OREANDA-NEWS. Fitch Ratings has placed EFG International AG's (EFGInt) and EFG Bank's 'A' Long-term Issuer Default Ratings (IDRs), 'F1' Short-term IDRs and 'a' Viability Ratings on Rating Watch Negative (RWN). A full list of rating actions is available at the end of this rating action commentary.

The rating action follows EFGInt's announcement on 22 February 2016 that it has agreed to acquire BSI Bank AG, a Switzerland-based private bank, from Brazil-based BTG Pactual SA (BB-/RWN/bb-). EFGInt expects to close the transaction in 4Q16.

EFGInt's ratings are aligned with those of EFG Bank. 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.

KEY RATING DRIVERS
IDRS AND VR
The RWN reflects Fitch's opinion that the transaction carries material execution risk and could result in a weakening of EFGInt's financial profile in the short-term. Higher-than-expected integration costs, which we expect to be largely front-loaded between 2016 and 2018, lower-than-expected cost synergies or higher-than-expected assets under management (AuM) outflows related to client attrition could all negatively affect the combined entity's financial profile. These execution risks arise against a backdrop of revenue and cost pressures and a weaker capital position at EFGInt, as its fully-loaded Basel III CET1 ratio fell 110bps in 2H15 to 12.8% at end-2015.

Significant execution risk arises from the large size of the acquisition. EFGInt expects the combined entity to be the fifth-largest wealth manager in Switzerland with about CHF170bn AuM. This would roughly double EFGInt's AuM and the number of client relationship officers (CRO) compared with end-2015. Initially, BSI will be a subsidiary of EFGInt, but we expect that EFGInt's group structure and organisation will be changed following the transaction.

Despite the material execution risk, we believe that the combined group's larger and more diversified AuM base should provide a sound foundation for stronger profitability and lower operating costs in the long-term. Both banks' geographic franchises are largely complementary across Europe, Asia and Latin America. Over the long term, this should strengthen the group's already well-diversified global franchise. EFGInt expects annual cost synergies of about CHF185m or 15% of the combined cost base by 2019, in addition to possible revenue synergies, which have not been included in its plan.

The CHF1.3bn estimated purchase price, which will be subject to further adjustments for changes in BSI's net new money and tangible book value, is equivalent to CHF100m less than BSI's IFRS tangible book value and about 120% of EFGInt's total equity at end-2015, to be paid with a combination of cash and own shares. As a result, EFGInt expects BTG to receive a 20% stake in EFGInt and a representation on the group's board.

The RWN also reflects contagion risk arising from regulatory and litigation issues currently affecting BSI. The seller has provided representations and warranties to EFGInt, which should protect the group from the financial effect of fines or similar charges except for extreme circumstances. In addition, the group could be exposed to reputation risk.

In 2015, EFGInt's underlying recurring net profit fell 30% despite a 3% rise in AuM. Operating income fell 3%, mainly due to a lower contribution from the life insurance portfolio, the challenging interest rate environment prevailing in Switzerland since the SNB's rate cut in January 2015 and more broadly in Europe, adverse currency developments and an adverse economic environment in overseas markets. Costs were burdened by a EUR21m settlement with the US Department of Justice (DoJ), following the conclusion of the DoJ's investigations into tax evasion by some of EFGInt's US clients. Increased CRO hiring also drove costs up.

EFGInt's capitalisation remains adequate, with a CET1 ratio of 12.8% and a total capital ratio of 16.8% at end-2015, which however fell from 14.2% and 18.7% respectively. The decline was driven by the inclusion of life insurance collateral loans in risk-weighted assets (RWAs), the DoJ settlement and an increase in the defined benefit pension liability due to low interest rates more than offseting capital generation from underlying earnings. EFGInt expects the combined entity's fully-applied Basel III total capital ratio to remain above 15% in 2016 before cost synergies materialise in the following year.

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 and because of the advanced state of resolution legislation in Switzerland. We believe that the announced acquisition does not increase the propensity of state support despite the bank's significantly increased size. Consequently, we have affirmed the SR and SRF at the lowest possible levels.

SUBORDINATED DEBT AND HYBRID SECURITIES
EFGInt's bons de participations are rated five notches below the holding company's 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.

RATING SENSITIVITIES
IDRS AND VR
We expect to resolve the RWN when the transaction is closed, 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. The ratings could be affirmed if earnings and capitalisation at both banks remain resilient until the completion of the transaction, and if there are clear signs that execution risk is managed prudently and that the protection against litigation risk arising from the transaction is adequate.

The resolution of the RWN will also take into account the impact of the acquisition on EFGInt's capitalisation and leverage, which will notably depend on the planned capital increase to finance part of the acquisition. Our assessment of the combined group's ability to achieve their targeted capital ratios will be an important rating driver.

We will also assess possible deviations from the expected cost synergies. This is an important factor in light of EFGInt and BSI's high cost-income ratios (86% and 80% respectively in 2015), which both significantly exceed EFGInt's 75% target.

In addition, we will take into account the nature, scope and risk profile of BSI's activities that EFGInt may identify as non-core and earmark for divestment. Conversely, a decision to retain a material share of BSI's lending business could increase the group's currently moderate exposure to on-balance sheet credit risk. Evidence that EFGInt may depart from its overall moderate risk appetite may exert downward pressure on the ratings.

A material decline in AuM over the coming quarters ahead of the transaction's closing could indicate a weakening franchise, which would put pressure on ratings. However, a certain degree of AuM volatility and funds outflows are inevitable following M&A transactions given the confidence-sensitive nature of the private banking business.

The resolution of the RWN would reflect our assessment of the combined group's structure and management, and how these can provide the targeted efficiency gains without threatening both brands' integrity.

EFGInt's IDR and VR could be notched down from EFG Bank's if double leverage at the holding company increases or if fungibility of capital and funding within the group decreases.

SUPPORT RATING AND SUPPORT RATING FLOOR
An upgrade of EFGInt's and EFG Bank's SRs and an upward revision of their respective SRFs are unlikely, given the Swiss regulatory environment and the group's business profile.

SUBORDINATED DEBT AND HYBRID SECURITIES
As both the bons de participations and the Tier 2 notes are notched off EFGInt's VR, their ratings are primarily sensitive to changes in EFGInt's VR. The 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 increases materially, for instance as a result of materially higher regulatory capital requirements.

The rating actions are as follows:

EFG International
Long-term IDR: 'A' placed on RWN
Short-term IDR: 'F1' placed on RWN
Viability Rating: 'a' placed on RWN
Support Rating affirmed at '5'
Support Rating Floor affirmed at 'No Floor'
Fiduciary certificates (ISIN XS0204324890) backed by preferred shares: 'BB+' placed on RWN

EFG Bank
Long-term IDR: 'A' placed on RWN
Short-term IDR: 'F1' placed on RWN
Viability Rating: 'a' placed 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+' placed on RWN

EFG International (Guernsey) Limited
Basel III-compliant Tier 2 subordinated debt: 'BBB+' placed on RWN