Fitch Ratings has revised the Outlook on Svenska Handelsbanken AB's (Handelsbanken) Long-Term Issuer Default Rating (IDR) to Stable from Negative and affirmed the Long-Term IDR at 'AA'.
Fitch has also affirmed Handelsbanken's Viability Rating (VR) at 'aa'. Fitch has also revised the Outlooks on the Long-Term IDRs of Handelsbanken's wholly owned subsidiaries, Stadshypotek AB (publ) and Handelsbanken Plc, to Stable from Negative and affirmed the IDRs at 'AA'. A full list of rating actions is below.
The Outlook revision is primarily driven by our expectation that Handelsbanken will be able to restore its operating profitability, with operating profit sustainably in excess of 3% of risk-weighted assets (RWA) from 2022, through a combination of cost measures and revenue growth. We expect the bank's asset quality to remain very strong and resilient. The Outlook revision also reflects reduced downside risks to our baseline expectations as economic recovery in Handelsbanken's home markets gathers pace.
KEY RATING DRIVERS
IDRS, VR, AND SENIOR NON-PREFERRED DEBT
The ratings reflect Handelsbanken's strong and resilient through-the-cycle financial metrics, which compare well with highly rated international peers. Its financial profile is underpinned by a highly successful, stable and traditional low-risk business model that focuses on long-term strategic objectives.
The bank's financial record compares well with other highly rated banks globally, particularly its low and stable loan impairment charges through the cycle. Revenue generation has remained healthy and revenue resumed growth in 2H20, despite pressure from the low interest rate environment and challenges to lending growth from the economic fallout from the coronavirus crisis. We expect revenue growth momentum to be maintained as economic recovery gathers pace.
Growth in expenses in recent years led to a limited deterioration in the bank's cost-to-income ratio to around 50%. Handelsbanken's management has taken actions to reduce cost growth, to maintain superior profit generation compared with peers. To offset IT and anti-money laundering related investment costs, the bank has been implementing cost-cutting measures since 2019, including a material reduction of the branch network in Sweden announced in 3Q20. The measures are aimed at reducing the underlying cost base to SEK20 billion by the end of 2022 (based on 2020 foreign exchange rates and excluding potential allocation to Oktogonen, the bank's profit-sharing scheme) from SEK21.9 billion in the 12 months to end-June 2020.
We do not expect branch closures, which accelerated in 2Q21, and the increased pace of the bank's digitalisation to challenge the bank's long-standing branch-centred business model. We expect costs (excluding Oktogonen allocation) to remain broadly flat in 2021 as cost savings are offset by a temporary increase in IT development costs. We also expect costs to come down significantly over 2022 as IT investments tail off and more savings are realised, which we expect will bring Handelsbanken's cost/income ratio below 50% on a sustained basis.
Handelsbanken's overall asset quality is very strong, supported by a consistently low risk appetite, with zero tolerance for credit losses, and strong risk controls. Gross Stage 3 loans amounted to a very low 0.3% of gross loans at end-June 2021. The bank's loan impairment charges were very low in 2020 despite the significant drop in GDP, at only 3bp of gross loans, and most of these were in the form of a management overlay as underlying credit losses were minimal. We believe that some asset quality weakening is possible but do not expect impaired loans to increase significantly above 0.5% of gross loans. We also do not expect a significant increase in loan impairment charges. So far in 1H21 impairment charges have been immaterial, and any increase may be at least partly absorbed by the management overlay.
Handelsbanken's risk-weighted capital ratios compare well with peers, with a common equity Tier 1 (CET1) ratio of 20.5% at end-June 2021. We expect the CET1 ratio to remain above 16% in the longer term given the bank's capital targets and the eventual upward normalisation of capital requirements. Handelsbanken's Basel leverage ratio of 4.9% is moderate for the bank's rating, but still acceptable. Handelsbanken's capital base is fairly small compared with that of international banks rated in the 'aa' category, although we believe this is offset by the bank's consistently low risk appetite and strong asset quality.
