Basellandschaftliche Kantonalbank

Primary Credit Analyst: Salla von Steinaecker, Frankfurt (49) 69-33-999-164; [email protected]

Secondary Contact: Fouad Bouhlou, Frankfurt (49) 69-33-999-191; [email protected]

Table Of Contents

Major Rating Factors

Outlook

Rationale

Related Criteria And Research

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1442873 | 301765380 Basellandschaftliche Kantonalbank

Additional SACP a+ Support +2 0 + + Factors

Anchor a- Issuer Credit Rating Business GRE Support +2 Adequate Position 0

Capital and Very Strong Earnings +2 Group Support 0 Risk Position Adequate 0 AA/Stable/A-1+

Funding Average 0 Sovereign Support 0 Liquidity Strong

Major Rating Factors

Strengths: Weaknesses:

• Strong retail banking franchise in Canton of • Concentration risk due to focus on residential Basel-Country. mortgage lending in the home region. • Sound financial profile, underpinned by very strong • Limited geographic, business, and earnings capitalization and stable earnings. diversification. • High quality loan book dominated by granular and • Little growth potential. well-collateralized residential mortgages.

Outlook: Stable

Standard & Poor's Ratings Services' stable outlook on Switzerland-based Basellandschaftliche Kantonalbank (BLKB) reflects that on the bank's majority owner and guarantor, the Canton of Basel-Country. The stable outlook also reflects our expectation that the bank's status as a government-related entity (GRE) and the "extremely high" likelihood of support will not change in the foreseeable future. Moreover, we expect that BLKB will maintain its sound financial profile, underpinned by its very strong capitalization and sound earnings capacity in the near term. We could take a negative rating action if BLKB's ties with Canton of Basel-Country were to loosen or changes to the canton's statutory guarantee were made. However, we currently consider this scenario unlikely and we expect BLKB's existing obligations will be grandfathered. A positive rating action is remote at this stage, in our view, as we do not expect BLKB to adjust its comparatively concentrated business model. However, a positive rating action on the Canton would trigger an upgrade of BLKB.

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Rationale

Our ratings on BLKB are based on its anchor of 'a-', its "adequate" business position, "very strong" capital and earnings, "adequate" risk position, "average" funding, and "strong" liquidity, as our criteria define these terms. The SACP is 'a+'.

We continue to consider BLKB to be a GRE with an "extremely high" likelihood of receiving timely and sufficient extraordinary support from the Canton of Basel-Country in times of stress. We base this opinion on BLKB's "very important" role and "integral" link to its home canton. This provides a two-notch uplift from the 'a+' SACP to arrive at the 'AA' issuer credit rating on BLKB.

Anchor: 'a' for banks operating solely in Switzerland The anchor reflects BLKB's Swiss headquarters and its credit exposures, which are almost exclusively to Swiss-domiciled counterparties.

Our bank criteria use our Banking Industry Country Risk Assessment (BICRA) economic risk and industry risk scores to determine a bank's anchor, the starting point in assigning an issuer credit rating. The BICRA score of '2' for Switzerland includes our evaluation of low economic risk and low industry risk. Consequently our anchor for a commercial bank operating only in Switzerland is 'a-'.

In this respect, we view Switzerland as a highly diversified and competitive economy, benefiting from one of the highest GDPs per capita in the world and very robust government finances. We believe that large parts of the Swiss banking market demonstrate a conservative risk and lending culture. That said, economic risk has increased, due to an acceleration of residential real estate price increases and real estate loan growth during the past few years, which has led to increasing economic imbalances.

The Swiss banking industry is supported by its sizable and very stable customer deposit base. Pure domestic Swiss banks have not loosened credit standards in recent years, thanks to sound earnings potential from core products. We consider regulatory standards to be more stringent than in other developed countries.

