Credit Opinion: Zuercher Kantonalbank

Transcription

1 Credit Opinion: Zuercher Kantonalbank Global Credit Research - 25 Nov 2015 Zurich, Switzerland Ratings Category Moody's Rating Outlook Stable Bank Deposits Aaa/P-1 Baseline Credit Assessment a2 Adjusted Baseline Credit Assessment a2 Counterparty Risk Assessment Aaa(cr)/P-1(cr) Senior Unsecured -Dom Curr Aaa Contacts Analyst Phone Michael Rohr/Frankfurt am Main Andrea Wehmeier/Frankfurt am Main Carola Schuler/Frankfurt am Main Perrine Bajolle/Frankfurt am Main Key Indicators Zuercher Kantonalbank (Consolidated Financials)[1] [2]6-15 [2]12-14 [2]12-13 [3]12-12 [3]12-11 Avg. Total Assets (CHF billion) [4]4.9 Total Assets (EUR billion) Total Assets (USD billion) [4]9.0 [4]5.0 Tangible Common Equity (CHF billion) Tangible Common Equity (EUR billion) [4]5.4 [4]9.5 Tangible Common Equity (USD billion) [4]5.4 [5] [6]17.2 Problem Loans / Gross Loans (%) Tangible Common Equity / Risk Weighted Assets (%) Problem Loans / (Tangible Common Reserve) (%) Equity + Loan Loss [5]10.4 Net Interest Margin (%) PPI / Average RWA (%) [5]0.8 [6]1.2 [5]0.5 [5] [5] [5]37.0 Market Funds / Tangible Banking Assets (%) Liquid Banking Assets / Tangible Banking Assets (%) Net Income / Tangible Assets (%) Cost / Income Ratio (%) Gross loans / Due to customers (%) Source: Moody's [5]101.6 [1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel III - fully-loaded or transitional phase-in; LOCAL GAAP [3] Basel II; LOCAL GAAP [4] Compound Annual Growth Rate based on LOCAL GAAP reporting periods [5] LOCAL GAAP reporting periods have been used for average calculation [6] Basel III - fullyloaded or transitional phase-in & LOCAL GAAP reporting periods have been used for average calculation

2 Opinion SUMMARY RATING RATIONALE Zuercher Kantonalbank's (ZKB) Aaa long-term deposit and senior unsecured debt ratings benefit from five notches of uplift from the bank's a2 adjusted baseline credit assessment (BCA) as a result of our government support analysis which considers ZKB as a 'government-backed' financial institution. ZKB's Counterparty Risk Assessment stands at Aaa(cr)/Prime-1(cr). ZKB's a2 BCA reflects the bank's (1) significant role within the canton's economy and its well-entrenched franchise in the Zurich area; (2) robust market position in wealth management and private banking; and (3) solid capitalisation and sound financials, such as its ability to generate profits sufficient to absorb a very high degree of unexpected losses without compromising its franchise stability. ZKB's a2 BCA, currently placed at the upper end of the scorecard range, also takes into account identified pressures, namely (1) the bank's partial exposure to confidence-sensitive wholesale funding sources; (2) the increasingly challenging operating environment, characterised by net interest margin compression and lower-thananticipated interest rates, which constrain the bank's profitability prospects; (3) the growth of ZKB's residential mortgage-loan portfolio in the highly dynamic Zurich region over recent years, which, albeit declining, may lead to increased susceptibility to a significant slowdown in the Swiss housing market; and (4) increased execution and franchise risks. These risks are inherent in the bank's private banking business, which is largely subject to changes in the regulatory environment, and are partly due to potential litigation charges in light of the current negotiations with US authorities over tax evasion. Rating Drivers - Senior creditors and deposit holders benefit from the canton's full guarantee for all of the bank's senior liabilities - The bank's partial exposure to confidence-sensitive wholesale funding sources is largely mitigated by its highlyliquid balance sheet - Profitability metrics are under pressure from challenging market environment - While capital buffers are solid, ZKB needs to continue meeting increased capital requirements as a local SIFI - Growth of residential mortgage-loan portfolio and uncertainties in ZKB's private banking business create challenges Rating Outlook Zuercher Kantonalbank's long-term ratings carry a stable outlook. What Could Change the Rating - Up There is no upside for the long-term ratings of ZKB at the Aaa level. There is currently no upward pressure on the bank's a2 BCA as indicated by the placing at the upper end of the scorecard range. However, ZKB's a2 BCA could stabilise or improve following a combination of (1) a significantly reduced exposure to 'market-funding' sources to below 20% of tangible banking assets; (2) a marked and sustainable improvement in risk-adjusted levels of recurring profitability and efficiency, displaying a net income/tangible assets ratio of more than 0.75%; (3) a further rebuild of the bank's capital buffers meaningfully over and above the tighter capital adequacy requirements as a domestic systemically important financial institution (local SIFI), leading to a sustainable tangible common equity/risk-weighted assets ratio of above 17%; and/or (4) a further improvement in the bank's problem loan ratio sustainably below 1.0% of gross loans. What Could Change the Rating - Down Downward pressure on ZKB's long-term debt and deposit ratings could be exerted by (1) a deterioration of the Canton of Zurich's (unrated) credit profile; or (2) a rising likelihood that the canton's guarantee for ZKB may be removed, implying a significant reduction of our 'government-backed' support assumption currently factored into the bank's long-term ratings.

