28.07.2015, 09:06
Fitch Affirms Korea Exchange Bank at 'A-'/Stable
OREANDA-NEWS. Fitch Ratings has today affirmed the Long-Term Foreign-Currency Issuer Default Rating (IDR) on Korea Exchange Bank (KEB) at 'A-'. The Outlook is Stable. A full list of rating actions is at the end of this Rating Action Commentary.
The merger between KEB and its sister Hana Bank (A-/Stable) is planned for September 2015. Fitch expects to withdraw in due course all the issuer ratings on whichever of the two banks will cease to exist once the merger is completed, and simultaneously transfer the ratings on the securities issues of the withdrawn entity to the surviving entity.
KEY RATING DRIVERS
IDRS, SENIOR DEBT, SUPPORT RATING AND SUPPORT RATING FLOOR
The bank's IDRs, senior debt ratings, Support Rating and Support Rating Floor reflect Fitch's continued belief of an extremely high probability that the South Korean state (AA-/Stable) would support KEB, if required. This view is based on KEB's systemic importance as a key commercial bank in Korea, with 5%-6% of the industry's total assets and deposits - and, more importantly, about 30% of the nation's trade finance, due to its entrenched foreign-currency clearing system.
The Stable Outlook reflects the Stable Outlook on South Korea.
Viability Rating
KEB's 'bbb+' VR reflects its solid company profile, backed by a dominant market position in foreign-currency operations, and healthy capitalisation, but also the challenging operating environment which the Korean authorities are trying to alleviate through borrower-friendly measures (eg four policy-rate cuts within one year). The VR also takes into account adequate overall financial metrics (although they have weakened since 2011), moderate management quality, and a somewhat more aggressive risk appetite than peers after coming under the control of Hana Financial Group (HFG).
KEB is a medium-sized commercial bank whose current franchise is significantly smaller than its bigger local competitors. However, the consolidated entity's overall company profile will be comparable with Korea's large commercial banks once KEB is integrated with Hana Bank.
The management of KEB and its parent HFG is quite stable, and most of its executive managers are internally promoted. Fitch has observed signs which suggest that HFG's management is more aggressive than its local competitors. It often sets challenging targets with short-implementation timeframes, which have exposed vulnerabilities in its operational risk control. That said, HFG has improved its controls, but there is room for further improvement.
KEB's reported loan quality has been slightly better than the local peer average, but the bank has a larger exposure to large corporates than its close peers. Corporate loans constitute 45% of total loans, most of which are unsecured. KEB has focused on growth in the mass SME market since its acquisition by HFG in February 2012, in an effort to mitigate concentration on large corporates and to offset weakening profitability.
The profitability of Korea's banks has been on a weakening trend since 2011, due to falling interest rates and various regulatory-driven costs, including continued social and political pressure on margins and fees. Fitch expects the sector's net interest margin (NIM) to bottom out towards year-end, assuming no further rate cuts by the central bank. KEB's underlying profitability (about 0.4% in terms of ROA) has been below the local commercial bank average for the past two years. Fitch expects KEB and Hana to incur a noticeable increase in expense due to the planned eventual integration, such as in a new IT system. No significant cost synergies will come in the short-term, given that HFG has agreed with KEB's labour force to maintain two separate HR systems for two years - and not to conduct any arbitrary restructuring.
KEB's Fitch Core Capital (FCC) ratio was 12.9% at end-1Q15 compared with the commercial bank average of 12.8%. HFG is highly likely to be designated as a D-SIB in late 2015, which is likely to force HFG to continue to shore up its capitalisation gradually. HFG's FCC ratio was 11.0% at end-1Q15, and has a high 130% common-equity double leverage.
KEB's loans/customer deposits ratio had improved to 112% by end-2014 from 116% at end-2013, mainly because of the spin-off of the credit card operation in September 2014. Its Basel III LCR was 95% at end-1Q15 compared with 108% for the local commercial bank average, reflecting KEB's smaller retail deposits base. Fitch expects KEB to gradually strengthen its liquidity in the future as the current 80% minimum is to be raised to 100% in 2019 (a 5pp increase every year).
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
KEB's Basel 3 Tier 2 notes are rated two notches below its Long-Term IDR, to reflect poor recovery expectations as a result of their subordinated status, and because the notes are to be fully and permanently written off upon hitting the point-of-non-viability (PONV).
