm really just trying to tell you and give you guidance out to give you an idea that 50 basis points for '20 is certainly around where we see it.

With respect to Basel IV, that's an interesting one. I tried to find some good in the recent TRIM letter and its associated impact, and the only one I could find is that impacts in Basel IV surely must be a lot less now. But I mean we're going to have to play that out. There's lots of things going on in the euro system. I don't think we ever felt that we were going to be hugely impacted by Basel IV, and I'm probably more convinced of that now than ever.

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Operator [21]

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Our next question is from Alicia Chung from Exane.

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Alicia Marianne Chung, Exane BNP Paribas, Research Division - Analyst on the Pan-European Banks Sector [22]

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Just a couple of questions for me. Firstly, just to go back on the mortgage TRIM impact, you said that the RWA density moved up from 29% to 41%. Could you just give a bit more color as to what exactly the ECB wasn't happy with? Was it key issue with the performing mortgages or the nonperforming mortgages as well?

Then secondly, just to go back on costs, can you explain in a bit more detail what was driving the 8% year-on-year increase in staff costs and especially when average staff numbers increased only 2%? And how should we think about staff growth and wage growth over the next 2 or 3 years from today?

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Donal Galvin, AIB Group plc - Group Treasurer & CFO [23]

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Okay. I'll take the TRIM question first. So I mean, again, the findings are still draft, and we're working through this with the regulator, but felt I wanted to give you an early line of sight. Going from 29% to 41%, I mean that landing point is certainly well above the European averages. I would look at the performing impact, whereby pre-TRIM we were at 25% for AIB mortgages and post-TRIM, we're 37%. So I think it's more on the performing area that's been impacted. It's not -- I wouldn't say it's an issue per se with AIB in a particular part of its model. I mean the reality is this is the result of the treatment of mortgages, mortgage holders, deep arrears through the crisis in Ireland, and this is just coming to fruition at the end of a quantitative process. So that's what I'd say there.

With respect to costs, wage inflation of 3%, I think is what we've always flagged. In terms of average FTEs, there are a few things year-on-year that would have impacted that, okay? Number one, we had -- we insourced -- we re-insourced some activities that in prior years had been overseas, so there was 100 bodies that we moved back onshore. That didn't really have a cost impact. It will kind of obviously increase staff cost and decrease depreciation, so that kind of goes into the number.

And then in terms of overall average headcount, there's a number of different items that are at play here. When -- the decision we took to maintain our FSG unit at its fully invested level has an associated impact in the organization for support areas, et cetera, as we work through all of these cases on a case-by-case basis. I mean all I would say is that the 1,300 people that you can see in the FSG unit, I mean, that is not a normalized situation for a bank with a normalized NPE ratio. But I think that we'll be able to provide more color on that later. So I'd say that's the main area of the FTE movements.

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Alicia Marianne Chung, Exane BNP Paribas, Research Division - Analyst on the Pan-European Banks Sector [24]

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That's very clear. And just to be clear on the number of staff in FSG, is it fair to assume that, that is now likely the peak level of staff? Or will you be expecting to recruit more? And in terms of those staff numbers falling, again, can we assume that they'll start to be run off after 2019 once you've met your target? Or will you expect to keep them on for a while later? I guess my bigger question is what can we expect in terms of 2020, 2021 staff cost run rate.

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Colin Hunt, AIB Group plc - CEO & Executive Director [25]

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So the FSG unit is doing a great job. It is probably the most difficult part of the bank in which to work, and we've got tremendous professionals doing an extraordinarily good job there. When I was doing my old job, I was notorious for going into FSG to raid it for high-quality bankers because the training they get there is absolutely exceptional. And some of the people who moved into leadership positions within my old division would have come from Jim O'Keeffe's world in FSG. I have no intention of seeing these people forced out of AIB when they complete their work, but we will be redeploying that across the rest of the group. And in so doing, we'll be replacing people who may be consultants or are on our staff as result of being daily wage contractors.

I'd also like to draw your attention to the fact that we still have a very, very high level of activity in terms of tracker enforcement. About 500 people work in the tracker program. We're going to close that particular chapter of our history, and those people will also be redeployed as for in the group replacing non-FTE employees.

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Alicia Marianne Chung, Exane BNP Paribas, Research Division - Analyst on the Pan-European Banks Sector [26]

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Got it. That makes sense. So it's probably fair to assume there's a sort of rebasing of staff levels, and we can just assume general wage inflation from here going forward.

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Operator [27]

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Our next question is from Chris Cant from Autonomous.

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Christopher Cant, Autonomous Research LLP - Partner, United Kingdom and Irish Banks [28]

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I just wanted to come back on calendar provisioning if I may. If I think about what we're seeing with the gains you've booked on portfolio sales, would you still expect to sell any further NPE portfolios in a capital neutral way? But you're actually booking some gains. So your coverage ratio might be low, but it's obviously adequate in terms of the market clearing price for these assets. If I then think about how calendar provisioning plays through in the 50 bps that you've guided to as a potential impact for next year, how does that actually materialize? Are you actually going to have to change your IFRS 9 expected loss models to say, actually, we were wrong last year and we now expect higher losses? Will it come through as a regulatory deduction potentially because you don't change your provisioning? How does that actually materialize in practice? Because your provisioning is obviously adequate as far as the market's concerned for these assets. And related to that, if you then go on to sell these assets, will you then recover that 50 bps in the sense that you go back to the clearing price, which is where you're currently marked?

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Donal Galvin, AIB Group plc - Group Treasurer & CFO [29]

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Thank you, Chris, for that high-level question. What I'm not going to do is give you the forward-looking NPE reduction plan. Okay? That...

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Colin Hunt, AIB Group plc - CEO & Executive Director [30]

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Despite any amount of provocation.

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Donal Galvin, AIB Group plc - Group Treasurer & CFO [31]

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That is obviously what you need to be able to calculate all of the moving parts associated with this, I mean, really just to ensure that the measurements don't get misused or miscalculated. That was the rationale for me really just trying to put a floor on the 2020 number of around 50 basis points. I mean how things work out from there, calendar provisioning will be an impact through capital. It's going to impact all banks throughout Europe. We've been on our long journey on reducing NPEs. I think what I would say is that we're going to aim to hit our or we will hit our target at the end of this year of circa 5%, and then we will look to move beyond that.

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Colin Hunt, AIB Group plc - CEO & Executive Director [32]

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Okay. We have run out of time, ladies and gentlemen. The clock is against us today, but thank you all very much indeed for being with us. And we look forward to seeing you. We have lots more to say in the spring. Thank you.