Credit Opinion: Volvofinans Bank AB

Transcription

1 Credit Opinion: Volvofinans Bank AB Global Credit Research - 02 Nov 2012 Gothenburg, Sweden Ratings Category Outlook Bank Deposits Bank Financial Strength Moody's Rating Rating(s) Under Review *Baa2/*P-2 **D+ * Rating(s) within this class was/were placed on review on October 30, 2012 ** Placed under review for possible downgrade on October 30, 2012 Contacts Analyst Phone Richard (Blake) B. Foster/London Simon Harris/London Jessica Svantesson/London Key Indicators Volvofinans Bank AB (Unconsolidated Financials)[1] [2]6-12 [2]12-11 [2]12-10 [2]12-09 Avg. Total Assets (SEK million) 29, , , ,214.1 [3]6.3 Total Assets (EUR million) 3, , , ,363.7 [3]12.0 Total Assets (USD million) 4, , , ,391.3 [3]7.5 Tangible Common Equity (SEK million) 3, , , ,816.3 [3]11.7 Tangible Common Equity (EUR million) [3]17.7 Tangible Common Equity (USD million) [3]13.0 Net Interest Margin (%) [4]16.6 PPI / Avg RWA (%) [5]1.3 Net Income / Avg RWA (%) [5]0.8 (Market Funds - Liquid Assets) / Total Assets (%) [4]53.1 Core Deposits / Average Gross Loans (%) [4]27.2 Tier 1 Ratio (%) [5]15.4 Tangible Common Equity / RWA (%) [5]16.8 Cost / Income Ratio (%) [4]53.0 Problem Loans / Gross Loans (%) [4]1.8 Problem Loans / (Equity + Loan Loss Reserves) (%) [4]8.4 Source: Moody's [1] All ratios are adjusted using Moody's standard adjustments [2] Basel II; IFRS [3] Compound Annual Growth Rate based on IFRS reporting periods [4] IFRS reporting periods have been used for average calculation [5] Basel II & IFRS reporting periods have been used for average calculation Opinion RECENT CREDIT DEVELOPMENTS

2 RECENT CREDIT DEVELOPMENTS On 30 October 2012, we placed the D+ Bank Financial Strength Rating (BFSR), Baa2 long-term and P-2 shortterm deposit ratings of Volvofinans Bank AB (Volvofinans) on review for downgrade. The review reflects our concerns related to (1) the increase in unsecured lending through the bank's credit card business and the increase in non-auto-related unsecured credit card lending; (2) the high, albeit reduced, dependence on market funding exhibited by the bank; and (3) uncertainty surrounding the involvement of AP6, the government pension scheme, which is a 40% shareholder in the bank. The review also reflects our concerns related to wider pressures on European auto financing groups following the rating actions taken on 19 October 2012 (please see press release: Of particular concern is Volvofinans's interconnectivity with, and financial strength of, its majority owners: the network of Volvo dealerships, for example in originating loans and providing guarantees on those loans. SUMMARY RATING RATIONALE Volvofinans's standalone D+ BFSR, which maps to baa3 (on review for downgrade) on the long-term scale, reflects its solid market share in car and truck financing in Sweden, good asset quality and operating efficiency. The ratings also recognise Volvofinans's dependence on activities in the Swedish automotive market and the impact of tougher capital market conditions on its wholesale funding profile. Volvofinans's long-term global local currency (GLC) deposit rating of Baa2 (on review for downgrade) is based on Moody's assessment of systemic support for Volvofinans, as well as the support provided by the entity's parents and low level of systemic support. In terms of parental support, the bank is 40% owned by the Swedish government pension fund (AP6) which also appoints the chairman of the board of Volvofinans; 50% owned by the Volvo dealers, the main users of the bank, and 10% owned by Volvo Cars Corporation. As a result, there is a onenotch uplift in the GLC deposit rating mapped from Volvofinans's baa3 standalone rating. Rating Drivers - Stable Franchise Position in Sweden - High Market Funding Reliance Despite Deposit Raising Efforts - Robust Capital Position and Strong Asset Quality - Concentration Risk Constrains Risk Positioning Rating Outlook Volvofinans's BFSR, long-term and short-term deposit ratings are on review for downgrade. What Could Change the Rating - Up Given the review for downgrade, we do not view the bank's ratings as having upside potential. What Could Change the Rating - Down A downgrade of the BFSR would be likely predicated on: (1) our assessment that the current rating levels may not adequately reflect the pressures stemming from the weakening operating environment; (2) our assessment that the current deposit base may not be sustainable in the longer term; (3) growth in unsecured lending exceeding that of the auto-lending side of the business; and/or (4) credit quality weakening to a greater extent than we assume in our base-case scenario, which would exert pressure on the bank's earnings and capitalisation. The long-term deposit ratings could be lowered should we consider that the probability of systemic support be reduced, for example by a change in ownership structure. DETAILED RATING CONSIDERATIONS Detailed considerations for Volvofinans Bank's currently assigned ratings are as follows: Bank Financial Strength Rating

