May 12, 2017 / 9:09 AM / in 6 months

Fitch Revises Outlook for Japan's Shizuoka Bank to Stable; Affirms Suruga Bank at 'A-'/Stable

(The following statement was released by the rating agency) TOKYO, May 12 (Fitch) Fitch Ratings has revised the Outlook for The Shizuoka Bank, Ltd. to Stable from Negative and affirmed the Long-Term Issuer Default Rating (IDR) at 'A'. In addition, Fitch has affirmed Suruga Bank Ltd.'s IDR at 'A-' with a Stable Outlook. A full list of rating action is at the end of this commentary. The Outlook revision for Shizuoka follows the affirmation of Japan's sovereign rating at 'A' and revision of the Outlook to Stable from Negative on 27 April 2017 (see <a href="https://www.fitchratings.com/site/pr/1022824 ">Fitch Revises Outlook on Japan to Stable; Affirms at 'A'.) Fitch expects the operating environment for Japanese banks to stabilise. Market sentiment has begun to improve as the domestic economy gains some positive momentum leading to low positive, instead of negative, domestic market interest rates. As a result, we have changed our outlook on the banking system to stable from negative as cyclical pressure is easing and credit costs remain low. This will support the stabilisation of Japanese regional banks' earnings in the fiscal year ending March 2018 (FYE18). Fitch believes regional banks that serve respective domestic regions' financial needs will remain more vulnerable to low interest rates and the competitive environment than Japan's major banks. This is due to their high dependence on interest revenue, with limited diversification of revenue sources, such as fees and overseas businesses. KEY RATING DRIVERS IDRS AND VIABILITY RATING (VR) The IDRs of Shizuoka and Suruga are driven by their VRs. Shizuoka's VR of 'a' reflects its strong capitalisation (with an FCC ratio of 17% and common equity tier 1 ratio of 16.3% at FYE17), which Fitch expects can be sustained over the medium term, although it will become more challenging should pressure on profitability increase. The bank has a leading franchise in Shizuoka Prefecture and potential buffers against credit-risk through high guarantee/collateral coverage, including public guarantees. Constraining factors for Shizuoka's VR include limited options to diversify its revenue base and the prevailing low interest rates coupled with intense competition increasingly pressuring profitability due to the bank's reliance on lending. Suruga's VR of 'a-' factors in its above-domestic peer profitability, with a return on assets of 0.9% for the nine months ending 2016, compared with the mega bank average of 0.4% and Shizuoka's 0.3%. Its operating profit/risk weighted assets ratio for the same period was 2.5%, compared with the mega bank average of 1.1% and Shizuoka's 0.7%. Suruga has also improved its net interest margin, with increased balance in higher-yield non-housing loans, whereas the net interest margins of domestic peers contracted. The bank's high profitability is backed by its unique business model, which differentiates itself from typical Japanese commercial banks by providing multi-purpose loans to a range of retail clients. Profitability is also supported by Suruga's proactive risk control, although to some degree it may reflect the bank's higher risk appetite. Suruga's VR is constrained by a lack of diversification due to its concentration on retail lending and small asset size, with consolidated total assets of JPY4.5 trillion at end-2016, compared with Shizuoka's JPY12 trillion. Strong funding and liquidity, sustained by a firm deposit base, are key strengths for Japan's banking system and underpin both banks' ratings. In addition, the banks' credit profiles are underpinned by adequate risk controls and buffers, particularly in terms of earning capacity. The Stable Outlook for Shizuoka's and Suruga's IDRs reflects the stable domestic operating environment and Fitch's view that overall asset quality will remain favourable and loss absorption buffers are sufficiently strong relative to the ratings. SUPPORT RATING AND SUPPORT RATING FLOOR Shizuoka's Support Rating of '2' and Support Rating Floor of 'BBB-' reflect Fitch's view that the sovereign has a strong propensity to support the bank, if necessary, due to Shizuoka's size relative to other banks in its prefecture and nationally. The bank accounts for 31% and 24% of Shizuoka prefecture's loans and deposits, respectively. Fitch believes the sovereign's propensity to support Suruga, which has a Support Rating of '4' and a Support Rating Floor of 'B', would be more limited due to its marginal systemic importance to Japan's financial system and small operational size, ranking 33rd in net asset size. RATING SENSITIVITIES IDRS AND VR Both banks' VRs and IDRs could be downgraded if unexpected deterioration in the operating environment increases performance volatility, resulting in the banks taking more risk, especially credit risk - the bulk of these banks' risks - without a corresponding increase in loss-absorption buffers. This also includes increased exposure to market risk, although Fitch expects it to be small, or involvement in industry consolidation, leading to potentially higher volatility in earnings or capital. Shizuoka's VR is sensitive to further downward pressure on profitability to a level that would affect its solid capitalisation, narrowing the gap between it and domestic peers. Its VR and IDR could also face negative rating action if the sovereign's rating or our Outlook on the rating was revised downward, in light of its ratings proximity to the sovereign. There is limited upside scope to Shizuoka's VR as it is rated at the same level as the sovereign. Suruga's VR is sensitive to the bank adopting a higher risk appetite to defend its competitive position without increasing its loss absorption buffers. Positive rating action for Suruga is likely to stem from further structural improvement in the domestic operating environment, leading to sustainable loan expansion and faster internal capital generation without a large increase in risk appetite. However, Fitch believes such structural improvement will take some time. SUPPORT RATING AND SUPPORT RATING FLOOR Shizuoka's Support Rating and Support Rating Floor are sensitive to a change in Fitch's assessment of the sovereign's ability and willingness to support the bank. A downgrade in the sovereign's ratings to 'A-' or below would be likely to lead to a downgrade in Shizuoka's Support Rating and Support Rating Floor. Suruga's Support Rating and Support Rating Floor are not immediately sensitive to the sovereign rating, as Fitch already factors in a limited probability of support. Changes to the regulatory support framework could lead to a change in our perception about the sovereign's propensity to support Suruga. The rating actions are as follows: Shizuoka: - Long-Term Foreign- and Local-Currency IDRs affirmed at 'A'; Outlook revised to Stable from Negative - Short-Term Foreign- and Local-Currency IDRs affirmed at 'F1' - Viability Rating affirmed at 'a' - Support Rating affirmed at '2' - Support Rating Floor affirmed at 'BBB-' Suruga: - Long-Term Foreign- and Local-Currency IDRs affirmed at 'A-'; Outlook Stable - Short-Term Foreign- and Local-Currency IDRs affirmed at 'F1' - Viability Rating affirmed at 'a-' - Support Rating affirmed at '4' - Support Rating Floor affirmed at 'B' Contact: Primary Analyst Kaori Nishizawa Director +81 3 3288 2783 Fitch Ratings Japan Limited Kojimachi Crystal City East Wing 3F 4-8 Kojimachi, Chiyoda-ku, Tokyo 102-0083 Secondary Analyst Naoki Morimura Director +81 3 3288 2686 Committee Chairperson Parson Singha Senior Director +66 2108 0151 Summary of Financial Statement Adjustments: Total assets and total liabilities exclude acceptances and guarantees from Japan's generally accepted accounting principles balance sheet to be globally comparable. 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