Fitch uses the support-driven IDR or the VR (whichever is higher) as the anchor rating for Korea's systemically important banks' Tier 2 instruments, including those for KEB. This is because they will be non-performing (or reach a PONV) when the issuing bank becomes insolvent or defaults, which is similar to the point at which senior debt is considered to be in default, and we expect pre-emptive support to be provided to avoid insolvency. KEB's notes have minimal non-performance risk relative to the bank's senior unsecured debt.
RATING SENSITIVITIES
IDRS, SENIOR DEBT, SUPPORT RATING AND SUPPORT RATING FLOOR
The IDRs, senior debt ratings, Support Rating and Support Rating Floor are potentially sensitive to any change in assumptions around the propensity or ability of the Korean authorities to provide timely support to the bank. This might arise if there is a change in the ability of the Korean authorities to provide support. Furthermore, global regulatory initiatives aimed at reducing implicit government support available to banks may cause downward pressure on the ratings.
Viability Rating (VR)
The bank's VR is sensitive to the planned integration with Hana Bank; a challenging operating environment which has been offset by the borrower-friendly measures by the Korean authorities; and its somewhat aggressive risk appetite.
Assuming KEB is the surviving entity in its merger with Hana Bank, a successful integration may lead to an upgrade of the VR. The integration with Hana Bank will double its franchise, and should contribute to improving the new combined entity's competitive position and funding in the long run.
The VR could be downgraded if there is a significant and unexpected increase in risk appetite (including from above-peer growth), which heightens the prospects of future deterioration in loan quality, and noticeable erosion in its capitalisation. However, Fitch does not expect the quality of KEB's loans to weaken substantially in the foreseeable future.
SUBORDINATED DEBT
KEB's Basel 3 Tier 2 subordinated debt ratings are broadly sensitive to the same considerations that might affect KEB's Long-Term IDR, which is the anchor for such securities.
The rating actions are as follows:
KEB
Long-Term Foreign-Currency IDR affirmed at 'A-'; Stable Outlook
Short-Term Foreign-Currency IDR affirmed at 'F1'
Viability Rating affirmed at 'bbb+'
Support Rating affirmed at '1'
Support Rating Floor affirmed at 'A-'
Senior unsecured debt affirmed at 'A-'
Subordinated debt (Basel 3-compliant Tier 2) affirmed at 'BBB'
The merger between KEB and its sister Hana Bank (A-/Stable) is planned for September 2015. Fitch expects to withdraw in due course all the issuer ratings on whichever of the two banks will cease to exist once the merger is completed, and simultaneously transfer the ratings on the securities issues of the withdrawn entity to the surviving entity.
KEY RATING DRIVERS
IDRS, SENIOR DEBT, SUPPORT RATING AND SUPPORT RATING FLOOR
The bank's IDRs, senior debt ratings, Support Rating and Support Rating Floor reflect Fitch's continued belief of an extremely high probability that the South Korean state (AA-/Stable) would support KEB, if required. This view is based on KEB's systemic importance as a key commercial bank in Korea, with 5%-6% of the industry's total assets and deposits - and, more importantly, about 30% of the nation's trade finance, due to its entrenched foreign-currency clearing system.
The Stable Outlook reflects the Stable Outlook on South Korea.
Viability Rating
KEB's 'bbb+' VR reflects its solid company profile, backed by a dominant market position in foreign-currency operations, and healthy capitalisation, but also the challenging operating environment which the Korean authorities are trying to alleviate through borrower-friendly measures (eg four policy-rate cuts within one year). The VR also takes into account adequate overall financial metrics (although they have weakened since 2011), moderate management quality, and a somewhat more aggressive risk appetite than peers after coming under the control of Hana Financial Group (HFG).
KEB is a medium-sized commercial bank whose current franchise is significantly smaller than its bigger local competitors. However, the consolidated entity's overall company profile will be comparable with Korea's large commercial banks once KEB is integrated with Hana Bank.
The management of KEB and its parent HFG is quite stable, and most of its executive managers are internally promoted. Fitch has observed signs which suggest that HFG's management is more aggressive than its local competitors. It often sets challenging targets with short-implementation timeframes, which have exposed vulnerabilities in its operational risk control. That said, HFG has improved its controls, but there is room for further improvement.
