Basler Kantonalbank : Standard & Poor's Rating BKB 01.12.2021

Basler Kantonalbank

Primary Credit Analyst:

Heiko Verhaag, CFA, FRM, Frankfurt + 49 693 399 9215; [e-mail]

Secondary Contact:

Harm Semder, Frankfurt + 49 693 399 9158; [e-mail]

Table Of Contents

Credit Highlights

Outlook

Key Metrics

Anchor: 'a-' As A Commercial Bank Operating In Switzerland

Business Position: Strong And Resilient, But A Regionally-Focused Market Franchise

Capital And Earnings: Very Strong Capitalization In A Global Context

Risk Position: Concentrated Credit Exposure, But Sound Asset Quality

Funding And Liquidity: Favorable Funding Profile From Retail Deposits And Supported By Cantonal Guarantee

Support: Four Notches Of Uplift For Extremely High Likelihood Of Extraordinary Government Support

Environmental, Social And Governance Factors: In Line With Peers Hybrid Issue Ratings

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Table Of Contents (cont.)

Key Statistics

Related Criteria

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	SACP	a		+	Support		+4	+	Additional	0
			Factors
	Anchor	a-
			ALAC				Issuer Credit Rating
						0
	Business	Adequate	0		Support
	Position
				GRE Support		+4
	Capital and
	Very Strong	+2
	Earnings
									AA+/Stable/A-1+
	Risk Position	Moderate	-1		Group		0
					Support
	Funding	Average
			0		Sovereign		0
	Liquidity	Adequate			Support
Credit Highlights
Key strengths				Key risks

Extremely high likelihood of support from the Swiss Canton	Limited growth prospects in the saturated Basel-City banking market.
of Basel-City.

Very strong capitalization supported by stable earnings generation.

Earnings pressure from the low interest-rate environment.

Very strong customer franchise in home region.

Relatively weak operating efficiency, expected to gradually improve through synergies with Bank Cler.

BKB's asset quality is expected to remain very robust. Despite the pandemic-driven recession, BKB's new loan loss provisions in 2020 were only Swiss francs (CHF) 11 million or 3 basis points (bps) of its loan book. We also expect no particular uptick in the coming years, considering the very robust Swiss real estate market. Nonetheless, its concentration in the mortgage market makes it susceptible to house price decreases in the future, should they occur.

Meeting BKB's 2025 financial targets will be challenging but, if achieved, should support its creditworthiness. Building on its market leading position, BKB expects to further streamline its operations and focus on profitable business in its core segments of retail, corporate, private banking, and asset management. Strong competition in the persisting low rate environment will continue to put pressure on margins and make it challenging to achieve its 2025 financial targets, specifically a return on equity of 6% (3.1% in 2020) and a cost-to-income ratio of 55% (64% in 2020).

Streamlining operations with subsidiary Bank Cler will support further efficiency gains. We consider BKB's risk-adjusted profitability and efficiency as being somewhat weaker than peers. Along with a somewhat stronger concentration in its mortgage book, we consider that its very strong capitalization partly overstates its loss-absorption capacity. Considering BKB's increased stake in Bank Cler to 100% since 2019, we observe a gradual operational integration that will likely support further efficiency gains over the next two years, by removing some overhead costs.

BKB's importance to the local economy will continue to support its franchise and rating. BKB is 100% owned by the Canton of Basel-City(AAA/Stable/A-1+) and benefits from a guarantee stated in BKB's law. Considering its important role in contributing to the development of the local economy, we continue to see an extremely high likelihood of

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support from the canton in case of financial distress. Unlike in neighboring canton, Basel-Land, we currently do not observe any discussions around a potential privatization or repeal of the cantonal guarantee. While revisions to BKB's law are expected, we think these will solely relate to the governance of BKB group and not to the role for or guarantee of the canton of Basel.

Outlook: Stable

S&P Global Ratings' stable outlook on Switzerland-based Basler Kantonalbank (BKB) reflects that on its owner and guarantor, the Canton of Basel-City(AAA/Stable/A-1+). We expect BKB will, for the foreseeable future, continue to benefit from an extremely high likelihood of timely and sufficient extraordinary support from the canton in the event of financial distress. In addition, we expect that BKB will maintain its sound market position and financial profile, underpinned by its very strong capitalization over the next 24 months.

Downside scenario

In our view, downside is currently remote. It could be triggered if we lowered our ratings on the canton--currently unlikely given the canton's stable outlook. Alternatively, we could consider a negative rating action if there was a change in BKB's role for or link with the canton, or changes in the statutory guarantee, potentially leading to a weaker assessment of BKB's status as a government-related entity (GRE). However, we currently consider this scenario as very unlikely and would expect BKB's existing obligations to be grandfathered.

