Global Banking Private Placement

May 2019 – Issue 4

Credit Journal

Global Banking

Private Placement

1

2

3

Banks

Regulation

Non-Bank Financial

Institutions

PAGE 2

PAGE 8

PAGE 11

6

4

5

News & Events

Meet the Analyst

Q&A with Kevin Duignan, Global Head of Financial Institutions Ratings

Global Focus

PAGE 20

PAGE 14

PAGE 16

Welcome to Credit Journal – a curated compilation of Fitch Ratings’ in-depth research and commentary. This latest

edition takes a deep dive into banks and non-bank ﬁnancial

institutions (NBFIs). With coverage of close to 3,000 banks,

securities firms, finance and leasing companies, financial

market infrastructure companies, business development companies (BDCs), and investment managers, we are a leading force in bank and NBFI ratings.

We hope this issue, as well as future ones, serve as reliable resources and help you make more informed investment decisions. We welcome comments for future issues,

including suggestions for topical or credit-specific research.

For our latest insights, please visit ﬁtchratings.com

Welcome

In this new edition of Fitch Ratings’ Credit Journal, I am pleased to share with you a snapshot of Fitch’s credit views in the Bank and Non-Bank Financial Institution (NBFI) sectors.

With heightened challenges of growth, stability, and risk at the end of the credit cycle, creditworthiness

considerations are a main focus for 2019, providing signiﬁcant opportunity for us to convey value-added

opinions and publish insightful bank and NBFI research.

Covering close to 3,000 banks and NBFIs worldwide, we are proud to be a leading force in ﬁnancial

institutions ratings, widely accepted by issuers, investors, and other debt capital markets participants. In 2018, we rated approximately $900 billion in bank and NBFI debt issuance globally and further developed our extensive relationships with global Financial Institution investors through ongoing collaboration.

Fitch has established itself as a leading voice in regulatory research, with consistent updates on the credit implications of supervisory initiatives, macro-prudential policies, conduct issues, and resolution outcomes, among other topics, some of which are included in this issue.

The recent introduction of ESG (Environmental, Social and Governance) Relevance Scores transparently and consistently displays the relevance of ESG elements to the credit rating decision. Although ESG risks

tend to have limited direct impact on bank ratings, nearly 20% of global financial institutions ratings are currently influenced by governance risk. As a result, this key initiative adds another dimension to Fitch’s offerings that will provide more comprehensive and robust commentary.

We very much welcome any feedback that you may have on our bank and NBFI ratings and research

oﬀerings. If you have any suggestions on research topics that you would like us to cover, please do not

hesitate to reach out to us, as we are always eager to address topics that are of interest to our readers.

Happy reading! Erwin van Lümich, CFA,

Head of Banks Business & Relationship Management

Sector Research

Banks Regulation Non-Bank Financial Institutions

Sector Research

leveraged loan market participants. Negative rating actions could be further exacerbated if the banks did

not adjust capital management practices to reﬂect

weakening market conditions.

Banks

Leveraged Lending: Where is the Risk in the U.S. Banking System?
Online Bank Deposit Betas Trend Up as

Competition Intensiﬁes

U.S. banks are exposed to leveraged lending risk in four ways: as underwriters and distributors through the syndication process; as holders of these loans on

balance sheets; as providers of ﬁnancing

to nonbank leveraged loan market participants active in this space; and as investors in CLOs.

Deposit betas for the largest U.S. online banks have steadily increased following a series of Federal Reserve interest rate hikes in 2017 and 2018. Deposit betas for traditional banks, while rising, continue to lag their online-only competitors. Traditional banks have had slower loan growth than online banks and already have a high proportion of their funding coming from deposits.

Leveraged loan risks to the U.S. banking system are manageable in the near term. Negative rating actions for banks would become more likely in the event of

a signiﬁcant market disruption for institutions, with

large on-balance sheet leveraged loan portfolios and considerable outstanding credit lines to nonbank
We estimate that cumulative deposit betas for online banks ranged from 43%-61% from the point of the

Fed’s ﬁrst rate hike in December 2015 through Q3 2018, with a median beta of 50%. Synchrony came

in at the low end of the range, while Sallie Mae was at the high end. Still, cumulative betas remain within expectations relative to assigned ratings.

Consolidation to Continue for U.S. Regional Banks

M&A activity in the U.S. banking sector could remain strong over the next 12-24 months for most banks. Although the majority of consolidation has been in the community bank and midsize bank space over the past decade, average deal sizes have risen almost every year since 2010. Recent sizable transactions indicate that M&A could be on the table for larger regional banks as well.