3 Challenges for ZKB's BCA may arise from (1) material asset-quality deterioration, i.e. a more-than-doubling of its current problem loan ratio to above 2%, especially if the deterioration is based on a marked slowdown in the Swiss real-estate market coupled with (2) a meaningful decline in the bank's tangible common equity/risk-weighted assets ratio from currently high levels; and/or (3) a decline in profitability levels to below 0.4% of tangible assets; and/or (4) a decline in ZKB's liquid banking assets to sustainably below 35% of tangible banking assets. In addition, adverse developments or excessive risk-taking in its capital markets business and/or higher-thanexpected litigation charges in connection with ongoing investigations into ZKB's former US business and alleged tax evasion by its clients may exert pressure on the bank's financial profile. DETAILED RATING CONSIDERATIONS SENIOR CREDITORS AND DEPOSIT HOLDERS BENEFIT FROM THE CANTON'S FULL GUARANTEE FOR ALL OF THE BANK'S SENIOR LIABILITIES The Canton of Zurich, the sole owner of the bank, provides an explicit guarantee for the bank's unsubordinated obligations stipulated in the Cantonal Banking Act. In addition, the canton provides a dotation capital frame of CHF3.0 billion, of which CHF2.425 billion has been drawn by ZKB. The frame has been increased by CHF500 million in April 2014 following the bank's request to increase the dotation capital of the canton by CHF2 billion to CHF4.5 billion. The canton further decided that ZKB will not be allowed (by law) to issue participation certificates to raise capital, forcing the bank to pursue alternative routes to restore its capital buffers following the declaration as a local SIFI by the Swiss National Bank (SNB) in November THE BANK'S PARTIAL EXPOSURE TO CONFIDENCE-SENSITIVE WHOLESALE FUNDING SOURCES IS LARGELY MITGATED BY ITS HIGHLY-LIQUID BALANCE SHEET With interbank liabilities of CHF33.8 billion as of end-june 2015, ZKB is a net borrower in the interbank market. Generally, this net reliance on confidence-sensitive market funding sources could be a constraint to ZKB's BCA that may exert pressure on ZKB's overall Financial Profile. However, we understand that a predominant part of ZKB's interbank funding is related to central bank counterparties, thereby reducing the confidence-sensitivity of these funds considerably. In addition, the bank's market funding reliance is further mitigated by the bank's liquid balance sheet consisting of CHF29.2 billion of cash as of 30 June 2015, adding to approximately CHF3.9 billion of financial investments as well as CHF16.2 billion of interbank assets. The bank's H loan-to-deposit ratio of 104% (2014: 104%) also speaks to a more balanced funding profile for ZKB's universal banking / lending operations. These considerations have conservatively been reflected in our ba1 Funding Structure score and our aa3 Liquid Resources score. PROFITABILITY METRICS ARE UNDER PRESSURE FROM CHALLENGING MARKET ENVIRONMENT ZKB is more reliant on earnings from its capital markets activities than most of its Swiss regional and cantonal bank peers. Adverse developments in such activities have the potential to lead to a deterioration in the bank's creditworthiness. Moreover, failure to re-engineer these activities in a highly competitive and ever-changing regulatory environment while preserving the risk-return profile of the business would put negative pressure on the BCA. We expect that ZKB's profitability metrics will further decrease, although we do not anticipate a more significant drop. This assessment is owing to (1) lower-than-anticipated interest rates as ZKB will not be able to re-price its deposits and/or other liabilities at the same pace to fully neutralise the effects of negative interest rates for cash deposits at the SNB; (2) intense competition as well as continued challenges in its private banking franchise; and/or (3) higher risk costs potentially caused by a less benign credit environment that leads to a gradual erosion in the bank's asset quality. In our view, this may be partially offset by the positive effects that the acquisition of Swisscanto (unrated) will have on ZKB's revenue mix, lowering its dependence on net interest income and thereby stabilising the bank's earnings. However, we anticipate the full effect to only become visible by the second half of For H1 2015, ZKB reported a 17% year-over-year increase in its net profit to CHF393 million (Swiss Bank Accounting Guidelines), driven by (1) significantly higher trading income of CHF213 million (up 39% year-overyear) and (2) higher fee and commission income of CHF318 million (up 15% year-over-year), largely related to the acquisition and subsequent full consolidation of Swisscanto. In addition, ZKB managed to keep net interest income at a high level (CHF549 million, up 2% year-over-year), driven by higher mortgage margins as well as the bank's ability to raise money in the interbank markets at negative rates and place it with the SNB. Mainly driven by the