Table 1 Basellandschaftliche Kantonalbank Key Figures --Year-ended Dec. 31--

(Mil. CHF) 2015* 2014 2013 2012 2011 Adjusted assets 23,495.0 21,743.8 20,517.9 19,232.6 18,725.6 Customer loans (gross) 18,344.7 18,301.6 17,345.8 16,444.7 15,695.4 Adjusted common equity 1,966.5 1,853.6 1,764.0 1,654.8 1,550.4 Operating revenues 184.5 356.5 349.8 364.0 364.6 Noninterest expenses 90.8 172.9 167.8 173.0 192.9 Core earnings 92.7 180.2 179.6 185.5 169.1

*Data as of June 30. CHF--CHF-Swiss Franc. N.A.--Not available. N/A--Not applicable. N.M.--Not meaningful.

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Business position: Well-established regional franchise in the Canton of Basel-Country We consider BLKB's business position to be adequate in comparison with other domestic banks, balancing its regional concentration with its exceptional business stability over the economic cycle.

BLKB is the eighth-largest cantonal bank in Switzerland in terms of assets and operates in the economically strong region of Northwestern Switzerland. As of June 30, 2015, the bank's total assets equaled Swiss franc (CHF) 23.5 billion (€21.9 billion). Similar to most cantonal banks, BLKB's business activities are mainly focused on residential mortgage lending (78% of the total loan book) and lending to small and midsize enterprises in the region (10%); lending to public bodies and others accounts for the remainder (12%). BLKB's business activities are accompanied by private banking operations (assets under management of about CHF 14 billion in 2014) and to a smaller extent by client-initiated trading activities, a business model that we do not expect to change in the medium term.

Although we expect BLKB to remain a market leader in its home canton, we continue to view the concentration of its business on primarily one Swiss canton as a rating weakness. However, we consider that the bank's very prudent approach to managing credit risks will enable it to continue generating stable revenues and to deal with challenges arising from its business concentration.

Furthermore, we view positively BLKB's investment in Swiss direct bank Swissquote Group (not rated) and the joint launch of an online platform for e-mortgage loans to offer loans countrywide, which provides BLKB with a limited but additional source of revenues. Although we expect the volumes to remain minor in the near term, this activity points to BLKB's efforts to test new products and distribution channels and its ambitions to eventually expand its use of e-banking offerings nationwide in the future. We also observe that BLKB is proactively executing strategic initiatives in order to cope with the changing landscape in the retail banking industry due to ongoing trends toward digitalization and standardization. We are confident that BLKB is capable of meeting these challenges in order to secure its current business position.

Table 2 Basellandschaftliche Kantonalbank Business Position --Year-ended Dec. 31--

(%) 2015* 2014 2013 2012 2011 Loan market share in country of domicile N/A 1.7 1.6 1.6 1.6 Deposit market share in country of domicile N/A 1.4 1.3 1.4 1.5 Total revenues from business line (mil. CHF) 202.9 357.4 361.1 365.3 371.3 Commercial & retail banking/total revenues from business line 100.0 100.0 100.0 100.0 100.0 Return on equity 5.3 6.1 6.3 6.6 6.9

*Data as of June 30. CHF--Swiss francs. N.A.--Not available. N/A--Not applicable. N.M.--Not meaningful. Capital and earnings: Very strong capitalization supported by stable earnings We anticipate that BLKB's stable earnings generation and its conservative capital policy will not change. Therefore, we assess BLKB's capital and earnings as very strong.

We expect BLKB's risk-adjusted capital ratio (RAC) to gradually increase to the range 23%-24% over the next 18-24

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1442873 | 301765380 Basellandschaftliche Kantonalbank months, compared with 22.7% at year-end 2014. The lower range compared with our previous RAC projection (and compared with a ratio of 25.3% in 2013) results mainly from the increased capital requirements under our capital framework, due to the higher economic risk we associate with exposures on Swiss counterparties following our revision of the BICRA assessment on Switzerland in December 2014. However, our expectation is that BLKB's capital buildup will exceed the growth in Standard & Poor's risk-weighted assets over the projection period, allowing it to maintain a RAC ratio that is very strong in a global comparison.

