Zuercher Kantonalbank

Transcription

1 Primary Credit Analyst: Bernd Ackermann, Frankfurt (49) ; Secondary Contact: Markus W Schmaus, Frankfurt (49) ; markus.schmaus@standardandpoors.com Table Of Contents Major Rating Factors Outlook Rationale Related Criteria And Research DECEMBER 9, Standard & Poor's. All rights reserved. No reprint or dissemination without Standard & Poor s permission. See Terms of Use/Disclaimer on the last page

2 SACP aa- + Support +3 + Additional Factors 0 Anchor a- Business Position Capital and Earnings Strong +1 Very Strong +2 Risk Position Adequate 0 Funding Liquidity Average Strong 0 ALAC Support 0 GRE Support +3 Group Support 0 Sovereign Support 0 Issuer Credit Rating AAA/Negative/A-1+ Major Rating Factors Strengths: Weaknesses: Strong domestic franchise, complemented by a sound country-wide presence in corporate lending, private banking, and asset management. Sound financial profile characterized by very strong capitalization and stable earnings. Close ties with the financially strong Canton of Zurich, facilitated by full ownership and a statutory guarantee. Some concentration risk due to focus on real estate lending in the home region. Reputational risk from possible prosecution by U.S. tax authorities. Weaker cost efficiency than peers. Outlook: Negative Standard & Poor's Ratings Services' outlook on Switzerland-based Zuercher Kantonalbank (ZKB) is negative. This reflects our view of continued legal and financial risk due to possible prosecution by the U.S. tax authorities. ZKB is included in a list of "Category 1" Swiss banks defined by the U.S. Department of Justice. "Category 1" banks are likely to face prosecution by the U.S. authorities and ZKB is therefore exposed to reputational risk. A negative action could be triggered over the next months if ZKB's business position were unexpectedly to weaken from comparably strong levels, in particular in private banking or asset management, as a result of the ongoing prosecution. We think that financial risk for ZKB from potential fines is manageable and in our base-case scenario we anticipate that fines would be offset by reserves and earnings. An improvement in ZKB's stand-alone credit profile (SACP) is unlikely at this stage in view of the bank's financial position, and ownership structure. We might revise the outlook to stable if reputational risk due to possible prosecution by the U.S. tax authorities was no longer expected. DECEMBER 9,

3 Rationale The ratings on ZKB reflect its anchor of 'a-', its "strong" business position, "very strong" capital and earnings, "adequate" risk position, "average" funding, and "strong" liquidity, as our criteria define these terms. The SACP is 'aa-'. We continue to consider ZKB a government-related entity (GRE) with an "extremely high" likelihood of receiving extraordinary government support in times of stress. We base this on our view of ZKB's "very important" role in the Canton of Zurich and its "integral" link to its home canton, which provides a three-notch uplift to our assessment of ZKB's SACP. Anchor:'a-' for banks operating in Switzerland Our bank criteria use our Banking Industry Country Risk Assessment (BICRA) economic risk and industry risk scores to determine a bank's anchor, the starting point in assigning an issuer credit rating. Our anchor for a commercial bank operating only in Switzerland is 'a-'. We apply this anchor to ZKB given that it operates only to a minor extent outside Switzerland. The BICRA score includes our evaluation of economic risk. In this respect, we view Switzerland as a highly diversified and competitive economy, benefiting from one of the highest GDPs per capita in the world and very robust government finances. We believe that large parts of the Swiss banking market demonstrate a conservative risk and lending culture, which has accompanied moderate growth of housing prices and loan portfolios. The Swiss banking industry is supported by its sizable and very stable customer deposit base. Purely domestic Swiss banks have not loosened credit standards in recent years, thanks to sound earnings potential from core products. We consider regulatory standards to be more stringent than in other developed economies. Table 1 Zuercher Kantonalbank Key Figures --Year-ended Dec (Mil. CHF) 2015* Adjusted assets 161, , , , ,986.0 Customer loans (gross) 89, , , , ,892.0 Adjusted common equity 9, , , , ,178.0 Operating revenues 1, , , , ,102.0 Noninterest expenses , , , ,336.0 Core earnings *Data as of June 30. CHF--Swiss Franc. N.A.--Not available. N/A--Not applicable. N.M.--Not meaningful. Business position: Solid operational stability owing to diverse business profile and strong franchise We consider ZKB's business profile to be "strong", reflecting the bank's diverse business activities and our expectation of sustainable revenue generation through the economic cycle. These strengths outweigh the bank's geographic concentration on the wider Zurich area. With total assets of Swiss franc (CHF) billion on June 30, 2015, ZKB is the largest cantonal bank and DECEMBER 9,