4 Swisscanto acquisition and higher personnel expenses, ZKB's cost base grew 13% year-over-year, to CHF681 million in H The bank's overall stability of earnings and its decreasing reliance on net interest income continue to be mitigating factors that we have considered positively in the bank's baa3 Profitability score. WHILE CAPITAL BUFFERS ARE SOLID, ZKB NEEDS TO CONTINUE MEETING INCREASED CAPITAL REQUIREMENTS AS A LOCAL SIFI Our a1 Capital score, positioned two notches below the historic ratio average, reflects the increased pressure on the bank's capital buffers through regulation, driven by ZKB's classification as a local SIFI as per decree by the SNB. During H1 2015, we positively note that ZKB was able to restore its capital buffers over and above the increased capital requirements, supported by (1) a CHF500 million increase of endowment capital made available by the canton (commitment of CHF3.0 billion, of which CHF2.425 billion is now 'in use' by ZKB); and (2) the successful issuance of CHF185 million and EUR500 million of low-trigger Tier 2 capital. As a result, as of 30 June 2015, ZKB's regulatory Common Equity Tier 1 (CET1) capital ratio stood at 16.1% and its total capital ratio stood at 18.2%, thereby already meeting the fully-loaded (2019) capital requirements as a Swiss local SIFI (currently 14.7% total capital ratio, including 0.7% resulting from the counter-cyclical capital buffer for domestic residential mortgage exposures that became fully effective 30 June 2014). Despite our anticipation of slightly reduced retained earnings, we therefore believe that ZKB will be able to continue meeting its tight capital requirements, potentially leading to improvements in its Capital score over time. This also reflects our view that the bank's measured dividend payout policy will continue (approximately 50% of annual net income has been distributed, totaling CHF3.5 billion over the past 10 years). GROWTH OF RESIDENTIAL MORTGAGE-LOAN PORTFOLIO AND UNCERTAINTIES IN ZKB'S PRIVATE BANKING BUSINESS CREATE CHALLENGES With a compound average growth rate in its mortgage loan book of 4.5% in the period 2007-H1 2015, to CHF72.4 billion (45% of total assets), ZKB has increased its susceptibility to a significant slowdown in the booming Zurich as well as the Swiss housing markets and/or during a prolonged period of weaker economic growth in Switzerland. This increased susceptibility has the potential to weaken the bank's capital buffers in an adverse scenario and has led to negative adjustments underlying our overall a2 Asset Risk score. This is mitigated by ZKB's re-stored capital buffers and a continued very low problem loan ratio of below 1% as of 30 June 2015 (2014: 0.9%), the latter comparing favourably with those of peers. Furthermore, the bank's loan book is highly granular and displays only a limited exposure to the high-end luxury segments within the retail residential mortgage market. Based on historically prudent underwriting standards, the mortgage loan book carries a lower loan-to-value ratio on average than those of its closest European banking peers, with only a negligible proportion invested in loan-to-value ranges above 80%. ZKB's private banking operations will continue to heighten execution and reputational risks, specifically with regard to the ongoing tax investigation into ZKB's US offshore business, constraining its Asset Risk score. The US investigations may result in a potentially large litigation charge that may be significant compared to the bank's net profits. The uncertainty regarding the final outcome of the investigation may further decelerate the growth of assets under management at ZKB. In addition to the bank's deliberate exit strategy in certain offshore markets, this uncertainty may negatively affect the bank's access to international cross-border customers and its related expansion strategy. ZKB has positioned itself as one of the larger providers of wealth and asset management offerings, both nationally and internationally. Following the acquisition of Swisscanto, it held total client assets under management of CHF262.1 billion as of 30 June 2015 (2014: CHF198.7 billion). Previous outflows in non-core private banking markets were offset by inflows in ZKB's core businesses amounting to CHF2.5 billion in H1 2015, or 1.3% of yearend client assets. We expect that asset flows will further stabilise upon finalisation of the US tax investigations into ZKB. Notching Considerations GOVERNMENT SUPPORT ZKB's long-term ratings receive a five-notch uplift to Aaa from the bank's a2 BCA. We assess ZKB as