We view BLKB's earnings capacity as strong and predictable, even compared with that of other cantonal banks. We expect the bank's profit before tax to be in the range €95 million-€105 million through 2015 and 2016 (it was CHF52 million in the first half of 2015). We expect BLKB's loan growth to slow down from 5.5% in 2014 to about 2%-3% in the next two years. At the same time, we anticipate that BLKB will focus on improving its lending margins in the mortgage loan business. The earnings will also be supported by stable fee and commission income driven by the securities and wealth management business. We expect the bank's dividend policy to remain in line with previous years, with a payout ratio of 50%-55%. Consequently, we estimate BLKB's three-year average earnings buffer, which measures the capacity for a bank's earnings to cover its normalized credit losses, at a very strong 150 basis points of its Standard & Poor's risk-weighted assets. This will, in our view, support the bank's capital buildup.

BLKB's Tier 1 ratio stood at 18.5% at year-end 2014. The quality of BLKB's total-adjusted capital is very high, as it consists only of core Tier 1 capital (share capital, capital surpluses, and reserves). We do not anticipate any measures by the Canton to increase or decrease capital in the near future. We believe that the Canton of Basel-Country, BLKB's 74% owner with 100% of voting rights, remains supportive of BLKB's capital position and that BLKB won't be required to make major or extraordinary dividend distributions that might weaken its RAC ratio.

Table 3 Basellandschaftliche Kantonalbank Capital And Earnings --Year-ended Dec. 31--

(%) 2015* 2014 2013 2012 2011 Tier 1 capital ratio N/A 19.0 18.7 16.7 16.7 S&P RAC ratio before diversification N.M. 22.7 25.3 23.7 23.8 S&P RAC ratio after diversification N.M. 18.4 20.3 19.7 20.0 Adjusted common equity/total adjusted capital 100.0 100.0 100.0 100.0 100.0 Net interest income/operating revenues 75.7 75.5 74.4 75.2 75.7 Fee income/operating revenues 17.1 18.5 18.7 17.3 17.8 Market-sensitive income/operating revenues 6.7 5.5 5.9 5.7 5.7 Noninterest expenses/operating revenues 49.2 48.5 48.0 47.5 52.9 Preprovision operating income/average assets 0.8 0.9 0.9 1.0 1.0 Core earnings/average managed assets 0.8 0.9 0.9 1.0 0.9

*Data as of June 30. N.A.--Not available. N/A--Not applicable. N.M.--Not meaningful.

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Table 4 Basellandschaftliche Kantonalbank Risk-Adjusted Capital Framework Data

Basel III Average Basel Standard & Average Standard (Mil. CHF) Exposure* RWA III RW (%) Poor's RWA & Poor's RW (%)

Credit risk Government and central banks 1,091 243 22 33 3 Institutions 1,667 450 27 307 18 Corporate 1,409 1,159 82 1,023 73 Retail 16,650 6,878 41 5,273 32 Of which mortgage 13,622 4,974 37 3,276 24 Securitization§ 0 0 0 0 0 Other assets 4 0 0 4 99 Total credit risk 20,821 8,731 42 6,639 32

Market risk Equity in the banking book† 102 124 122 576 564 Trading book market risk -- 45 -- 68 -- Total market risk -- 170 -- 644 --

Insurance risk Total insurance risk ------0 --

Operational risk Total operational risk -- 661 -- 881 -- (Mil. CHF) Basel III Standard & % of Standard & RWA Poor's RWA Poor's RWA

Diversification adjustments RWA before diversification 9,795 8,165 100 Total Diversification/concentration -- 1,926 24 adjustments RWA after diversification 9,795 10,091 124 (Mil. CHF) Tier 1 Total adjusted Standard & Poor's capital Tier 1 ratio (%) capital RAC ratio (%)

