CREDIT OPINION 1 April 17 SEB Update following the publication of year-end 16 results Update Summary Rating Rationale We assign an a baseline credit assessment (BCA) and Aa long-term senior unsecured debt and deposit ratings to SEB. We also assign short-term debt and deposit ratings of Prime and a long- and short-term Counterparty Risk Assessment (CRA) of Aa(cr)/Prime(cr) to the bank. RATINGS SEB Domicile Sweden Long Term Debt Aa Type Senior Unsecured - Fgn Curr Outlook Stable Long Term Deposit Aa Type LT Bank Deposits - Fgn Curr Outlook Stable Please see the ratings section at the end of this report for more information. The ratings and outlook shown reflect information as of the publication date. SEB's a BCA reflects the bank's strong credit quality, solid capitalisation and improved recurring earnings, to which the bank's focus on corporate banking could add earnings cyclicality. However, similarly to many Nordic peers, the BCA is constrained by the bank s high reliance on market funding, which renders it vulnerable to changes in investor sentiment and market conditions. SEB's Aa long-term long term deposits and senior unsecured debt ratings include a twonotch uplift resulting from our advanced Loss Given Failure (LGF) analysis, reflecting our view that the bank s junior depositors and senior creditors face a very low loss given failure. In addition, our moderate assessment of government support translates into a further notch uplift included in these ratings. Exhibit 1 Rating Scorecard - Key Financial Ratios Analyst Contacts Louise Lundberg 46-8-55-6568 VP-Sr Credit Officer louise.lundberg@moodys.com SEB (BCA: a) 5% % 5% 15% % 1% Maria Asensio 44--77778 Associate Analyst maria.asensio@moodys.com % Sean Marion 44--77756 Managing Director Financial Institutions sean.marion@moodys.com 4% % Andrea Usai 44--77758 Senior Vice President andrea.usai@moodys.com Jean-Francois 44--777-565 Tremblay Associate Managing Director jean-francois.tremblay@moodys.com Median a-rated banks 5% 15% 1% 5%.6% Asset Risk: Problem Loans/ Gross Loans.% 4.%.% 5% %.7% Profitability: Net Funding Structure: Liquid Resources: Liquid Capital: Banking Market Funds/ Tangible Tangible Common Income/ Assets/Tangible Tangible Banking Assets Assets Equity/Risk-Weighted Banking Assets Assets Solvency Factors (LHS) Source: Moody's Banking Financial Metrics Liquidity Factors (RHS)
Credit Strengths SEB s credit quality is strong although its focus on large corporate banking implies a degree of concentration risk Solid capitalisation underpinned by a strong earnings generation capacity Good profitability, which is nevertheless under negative pressure in the current low interest-rate environment. Focus on corporate banking could add earnings cyclicality Our advanced LGF analysis indicates a very low loss given failure for junior depositors and senior unsecured creditors, resulting in a two-notch uplift in the relevant ratings, from the firm s a adjusted BCA The long-term deposit and senior unsecured debt ratings incorporate one notch of government support uplift Credit Challenges High reliance on confidence-sensitive market funding, which is partly mitigated by proven access to debt markets, a resilient domestic covered bond market, and strong liquidity Rating Outlook The outlook on SEB s ratings is stable, as we expect the bank to continue to offset negative profitability pressures in the current low interest rate environment, over the next 18 months. Factors that Could Lead to an Upgrade SEB s BCA could be upgraded if the bank (1) improves the profitability of its core activities without increasing its risk profile, () reduces its reliance on market funding, and/or () further improves its funding position, for example through lengthening the maturity of its funding profile, increasing the proportion of deposit funding and/or strengthening its liquidity position. A higher BCA would likely lead to a ratings upgrade. Factors that Could Lead to a Downgrade The ratings could be downgraded if the bank s (1) operating environment deteriorates beyond our current expectations, () asset risk increases for example due to higher exposures to cyclical sectors or higher reliance on capital markets activities, () reliance on confidence sensitive market funding increases; and/or (4) profitability reduces sharply or earnings volatility rises. This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history. 1 April 17 SEB: Update following the publication of year-end 16 results