The announced merger of equals involving BB&T Corp. and SunTrust Banks, Inc. could serve as a template for further consolidation among regional banks looking to compete directly with the largest national banks.

However, the financial and strategic benefits associated with the deal are compelling and could prove difficult

to replicate.

Fitch Ratings | Global Banking – 3

Sector Research

Southern European Banks’ Funding Will

Beneﬁt From TLTRO-III

Asset Quality Review

The ECB’s new targeted longer-term reﬁnancing operations (TLTRO-III) will reduce reﬁnancing risks

and costs for Italian banks at a time when their access to wholesale markets is challenging, and will provide

funding ﬂexibility to Spanish banks. The Italian and

Spanish banking sectors are the two largest takers of ECB funds in Europe.

Credit Stabilizes for U.S. Credit Card Issuers

Increases in net charge-oﬀs (NCOs) and early stage

delinquencies continued to moderate for U.S.

credit card issuers in 3Q18, but the respite in credit

performance was partially driven by temporary factors.

Net charge-oﬀs for general purpose and retail card

issuers increased 13bps and 10 bps on average, respectively, year over year.
The new series of two-year facilities also aims to

encourage lending as it is designed as a still relatively cheap source of funding for banks. In Italy, however, the cheap funding is likely to contribute to continued weak loan pricing and depressed net interest income.

TLTRO-III could also aﬀect loan pricing in other markets, if take-up is signiﬁcant. In other western European markets, we expect TLTRO-III take-up to be mostly

opportunistic, except in Greece and Cyprus, where there is a more structural need given the high cost of wholesale funding.

U.S. Auto Loan Credit Improves

The credit performance of U.S. auto loans strengthened

in 2018 with net charge-oﬀs for the largest auto lenders declining year-over-year in 4Q18. Delinquency trends were more mixed among auto lenders in 4Q18 but

also declined on a year-over-year basis. We believe the

favorable credit performance in 2018 largely reﬂected

a stronger U.S. economic backdrop, but we expect weaker trends to emerge this year.

Anti-Money Laundering Scrutiny

Catching Up with Nordic Banks

Nordic banks’ cross-border operations in the Baltic region are under increasing scrutiny as EU authorities enforce stronger anti-money laundering (AML) regimes. The EU crackdown on money laundering should ultimately be positive for the European banking sector as it addresses past shortcomings and reduces litigation risk.

Investigations that reveal money laundering or governance failures may, however, cause reputational

damage for the banks directly aﬀected and faltering investor conﬁdence could spread to other

banks, particularly in banking systems with a high degree of wholesale funding, concentration, and interconnectedness. Banks would typically be subject to

negative rating action if ﬁnes, business restrictions, and

remediation actions more permanently weighed on

capitalization, franchise and funding proﬁles. Findings

Sector Research

that reveal broad-based weaknesses or failings in risk management or governance could also lead to negative rating actions.

including the Royal Commission, that identiﬁed

shortcomings in conduct, governance, and compliance, and will all be engaged in remediation that could distract management from day-to-day business. These challenges come amid other near-term pressures on earnings from a generally tougher operating environment.

Turkish Banks Have Notable Cushion Against Weaker Asset Quality

The Turkish banking sector’s profitability and capital buffers still provide a significant cushion against a

potential marked deterioration in asset quality, driven by the weaker operating environment. We stressed the sector’s capital ratios over two years for a sharp rise in non-performing loans (NPLs), a weakening in

proﬁtability and Turkish lira depreciation. These factors

constitute the key risks to solvency, in our view.
The four major banks–Australia and New Zealand Banking Group, Commonwealth Bank of Australia, National Australia Bank, and Westpac–have large market shares across most products in Australia and New Zealand, which support strong earnings and balance sheets, and help moderate risk appetite compared with

many international peers. However, it may be diﬃcult

for the banks to exercise these advantages fully in an environment of increased public and regulatory scrutiny, as well as pressure to increase their focus on customers rather than shareholders.

Our analysis shows that loss-absorption buﬀers remain

solid, despite moderate erosion mainly due to the weaker lira. In only two of the six scenarios do sector capital ratios fall below required minimum levels. Capital ratios remain above these levels in the other scenarios,

but NPLs signiﬁcantly above 10% would pressure solvency, and potentially ratings, depending on speciﬁc

banks’ resilience.