Capital ratio Capital ratio before adjustments 1,861 19.0 1,854 22.7 Capital ratio after adjustments‡ 1,861 19.0 1,854 18.4

*Exposure at default. §Securitization exposure includes the securitization tranches deducted from capital in the regulatory framework. †Exposure and Standard & Poor's risk-weighted assets for equity in the banking book include minority equity holdings in financial institutions. ‡Adjustments to Tier 1 ratio are additional regulatory requirements (e.g. transitional floor or Pillar 2 add-ons). RWA--Risk-weighted assets. RW--Risk weight. RAC--Risk-adjusted capital.CHF--Swiss franc. Sources: Company data as of Dec. 31, 2014, Standard & Poor's. Risk position: High concentration in residential mortgage lending, but prudent risk metrics We assess BLKB's overall risk position as adequate, reflecting our opinion that the bank's RAC ratio adequately captures its risk profile. We also note positively that BLKB's business model concentrates on well-collateralized low-risk lending categories, such as mortgages, small and midsize enterprises, and corporates, with only a small exposure to market-sensitive business.

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BLKB's loan book of CHF18.3 billion, which is dominated by residential real estate loans in the Canton of Basel-Country, will in our view continue showing very strong asset quality. We expect the loan book to grow at a somewhat lower pace than previous years, as the management is putting more emphasis on risk-adjusted margins over volume growth. That said, we still consider that the regional focus of the loan book exposes the bank to concentration risks. These concentration risks are partly offset by the high granularity and collateralization of the mortgage loan portfolio (estimated average loan-to-value ratio of 55% for mortgage loans) and lower average credit limits compared with other domestic banks. However, like its domestic peers, BLKB remains exposed to the risks related to a potential correction phase in Swiss residential real estate markets following continued price increases in past years.

Positively, we believe that the bank will maintain its conservative underwriting standards in new mortgage lending, helping it to report a marginal level of nonperforming loans in its loan book. This supports our estimate that the cost of risk will be less than 5 basis points over the next two years, which we expect to be below the industry average.

In order to diversify its loan book, BLKB selectively participates with moderate amounts (CHF20 million-CHF30 million) in syndicated corporate loans to large corporates across Switzerland. We don't believe that this activity, which currently represents less than 5% of BLKB's lending and focuses on highly rated corporates, will expose BLKB to any elevated credit risks that would impair our assessment of its risk position.

In our view, BLKB's interest rate risk is low, as it is less engaged in lock-down-periods longer than five years in its loan book. We observe that BLKB is mitigating its asset-liability risk by running its lending and refinancing activities with matching maturities.

We understand that the bank's private banking activities have never been focused on offshore business, and only to a limited extent on cross-border business, due to geographic proximity with France and Germany. In our view, the bank has also applied a prudential approach in its private banking business. This is emphasized by BLKB's status as a financial institution in category 4 of the current ongoing U.S. tax program. We therefore do not expect the bank to fall foul of foreign tax authorities.

Table 5 Basellandschaftliche Kantonalbank Risk Position --Year-ended Dec. 31--

(%) 2015* 2014 2013 2012 2011 Growth in customer loans 0.5 5.5 5.5 4.8 6.9 Total diversification adjustment / S&P RWA before diversification N.M. 23.6 24.3 20.1 19.1 Total managed assets/adjusted common equity (x) 12.0 11.7 11.6 11.6 12.1 New loan loss provisions/average customer loans 0.0 0.0 0.0 0.0 0.0 Net charge-offs/average customer loans N.M. 0.0 0.0 0.1 0.0 Gross nonperforming assets/customer loans + other real estate owned N/A 0.0 0.1 0.1 0.2 Loan loss reserves/gross nonperforming assets N/A N.M. 778.5 702.1 431.8

*Data as of June 30. N.A.--Not available. N/A--Not applicable. N.M.--Not meaningful.

