Fitch Maintains EFG International's 'A' on RWN
The rating actions are part of Fitch's periodic review of Swiss private banks. The RWN reflects the impact on the bank's capitalisation, asset quality and the execution risk relating to the planned acquisition and integration by EFGInt of BSI, which it expects to complete in 4Q16. On 11 May 2016, EFGInt completed an ordinary share capital increase ahead of the acquisition, for which it is yet to receive full regulatory approvals. Fitch expects to resolve the RWN when the acquisition is finalised.
FINMA's approval of EFGInt's acquisition of BSI is conditional upon the integration and dissolution of BSI as a legal entity by end-1H17. The accelerated schedule for integration includes the migration of part of BSI Bank (Singapore) Ltd's assets to EFG Bank's Singapore branch by end-November 2016.
The ratings were placed on RWN in February 2016, when the acquisition was announced (see 'Fitch Places EFG International on RWN on BSI Acquisition Plan', at www. fitchratings. com)
KEY RATING DRIVERS
IDRS AND VR
EFGInt's ratings are aligned with those of EFG Bank, the group's main operating entity. We assess the group on a consolidated basis because the individual operating entities' credit profiles cannot be meaningfully disentangled. This is because their highly cohesive strategy, governance and risk management result in ordinary support being available to EFG Bank from other group companies. The rating equalisation also takes into account EFGInt's role as holding company and the absence of double leverage.
The IDRs and VRs reflect the group's company profile as a globally operating private bank with a well-diversified franchise. The group has a well-established wealth management franchise, with CHF80.6bn assets under management (AuM) at end-1H16. EFGInt has completed its restructuring it started in 2011, under which the business model has been simplified by concentrating on its core private banking activities.
The acquisition of BSI should provide it with around CHF77bn AuM, although the negative publicity following FINMA's findings of "serious breaches of money laundering regulations" in BSI's Singapore operations has in our view heightened the risk that outflows in AuM related to client attrition could be larger than expected.
We view EFGInt's capitalisation as being currently adequate. The group reported a 12.8% fully loaded CET1 ratio at end-2015 and an 18.5% CET1 ratio at end-1H16, following the capital increase in relation to the planned acquisition. However, we expect the completion of BSI's acquisition to result in significantly weaker capitalisation at the lower end of private banking peers' capital ratios. In May 2016, EFGInt raised CHF295m in capital from the equity market to fund part of the transaction, CHF205m lower than plans unveiled in February. This CHF205m difference was addressed by EFGInt offering an additional CHF178m in share consideration to BTG Pactual SA (BTG; BB-/RWN/bb-), BSI's current owner, who also fully subscribed to EFGInt's CHF34m AT1 issuance. This has broadly neutral implications for the combined group's pro-forma CET1 and total capital ratios compared with the plans unveiled in February. BTG will consequently hold a 30% stake in the combined entity, and two of its representatives have been elected to join EFGInt's Board of Directors.
We believe that EFGInt's main risks are operational and reputational and these could be raised by BSI's operational and litigation risks and associated contingent liabilities. There are currently material protection arrangements in place, including a sizeable Swiss escrow account, representations and warranties covering up to the final purchase price related to certain contingent liabilities and purchase price adjustments reflecting net new money outflows in excess of CHF7.7bn since end-November 2015 and changes in IFRS tangible book value. However, these may not be sufficient to mitigate the risks.
We expect EFGInt to take further steps to ensure a sound risk management framework for the combined entity, given BSI's risk control deficiencies identified by FINMA and the MAS. The repayment of CHF95m profits from BSI's fund for general banking risks ordered by FINMA in relation to BSI's Singapore operations has eliminated a large source of uncertainty. However, further legal action related to the Malaysian sovereign wealth fund 1MDB or to other cases cannot be excluded, and any potential financial impact is at this stage difficult to assess.
Similar to most private banks, EFGInt has moderate exposure to on-balance sheet risks, reflecting its conservative risk appetite. The loan book is fairly short-term and almost exclusively collateralised or secured. Nonetheless, we believe that EFGInt's risk appetite remains higher than its higher-rated peers due to the bank's fairly sizeable residential mortgage loan book and large portfolio of US life insurance policies. In addition, we believe that the acquisition of BSI could lead to additional on-balance sheet risks, given its significant on balance-sheet lending and FX sales and trading operations. This would likely put pressure on asset quality and market risk.
Our assessment also takes into account a potential material impairment of the bank's held-to-maturity life insurance portfolio, whose carrying value at end-1H16 was CHF280m above its fair value, owing to recently announced - and contested - premium increases.