Indian Banks Beneﬁt from Lower

Slippages but Challenges Remain

The Indian banking sector’s non-performing loan

(NPL) ratio improved in the ﬁrst nine months of the ﬁnancial year to March 2019 but slow NPL resolution

and weak capital are likely to keep the banks’ overall pace of recovery tepid. Lower fresh slippages and better recoveries were instrumental in lowering the Indian

Conduct and Compliance Issues Weigh on Australian Banks

Australia’s major banks will continue to face heightened regulatory scrutiny following recent public inquiries,

Sector Research

banking sector’s gross NPL ratio to 10.8% during the

same period from 11.5% at March 2018.

global economy. This is balanced, however, by their leading domestic franchises, sound domestic asset quality on the back of a stable economy with forecasted GDP growth of 1.9% in 2019, low

unemployment, and satisfactory corporate proﬁtability.

Fitch sees the banks as making progress in arresting the downward trend of net interest margins on domestic and overseas loans.
Indian banks, however, continue to face challenges on multiple fronts. The banking sector’s weak earnings, in

particular state-owned banks, and thin capital buﬀers,

remain at risk from aging provisions, which stem from

the slow resolution of the sector’s USD150 billion NPL stock. Overall credit costs, despite a decline in

percentage terms from previous years, remained high compared with most state banks’ weak pre-provision

proﬁts. As a result, several state banks reported losses

while the common equity Tier 1 for nearly half of the 21 state banks was below the minimum 8% required by

ﬁscal 2020.

The mega banks’ search for loan growth overseas will

raise their overall risk proﬁles in 2019, while vulnerability

to credit and market risk could rise in line with seeking higher returns on foreign securities investments. We believe the banks will continue to balance risktaking and capital retention, but rapid expansion

without corresponding buﬀers would have negative

implications for the ratings

Japan’s Mega Banks in Search for Proﬁt;

Shift to Higher Risk Continues in 2019

Slow Proﬁt Growth at China Banks to Pressure Capitalization

Japan’s “mega banks” are expected to face challenges from low domestic interest rates, rising foreigncurrency funding costs, competition and an uncertain

Latest ﬁnancial results from Chinese banks show that their net proﬁts continued to be weighed down by the

challenging operating environment, despite regulatory

efforts to support their profitability. Net profit growth

should be in the single digits in the medium term, and

this slow proﬁt growth is likely to put Chinese banks’

capitalization under pressure as growth in their risk-

weighted-assets continues to outpace that of net proﬁt

and assets. We have a negative sector outlook on Chinese

banks, reﬂecting banks’ struggles to meet regulatory

requirements while sustaining adequate loan

expansion to support economic growth. Banks’ proﬁt

growth in 2018 was also dragged down by higher

impairment charges, due to increased eﬀorts to resolve

NPLs subsequent to tightened NPL recognition against overdue loans and also partly due to IFRS 9 adoption.

Sector Research

Most Deals Involving Small Community Banks

($ Mil.)

Assets $100 Mil.–$1 Bil. (RHS)

Assets > $1 Bil. (RHS)

Assets < $100 Mil. (RHS)

Assets per Bank (LHS)

12,000

4

3210
10,000 8,000 6,000 4,000 2,000 0

2000

2005

2010

2015

2016

2017

3Q18

Source: Fitch Ratings, FDIC.

Indian Banks’ Gross NPL Ratio

9MFY19

FY18

FY17

(%)

32

24 16
80

Public banks (large)

Public banks (medium)

Private banks

Source: Banks, Fitch; banks in each sub-category arranged in descending order of 9MFY19 gross NPL ratio.

9MFY= Nine-month ﬁscal year.

Sector Research

ﬁnancial crime. We have researched comprehensively

into anti-money laundering and sanction evasion, thus highlighting the implications for banks’ credit ratings.

Regulation

For banks, it is regulatory action which tends to lead to default-like situations, unlike other credit sectors. Our research cuts through the complexity, by providing primers on regulatory topics and regional compendium guides that highlight

–Monsur Hussein, Head of Bank Regulatory Research

Global Bank Regulatory Outlook: Tighter Supervision, Focus on Pillar 2 and Macroprudential Policies, Conduct Risks

With no new signiﬁcant regulation expected in

2019, there’s a stable outlook for the global bank regulatory environment. Authorities within key banking

jurisdictions will focus on implementing in-ﬂight

regulations and strong supervision. In developing

markets, ﬁnancial stability topics may be prioritized over regulatory reforms, due to spill-over eﬀects from U.S.

policy rates and U.S. dollar foreign-exchange liquidity concerns.

jurisdictional diﬀerences and key trends.