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Funding and liquidity: Strong retail franchise provides funding stability We consider BLKB's funding to be average and its liquidity to be strong, as the bank has limited reliance on wholesale funding.

We expect that BLKB's stable funding ratio will remain at a comfortable level of about 105%-110% over the next two years, underpinning our assessment of its funding profile as average. The bank's funding will continue to benefit from a high level of core customer deposits, which constitute more than 74% of the total funding base, as well as from the strong equity stake on its balance sheet, comprising about 9% of total assets at June-end 2015. We consider that the bank's customer deposits will remain very durable, owing to BLKB's business stability and the statutory guarantee of its liabilities from the Canton of Basel-Country.

However, the loan portfolio continues to exceed the deposit base as demonstrated by BLKB's customer loans-to-deposit ratio which has ranged between 115% and 120% over the past five years (117% as of June 30, 2015), which indicates BLKB's reliance on other means for funding. Consequently, BLKB takes advantage of wholesale funding, mainly covered bonds (7% of funding base) and unsecured bonds (12% of funding base) at very low cost. We continue to observe improvements in the maturity structure of BLKB's liabilities compared with past years. We estimate the annual refinancing needs to be about CHF400 million-CHF450 million, while we observe larger maturities of CHF500 million–CHF750 million due in 2017-2019. Given BLKB's sound financial position, we believe that these refinancing volumes will be manageable.

We believe that BLKB's funding profile would not weaken during an economic downturn. Evidence for this is in the "flight to quality" during the most recent crises, which has strengthened BLKB's funding profile, and the continuous increase in customer deposits over the past years, despite the low interest rates the bank has offered.

Our assessment of BLKB's liquidity as strong reflects our estimate of the bank's superior one-year liquidity ratio (broad liquid assets to short-term wholesale funding) at about 6.9x as of year-end 2014. We consider the bank's liquidity coverage--consisting mainly of securities eligible for repurchase at the Swiss central bank--to be strong, indicating the availability of sufficient liquid assets to withstand a lack of access to wholesale funding for more than 12 months.

Table 6 Basellandschaftliche Kantonalbank Funding And Liquidity --Year-ended Dec. 31--

(%) 2015* 2014 2013 2012 2011 Core deposits/funding base 74.0 79.2 78.2 79.4 79.9 Customer loans (net)/customer deposits 116.6 118.1 120.6 120.8 116.9 Long term funding ratio 95.6 98.2 97.6 97.9 95.6 Stable funding ratio N/A 109.7 108.1 105.9 105.4 Short-term wholesale funding/funding base 4.8 2.0 2.6 2.3 4.9 Broad liquid assets/short-term wholesale funding (x) N/A 6.9 5.0 5.0 2.6 Net broad liquid assets/short-term customer deposits N/A 15.2 13.7 12.0 10.4 Short-term wholesale funding/total wholesale funding 18.4 9.5 12.0 11.0 24.3 Narrow liquid assets/3-month wholesale funding (x) N/A 10.3 7.3 6.8 3.1

*Data as of June 30. N.A.--Not available. N/A--Not applicable. N.M.--Not meaningful.

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Support: Two notches of support from the Canton of Basel-Country We regard BLKB as a GRE and assess as extremely high the likelihood that BLKB's owner, the Canton of Basel-Country, would provide timely and sufficient support to BLKB. We base our assessment on the bank's integral link with the Canton of Basel-Country, which we expect to provide considerable and timely credit support in all circumstances to BLKB due to its full control of the bank (100% of voting rights) and its provision of a statutory guarantee for the bank's liabilities. Our assessment is also based on BLKB's very important role for the canton, owing to the significant impact of the bank's activities for the local economy. Because of this, we incorporate a two-notch uplift from BLKB's 'a+' SACP to the long-term rating. We do not envisage that the bank's GRE-status and our view of an extremely high likelihood of extraordinary government support will change in the medium term.