4 fourth-largest bank in Switzerland with an estimated market share of 8%-10% in customer deposits and customer lending. While we consider concentration on the wider Zurich area to be a weakness for the ratings, we view positively the bank's long-standing presence in its home region, one of Switzerland's economically strongest regions, with a leading market share of about 40% in retail banking. Compared with other Swiss cantonal bank peers, this concentration is offset by diverse business activities conducted on a national scale, including corporate lending to small and midsize enterprises and large corporations, as well as private banking. Furthermore, ZKB provides services for other cantonal banks as an originator of syndicated loans and a participant in the market for traded structured investment products, where it is one of the largest players in Switzerland, a position we expect it to maintain. Furthermore, on April 1, 2015, ZKB took over Swisscanto, an asset management company previously owned by the country's cantonal banks collectively. In our view, Swisscanto further complements ZKB's product offering and strengthens its business profile and earnings capacity. ZKB is combining its asset management activities under Swisscanto, thereby creating a the country's third-largest investment fund manager, with assets under management by ZKB of about CHF78.7 billion at June 30, We regard the takeover generally as a good strategic fit for ZKB given the revenue diversification it brings, the potential for cost synergies, and the complementary product ranges. However, Swisscanto also brings certain challenges such as general margin pressure on active fund managers in a low-yield environment, as well as increasing competition and regulation around product suitability and pricing transparency. Moreover, compared with most commercial banks in Europe, ZKB has demonstrated sound profitability, particularly during the most recent financial crises. We expect its solid revenues to benefit from a strong annuity characteristic with only about 15% coming trading or market sensitive income. This is underpinned by the bank's very stable and long-standing customer base, which we expect it to maintain thanks to its public ownership and the guarantee from the canton. We believe that the acquisition of Swisscanto will increase the revenue diversification into fee income. We estimate that fee income will contribute about 35% of revenues over the next two years, from between 25%-30% previously. Interest income, mainly from its deposit-taking and lending activities, should account for about 50% of total revenues. Moreover, we believe that the bank's financial targets are focused on long-term value for its owner, the Canton of Zurich, and that the bank will continue to benefit from the strong support of its owner. This was demonstrated by an amended cantonal bank law that came into effect on Jan. 1, 2015, which included an increase of the canton's endowment capital facility for ZKB by CHF500 million. ZKB drew CHF500 million on this facility on June 30, 2015, leaving a residual facility of CHF575 million. We do not expect ZKB will utilize the residual capital buffer in the near term. However, we note the availability of such funds, if ever needed. Table 2 Zuercher Kantonalbank Business Position --Year-ended Dec (%) 2015* Total revenues from business line (currency in millions) 1, , , , ,136.0 Other revenues/total revenues from business line Return on equity DECEMBER 9,