In our view, unchanged potential extraordinary support from the canton would cushion a material multi-notch deterioration of BKB's stand-alone creditworthiness, with the ratings on the senior unsecured debt remaining unchanged. Ratings on the subordinated instruments could, however, be directly affected if the bank's stand-alone credit profile (SACP) deteriorated, which could happen, for example, if the bank depleted its strong capital base due to high unexpected losses caused by the COVID-19 pandemic or if the bank's efficiency and profitability did not improve over medium term to be more in line with peers.

Upside scenario

A positive rating action is currently very remote. This could only be triggered if BKB's SACP improved by two or more notches. Ratings on the subordinated instruments could be directly affected if the bank's SACP improved. However, we regard it as unlikely given our expectation that the bank will not materially change its concentrated business model and that it will continue to lag behind cantonal peers with regard to risk-adjusted profitability and efficiency.

Key Metrics

Basler Kantonalbank--Key Ratios And Forecasts

		--Fiscal year ended Dec. 31--
(%)	2019a	2020a	2021f	2022f	2023f
Growth in operating revenue	(0.7)	(1.9)	4.8-5.9	1.6-1.9	0.8-0.9
Growth in customer loans	4.1	3.3	3.6-4.4	3.6-4.4	2.7-3.3
Growth in total assets	1.8	21.5	6.7-8.2	2.1-2.6	1.6-2.0
Net interest income/average earning assets (NIM)	0.9	0.9	0.8-0.90.75-0.85	0.75-0.85
Cost to income ratio	69.6	69.1	63.9-67.262.2-65.4	61.1-64.2
Return on average common equity	2.9	2.8	3.0-3.3	3.2-3.5	3.2-3.6

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Basler Kantonalbank--Key Ratios And Forecasts	(cont.)
		--Fiscal year ended Dec. 31--
(%)	2019a	2020a	2021f	2022f	2023f
Return on assets	0.3	0.2	0.2-0.3	0.2-0.3	0.2-0.3
New loan loss provisions/average customer loans	0.0	0.0	0.0	0.0	0.0
Gross nonperforming assets/customer loans	0.3	0.3	0.4-0.5	0.3-0.5	0.3-0.5
Net charge-offs/average customer loans	(0.0)	0.2	0.0	0.0	0.0
Risk-adjusted capital ratio	23.7	21.0	20.4-21.4	20.2-21.3	20.3-21.3

All figures are S&P Global Ratings-adjusted.a--Actual.f--Forecast.NIM--Net interest margin.

Anchor: 'a-' As A Commercial Bank Operating In Switzerland

Our anchor for a bank operating mainly in Switzerland is 'a-'. This is based on our assessment of a '2' economic risk score and '2' industry risk score for Switzerland on a scale of 1-10 (where '1' represents the lowest risk and '10' the highest). We consider the trend for economic and industry risk in Switzerland as stable.

We expect Switzerland's economy to have contracted materially in 2020 due to the pandemic but to fully recover over the coming two years. Under this base case, we think the Swiss banking sector will remain resilient, supported by very high household income levels and a proven stress-resilient corporate sector. We think the Swiss authorities' material support measures should cushion the short-term effect on Swiss banks' loan books. Additionally, we view positively banks' prudent loan underwriting standards and high collateralization of the residential mortgage loans, which dominate most banks customer portfolios. Considering these factors, we expect only a limited increase in credit losses, from historical low levels. We also expect that price growth in the owner-occupied segment to remain muted in the wake of the pandemic. However, a particular risk remains the investment property segment, where we already observed signs of a price correction before the pandemic.

Our view of industry risk in Switzerland encompasses the stability of the domestic banking sector and our expectation that damage from the pandemic will remain contained. We view positively the limited presence of foreign players, the banks' high capitalization levels in an international comparison, and their low reliance on capital markets for funding. In our view, the Swiss regulator remains ahead in terms of both regulatory oversight and innovations. We think FINMA's thorough investigations of past international large-scalemoney-laundering cases has improved market discipline. In particular, we consider compliance with the highest anti-money-laundering standards to be crucial to the stability of the banking sector, reflecting the importance of the wealth management industry.

We expect that banks' interest margins will gradually decline further in a low-interest-rate environment. However, we expect that repricing of lending products, additional fee income from investment advisory-related activities, and ongoing cost management could offset some of the pressure. We consider risk for Swiss banks from tech disruption as limited as of today given the small size of the market, it high barriers to entry, and its technologically well-equipped banks.

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