3 The assigned standalone D+ BFSR is one notch lower than the C- outcome generated by Moody's bank financial strength scorecard, reflecting Moody's concerns on the vulnerability of Volvofinans's funding model and its continued expansion into credit card services. - Stable Franchise Position in Sweden Volvofinans offers consumer finance loans and leasing contracts to private and corporate customers purchasing vehicles through Volvo dealers. In addition, it provides credit card services to more than one million customers. The bank's franchise is underpinned by its widely recognised brand name and sustained leading market share in vehicle finance in Sweden, despite operating in a niche market. Volvofinans's business model is built upon a strong financial incentive for the Volvo dealers, which own 50% of the bank, to distribute Volvofinans's financial products creating a level of interdependence. The Swedish network of Volvo dealers comprises 69 dealerships and 200 sales outlets, and employs around 8,000 staff. At end-june 2012, Volvofinans financed around 50% of the sales of new cars by Volvo dealers in Sweden and of new Volvo trucks (excluding sales through Volvo Truck Centre). Volvo's car sales have maintained a relatively stable market share in Sweden of approximately 20% over the past ten years. The Swedish market share of Volvo trucks is over 40%. The relatively high penetration rate, consistent economic performance of Volvo cars, and the comparatively slight impact of the financial crisis on Sweden have combined to support Volvofinans over a number of years. Volvo dealers have, since 2007, been able sell other car brands (in addition to Volvo and Renault), which has helped to improve both franchise value and earnings stability for Volvofinans. However, as set out in the concentration section below, we believe Volvofinans's concentrations both in terms of industry and in terms of to the brokers themselves, remains a credit negative. Volvofinans also offers fleet financing and administration services (all car types in the fleet, not specifically limited to Volvos and Renaults) and the issuance of credit cards (Volvo Cards) that were historically used exclusively to pay for auto-related expenses such as fuel and car servicing but, following the addition of a VISA offering in 2006, can now be used for much wider purchases. Volvofinans enjoys a robust market position in Sweden which is supported by a relatively stable earning base but somewhat constrained by low earnings diversification. - High Market Funding Reliance Despite Deposit Raising Efforts Although Volvofinans's deposit base has grown rapidly over the past two years to SEK10.6 billion at end-june 2012 (SEK2.5 at end-2010), the bank remains heavily dependent on wholesale funding. Market funding represents approximately 55% of total funding (including bilateral bank loans of 12%) and deposits 45% of total funding as of end-june We also note that at end-june 2012, more than 25% of market funding was in short-term maturities although we recognise the steps taken by Volvofinans over the last few years to extend and diversify their maturity profile. Volvofinans also has a liquidity line from its owners, AP6 and Volvo dealers, of SEK1.2 billion, which has never been utilised. We view the move towards lower reliance on short-term market funding and increased deposits positively as we generally view deposits as a more stable funding source. However, we believe that Volvofinans has had to pay a relatively high price for its deposits and may well have benefitted from the current market conditions where attractive rates are uncommon, leading us to question the sustainability of the deposit base. We also believe that that internet deposits can be less stable than more traditional deposits which may impact funding stability. This will be a key area we further analyse during the review process. Volvofinans's liquidity policies can be summarised as follows: (i) in a `winding up' scenario, the sum of total funding, equity and available credit facilities shall always exceed 100% of the existing asset portfolio; (ii) the bank's liquidity reserve must be at least 5% of lending; (iii) loans due in any individual week must not exceed 15% of unutilised credit facilities; (iv) long-term funding, must be a minimum of 60% of total funding; and (v) all short-term maturing debt must be covered by the bank's liquidity reserve (SEK3.6billion at end-december 2011) and committed back-up facilities (SEK8.4 billion at end-december 2011). Furthermore, Moody's notes that Volvofinans's back-up facilities do not contain material adverse change (MAC) clauses that could hinder drawdowns. Volvofinans's funding model, with its heavy reliance on market funding, proved to be vulnerable during the financial crisis, forcing the bank to join the Swedish government's guaranteed funding programme. This vulnerability was further exacerbated by the short-term nature of its funding profile, rendering the bank heavily dependent on a liquid funding market. Moody's notes, however, that Volvofinans has not issued any government guaranteed debt since July 2009 following a stabilisation of financial markets, and in April 2010 the bank did not renew its affiliation to the