5 Table 2 Zuercher Kantonalbank Business Position (cont.) *Data as of June 30. N.A.--Not available. N/A--Not applicable. N.M.--Not meaningful. Capital and earnings: Very strong capital remains the key rating strength We assess ZKB's capital and earnings as very strong compared with all the banks we rate globally. We expect ZKB's risk-adjusted capital (RAC) ratio to be in the range of % over the next months compared with 19.0% at year-end 2014, which was prior to the Swisscanto acquisition. ZKB's RAC ratio, which does not capture the above-mentioned additional available endowment capital, is in the middle range for rated Swiss cantonal banks, with RAC ratios of up to 24%, but at the upper end of the range of RAC ratios of all banks we rate globally. Our projected RAC ratio is about 150 basis points higher than the one we projected 12 months ago. The June 30, 2015, CHF500 million capital increase by the canton is the main driver behind this improvement. We understand the bank drew on this facility to anticipate and increase its buffer over potential additional regulatory capital requirements that are currently being explored by bank regulators internationally. Our RAC projection also takes into account the goodwill payments on Swisscanto to the former owners, some of which is delayed until 2018 and variable depending on the sales performance of the former owners. We also incorporate that the takeover will generate integration cost and IT expenses for the first two years after the takeover, meaning that the net profit contribution by the Swisscanto transaction will initially be very limited. Otherwise, we anticipate slight loan growth only, partly offsetting net interest margin pressure from the negative interest rate environment in Switzerland. We also expect ZKB to maintain its dividend distributions to the canton at about 50% of core earnings. Also, from 2015, ZKB will pay compensation to the canton for the cantonal guarantee, amounting to CHF10 million pro rata for the first six months The quality of ZKB's capital and earnings adds to our capital assessment. This is supported by the bank's stable return on assets and our analysis that the share of hybrid capital instruments within total adjusted capital will remain low at around 5%. We anticipate that the bank's cost efficiency ratio may hover around 67% for the next two years, which is weaker than those of its main cantonal bank peers typically in the range of 50%-60%. The projected ratio is slightly weaker than those of recent periods and outside management's target range. However, the main reason for the deterioration is the integration cost related to Swisscanto, which, over time, should result in significant cost savings given the overlapping infrastructure and complementary product range. We also consider that the lower cost efficiency reflects the bank's broader and nationwide set of operations and higher staff compensation levels in Zurich. Table 3 Zuercher Kantonalbank Capital And Earnings --Year-ended Dec (%) 2015* Tier 1 capital ratio S&P RAC ratio before diversification N.M S&P RAC ratio after diversification N.M Adjusted common equity/total adjusted capital Net interest income/operating revenues DECEMBER 9,

6 Table 3 Zuercher Kantonalbank Capital And Earnings (cont.) Fee income/operating revenues Market-sensitive income/operating revenues Noninterest expenses/operating revenues Preprovision operating income/average assets Core earnings/average managed assets *Data as of June 30. N.A.--Not available. N/A--Not applicable. N.M.--Not meaningful. Table 4 Zuercher Kantonalbank RACF [Risk-Adjusted Capital Framework] Data (Mil. CHF) Exposure* Basel II RWA Average Basel II RW (%) Standard & Poor's RWA Average Standard & Poor's RW (%) Credit risk Government and central banks 30,660 1, Institutions 10,819 3, , Corporate 18,806 12, , Retail 68,577 30, , Of which mortgage 54,249 19, , Securitization Other assets 1,131 1, , Total credit risk 129,993 48, , Market risk Equity in the banking book Trading book market risk -- 3, , Total market risk -- 3, , Insurance risk Total insurance risk Operational risk Total operational risk -- 3, , (Mil. CHF) Basel II RWA Standard & Poor's RWA % of Standard & Poor's RWA Diversification adjustments RWA before diversification 58,819 51, Total Diversification/Concentration Adjustments -- (67) (0) RWA after diversification 58,819 51, (Mil. CHF) Tier 1 capital Tier 1 ratio (%) Total adjusted capital Standard & Poor's RAC ratio (%) Capital ratio Capital ratio before adjustments 9, , Capital ratio after adjustments 9, , DECEMBER 9,

