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July 24 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has affirmed Banque Internationale a Luxembourg's (BIL) Long-term Issuer Default Rating (IDR) at 'A-' and its Viability Rating (VR) at 'bbb+'. The Outlook on the Long-term IDR is Negative. A full list of rating actions is available at the end of this rating action commentary. The rating actions follow a periodic review of major Benelux banking groups.
KEY RATING DRIVERS - IDRS, SUPPORT RATING, SUPPORT RATING FLOOR AND SENIOR DEBT RATING
BIL's Long-term IDR and senior debt ratings are driven by its Support Rating Floor (SRF). This reflects Fitch's view that there would be an extremely high probability that the state of Luxembourg (AAA/Stable) would provide support to BIL, if required, without senior unsecured creditors suffering losses. This view is underpinned by BIL's position as a systemically important domestic bank in Luxembourg and the local authorities' track record of providing support to such institutions.
The Negative Outlook reflects Fitch's view there is a clear intention ultimately to reduce implicit state support for financial institutions in the EU, as demonstrated by a series of legislative, regulatory and policy initiatives. We expect the EU's Bank Recovery and Resolution Directive (BRRD) to be implemented into national legislation in 2H14 or in 1H15. We also expect progress towards the Single Resolution Mechanism (SRM) for eurozone banks in this timeframe. In Fitch's view, these two developments will dilute the influence Luxembourg has in deciding how its domestic banks are resolved and increase the likelihood of senior debt losses in its banks if they fail solvability assessments.
KEY RATING SENSITIVITIES - IDRS, SUPPORT RATING, SRF AND SENIOR DEBT RATING
The ratings are sensitive to a weakening of Fitch's assumptions around the ability or propensity of Luxembourg to provide timely support to the bank. The Support Rating and SRF are primarily sensitive to further progress made in implementing the BRRD and the SRM. The directive requires 'bail in' of creditors by 2016 before an insolvent bank can be recapitalised with state funds. A functioning SRM and progress on making banks 'resolvable' without jeopardising the wider financial system are areas of focus for eurozone policymakers. Once these are operational they will become an overriding rating factor, as the likelihood of banks senior creditors receiving full support from the sovereign if ever required, despite their systemic importance, will diminish substantially, unless mitigating factors arise in the meantime.
Fitch expects that the BRRD will be enacted into domestic legislation in the near team and progress made on establishing the SRM is looking close to being ready in the next one to two years. Fitch expects then to downgrade BIL's Support Rating to '5' and revise its SRF to 'No Floor'. Such a downward revision of the SRF is likely to result in downgrades of the Long-term IDR and long-term senior debt rating to the level of BIL's VR, currently at 'bbb+'. BIL's Short-term IDR would then likely be downgraded to 'F2'.
BIL's VR reflects the bank's geographic focus in retail and commercial banking in Luxembourg, a small and mature, albeit strong, economy, and the challenges currently facing the Luxembourg private banking industry. It also takes into account BIL's healthy customer deposit-driven funding base, providing the bank with ample liquidity, and strong capital ratios (Fitch Core Capital - FCC - to weighted risks ratio of 17.6% at end-2013).
The bank is active in retail and private banking, which provide it with a stable and large (relative to its loan book) deposit base, ample liquidity and recurring earnings. With customer deposits far exceeding the loan book, the excess funding is invested in cash and high-quality securities (mostly highly-rated sovereign bonds). These liquid assets represent approximately 30% of total assets, which is very high compared with the average for European banks.
The quality of BIL's customer loan book is overall healthy, supported by sound underlying fundamentals of the Luxembourg economy. While impaired loans represented a modest 2.8% of total loans at end-2013, an additional 2.1% of gross loans had arrears exceeding 90 days, but were not impaired. These largely relate to loans to individuals, typically backed by collateral such as real estate or securities.
BIL's capital ratios are strong, but Fitch believes they could weaken when dividend payment resume. Precision Capital (Precision, a Luxembourg-based bank holding company investing Qatari funds) acquired 90% of BIL's capital from Dexia when the latter was placed in resolution in 2011. Since then, no dividend was paid given the activation of a 'dividend stopper' provision from perpetual securities. In Fitch's base case, notwithstanding dividend payout capital ratios will remain materially above minimum requirements. The capital ratios benefit from low risk-weighting on large holdings of sovereign bonds and leverage measured by tangible common equity to tangible assets is still satisfactory at 4% at end-2013.
The VR would benefit from BIL defending its franchise in private banking from a difficult operating environment marked by new regulations, higher client expectations and fierce competition. A successful strategy resulting in net inflows of client funds and continued improvement in profitability could be rating-positive.
Fitch does not expect any significant weakening, if any, of the bank's franchise from the 'automatic transfer of information' to foreign tax administrations. Material outflows of its assets under management as a consequence of this legal change would be detrimental to BIL's VR. A significant deterioration in BIL's capitalisation beyond Fitch's forecasts after dividend payment resumes, and a less prudent investment strategy negatively impacting the bank's liquidity and risk profile would be detrimental to its VR. Finally, the VR is also sensitive to prolonged worsening in asset quality, causing higher-than-expected loan impairment charges, although this is not expected by Fitch.
KEY RATING DRIVERS AND SENSITIVITIES - SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
BIL's subordinated (Tier 2) debt securities are rated one notch below its VR to reflect below- average loss severity of this type of debt when compared to average recoveries.
BIL's perpetual capital notes (XS0132253468) are notched down four levels from BIL's VR to incorporate higher expected loss severity compared with senior unsecured creditors (two notches) and incremental non-performance risk (two notches). Following BIL's profit recovery in 2012 and 2013 and the allocation of funds to restoring the securities' principal as decided by the latest AGM, coupon payments resumed in July 2014 and Fitch expects the securities to continue to perform. The coupon suspension triggered a two-year period of 'dividend stopper', after which dividends payment could resume (from 2017). As all these securities are notched down from BIL's VR, their rating is primarily sensitive to changes in the VR. The notes' rating is also sensitive to a change in Fitch's assessment of the notes' non-performance risk relative to that captured in BIL's VR.
The rating actions are as follows:
Long-term IDR affirmed at 'A-'; Outlook Negative
Short-term IDR affirmed at 'F1'
Support Rating affirmed at '1'
Support Rating Floor affirmed at 'A-'
Viability Rating affirmed at 'bbb+'
Senior debt affirmed at 'A-'/'F1'
Market-linked notes affirmed at 'A-emr'
Subordinated debt affirmed at 'BBB'
XS0132253468 perpetual capital notes affirmed at 'BB'