BLKB benefits from the Canton of Basel-Country's statutory guarantee, which ultimately covers all of BLKB's liabilities, excluding nonvoting participation certificates ("Partizipationskapital"). However, we note that the guarantee does not explicitly ensure timely repayment, as defined by our criteria. Nevertheless, we believe that the canton has strong incentives to help BLKB meet its obligations on time, owing to the bank's importance to the regional economy and to prevent reputational damage.

Additional rating factors: None No additional factors affect this rating.

Related Criteria And Research

Related Criteria • Rating Government-Related Entities: Methodology And Assumptions, March 25, 2015 • Quantitative Metrics For Rating Banks Globally: Methodology And Assumptions, July 17, 2013 • Revised Market Risk Charges For Banks In Our Risk-Adjusted Capital Framework, June 22, 2012 • Banks: Rating Methodology And Assumptions, Nov. 9, 2011 • Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011 • Bank Capital Methodology And Assumptions, Dec. 6, 2010 • Methodology For Mapping Short- And Long-Term Issuer Credit Ratings For Banks, May 4, 2010 • Use Of CreditWatch And Outlooks, Sept. 14, 2009

Related Research • Banking Industry Country Risk Assessment Update: August, Aug. 20, 2015 • Swiss Canton of Basel-Country 'AA+/A-1+' Ratings Affirmed On Robust Economy And Exceptional Liquidity; Outlook Stable, July 17, 2015 • Switzerland Ratings And BICRA Unaffected By Swiss National Bank's Change In Exchange Rate Policy, Jan. 15, 2015 • Banking Industry Country Risk Assessment: Switzerland, Jan. 7, 2015 • Various Ratings Actions On Swiss Banking Groups On Rising Economic Imbalances, Dec. 1, 2014 • Basellandschaftliche Kantonalbank Downgraded To 'AA+' From 'AAA' On Similar Action On Basel-Country; Outlook Negative, Jan. 20, 2014 • Swiss Canton of Basel-Country Long-Term Rating Lowered To 'AA+' On Weak Budgetary Performance; Outlook Stable, Jan. 17, 2014

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Anchor Matrix

Economic Risk Industry Risk 1 2 3 4 5 6 7 8 9 10 1 a a a- bbb+ bbb+ bbb - - - -

2 a a- a- bbb+ bbb bbb bbb- - - - 3 a- a- bbb+ bbb+ bbb bbb- bbb- bb+ - - 4 bbb+ bbb+ bbb+ bbb bbb bbb- bb+ bb bb - 5 bbb+ bbb bbb bbb bbb- bbb- bb+ bb bb- b+ 6 bbb bbb bbb- bbb- bbb- bb+ bb bb bb- b+ 7 - bbb- bbb- bb+ bb+ bb bb bb- b+ b+ 8 - - bb+ bb bb bb bb- bb- b+ b 9 - - - bb bb- bb- b+ b+ b+ b 10 - - - - b+ b+ b+ b b b-

Ratings Detail (As Of August 26, 2015) Basellandschaftliche Kantonalbank Counterparty Credit Rating AA/Stable/A-1+ Counterparty Credit Ratings History 01-Dec-2014 AA/Stable/A-1+ 20-Jan-2014 AA+/Negative/A-1+ 03-Jul-2012 AAA/Negative/A-1+ Sovereign Rating Swiss Confederation AAA/Stable/A-1+ Related Entities Basel-Country (Canton of) Issuer Credit Rating AA+/Stable/A-1+ Senior Unsecured AA Senior Unsecured AA+ *Unless otherwise noted, all ratings in this report are global scale ratings. Standard & Poor's credit ratings on the global scale are comparable across countries. Standard & Poor's credit ratings on a national scale are relative to obligors or obligations within that specific country. Issue and debt ratings could include debt guaranteed by another entity, and rated debt that an entity guarantees.

Additional Contact: Financial Institutions Ratings Europe; [email protected]

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