7 Table 4 Zuercher Kantonalbank RACF [Risk-Adjusted Capital Framework] Data (cont.) *Exposure at default. Securitisation Exposure includes the securitisation tranches deducted from capital in the regulatory framework. Exposure and Standard & Poor's risk-weighted assets for equity in the banking book include minority equity holdings in financial institutions. Adjustments to Tier 1 ratio are additional regulatory requirements (e.g. transitional floor or Pillar 2 add-ons). RWA--Risk-weighted assets. RW--Risk weight. RAC--Risk-adjusted capital.chf--swiss Franc. Sources: Company data as of Dec. 31, 2014, Standard & Poor's. Risk position: Increasing residential housing prices, and pending legal actions pose a potential risk We consider ZKB's risk position to be adequate, and in line with the economic risk score of '2' for Swiss domestic exposures. It also reflects the bank's high-quality residential mortgage portfolio and generally sound asset quality. We note that ZKB's business model continues to concentrate on lower-risk retail lending, collateralized mortgage loans, lending to small and midsize enterprises, and corporate lending. Loans collateralized by residential real estate loans account for about 68% of ZKB's loan book but only 37% of its total assets. This is lower than for other cantonal banks due to ZKB's broader business range, including a higher share of trading securities (7% of total assets), but also high amounts of cash and reserves at the central bank (17%) and loans to other banks (10%). Moreover, ZKB's exposure to real estate markets is offset, in our opinion, by what we regard as conservative underwriting standards, prudent risk management, high granularity, and high levels of collateralization. This should enable the bank to maintain its favorable loan-loss record. In line with its cantonal bank peers, new loan-loss provisions on customer loans have been very low in recent years on the back of favorable economic environment and rising house prices (1 basis point only in the first half of 2015). Nevertheless, in our view, continued house price increases over the long term in Switzerland, specifically in the Zurich region, could lead to a heightened risk of correction and possibly higher credit losses than in the past five years. Loans collateralized by commercial real estate, collateralized by other means, or unsecured account for about 32% of customer lending, which is higher than that of the bank's cantonal bank peers. In our opinion, such exposures tend to be riskier than purely residential real estate lending. If Switzerland's export-oriented industries were to suffer materially--which we currently do not expect--from the sustained strength of the Swiss franc, these exposures could lead to higher loan losses, in our view. Although ZKB typically grants syndicated loans without collateral, we expect the bank will maintain stringent monitoring, even of high quality large exposures. Growth in customer loans has been moderate at an average annual rate of 5.7% since This is in line with Swiss domestic peers, although somewhat at the upper end. We note, however, that growth figures at ZKB are more volatile given that they may include more substantial portions of reverse repo transactions than peers. We expect elevated legal risk from pending legal actions by the U.S. Department of Justice against Swiss banks will continue. ZKB is under investigation for allegedly helping U.S. clients to evade tax payments by accepting client transfers of undeclared funds. The bank is included in a list of "Category 1" Swiss banks defined by the U.S. Department of Justice. Although "Category 1" banks are likely to face prosecution by the U.S. authorities, we think that any resulting financial risk for ZKB is still manageable and believe that in our base-case scenario potential fines imposed will not affect the bank's very strong capital position. ZKB's securities portfolio amounted to CHF14.0 billion as of June 30, We regard the asset quality of the non-trading securities portfolio (worth CHF3.9 billion) as sound. The portfolio focuses on Swiss covered bonds, as well DECEMBER 9,

