CREDIT OPINION September 16 SEB Update following the publication of Q-16 results Update Summary Rating Rationale We assign an a baseline credit assessment (BCA) and 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 Type Senior Unsecured - Fgn Curr Outlook Stable Long Term Deposit 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, which in our view are potentially more volatile than peers because the bank is more reliant on capital markets activities than some of its competitors. 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 long-term long term deposits and senior unsecured debt ratings include a two-notch 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 Contacts Andrea Usai 44-77758 Senior Vice President andrea.usai@moodys.com Mathias Kuelpmann 49-69-77-98 Senior Vice President mathias.kuelpmann@moodys.com Aleksander 44--777954 Henskjold Associate Analyst aleksander.henskjold@moodys.com Oscar Heemskerk 44--777-55 Associate Managing Director oscar.heemskerk@moodys.com Sean Marion 44--77756 Managing Director Financial Institutions sean.marion@moodys.com Source: Moody's Financial Metrics
Credit Strengths SEB s credit quality is strong although its focus on corporate and investment banking increases 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 also adds 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 capital markets and strong liquidity Rating Outlook The outlook on SEB s ratings is stable, reflecting our view that we do not expect material changes in the bank's credit fundamentals 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 confidencesensitive market funding increases; and/or (4) profitability reduces sharply or earnings volatility rises. 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 (%) 66 15 14 1 1 Avg. 48164. 57965.4 86586.8 14916.8 171. 1474.4.5 1. 6..8.4.6 54. 79664. 489.7 74.5 118. 149.1 15565.7.6. 5.9.8.7.8 49.8 647. 4969. 76.8 1611. 17.6 1547.1.8 19.6 8.4.8.8.9 49.1 497. 6478. 64851.8 1449. 11689. 1617..7 17. 8.6.8..7 5. 85184. 6644. 517. 9175. 151.9 1861.5 1.1 1. 14..8 1.9.6 58.4 1.54 -.84-5.4 8.54 6.4 1.64.85.6 8.65.85.6.75 5.95 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. September 16 SEB: Update following the publication of Q-16 results
Market Funds / Tangible Banking Assets (%) Liquid Banking Assets / Tangible Banking Assets (%) Gross loans / Due to customers (%) 6.8 4.7 154.6 4.1 4.8 15.7 4.9 7.9 144.4 41..4 154.1 4.. 144.4 7.55 8.65 15.5 [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 based on IFRS reporting periods [5] IFRS reporting periods have been used for average calculation [6] Basel III - fully-loaded or transitional phase-in & IFRS reporting periods have been used for average calculation Source: Moody's Financial Metrics Detailed Rating Considerations SEB s credit quality is strong, although its focus on corporate and investment banking increases 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.7 trillion (EUR84 billion) at end-june 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 investment banking. Our score for Asset Risk reflects a relatively low and reducing level of non-performing loans (NPLs), which has been management s focus in recent years, as evidenced by the reduction in the NPL ratio (our definition) to.5% at end-june 16 compared to.6% at end-15,.8% at end-14 and 1.5% at end-11 (see Exhibit ). The score also takes into account the bank s stronger focus on corporate and investment banking compared to the other Swedish peers. Although these activities mostly support SEB s corporate client base, we consider them inherently riskier, more complex and opaque than traditional retail and commercial banking operations, weighing on our assessment of SEB's Asset Risk. Exhibit SEB Has Reduced Its Portion of Problem Loans Over The Past Few Years SEB: Problem loans over gross loans Source: Moody's Financial Metrics SEB is exposed to the Baltic countries (around 8% of gross loans excluding 'unclassified' exposures, at end-june 16); this was the main driver of SEB's credit-quality deterioration during the 8/9 financial crisis. It also has a small franchise in Germany (around 9% of gross loans at end-june 16) through its wholly owned subsidiary SEB AG (LT deposits A stable, BCA baa), which mainly operates in the corporate banking arena, including commercial real estate (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 5% and % of SEB's loan portfolio respectively, as at endjune 16. However, we understand that a large portion of SEB s property-management exposure (46% at end-june 16) relate to multi-family properties and residential real-estate management, which we consider to be less risky than more traditional commercial property lending. We believe that SEB's high single-borrower concentrations result from the limited number of large domestic enterprises in Sweden, but recognise that the Swedish economy is fairly diversified across industries. September 16 SEB: Update following the publication of Q-16 results
Solid capitalisation underpinned by a strong earnings generation capacity In our view, SEB's capitalisation is a good mitigant to Asset Risk. At end-june 16, SEB's Common Equity Tier 1 (CET1) ratio under Basel III/CRD IV was 18.7%, an increase from 17.% a year earlier, resulting from retained earnings and a reduction in risk weighted assets from a shift in corporate exposures towards lower risk-weights and lower market risk. 