KEB's reported loan quality has been slightly better than the local peer average, but the bank has a larger exposure to large corporates than its close peers. Corporate loans constitute 45% of total loans, most of which are unsecured. KEB has focused on growth in the mass SME market since its acquisition by HFG in February 2012, in an effort to mitigate concentration on large corporates and to offset weakening profitability.
The profitability of Korea's banks has been on a weakening trend since 2011, due to falling interest rates and various regulatory-driven costs, including continued social and political pressure on margins and fees. Fitch expects the sector's net interest margin (NIM) to bottom out towards year-end, assuming no further rate cuts by the central bank. KEB's underlying profitability (about 0.4% in terms of ROA) has been below the local commercial bank average for the past two years. Fitch expects KEB and Hana to incur a noticeable increase in expense due to the planned eventual integration, such as in a new IT system. No significant cost synergies will come in the short-term, given that HFG has agreed with KEB's labour force to maintain two separate HR systems for two years - and not to conduct any arbitrary restructuring.
KEB's Fitch Core Capital (FCC) ratio was 12.9% at end-1Q15 compared with the commercial bank average of 12.8%. HFG is highly likely to be designated as a D-SIB in late 2015, which is likely to force HFG to continue to shore up its capitalisation gradually. HFG's FCC ratio was 11.0% at end-1Q15, and has a high 130% common-equity double leverage.
KEB's loans/customer deposits ratio had improved to 112% by end-2014 from 116% at end-2013, mainly because of the spin-off of the credit card operation in September 2014. Its Basel III LCR was 95% at end-1Q15 compared with 108% for the local commercial bank average, reflecting KEB's smaller retail deposits base. Fitch expects KEB to gradually strengthen its liquidity in the future as the current 80% minimum is to be raised to 100% in 2019 (a 5pp increase every year).
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
KEB's Basel 3 Tier 2 notes are rated two notches below its Long-Term IDR, to reflect poor recovery expectations as a result of their subordinated status, and because the notes are to be fully and permanently written off upon hitting the point-of-non-viability (PONV).
Fitch uses the support-driven IDR or the VR (whichever is higher) as the anchor rating for Korea's systemically important banks' Tier 2 instruments, including those for KEB. This is because they will be non-performing (or reach a PONV) when the issuing bank becomes insolvent or defaults, which is similar to the point at which senior debt is considered to be in default, and we expect pre-emptive support to be provided to avoid insolvency. KEB's notes have minimal non-performance risk relative to the bank's senior unsecured debt.
RATING SENSITIVITIES
IDRS, SENIOR DEBT, SUPPORT RATING AND SUPPORT RATING FLOOR
The IDRs, senior debt ratings, Support Rating and Support Rating Floor are potentially sensitive to any change in assumptions around the propensity or ability of the Korean authorities to provide timely support to the bank. This might arise if there is a change in the ability of the Korean authorities to provide support. Furthermore, global regulatory initiatives aimed at reducing implicit government support available to banks may cause downward pressure on the ratings.
Viability Rating (VR)
The bank's VR is sensitive to the planned integration with Hana Bank; a challenging operating environment which has been offset by the borrower-friendly measures by the Korean authorities; and its somewhat aggressive risk appetite.
Assuming KEB is the surviving entity in its merger with Hana Bank, a successful integration may lead to an upgrade of the VR. The integration with Hana Bank will double its franchise, and should contribute to improving the new combined entity's competitive position and funding in the long run.
The VR could be downgraded if there is a significant and unexpected increase in risk appetite (including from above-peer growth), which heightens the prospects of future deterioration in loan quality, and noticeable erosion in its capitalisation. However, Fitch does not expect the quality of KEB's loans to weaken substantially in the foreseeable future.
SUBORDINATED DEBT
KEB's Basel 3 Tier 2 subordinated debt ratings are broadly sensitive to the same considerations that might affect KEB's Long-Term IDR, which is the anchor for such securities.
The rating actions are as follows:
KEB
Long-Term Foreign-Currency IDR affirmed at 'A-'; Stable Outlook
Short-Term Foreign-Currency IDR affirmed at 'F1'
Viability Rating affirmed at 'bbb+'
Support Rating affirmed at '1'
Support Rating Floor affirmed at 'A-'
Senior unsecured debt affirmed at 'A-'
Subordinated debt (Basel 3-compliant Tier 2) affirmed at 'BBB'
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