8 as sovereign and public sector obligors in Switzerland and Germany, and on European supranational institutions. Most of the bank's trading revenues are client initiated, and slightly more volatile than its interest and fee business. ZKB also engages in proprietary trading operations as a market maker and an issuer of structured products. Although these operations are limited, they increase the volatility of the bank's earnings. However, we believe that the bank will maintain a low risk appetite and that its risk management tools will allow it to closely monitor these activities. Table 5 Zuercher Kantonalbank Risk Position --Year-ended Dec (%) 2015* Growth in customer loans Total diversification adjustment / S&P RWA before diversification N.M. (0.1) (0.3) Total managed assets/adjusted common equity (x) New loan loss provisions/average customer loans Net charge-offs/average customer loans N.M Gross nonperforming assets/customer loans + other real estate owned N/A Loan loss reserves/gross nonperforming assets N/A *Data as of June 30. N.A.--Not available. N/A--Not applicable. N.M.--Not meaningful. Funding and liquidity: Ample coverage of loans through customer deposits ZKB's exhibits an average funding profile compared with other banks in Switzerland that we rate, whereas its liquidity is strong compared with global banks. In our view, ZKB continues to benefit substantially from the cantonal guarantee, which allows the bank to maintain a strong franchise with a widespread and loyal depositor base. The bank's loan-to-deposit ratio was 104.8% on June 30, 2015, and is likely to remain balanced, not taking into account the bank's large equity position at about 11% of customer loans. We expect ZKB's stable funding ratio to remain at a comfortable level of well above 100% over the medium term, compared with 106% as of year-end The remainder of ZKB's funding mix is made up of interbank funding and capital market funding via secured and unsecured instruments. Due to the bank's status as a GRE, we expect its wholesale funding sources to remain stable or even benefit from a flight-to-quality effect in more challenging economic conditions. Our assessment of ZKB's liquidity as "strong" reflects the bank's very favorable liquidity position, which in our view would allow it to endure more than 12 months with no access to market funding. This is demonstrated by the bank's liquidity ratio (broad liquid assets to short-term wholesale funding) of 1.4x as of year-end We note that since 2012, ZKB has substantially increased its cash reserves held with the central bank, reaching CHF29.2 billion as of June 30, 2014, from CHF8.5 billion as of year-end We expect ZKB will maintain strong liquidity and remain less sensitive than other commercial banks in a more challenging operating environment. DECEMBER 9,

9 Table 6 Zuercher Kantonalbank Funding And Liquidity --Year-ended Dec (%) 2015* Core deposits/funding base Customer loans (net)/customer deposits Long term funding ratio Stable funding ratio Short-term wholesale funding/funding base Broad liquid assets/short-term wholesale funding (x) Net broad liquid assets/short-term customer deposits Short-term wholesale funding/total wholesale funding Narrow liquid assets/3-month wholesale funding (x) *Data as of June 30. N.A.--Not available. N/A--Not applicable. N.M.--Not meaningful. Support:"Extremely high" likelihood of extraordinary government support We consider ZKB to be a GRE, given its full ownership by the Canton of Zurich. The long-term rating on ZKB is three notches higher than the bank's SACP, reflecting our opinion that there is an extremely high likelihood of timely and sufficient extraordinary support for ZKB from its owner in the event of financial distress. We base this on our view of the bank's "integral" link with and "very important" role for the canton. We base this assumption on the existing cantonal guarantee, which is stipulated by law, as well as ZKB's ownership structure and its importance for Zurich's regional economy. We think any default by ZKB would have a significant systemic impact on the regional economy. A decision by the Swiss National Bank in November 2013 to classify ZKB as systemically important has no impact on our ratings. Based on enhancements to the Swiss bank resolution regime coming into effect on Jan. 1, 2016, we consider it uncertain that the Swiss sovereign would provide extraordinary government support to systemically important commercial banks. We also consider the Swiss resolution regime to be effective--that is, likely to ensure an orderly bail-in of liabilities to ensure that stressed systemically important institutions remain a going concern. We can therefore include notches of uplift for systemically important commercial banks that we expect will build sizable bail-in capacity buffers (additional loss-absorbing capacity) over the coming two to four years. Potentially, this could include ZKB. However, we consider GRE support to be the stronger external support element given that it provides more notches of uplift than any uplift potentially available under our criteria for additional loss-absorbing capacity. Moreover, in our view the Swiss resolution framework does not impede cantonal owners' ability to provide extraordinary support to banks that we consider to be GREs. Additional rating factors: No additional factors affect this rating. Hybrid issue ratings Our 'A' ratings on ZKB's two Tier 2 subordinated bond (T2) issuances reflect our analysis of the instruments and our assessment of ZKB's SACP at 'aa-'. We understand that the bonds do not benefit from the cantonal guarantee provided by the Canton of Zurich and consequently we notch down from our SACP assessment for the bank. The issue ratings are two notches below our SACP assessment for ZKB because we apply one notch for the instruments' subordination DECEMBER 9,