Wholesale funding is an important funding source for Nordic banks, and Handelsbanken is no exception, making strong liquidity management key for the ratings. It has a fairly sizeable portion of short-term wholesale debt, although this is largely matched by cash deposits with central banks. The domestic loan book is funded by local deposits and Swedish covered bonds, which Fitch views as a stable source of funding, and the latter benefit from a captive investor base. Handelsbanken also uses the international bond markets for diversification and for its non-domestic lending. The bank's outstanding access to the debt capital markets, supported by a strong and geographically diversified funding platform, was demonstrated by its ability to issue at the peak of the market turmoil in 2Q20.
Senior non-preferred notes are rated in line with Handelsbanken's IDRs, and are direct, unsecured and senior obligations of the bank. Fitch views the probability of default on the senior non-preferred debt as the same as the probability of default of the bank.
SENIOR PREFERRED DEBT, DEPOSITS AND DERIVATIVE COUNTERPARTY RATING
Handelsbanken's long-term senior preferred debt and deposit ratings of 'AA+' and Derivative Counterparty Rating (DCR) of 'AA+(dcr)' are one notch above the bank's Long-Term IDR, to reflect the protection that could accrue to senior preferred debt from the bank's more junior resolution debt buffers.
Under the previous regulations only senior non-preferred or more junior debt was eligible to meet the minimum requirement for own funds and eligible liabilities (MREL) in Sweden. This drove the uplift for senior preferred liabilities and the equalisation of senior non-preferred debt rating with the Long-Term IDR. The recent enactment of the finalised second Bank Recovery and Resolution Directive into Swedish legislation introduced a cap on subordination requirement (binding from 2024), which will change the required resolution buffer composition. Handelsbanken should receive its new MREL from the Swedish resolution authority in 2H21.
Based on the policy paper published by the resolution authority in early July 2021 and assuming a normalised CET1 ratio and combined buffer requirements, we expect Handelsbanken's buffer of subordinated and senior non-preferred debt to be comfortably above 10% of RWA in the long term (balance sheet value at end-June 2021: 8.3% of RWA). Consequently, we believe that Handelsbanken's long-term senior preferred debt and deposit ratings and DCR will continue to benefit from the one-notch uplift and its long-term senior non-preferred debt with remain equalised with the Long-Term IDR.
SUBSIDIARIES AND AFFILIATED ENTITIES
Handelsbanken and Stadshypotek, its mortgage lending subsidiary, share common VRs, reflecting Stadshypotek's large size (almost half of group assets) and its close integration into the group, meaning the entities' credit profiles cannot be meaningfully disentangled. Consequently, Stadshypotek's IDRs are aligned with those of Handelsbanken.
The IDRs of Handelsbanken Plc, the UK-based wholly-owned subsidiary, are equalised with the ratings of Handelsbanken, reflecting Fitch's belief of an extremely high probability of support from the parent for its UK subsidiary. This is based on our view that the UK subsidiary is an integral part of Handelsbanken, operating in one of the group's home markets. In addition, Fitch sees significant reputational risk for the group from a default of the UK subsidiary in particular, given the former's reliance on wholesale funding.
We have not assigned a VR to Handelsbanken Plc, as its strong integration with its parent means it cannot currently be meaningfully analysed on a standalone basis.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The ratings on the subordinated and additional Tier 1 debt issued by Handelsbanken are notched off the bank's VR. In accordance with Fitch's criteria, subordinated debt is rated two notches below Handelsbanken's VR reflecting baseline notching for loss severity for this type of debt.
Additional Tier 1 securities are rated four notches below Handelsbanken's VR to reflect poor recoveries of these securities given their deep subordination (two notches from the VR) as well as the high incremental risk of non-performance (an additional two notches). Our assessment is based on the bank operating with a CET1 ratio that is comfortably above MDA thresholds and our expectation that this will continue.
SUPPORT RATING AND SUPPORT RATING FLOOR
The '5' Support Ratings and the 'No Floor' Support Rating Floors of Handelsbanken and Stadshypotek reflect Fitch's view that senior creditors cannot rely on receiving full extraordinary support from the Swedish sovereign in the event that the banks become non-viable. The EU's Bank Recovery and Resolution Directive provides a framework for resolving banks that is likely to require senior creditors participating in losses, if necessary, instead of, or ahead of, a bank receiving sovereign support.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Handelsbanken's ratings are primarily sensitive to Fitch's expectation that the group will continue to operate a conservative business model and maintain strong financial metrics through the cycle. We would downgrade Handelsbanken's Long-Term IDR and VR if, contrary to our baseline expectation, Handelsbanken is unable to regain superior cost efficiency and its operating profit/RWA ratio falls below 3% on a sustained basis.