Key Indicators Exhibit SEB (Consolidated Financials) [1] Total Assets (SEK million) Total Assets (EUR million) Total Assets (USD million) Tangible Common Equity (SEK million) Tangible Common Equity (EUR million) Tangible Common Equity (USD million) Problem Loans / Gross Loans (%) Tangible Common Equity / Risk Weighted Assets (%) Problem Loans / (Tangible Common Equity + Loan Loss Reserve) (%) Net Interest Margin (%) PPI / Average RWA (%) Net Income / Tangible Assets (%) Cost / Income Ratio (%) Market Funds / Tangible Banking Assets (%) Liquid Banking Assets / Tangible Banking Assets (%) Gross loans / Due to customers (%) 16 15 14 1 1 Avg.,4,56 5,659 67,547 15,49 14,14 14,915.5. 5.4.8.6.7 51. 4.. 151.5,79,664 48,9 7,44 11,8 14,9 15,566.6. 5.9.8.7.8 49.4 4.1 4.8 15.7,64,7 49,69,77 1,611 1,7 15,47.8 19.6 8.4.8.8.9 49.1 4.9 7.9 144.4,4,97 64,78 64,85 1,449 11,689 16,17.7 17. 8.6.8..7 5. 41..4 154.1,85,184 66,44 51,7 9,175 1,514 1,86 1.1 1. 14..8 1.9.6 58.4 4.. 144.4 1.64.4-6.64 1.74 7.74 1.84.75.56 8.55.85.46.75 5.5 6.95 8.5 149.65 [1] All figures and ratios are adjusted using Moody's standard adjustments [] Basel III - fully-loaded or transitional phase-in; IFRS [] Basel II; IFRS [4] Compound Annual Growth Rate (%). Any interim period amounts presented are assumed to be fiscal year end amounts for calculation purposes [5] Simple average of periods presented [6] Simple average of Basel III periods presented Source: Moody's Financial Metrics Detailed Rating Considerations SEB s credit quality is strong, although its focus on large corporate banking implies a degree of concentration risk SEB's credit quality is supported by its strong franchise and good underwriting standards. SEB is the third-largest bank in Sweden (Aaa stable), with total assets of SEK.6 trillion (EUR74 billion) at YE 16. It has strong domestic market positions in retail banking, wealth management and commercial banking. SEB is also one of the largest financial groups in the Nordic region, where it has a leading market position in corporate and, albeit to a lesser extent, in investment banking. Our score for asset risk reflects a low and reducing level of non-performing loans (NPLs), as evidenced by the gradual reduction in the problem loan ratio (our definition) to.5% at YE 16 compared to 1.5% at YE 11 (see Exhibit ). The score incorporates the bank s stronger focus on corporate and investment banking compared to its Swedish peers, as building and maintaining long-term relationships with large corporates is an important foundation for the bank. Although it introduces a degree of concentration risk, SEB's large corporate clients are diversified both across industries and geographies. 1 April 17 SEB: Update following the publication of year-end 16 results
Exhibit 4 SEB Has Reduced Its Portion of Problem Loans Over The Past Few Years SEB: Problem Loans over gross loans 1.6% 1.4% 1.% 1.%.8%.6%.4%.%.% 11 1 1 14 15 16 Source: Moody's Financial Metrics SEB is exposed to the Baltic countries (around 8% of gross loans excluding 'unclassified' exposures, at YE 16), which was the main driver of the bank's deterioration in asset quality due to the Baltic financial crisis in 8-9. SEB also has a small franchise in Germany (8% of gross loans at YE 16) through its wholly owned subsidiary SEB AG (LT deposits A stable, BCA baa), which mainly operates in the corporate banking arena (see SEB AG Credit Opinion for further details). SEB's loan book has high borrower concentrations, due to the bank's corporate banking business, which is focussed on large companies. Corporate and property-management exposures accounted for around 7% and 1% of SEB's loan portfolio respectively, as of YE 16. However, a large portion of the bank's property-management exposure relate to housing cooperatives and residential real-estate management (47% at YE 16), which we view as less risky than commercial property lending. We believe that SEB's high singleborrower concentrations result from the limited number of large domestic enterprises in Sweden, but recognise that these companies are diversified across industries and geographies, and acknowledge the bank's comprehensive risk management framework in this area. Solid capitalisation underpinned by a strong earnings generation capacity We consider SEB's capitalisation to be solid relative to its risk profile, and acknowledge that it is supported by a strong earnings generation capacity. At YE 16, SEB's Common Equity Tier 1 (CET1) ratio under Basel III/CRD IV was 18.8%. The bank's capital headroom (i.e. excess of CET1 capital above the regulatory requirement) stood at 19 bps at YE 16, above management's target of around 15 bps. Similarly to the other Nordic peers, we apply a downwards adjustment to SEB s capital score in our BCA scorecard to take into account higher leverage compared to the average for similarly rated peers. SEB already meets its increased capital requirements, which were imposed by the Swedish financial supervisory authority (Finansinspektionen, SFSA) following the completion of the annual supervisory and evaluation process (SREP). As a consequence, the SFSA applied a Pillar capital surcharge for increased risk weights for corporate exposures and introduced a maturity floor of.5 years for these exposures, based on its preliminary calculations. The additional capital requirement for increased risk weights for corporate exposures will eventually be transitioned to the bank's Pillar 1 capital requirement from Pillar. However, this impact will partly be mitigated by the SEK14 billion inflated RWAs that SEB already applies in anticipation of the new requirement. 4 1 April 17 SEB: Update following the publication of year-end 16 results