4 July 2009 following a stabilisation of financial markets, and in April 2010 the bank did not renew its affiliation to the Swedish government's bank guarantee scheme. In Q2 2012, Volvofinans repurchased the final governmentguaranteed bonds and consequently have now left the programme. Volvofinans's liquidity management and overall rating remains constrained by the high reliance on whole sale market funding. - Robust Capital Position and Strong Asset Quality Volvofinans's end-june 2012 Tier 1 ratio of 16.7% under Basel II with transitional floors marked a small improvement on the end-2011 figure of 16.3%. For Basel II purposes, the bank applies the standard approach; however, Moody's notes that the Swedish Financial Services Authority (FSA) approved the bank's Internal Ratings Based (IRB) model for households and since June 2011 the portfolio has been valued according to the IRB method. Credit risk for vehicle financing at Volvofinans benefits from a three-stage process whereby losses are only taken if: (1) the end customer suspends payments; (2) the dealership suspends payments; and (3) the market value of the vehicle is less than the residual value of the loan. Under this framework, the Volvo dealers assume most of the credit risk and have formally agreed to buy back any problem loans although the corollary of this is that Volvofinans's margins on auto financing business are lower than would otherwise be the case. Should a dealership fail, Volvofinans has the power to directly contact the borrowers and repossess the car. Borrowers remain personally liable if the forced sale of the car does not cover the loan. This structure once again highlights the interdependence between Volvofinans and the Volvo dealers. Volvofinans's problem loans relate mainly to its credit card receivables, as most of the vehicle financing is guaranteed by dealers. Problem loans for credit card receivables accounted for 5.7% of credit card lending at end (end-2010: 6.8%). We note however, that credit card lending accounts for around 7% of Volvofinans's total lending at end-2011, and that Volvofinans charges a much higher rate of interest for this type of lending to account for the larger credit losses. - Concentration Risk Constrains Risk Positioning Volvofinans's overall risk positioning is characterised by a high industry concentration risk related to the auto industry in general, and to the Volvo dealerships on which it relies for much of its business and for the auto loan guarantees. The auto industry concentration means that Volvofinans's performance is largely correlated to the performance of the Swedish auto industry, most specifically Volvo cars and trucks. We note the diversification benefit of the unsecured lending and the resilient performance of the Swedish auto market compared to its European peers, but believe that such concentration remains a key risk to the bank, particularly as the economic troubles across Europe remain severe. Unlike many of its auto financing peers, Volvofinans is not owned by a single car marque and dealer inventory financing only constitutes a very limited share of its loan book. We also note that a significant share of Volvofinans's deposits come from the dealerships. However, we believe that Volvofinans's dependence on the dealers, in terms of originating the loans (albeit using Volvofinans's credit model), the guarantees the dealers provide, and Volvofinans's stated strategic objective to support the dealer's business leaves the bank exposed to the success of auto dealers. Volvofinans is 50% owned by Volverkinvest, the investment vehicle owned by 69 Volvo dealers in Sweden, with 40% held by the Swedish state-owned pension fund AP6 and the remaining 10% held by Volvo Cars Corporation. Moody's notes that the chairman of the board of Volvofinans is also a member of AP6. We note that In 2011, the Swedish government appointed a Special Investigator to evaluate the wider Swedish pension system. The conclusions and recommendations of the report include the possibility of merging AP6, the only fund with a mandate for Swedish private equity investments such as that in Volvofinans, with one or more of the other funds, although the exact investment mandate for such a merged fund remains unclear. The report's recommendations will next be considered by the government before any legislation is drafted. Moody's has previously regarded the involvement of AP6 as shareholder as supportive of Volvofinans's credit quality, and consequently any changes to the rating agency's perception of AP6's role may have credit implications. Market risk appetite is low, as (i) Volvofinans eliminates mismatching between lending and funding interest periods, (ii) foreign currency risk related to foreign funding is hedged using interest and currency swaps and (iii) the bank does not have any equity risk. At YE2011, the bank's interest-rate risk in relation to a 100-basis-point parallel shift in

