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Fitch Rates IBK's Basel III AT1 Notes 'BB+(EXP)'
July 12, 2017 / 10:15 AM / in 4 months

Fitch Rates IBK's Basel III AT1 Notes 'BB+(EXP)'

(The following statement was released by the rating agency) SEOUL, July 12 (Fitch) Fitch Ratings has assigned the proposed US dollar-denominated perpetual subordinated notes of South Korea's Industrial Bank of Korea (IBK; AA-/Stable) an expected rating of 'BB+ (EXP)'. While the size of the issue has yet to be determined, the notes have a call option after five years and each interest payment date thereafter. The notes will be issued under IBK's USD8 billion global medium-term note programme, which was last updated on 30 June 2017. IBK will use the proceeds for its general corporate purposes. We expect the notes to qualify as Basel III Additional Tier-1 (AT1) securities for regulatory capital purposes. The final rating is contingent upon the receipt of final documents conforming to the information already received. KEY RATING DRIVERS Fitch rates the Basel III AT1 notes four notches below IBK's Viability Rating (VR) of 'a-' by applying two notches for loss severity relative to the recovery prospects of senior unsecured debt and another two notches for the high incremental non-performance risk relative to the anchor rating. The anchor rating of the notes is the VR, which is consistent with Fitch's criteria and captures the notes' going-concern loss-absorption feature - the coupon omission risk. The two notches for the incremental non-performance risk are lower than the typical three notches Fitch would apply to a Korean commercial bank's AT1 notes with similar terms and conditions to IBK's. Management is given full discretion on coupon payments or omissions. However, Fitch views that in practice this decision would be in effect dictated by South Korea's government (AA-/Stable), the policy bank's controlling shareholder and ultimate support provider. We expect the government to be reluctant to allow a coupon omission due to wider implications for the banking system, for example on funding costs. The repercussions of omitting a coupon would potentially not be limited to IBK as the Korean financial system benefits from the stability provided by its policy banks, which in aggregate account for about a quarter of the system's total assets and loans. The two notches for loss severity reflect the notes' poor recovery prospects because the AT1 notes will be fully and permanently written-off if and when IBK is designated by the local regulator as an insolvent financial institution according to Article 2 of the Act on the Structural Improvement of the Financial Industry, the key resolution legislation in Korea. This means that investors would not recover any of their investment. The coupon payments may be partially or fully restricted if IBK's regulatory capital ratios fall into the capital buffer zone (for more details on the capital buffer zone, see <a href="https://www.fitchratings.com/site/pr/1001124">Fitch: AT1 Coupon Risk in Focus on New Korean Bank Capital Rules, dated 17 March 2016). At end-1Q17, IBK would have surpluses of 2.6 percentage points (pp), 2.5 pp and 2.8 pp to the fully phased-in additional buffer requirements of Common Equity Tier-1, Tier-1 and total capital-adequacy ratios in 2019, respectively, assuming the current 0% countercyclical capital buffer holds. Moreover, a forceful coupon cancellation may be triggered if the local regulator imposes against IBK prompt-corrective measures, pursuant to Article 97 of the Regulation on Supervision of Banking Business. It can also be triggered if the regulator imposes on IBK an emergency measure (eg restrictions on acceptance of deposits and a prohibition on repayment of debts) pursuant to Article 38 of the same regulation. The government has been a responsible shareholder of its policy banks as it has helped them meet all their regulatory capital requirements, mostly by injecting capital into the banks in a proactive manner, and effectively preventing the policy banks' capital ratios from falling into the capital buffer zone. Fitch believes that there is an extremely high probability of the government providing continued ongoing support, if needed, to IBK, and currently does not have concerns over IBK's ability to avoid falling into the capital buffer zone. RATING SENSITIVITIES The rating of IBK's Basel III AT1 notes is sensitive to a change in IBK's Viability Rating, which in turn is sensitive to IBK's operating environment and risk appetite. (For details, see <a href="https://www.fitchratings.com/site/pr/1026041">Fitch Affirms 3 Korean Policy Banks' IDRs; IBK's VR Rated 'a-', dated 4 July 2017). The rating of the notes is also sensitive to a change in Fitch's assumptions about the notching for incremental non-performance risk. For example, it could be widened if Fitch develops concerns over IBK's ability and flexibility to service full coupon payments on time, which potentially depends on the government's propensity to provide support to IBK. Contact: Primary Analyst Matt Choi Associate Director +82 2 3278 8372 Fitch Australia Pty Ltd, Korea Branch 9F Kyobo Securities Building 97, Uisadang-daero, Yeongdeungpo-Gu Seoul 07327, South Korea Secondary Analyst Heakyu Chang Senior Director +82 2 3278 8363 Committee Chairperson Parson Singha, CFA Senior Director +662 108 0151 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. 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