The Swedish FSA increased the countercyclical buffer for Swedish banks by 5 bps to.% from March 17, which the bank already meets. We expect SEB to be able to meet future capital requirements mainly through retained profits. The bank has a range of other capital accretion tools at its disposal, if needed. Good profitability, which is nevertheless under negative pressure in the prolonged low interest-rate environment. Focus on corporate banking may add to earnings cyclicality SEB has improved its profitability in recent years, as evidenced by a net income/tangible assets of.65% in 16. Going forward, we expect profitability to remain under pressure due to competition, prolonged low interest rates and challenging market conditions, over the next few quarters. The bank s earnings are well diversified by activity (see Exhibit 4) although a large portion (around 4% at YE 16, excluding one-offs) originate from Large Corporates & Financial Institutions (previously Merchant Banking), the performance of which are more dependent on market conditions. For this reason, we consider earnings from these activities as potentially more volatile than more traditional retail and commercial banking, even though SEB has shown a high degree of earnings stability over the recent past. Exhibit 5 SEB: Operating Income by Division and Activity in fourth Quarter 16 Net interest income Net fee and commission income Net financial income Net other income 6 5 4 1 Large Corporates & Financial Institutions Corporate & Private Customers Baltic Life & Investment Management Source: Company reports SEB's cost-to-income ratio has traditionally been higher than its Nordic peers, reflecting its business mix, which is more reliant on Large Corporates & Financial Institutions. These activities are characterised by higher personnel costs that recognises the degree of employee specialisation. While SEB has made significant efforts to improve its cost efficiency in recent years, cost-to-income ratio was 51% in 16, which remains higher than domestic peers albeit lower in comparison to many European peers. High reliance on confidence sensitive market funding, which is mitigated by access to diverse capital markets and strong liquidity Similar to many of its Nordic peers and despite reducing its dependence in recent years (see Exhibit 5), SEB continues to have a relatively high share of wholesale funding, which we consider as a key credit weakness. This is evidenced by a relatively high average market funding/average total funding of 4% at YE 16. 5 1 April 17 SEB: Update following the publication of year-end 16 results
Exhibit 6 SEB Has Reduced Its Reliance on Market Funding Over the Past Few Years SEB: Market funds over tangible banking assets 55% 5% 45% 4% 5% % 7 8 9 1 11 1 1 14 15 16 Source: Moody's Financial Metrics In our view, SEB's overall liquidity and funding profiles are adequate. SEB s funding comes from retail deposits (16% of total funding as of YE 16), corporate deposits (5%), interbank deposits (7%), and mortgage covered bonds (19%). SEB is more reliant than its Nordic peers on corporate deposits, which we view as more volatile than retail deposits because these tend to be larger and more sensitive to changes in market yields. However, we note that SEB's sizeable corporate deposit base partly reflects a strong market position in the cash management and custody business, which are less volatile than other corporate deposits. SEB reported a strong Liquidity Coverage Ratio (LCR) in all currencies of 168%, at YE 16. As indicated in our banks methodology, we reflect the greater stability of covered bonds compared to unsecured market funding through a standard adjustment to the funding structure ratio. Given the long history of the Swedish and Danish covered bond markets, local currency and deep domestic investor base, we make additional (positive) adjustments for covered bonds issued in these two markets. SEB s liquid banking assets/tangible banking assets was % at YE 16, which corresponds to a ba score for liquid resources in our BCA scorecard. In our view, the bank s strong liquidity position largely mitigate refinancing risk from the dependence on wholesale funding. SEB'S BCA is supported by Sweden's 'Very Strong-' Macro Profile SEB has the majority of its operations in the Nordic countries (around 79% of gross loans at YE 16) with the