5 does not have any equity risk. At YE2011, the bank's interest-rate risk in relation to a 100-basis-point parallel shift in interest rates was SEK57 million, corresponding to around 2% of Tier 1 capital. Global Local Currency Deposit Rating (Joint Default Analysis) Moody's assigns GLC deposit ratings of Baa2/Prime-2 (on review for downgrade) to Volvofinans. The GLC deposit ratings are supported by Volvofinans's standalone credit strength of baa3 (on review for downgrade) and receive a one-notch of uplift due to our assessment of a low probability of systemic support in case of need, and due to a limited degree the support provided by its parents. Foreign Currency Deposit Rating Volvofinans's foreign currency deposit ratings are unconstrained given that Sweden has a country ceiling of Aaa. Foreign Currency Debt Rating Volvofinans's foreign currency debt ratings are unconstrained given that Sweden has a country ceiling of Aaa. ABOUT MOODY'S BANK RATINGS Bank Financial Strength Rating Moody's Bank Financial Strength Ratings (BFSRs) represent Moody's opinion of a bank's intrinsic safety and soundness and, as such, exclude certain external credit risks and credit support elements that are addressed by Moody's Bank Deposit Ratings. Bank Financial Strength Ratings do not take into account the probability that the bank will receive such external support, nor do they address risks arising from sovereign actions that may interfere with a bank's ability to honour its domestic or foreign currency obligations. Factors considered in the assignment of Bank Financial Strength Ratings include bank-specific elements such as financial fundamentals, franchise value, and business and asset diversification. Although Bank Financial Strength Ratings exclude the external factors specified above, they do take into account other risk factors in the bank's operating environment, including the strength and prospective performance of the economy, as well as the structure and relative fragility of the financial system, and the quality of banking regulation and supervision. Global Local Currency Deposit Rating A deposit rating, as an opinion of relative credit risk, incorporates the Bank Financial Strength Rating as well as Moody's opinion of any external support. Specifically, Moody's Bank Deposit Ratings are opinions of a bank's ability to repay punctually its deposit obligations. As such, Moody's Bank Deposit Ratings are intended to incorporate those aspects of credit risk relevant to the prospective payment performance of rated banks with respect to deposit obligations, and includes: intrinsic financial strength, sovereign transfer risk (in the case of foreign currency deposit ratings), and both implicit and explicit external support elements. Moody's Bank Deposit Ratings do not take into account the benefit of deposit insurance schemes which make payments to depositors, but they do recognize the potential support from schemes that may provide assistance to banks directly. According to Moody's joint default analysis (JDA) methodology, the global local currency deposit rating of a bank is determined by the incorporation of external elements of support into the bank's Baseline Credit Assessment. In calculating the GLC rating for a bank, the JDA methodology also factors in the rating of the support provider, in the form of the local currency deposit ceiling for a country, Moody's assessment of the probability of systemic support for the bank in case a stress situation occurs and the degree of dependence between the issuer rating and the LCDC. National Scale Ratings National scale ratings are intended primarily for use by domestic investors and are not comparable to Moody's globally applicable ratings; rather they address relative credit risk within a given country. A Aaa rating on Moody's National Scale indicates an issuer or issue with the strongest creditworthiness and the lowest likelihood of credit loss relative to other domestic issuers. National Scale Ratings, therefore, rank domestic issuers relative to each other and not relative to absolute default risks. National ratings isolate systemic risks; they do not address loss expectation associated with systemic events that could affect all issuers, even those that receive the highest ratings on the National Scale.