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 rated peers. In March 16, the Swedish Financial Supervisory Authority announced that it will increase capital requirements for banks corporate exposures, which SEB estimates it could reduce its CET1 by less than 1 basis points. Although the final calibration has yet to be published, we expect SEB to be able to meet this new requirement and preserve its solid capital position, among others, through increased profit retention. We also note that the capital floor for residential mortgages in Sweden (5%) is included in the Pillar capital requirement. This results in higher capital ratios for Swedish banks compared to peers in other European countries, such as Norway, where this is included in Pillar 1, which translates into higher risk-weighted assets. As a reference, SEB's capital requirement for domestic mortgages resulted in a 19 basis point increase in its Pillar CET1 capital requirement. Good profitability, which is nevertheless under negative pressure in the current low interest-rate environment. Focus on corporate banking also adds earnings cyclicality SEB has improved its profitability in recent years, as evidenced by a Net Income / Tangible Assets of.8% in 15 (.6% in the first half of 16), in line with the previous full years but higher than.7% and.6% in 1 and 1, respectively. However, we expect profitability to remain under pressure due to fiercer 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 45% in 15, excluding one-offs) originate from Large Corporates & Financial Institutions (previously Merchant Banking), the performance of which depends on market conditions. For this reason, we consider earnings from these activities as more volatile than more traditional retail and commercial banking. Exhibit 4 SEB: Operating Income by Division and Activity in Second Quarter 16 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 in recent years SEB has made significant efforts to improve its cost efficiency, its first half-16 cost-to-income ratio was 54%, which remains higher than domestic peers. 4 September 16 SEB: Update following the publication of Q-16 results
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 reductions in recent years (see Exhibit 5), SEB continues to rely on a high stock of wholesale funding, which we consider as its key credit challenge. This is evidenced by a relatively high Average Market Funding / Average Total Funding of 7% at end-june 16. Exhibit 5 SEB Has Reduced Its Reliance on Market Funding Over the Past Few Years SEB: Market funds over tangible banking assets Source: Moody's Financial Metrics In our view, SEB's overall liquidity and funding profiles are adequate. SEB s funding comes from retail deposits (around 15% of total funding as at end-june 16), corporate deposits (4%), interbank deposits (around 5%), and mortgage covered bonds (19% of total funding) issued by Sweden and Germany. 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 Liquidity Coverage Ratio (LCR) in all currencies of 19%, as at end-june 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 cover bonds issued in these two markets. SEB s Liquid Banking Assets / Tangible Banking Assets was around 5% at end-june 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 high stock of wholesale market 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 76% of gross loans at end-june 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 Q 16 financials (66% of deposits are junior). 5 September 16 SEB: Update following the publication of Q-16 results
Our advanced LGF analysis indicates a very low loss given failure for junior depositors and senior unsecured creditors, resulting in a twonotch uplift in the relevant ratings, from the firms a adjusted BCA. 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 ratings. For junior securities, we continue to believe that potential government support is low and these ratings do not include any related uplift. 6 September 16 SEB: Update following the publication of Q-16 results
Rating Methodology and Scorecard Factors Exhibit 6 SEB Macro Factors Weighted Macro Profile Very Strong - Financial Profile Factor 7 1% Historic Macro Ratio Adjusted Score Credit Trend Assigned Score Key driver #1 Key driver # Sector concentration Solvency Asset Risk Problem Loans / Gross Loans.7% a Market risk Capital TCE / RWA 1.% a Nominal leverage Profitability Net Income / Tangible Assets.6% baa baa Expected trend Combined Solvency Score Liquidity Funding Structure Market Funds / Tangible Banking Assets aa a 4.1% baa baa Market funding quality Liquid Resources Liquid Banking Assets / Tangible Banking Assets 4.8% ba ba Stock of liquid assets Deposit quality 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 baa Balance Sheet Other liabilities Deposits Preferred deposits Junior Deposits Senior unsecured bank debt Dated subordinated bank debt Junior subordinated bank debt Preference shares (bank) Senior unsecured holding company debt Dated subordinated holding company debt Junior subordinated holding company debt Preference shares (holding company) Equity Total Tangible Banking Assets in-scope (SEK) 8,79 759,6 58,17 51,89 19,,897 % in-scope 4.9% 41.5% 14.1% 7.4% 1.4% 1.% at-failure (SEK) 94,97 61,47 45, 75,817 19,,897 % at-failure 51.4%.9% 1.4%.5% 1.4% 1.% 54,894 1,89,81.% 1% 54,894 1,89,81.% 1% September 16 baa a Aaa a-ba a a SEB: Update following the publication of Q-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.% 4.% 5.% 14.6% Senior unsecured bank debt 5.% 4.% 14.6% 4.% 1 Dated subordinated bank debt 4.%.% 4.%.% ba (hyb) Junior subordinated bank debt.%.%.%.% baa Non-cumulative bank preference shares.%.%.%.% - 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 (hyb) baa baa (hyb) Government Local Currency rating Foreign Currency Support notching rating 1 Aa (cr) 1 -Ba (hyb) -Baa -Baa (hyb) Source: Moody's Financial Metrics Ratings Exhibit 7 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 /P a a Aa(cr)/P(cr) 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 (cr)/p(cr) Source: Moody's Investors Service 8 September 16 SEB: Update following the publication of Q-16 results
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Contacts Andrea Usai Senior Vice President andrea.usai@moodys.com 1 September 16 CLIENT SERVICES 44-77758 Aleksander Henskjold 44--777954 Associate Analyst aleksander.henskjold@moodys.com Americas 1-1-5565 Asia Pacific 85-551-77 Japan 81--548-41 EMEA 44--777-5454 SEB: Update following the publication of Q-16 results