vast majority in Sweden. SEB s macro profile is 'very strong-', in line with that of Sweden. Notching Considerations Loss Given Failure We apply our advanced Loss Given Failure (LGF) analysis to SEB as the bank is incorporated in Sweden, which we consider to be an Operational Resolution Regime because it is subject to the EU Bank Recovery and Resolution Directive (BRRD). For this analysis we assume residual tangible common equity of % and losses post-failure of 8% of tangible banking assets, a 5% run-off in junior wholesale deposits, a 5% run-off in preferred deposits, and assign a 5% probability to deposits being preferred to senior unsecured debt. These are in line with our standard assumptions. For calibrating our LGF analysis, we use the deposit split as provided by SEB in its Q4 16 financials (67% of deposits are junior). Our advanced LGF analysis indicates a very low loss given failure for junior depositors and senior unsecured creditors, resulting in a two notch uplift in the relevant ratings, from the firms a adjusted BCA. 6 1 April 17 SEB: Update following the publication of year-end 16 results
Government Support We assess a moderate probability of Government Support for SEB s long-term senior unsecured and junior depositors, resulting in a further one-notch uplift incorporated in the relevant Aa ratings. For junior securities, we continue to believe that potential government support is low and these ratings do not include any related uplift. 7 1 April 17 SEB: Update following the publication of year-end 16 results
Rating Methodology and Scorecard Factors Exhibit 7 SEB Macro Factors Weighted Macro Profile Very Strong - Factor Historic Macro Ratio Adjusted Score Credit Trend Assigned Score Key driver #1 Solvency Asset Risk Problem Loans / Gross Loans.6% a Single name concentration Capital TCE / RWA.% a Nominal leverage Profitability Net Income / Tangible Assets.7% baa baa Return on assets Combined Solvency Score Liquidity Funding Structure Market Funds / Tangible Banking Assets 4.% Liquid Resources Liquid Banking Assets / Tangible Banking Assets.% Combined Liquidity Score Financial Profile Business Diversification Opacity and Complexity Corporate Behavior Total Qualitative Adjustments Sovereign or Affiliate constraint: Scorecard Calculated BCA range Assigned BCA Affiliate Support notching Adjusted BCA Balance Sheet Other liabilities Deposits Preferred deposits Junior Deposits Senior unsecured bank debt Dated subordinated bank debt Preference shares (bank) Equity Total Tangible Banking Assets 8 1% 1 April 17 aa Key driver # a baa ba baa in-scope (SEK million) 91,474 78,584 58,5 54,1 17,81,76 9,959 6,451,15,41 baa Market funding quality ba Stock of liquid assets Deposit quality baa a Aaa a-ba a a % in-scope 45.% 8.8% 1.8% 6.% 1.8% 1.5%.5%.% 1% at-failure (SEK million) 1,57,469 68,589 45,4 9,49 17,81,76 9,959 6,451,15,41 % at-failure 5.5% 1.7% 1.% 19.5% 1.8% 1.5%.5%.% 1% SEB: Update following the publication of year-end 16 results
Debt class De jure waterfall De facto waterfall Notching LGF Assigned Additional Preliminary LGF notching Rating Instrument Sub- Instrument SubDe jure De facto notching guidance notching Assessment volume + ordination volume + ordination versus Subordination Subordination BCA Counterparty Risk Assessment 5.% 5.% 5.% 5.% aa (cr) Deposits 5.% 5.% 5.% 15.8% Senior unsecured bank debt 5.% 5.% 15.8% 5.% 1 Dated subordinated bank debt 5.%.5% 5.%.5% ba Junior subordinated bank debt.5%.5%.5%.5% baa Non-cumulative bank preference shares.5%.%.5%.% - baa (hyb) Instrument class Counterparty Risk Assessment Deposits Senior unsecured bank debt Dated subordinated bank debt Junior subordinated bank debt Non-cumulative bank preference shares Loss Given Failure notching Additional Preliminary Rating Notching Assessment - aa (cr) ba baa baa (hyb) Government Support notching Local Currency Rating 1 1 1 Aa (cr) Aa Aa ---- Foreign Currency Rating -Aa Aa Ba Baa Baa (hyb) Source: Moody's Financial Metrics Ratings Exhibit 8 Category SEB Outlook Bank Deposits Baseline Credit Assessment Adjusted Baseline Credit Assessment Counterparty Risk Assessment Issuer Rating Senior Unsecured Subordinate Jr Subordinate MTN Pref. Stock Non-cumulative Commercial Paper Moody's Rating Stable Aa/P a a Aa(cr)/P(cr) Aa Aa Ba (P)Baa Baa (hyb) P SEB AG Outlook Bank Deposits Baseline Credit Assessment Adjusted Baseline Credit Assessment Counterparty Risk Assessment Stable A/P baa a Aa(cr)/P(cr) Source: Moody's Investors Service 9 1 April 17 SEB: Update following the publication of year-end 16 results
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Analyst Contacts Maria Asensio Associate Analyst maria.asensio@moodys.com 11 1 April 17 CLIENT SERVICES 44--77778 Americas 1-1-5565 Asia Pacific 85-551-77 Japan 81--548-41 EMEA 44--777-5454 SEB: Update following the publication of year-end 16 results