EFGInt's underlying profitability has remained adequate, but has been affected by large conduct costs and revenue pressure that have depressed overall returns. Should planned annual cost synergies of CHF185m by 2019 be successfully delivered, this would provide a sound foundation for stronger profitability in the long-term. Economies of scale and cost containment, which saw good progress at EFGInt in 1H16, will be important earnings drivers amid revenue challenges, including subdued client transactions, outflows linked to client tax regularisation in Latin America and low advisory mandate penetration.
The RWN on the Short-Term IDRs is driven by the RWN on the Long-Term IDRs. We believe that the strong liquidity profiles of both the buyer and the target could trigger an affirmation at 'F1' if (as we currently expect) the Long-Term IDR does not fall below 'A-' upon resolution of the RWN.
SUPPORT RATING AND SUPPORT RATING FLOOR
EFGInt's and EFG Bank's Support Ratings (SR) and Support Rating Floors (SRF) reflect our view that support from the Swiss authorities cannot be relied upon, primarily because of the group's low systemic importance. The group caters for an affluent client base and does not have a retail deposit franchise in Switzerland.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
EFGInt's bons de participations are rated five notches below the holding company's Viability Rating (VR) to reflect their fully discretionary coupon deferral and high loss severity.
The Tier 2 notes issued by EFG International (Guernsey) Limited and EFG Funding (Guernsey) Limited and guaranteed by EFGInt, are rated two notches below EFGInt's VR to reflect high loss severity given the notes' permanent and full point-of non-viability write-down feature.
The RWN on the bons de participations and the Tier 2 notes reflects the RWN on the issuer/guarantor's and our unchanged assessment of loss severity and incremental non-performance risk.
RATING SENSITIVITIES
IDRS AND VR
We expect to resolve the RWN when the acquisition is completed, which EFGInt expects to be in 4Q16, or shortly thereafter once there is greater clarity on the extent and management of execution risks. Therefore, the RWN could extend beyond the typical six-month review horizon if technical, legal and regulatory aspects delay the conclusion of the transaction.
We expect that any downgrade of the Long-Term IDR and VR would likely be limited to one notch. An affirmation appears unlikely at this stage in light of the significantly weaker pro-forma capitalisation of the enlarged group.
The IDRs and VRs are also sensitive to our assessment of the enlarged group's asset quality and risk appetite, which could come under pressure should EFGInt retain a material share of BSI's loan book, or should there be a material impairment in EFGInt's life insurance portfolio.
Should AuM outflows resulting from client attrition be materially larger than EFGInt's current guidance, and should these outflows threaten the integrity of EFG Bank's and BSI's franchises, then this could lead to further rating pressure. The ratings are also sensitive to lower-than-expected cost synergies over the lifetime of the integration process and to any outsized litigation loss not covered by existing protection arrangements.
Upside to the ratings is remote in the short-term as indicated by the RWN, but could arise in the long term, contingent on a significantly strengthened capitalisation, a stabilisation of the combined entity's franchise and improving cost efficiency.
EFGInt's Long-Term IDR and VR could be notched down from EFG Bank's if double leverage at the holding company increases or if fungibility within the group decreases, which we do not expect in the foreseeable future.
SUPPORT RATING AND SUPPORT RATING FLOOR
An upgrade of EFGInt and EFG Bank's SRs and an upward revision of the SRFs are unlikely, given the group's low systemic importance.
SUBORDINATED DEBT AND HYBRID SECURITIES
The ratings of the bons de participations and the Tier 2 notes are primarily sensitive to changes in EFGInt's VR. Their ratings are also sensitive to changes in their notching, which in the case of the bons de participations could arise if their non-performance risk rises materially, for instance due to higher regulatory capital requirements.
The rating actions are as follows:
EFG International
Long-Term IDR 'A' maintained on RWN
Short-Term IDR 'F1' maintained on RWN
Viability Rating 'a' maintained on RWN
Support Rating affirmed at '5'
Support Rating Floor affirmed at 'No Floor'
Fiduciary certificates (XS0204324890) backed by preferred shares 'BB+' maintained on RWN
EFG Bank
Long-Term IDR 'A' maintained on RWN
Short-Term IDR 'F1' maintained on RWN
Viability Rating 'a' maintained on RWN
Support Rating affirmed at '5'
Support Rating Floor affirmed at 'No Floor'
EFG Funding (Guernsey) Limited
Basel III-compliant Tier 2 subordinated debt 'BBB+' maintained on RWN
EFG International (Guernsey) Limited
Basel III-compliant Tier 2 subordinated debt 'BBB+' maintained on RWN
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