6 Foreign Currency Deposit Rating Moody's ratings on foreign currency bank obligations derive from the bank's local currency rating for the same class of obligation. The implementation of JDA for banks can lead to a high local currency ratings for certain banks, which could also produce high foreign currency ratings. Nevertheless, it should be reminded that foreign currency deposit ratings are in all cases constrained by the country ceiling for foreign currency bank deposits. This may result in the assignment of a different, and typically lower, rating for the foreign currency deposits relative to the bank's rating for local currency obligations. Foreign Currency Debt Rating Foreign currency debt ratings are derived from the bank's local currency debt rating. In a similar way to foreign currency deposit ratings, foreign currency debt obligations may also be constrained by the country ceiling for foreign currency bonds and notes, however, in some cases the ratings on foreign currency debt obligations may be allowed to pierce the foreign currency ceiling. A particular mix of rating factors are taken into consideration in order to assess whether a foreign currency bond rating pierces the country ceiling. They include the issuer's global local currency rating, the foreign currency government bond rating, the country ceiling for bonds and the debt's eligibility to pierce that ceiling. About Moody's Bank Financial Strength Scorecard Moody's bank financial strength model (see scorecard below) is a strategic input in the assessment of the financial strength of a bank, used as a key tool by Moody's analysts to ensure consistency of approach across banks and regions. The model 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 Volvofinans Bank AB Rating Factors [1] A B C D E Total Score Qualitative Factors (50%) C- Factor: Franchise Value D Market Share and Sustainability x Geographical Diversification x Earnings Stability x Earnings Diversification [2] x Factor: Risk Positioning D Corporate Governance [2] Ownership and Org. Complexity Key Man Risk Insider and Related-Party Risks Controls and Risk Management x - Risk Management x - Controls x Financial Reporting Transparency x - Global Comparability x - Frequency and Timeliness x - Quality of Financial Information x Credit Risk Concentration Borrower Concentration Industry Concentration Liquidity Management x Trend

7 Market Risk Appetite x Factor: Operating Environment B+ Economic Stability x Integrity and Corruption x Legal System x Financial Factors (50%) C- Factor: Profitability D PPI / Average RWA - Basel II 1.28% Net Income / Average RWA - Basel II 0.75% Factor: Liquidity E (Market funds - Liquid Assets) / Total Assets 58.80% Liquidity Management x Factor: Capital Adequacy A Tier 1 Ratio - Basel II 14.93% Tangible Common Equity / RWA - Basel II 14.80% Factor: Efficiency B Cost Income ratio 52.54% Factor: Asset Quality B+ Problem Loans / Gross Loans 1.77% Problem Loans / (Shareholders' Equity + Loan Loss 8.36% Reserves) Lowest Combined Financial Factor Score (15%) E Economic Insolvency Override Neutral Aggregate Score C- Assigned BFSR D+ [1] - Where dashes are shown for a particular factor (or sub-factor), the score is based on non-public information. [2] - A blank score under Earnings Diversification or Corporate Governance indicates the risk is neutral Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. ("MIS") AND ITS AFFILIATES 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 NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. CREDIT RATINGS AND MOODY'S PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS AND MOODY'S PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. NEITHER CREDIT RATINGS NOR MOODY'S PUBLICATIONS COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODY'S ISSUES ITS CREDIT RATINGS AND PUBLISHES MOODY'S PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE.

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