March 7, 2013 / 2:26 PM / 5 years ago

Fitch affirms ZKB's IDR at 'AAA'/stable & VR at 'a+'

March 7 (Reuters) - (The following statement was released by the rating agency) Fitch Ratings has affirmed Zuercher Kantonalbank’s (ZKB) Long-term IDR at ‘AAA’ with a Stable Outlook and its Viability Rating (VR) at ‘a+'. A full list of rating actions is at the end of this rating action commentary. KEY RATING DRIVERS - IDRs, SUPPORT RATING AND SUPPORT RATING FLOOR ZKB’s Long-term IDR is equalised with that of its guarantor and sole owner, the Canton of Zurich (AAA/Stable; see ‘Fitch Affirms Canton of Zurich at ‘AAA’; Outlook Stable’ dated 20 February 2013). According to an explicit guarantee provided to the bank under a specific cantonal legislation (ZKB Law), the Canton of Zurich guarantees all of ZKB’s liabilities except subordinated debt and hybrid (participation) capital. While the guarantee does not address the question of timeliness of support, Fitch believes that any necessary support would be provided in a timely fashion, if necessary, given the extremely high importance of the bank for the canton and the Swiss economy as a whole, and the potential repercussions for the local and national financial sector of its failure. The strategic importance of the bank for the canton is emphasised by ZKB’s mandate (Leistungsauftrag) detailed in the ZKB Law, which prescribes that ZKB’s activities have to be centred on the Canton of Zurich, with limited nationwide or global activities permitted. The Canton of Zurich is also required to maintain a canton bank according to the cantonal constitution. At end-2011, ZKB had deposit and mortgage market shares in the Canton of Zurich of 41% and 43%, respectively, and was Switzerland’s third-largest bank by total assets. Zurich is Switzerland’s largest canton, accounting for 22% of the country’s GDP at end-2010 and 18% of its population at end-2011. KEY RATING DRIVERS - VR The affirmation of ZKB’s VR reflects the bank’s leading franchise in one of the country’s economically strongest and largest regions, its moderate overall risk profile and good asset quality, adequate profitability as well as its sound capital and funding profile. The VR also takes into account ZKB’s exposure to the Zurich real estate market, which shows signs of overheating. While increasing real estate-related losses clearly represent the most significant downside risk to ZKB’s VR, the affirmation is based on the agency’s expectation that loan impairment charges, although likely to moderately increase in 2013, will remain manageable. The risk profile of ZKB’s property market exposure is further supported by the bank’s below-average growth rates in residential (71% of gross loans at end-H112) and commercial (17%) mortgage loans in 2012, the books good granularity and moderate loan-to-value ratios. ZKB’s profitability remained relatively stable over the past year, with preliminary end-2012 operating profit (excluding one-off pension reserve costs) reported as CHF744m (end-2011: CHF769m). Profitability is under pressure from the bank’s high cost base, although management is working to address this. Cost management is particularly important in light of the bank’s limited ability to increase revenues through diversification; the bank’s mandate restricts activities to those which are low-risk and predominantly local. Around half of the bank’s net income is paid out in dividends to the Canton of Zurich. ZKB announced in January 2013 that it had made an application to the canton to increase the amount of endowment capital available to the bank by CHF2bn to CHF4.5bn. In addition, ZKB applied to revise the ZKB law to impose for the first time a guarantee fee on the bank for the cantonal support, estimated by the bank to cost around CHF20m per year. The ZKB Law is undergoing review by the cantonal parliament. An expected ratification date has not been announced. RATING SENSITIVITIES - IDRS, SUPPORT RATING AND SUPPORT RATING FLOOR ZKB’s support-driven ratings are sensitive to rating changes relating to the Canton of Zurich. Any negative rating action on the Canton would be directly reflected by ZKB’s Long-term IDR and SRF. As ZKB represents the bulk of the canton’s contingent liabilities, an increase in ZKB-related contingent liabilities could have a negative rating impact on the canton’s and ultimately ZKB’s support-driven ratings. Higher contingent liabilities for the canton could, for instance, be indicated by a significantly lower VR for ZKB indicating higher potential support requirements for the canton. The support-driven ratings are also sensitive to any changes in the relationship between the canton and ZKB, not expected by Fitch, which would call into question the timeliness and/or completeness of the state guarantee for senior creditors. RATING SENSITIVITIES - VR ZKB’s VR is primarily sensitive to negative developments in the Zurich residential and to a lesser degree the commercial property market. Fitch currently assumes a moderate correction in Zurich’s residential property market in 2013 and stress tests performed on ZKB’s exposure indicate that the bank could comfortably absorb LICs relating to a moderate fall in prices. However, should the anticipated price correction be significantly more pronounced than currently anticipated (i.e. more than a 15% fall in prices), this could be negative for ZKB’s VR. ZKB’s VR is furthermore sensitive to adverse developments concerning the inquiries of US tax authorities regarding US off-shore private banking clients initiated in 2012. While the VR factors in some costs relating to a potential settlement with US tax authorities, it is sensitive to the potential settlement amount being significantly larger than currently anticipated by Fitch, as this would reduce ZKB’s financial flexibility and damage the bank’s reputation. The rating actions are as follows: Long-term IDR: affirmed at ‘AAA’; Outlook Stable Short-term IDR: affirmed at ‘F1+’ Support Rating: affirmed at ‘1’ Support Rating Floor: affirmed at ‘AAA’ Viability Rating: affirmed at ‘a+’ Fitch may have provided another permissible service to the rated entity or its related third parties. Details of this service can be found on Fitch’s website in the EU regulatory affairs page.

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