Signiﬁcant post-crisis reforms to reduce bank failure

risk mean that sovereign support cannot be relied on for North American and Western European banks.

Alongside thorough analysis of banks’ ﬁnancial credit

metrics, insights into the regulatory playbook and the

applicable legal tools are key. Our research reports

and commentary on bank resolution, including bail-in regime updates, enable market participants to keep up-to-date with changes in the regulatory and political environment, and to gauge the risk of bail-in on senior debt instruments.

What to Watch

• Regulatory guidelines and supervisory practice changes more likely than new rules
• U.S. regulatory roll-back that loosens standards for larger banks would be credit negative, but U.S. G-SIBs have been excluded from much of the proposed relief for midsize banks
The focus on capital rules that characterized the

early years after the ﬁnancial crisis has shifted toward

supervision and conduct, and increasingly toward

Outlook Summary

Global

NA

LATAM

Tighter Stable

WE

CEE

MEA

Stable Stable Stable Stable Stable Tighter Tighter

APAC

Stable Tighter Stable Tighter Stable Tighter Tighter

Capital Numerator

Stable

Looser

Looser Looser Stable Looser Looser Stable
Stable Looser Looser Stable Looser Tighter Stable
Stable Stable Stable Stable Stable Tighter Stable

Capital Denominator Stable Leverage Ratio

Macroprudential

Liquidity

Looser Stable Stable Tighter Stable
Stable Stable Tighter Tighter Stable

Supervision Resolution

Source: Fitch Ratings

Sector Research

• Supervisory tweaks to increase model RWAs, e.g.,

input parameter ﬂoors, particularly for real estate and

high-risk exposures-more likely in APAC and EU than elsewhere

• An IFRS 9 Stage 2 signiﬁcant increase in credit risk deﬁnitions that diverge from bank to bank, and

incorporation of restructured loans into Stage 3, which may vary loan provisions
• Scrutiny of regulatory arbitrage and “optimization” may lead to sudden ratio changes

• Financial and non-ﬁnancial penalties and remedial

actions linked to conduct issues, e.g. anti-money laundering or sanctions evasions can take time to materialize

ECJ Opens Door to Deposit Guarantee

Schemes for Failing Banks

The European Court of Justice’s (ECJ) ruling that support from a private-sector deposit guarantee scheme did not constitute illegal state aid will make it easier to use these schemes to restructure failing banks. We believe that private deposit guarantee schemes could be an attractive way to deal with small failing banks. This is particularly the case as banks with total assets below EUR100 billion will not be subject to mandatory subordination requirements under EU Minimum Requirements for own funds and Eligible Liabilities rules. The ruling also served as a reminder that EU State Aid rules only apply where a public authority intervenes, or where it can be shown that the private body is under

the inﬂuence or control of the public authorities.

IBOR Transition Gains Momentum, but

Key Risks Not Yet Addressed

Substantial progress in recent months will better

prepare ﬁnancial markets for the discontinuation of IBOR indices, but transition risks remain. Our ratings

address the payment of interest (and principal) in accordance with the underlying terms of an obligation

and would not be directly aﬀected by transition from

one reference rate to another or any accompanying

Sector Research

spread adjustment. However, elements of IBOR

transition could, if not appropriately addressed and managed, become rating relevant through operational costs, valuation, hedging, legal risks, and increased basis risk.
Basel Committee on Banking Supervision. The stepup is mainly due to a requirement for some EU banks

to reﬂect their history of operational risk losses as an

add-on when calculating how much capital to hold

for potential future losses. The impact is signiﬁcant

because several banks’ recent history includes large

ﬁnes for misselling and other regulatory breaches.

Whether these risks crystallize will depend on further progress addressing these issues on a sector, issuer and

transaction basis. We believe the ﬁnancial institutions

and securitization sectors are most exposed to transition challenges.

CECL Implementation Expected to be Ratings Neutral to U.S. Financial Institutions

Operational Risk Capital May Rise for EU

Banks but Fall in the U.S.

The pending implementation of the U.S. accounting standard for current expected credit loss (CECL) reserves by the Financial Accounting Standards Board is not expected to result in ratings actions on adoption. That said, CECL is expected to be more impactful for banks than NBFIs as banks will need to meet regulatory capital ratios post-CECL implementation, whereas NBFIs are not bound by similar regulatory constraints.