Although we expect Handelsbanken's asset quality to remain resilient, an expected increase in the impaired loan ratio to materially above 1% without expectations of a rapid improvement would also lead to a downgrade of the Long-Term IDR and VR. Fitch expects Handelsbanken to maintain its CET1 ratio above the 16% trigger for a 'aa' assessment for capitalisation & leverage. A failure to do so would also lead to a downgrade.
Weaker investor perception, particularly if driven by concerns about the Swedish housing market, could affect long-term access or pricing of debt issuance and be rating negative. Fitch does not believe this is a likely scenario.
The senior non-preferred and senior preferred debt and deposit ratings and the DCR would be downgraded if the bank's IDRs are downgraded. They are also sensitive to our expectation that Handelsbanken will build up and maintain on a sustained basis a buffer of subordinated and senior non-preferred debt of at least 10% of RWA.
The Tier 2 subordinated and additional Tier 1 debt ratings would be downgraded if Handelsbanken's VR was downgraded. The rating of the additional Tier 1 securities is also sensitive to Fitch's assessment of their incremental non-performance risk relative to the risk captured in Handelsbanken's VR.
Stadshypotek's and Handelsbanken Plc's IDRs are sensitive to changes in Handelsbanken's IDRs. Stadshypotek's ratings are also sensitive to reduced integration within Handelsbanken, which we view as unlikely. Handelsbanken Plc's ratings are also sensitive to a change in Handelsbanken's propensity to support its UK subsidiary. This could be driven by a change in Fitch's view of the subsidiary's role in the group. In particular, if we perceive that the UK is no longer a core market for Handelsbanken, this would likely be negative for the ratings.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
An upgrade of Handelsbanken's Long-Term IDR and VR is unlikely given their very high level and would require a substantial strengthening of the franchise that could follow from wider geographic and borrower diversification without diluting the bank's strong asset quality and profitability.
The long-term senior preferred debt, senior non-preferred debt and deposit ratings and the DCR would be upgraded if Handelsbanken's Long-Term IDR is upgraded and if we continue to expect the buffer of senior non-preferred and more junior debt to exceed 10% of RWAs. The subordinated and additional Tier 1 debt ratings would be upgraded if Handelsbanken's VR is upgraded.
Stadshypotek's and Handelsbanken Plc's ratings would be upgraded if Handelsbanken's Long-Term IDR was upgraded.
An upgrade of the Support Ratings and upward revision of the Support Rating Floors would be contingent on a positive change in the sovereign's propensity to support its banks. While not impossible, this is highly unlikely in Fitch's view, in light of the prevailing resolution regime.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS
The ratings of Handelsbanken Plc and Stadshypotek AB (publ) are linked to the ratings of their parent, Svenska Handelsbanken.
ESG CONSIDERATIONS
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg
RATING ACTIONSENTITY/DEBT RATING PRIOR
Svenska Handelsbanken AB LT IDR AA Affirmed AA
ST IDR F1+ Affirmed F1+
Viability aa Affirmed aa
Support 5 Affirmed 5
Support Floor NF Affirmed NF
DCR AA+(dcr) Affirmed AA+(dcr)
subordinated
LT A- Affirmed A-
Senior non-preferred
LT AA Affirmed AA
subordinated
LT A+ Affirmed A+
long-term deposits
LT AA+ Affirmed AA+
Senior preferred
LT AA+ Affirmed AA+
Senior preferred
ST F1+ Affirmed F1+
short-term deposits
ST F1+ Affirmed F1+
Stadshypotek AB (publ) LT IDR AA Affirmed AA
ST IDR F1+ Affirmed F1+
Viability aa Affirmed aa
Support 5 Affirmed 5
Support Floor NF Affirmed NF
Handelsbanken Plc LT IDR AA Affirmed AA
ST IDR F1+ Affirmed F1+
Support 1 Affirmed 1
VIEW ADDITIONAL RATING DETAILS
Additional information is available on www.fitchratings.com
SVENSKA HANDELSBANKEN AB 