5 'government-backed' by its regional authority, the Canton of Zurich, which is the sole owner of the bank and provides an explicit guarantee for the bank's unsubordinated obligations. The bank continues to remain an important financial institution within the regional economy as a public law institute ('oeffentlich-rechtliche Anstalt') of the canton. Furthermore, we assess the probability of systemic support for ZKB in the event of a stress scenario to be moderate, owing to ZKB's high national market shares in key banking products and its relative importance to the country's banking system. Issuer Profile ZKB, established in 1870 by the Canton of Zurich, is the fourth-largest Swiss bank by total assets and the largest Swiss cantonal bank with total assets of CHF162 billion as of end-june ZKB has a solid retail and commercial banking franchise and a very strong position in the Canton of Zurich, with market shares of approximately 35% of the mortgage loan market (7.8% at Swiss national level as of year-end 2014) and a share of roughly 28% of the deposit base (7.5% national). ZKB benefits from strong market positions in commercial and investment banking services for mid-sized and large corporate clients, and is one of the leaders in terms of domestic investment banking operations in Switzerland, as evidenced by its position as the number one originator of Swiss franc-denominated domestic bond issuances and the third-largest equity derivative market counterparty. Output of the Baseline Credit Assessment Scorecard Our Scorecard is designed to capture, express and explain in summary form our Rating Committee's judgment. When read in conjunction with our research, a fulsome presentation of our judgment is expressed. As a result, the output of our Scorecard may materially differ from that suggested by raw data alone (though it has been calibrated to avoid the frequent need for strong divergence). The Scorecard output and the individual scores are discussed in rating committees and may be adjusted up or down to reflect conditions specific to each rated entity. Rating Factors Zuercher Kantonalbank Macro Factors Weighted Macro Profile Very Strong - Financial Profile Factor Historic Ratio Macro Adjusted Score Solvency Asset Risk Problem Loans / Gross Loans Credit Trend Assigned Score Key driver #1 1.1% aa2 a2 Operational risk Capital TCE / RWA 17.7% aa2 a1 Capital retention Profitability Net Income / Tangible Assets 0.5% baa3 baa3 Combined Solvency Score a1 a3 Liquidity Funding Structure Market Funds / Tangible Banking Assets 38.2% ba2 ba1 Market funding Key driver #2 Market risk Stress capital resilience

6 Liquid Resources Liquid Banking Assets / 37.1% aa3 aa3 Tangible Banking Assets Combined Liquidity Score baa2 baa1 quality Financial Profile a3 Qualitative Adjustments Adjustment Business Diversification 0 Opacity and Complexity 0 Corporate Behavior 0 Total Qualitative Adjustments 0 Sovereign or Affiliate constraint Scorecard Calculated BCA range - a2 - baa1 Assigned BCA a2 Affiliate Support notching 0 Adjusted BCA a2 Instrument Class Loss Given Failure notching Additional notching Preliminary Rating Assessment Government Support notching Local Currency rating Foreign Currency rating Deposits 0 0 a2 5 Aaa Aaa Senior unsecured bank 0 0 a2 5 Aaa debt This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history Moody s Corporation, Moody s Investors Service, Inc., Moody s Analytics, Inc. and/or their licensors and affiliates (collectively, MOODY S ). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. AND ITS RATINGS AFFILIATES ( MIS ) ARE MOODY S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODY S ( MOODY S PUBLICATIONS ) MAY INCLUDE MOODY S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODY S OPINIONS INCLUDED IN MOODY S PUBLICATIONS ARE

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