10 and one notch for their contingent capital clause (see paragraphs and 90 in our "Bank Hybrid Capital And Nondeferrable Subordinated Debt Methodology And Assumptions," published Jan. 29, 2015, on RatingsDirect). We do not apply additional notching for the mandatory write-down trigger at a 5% regulatory common equity Tier 1 ratio of ZKB, given that it is set at a level that we consider to be a nonviability trigger. Related Criteria And Research Related Criteria General Criteria: Group Rating Methodology - November 19, 2013 Criteria - Financial Institutions - Banks: Quantitative Metrics For Rating Banks Globally: Methodology And Assumptions - July 17, 2013 Criteria - Financial Institutions - Banks: Methodology For Mapping Short- And Long-Term Issuer Credit Ratings For Banks - May 04, 2010 Commercial Paper I: Banks, March 23, 2004 Criteria - Financial Institutions - Banks: Bank Hybrid Capital And Nondeferrable Subordinated Debt Methodology And Assumptions - January 29, 2015 Criteria - Financial Institutions - Banks: Revised Market Risk Charges For Banks In Our Risk-Adjusted Capital Framework - June 22, 2012 Criteria - Financial Institutions - Banks: Banks: Rating Methodology And Assumptions - November 09, 2011 Criteria - Financial Institutions - Banks: Banking Industry Country Risk Assessment Methodology And Assumptions - November 09, 2011 Criteria - Financial Institutions - Banks: Bank Capital Methodology And Assumptions - December 06, 2010 General Criteria: Rating Government-Related Entities: Methodology And Assumptions - March 25, 2015 General Criteria: Use Of CreditWatch And Outlooks - September 14, 2009 Related Research Banking Industry Country Risk Assessment: Switzerland, Sept. 9, 2015 Anchor Matrix Industry Risk Economic Risk a a a- bbb+ bbb+ bbb a a- a- bbb+ bbb bbb bbb a- a- bbb+ bbb+ bbb bbb- bbb- bb bbb+ bbb+ bbb+ bbb bbb bbb- bb+ bb bb - 5 bbb+ bbb bbb bbb bbb- bbb- bb+ bb bb- b+ 6 bbb bbb bbb- bbb- bbb- bb+ bb bb bb- b+ 7 - bbb- bbb- bb+ bb+ bb bb bb- b+ b bb+ bb bb bb bb- bb- b+ b bb bb- bb- b+ b+ b+ b b+ b+ b+ b b b- DECEMBER 9,

11 Ratings Detail (As Of December 9, 2015) Zuercher Kantonalbank Counterparty Credit Rating Subordinated Counterparty Credit Ratings History AAA/Negative/A Jul-2012 Foreign Currency AAA/Negative/A Jan Oct-1994 A AAA/Stable/A-1+ AAA/Negative/A Jul-2012 Local Currency AAA/Negative/A Jan Jun-1995 Sovereign Rating Swiss Confederation Related Entities Zurich (Canton of) Issuer Credit Rating Senior Unsecured AAA/Stable/A-1+ AAA/Negative/A-1+ AAA/Stable/A-1+ AAA/Stable/-- *Unless otherwise noted, all ratings in this report are global scale ratings. Standard & Poor's credit ratings on the global scale are comparable across countries. Standard & Poor's credit ratings on a national scale are relative to obligors or obligations within that specific country. Issue and debt ratings could include debt guaranteed by another entity, and rated debt that an entity guarantees. AAA Additional Contact: Financial Institutions Ratings Europe; FIG_Europe@standardandpoors.com DECEMBER 9,

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