Fitch Ratings has affirmed The Shizuoka Bank, Ltd.'s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'A-' and the Viability Rating (VR) at 'a-'.

The Outlook on the IDRs is Stable.

At the same time, Fitch is withdrawing Shizuoka's Support Rating and Support Rating Floor as they are no longer relevant to the agency's coverage following the publication of our updated Bank Rating Criteria on 12 November 2021. In line with the updated criteria, we have assigned Shizuoka a Government Support Rating (GSR) of 'bbb-'.

Key Rating Drivers

IDRS AND VIABILITY RATING

The IDRs of Shizuoka are driven by its VR, which reflects its intrinsic credit profile. The bank's VR is at the same level as the implied VR and is influenced by Fitch's assessment on the operating environment (OE) for Japanese banks at 'a-'. We revised the OE factor outlook to stable from negative, as we have done for the major Japanese banks, driven by our belief that the downside risks are being alleviated by the gradual recovery of the economy. The OE factor midpoint at 'a-' is below the implied 'aa' category score for Japan, reflecting Japan's sovereign rating (A/Negative) and our expectation of low trend growth.

The rationale for the revision of the outlook on the OE score is similar to the reason for the change to a stable outlook on the asset quality and capitalisation and leverage scores.

The bank has maintained sound asset quality, with non-performing loans/total loans at 1.1% at end-September 2021, which Fitch regards as supported by the bank's adequate risk controls and government stimulus. Fitch believes Shizuoka's loan portfolio is more vulnerable to an economic recession than that of mega bank peers because over 70% of the loans are to SMEs, which are typically at a higher risk of delinquency in downturns. However, we expect any deterioration in asset quality to be within our base case, with adequate rating headroom at Shizuoka's current rating.

Fitch expects Shizuoka's capitalisation to remain strong with a common equity Tier 1 (CET1) ratio of 16.6% at end-September 2021, higher than those of the Japanese mega banks. While capital accumulation may be slow as profitability is under pressure, we expect the bank to maintain sufficient levels of capital without taking excessive risk.

Structural issues facing the Japanese banking industry remain, and Fitch expects Shizuoka to continue to face challenges in attaining higher profitability. We have lowered our assessment on the earnings and profitability score to 'bbb-/stable' from 'bbb/negative' and the bank's low profitability will remain a key weakness of its intrinsic credit profile. This is partly due to its narrower business focus on lending and less geographic diversification in its operations compared with the major domestic banks. Nonetheless, the bank is working on cost reduction and expanding fee-generating business, which is starting to contribute to profitability.

The VR also considers the bank's strong market position in the Shizuoka prefecture with the largest market share in loans (over 35%). This underpins our Business Profile score of 'a-', which is above the implied 'bbb' category score. The bank has a longstanding leading franchise in the prefecture and strong relationships with clients in the region.

In accordance with Fitch criteria, the bank's Short-Term IDR of 'F1' is at the higher of the two options available at a Long-Term IDR of 'A-', supported by the funding and liquidity score of 'a'.

GOVERNMENT SUPPORT RATING

Shizuoka's 'bbb-' GSR reflects our view of a high probability of support from the Japanese sovereign, if necessary, due to the bank's large market presence in the Shizuoka prefecture. However, the bank lacks the systemic importance of its mega bank peers despite its strong franchise and share of deposits and loans in the prefecture.

Rating Sensitivities

Factors that could, individually or collectively, lead to negative rating action/downgrade:

IDRS AND VIABILITY RATING

The VR could come under pressure from a combination of a sustained deterioration in the operating profit/risk-weighted assets ratio to below 0.75% (six months ending September 2021: 0.87%) for a prolonged period with unclear prospects of improvement, higher credit costs due to weaker asset quality (NPL ratio above 2%) for a sustained period, and/or a reduction in capitalisation (with a CET1ratio consistently below 15%).

Involvement in industry consolidation, leading to potentially higher volatility in earnings or capital, or deterioration of asset quality, could also lead to negative rating action.

GOVERNMENT SUPPORT RATING

Fitch may take negative action on the bank's GSR if we believe the government's propensity to support the bank is lowered or the ability to support the bank has deteriorated significantly.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

IDRS AND VIABILITY RATING

Potential upside for the ratings is limited. Substantial improvement in the operating environment and positive rating action on Japan's sovereign rating would be a prerequisite for any upgrade of the VR. It would need to be accompanied by a material and sustainable improvement in the bank's profitability along with an improvement in our assessment of the risk profile and asset quality.

GOVERNMENT SUPPORT RATING

Shizuoka's GSR could be upgraded if Fitch believes there is a higher propensity for the sovereign to provide support to the bank. This may happen if the bank's systemic importance increases, reflected in a meaningful national market share. However, we consider such prospects to be low over the medium term due to the bank's regional focus.

VR ADJUSTMENTS

The OE score of 'a-' has been assigned below the 'aa' category implied score due to the following adjustment reason: Sovereign Rating (negative) and Economic Performance (negative).

The Business Profile score of 'a-' has been assigned above the 'bbb' category implied score due to the following adjustment reason: Market Position (positive).

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

Summary of Financial Adjustments

Total assets and total liabilities exclude acceptances and guarantees from Japan's generally accepted accounting principles balance sheet to be globally comparable.

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.

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

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