NongHyup Bank #A+/A-1# Ratings Affirmed With Stable SACP Revised To #bbb+# On Stronger Capitalization

Stocks and Financial Services Press Releases Friday April 27, 2018 16:23
HONG KONG--27 Apr--S&P Global Ratings

HONG KONG (S&P Global Ratings) April 27, 2018--S&P Global Ratings said today that it had affirmed its 'A+' long-term and 'A-1' short-term issuer credit ratings on Korea-based NongHyup bank (NHB). The outlook on the long-term rating is stable. At the same time, we affirmed the 'A+/A-1' long- and short-term issue ratings on the bank.

We affirmed the ratings to mainly reflect our view that we expect NHB to maintain its very important role and very strong link with the Korean government.

NHB was established under the Agricultural Cooperatives Act with a mandate to improve the economic and social status of member cooperatives and farmers. The bank provides policy loans to farmers and member cooperatives. It is a fully owned subsidiary of NongHyup Financial Group (NHFG), which is, in turn, a fully owned subsidiary of NongHyup Agricultural Cooperative Federation (NACF). NHB financially supports NACF by paying dividends and brand usage fees that help NACF provide public services to farmers and the general public at thin margins.

We believe the government would likely inject capital into the group if NHB were to come under significant pressure, despite NHB having no existing direct government ownership. This is because of the government's track record of similar support to other policy banks. We also note that the government provided financial support to NACF in the form of subsidies in relation to NACF's reorganization in 2012.

We consider the bank's stronger capitalization has improved its stand-alone credit profile (SACP) to 'bbb+' from 'bbb'. The SACP is not a major rating driver given the bank's status as a government-related entity (GRE). In our view, NHB's growth appetite has reduced meaningfully given its focus on managing risks and the Korean government's tight monitoring of household loan growth. We estimate the bank will generate loan growth of about 5% annually for the coming few years compared with about 10% growth in 2014-2016.

We also expect NHB will likely sustain its improved profitability mainly backed by its stabilized credit costs and asset quality. Provisioning charges should reduce for exposures related to some large corporates in the shipbuilding and shipping sectors. In 2017, NHB's core earnings to adjusted assets increased to about 0.30% from about 0.10% in 2016, mainly due to lower credit costs.

We also do not expect parent entity NHFG to substantially increase NHB's dividend payout ratio, considering the bank's needs to comply with regulatory capital ratios. We also think NHFG's appetite for inorganic growth is not high following its acquisition of one of the largest domestic securities company in 2014. Overall, we estimate NHB's risk-adjusted capital (RAC) ratio before diversification and concentration adjustments to remain 8.5%-9.0% in the coming 18 to 24 months, sitting comfortably within our adequate range.

We expect NHB's business position to remain strong. NHB is the fifth-largest bank in Korea in terms of its share of about 9% of loans and deposits as of December 2017. NHB has a strong market position with good brand recognition, particularly in rural areas, backed by the largest branch network in Korea. The bank also has a well-diversified customer base in terms of both geography and sector. In our view, NHB's management team will focus on managing risks and continue focusing on the bank's loan growth toward less risky segments such as secured household and small and mid-size enterprise lending over the next few years.

That said, compared with its major Korean commercial bank peers, NHB has relatively weak profitability, partially because of its low-margin-policy lending to farmers and its role of building financial infrastructure in rural areas. In addition, a sizable amount of the bank's cash is channeled to its ultimate parent, NACF, in the form of brand-usage fees and dividends. NACF uses the funds to support thin-margin projects such as educating cooperatives and farmers, administrative infrastructure, and marketing of agricultural products and livestock, which provide a full supply chain of services to farmers.

In our view, NHB has more vulnerable corporate exposures than its commercial bank peers', despite some improvement in recent years. NHB's remaining exposures to risky industries, such as shipbuilding, shipping, real estate project financing, and construction, could continue to weigh on the bank's asset quality and profitability, especially under unfavorable economic conditions. The bank's nonperforming loan ratio improved to about 1.0% by the end of 2017 from about 2.3% by the end of 2015. The ratio is in line with the domestic banking industry average, but still higher than the major commercial bank peers' average of about 0.7%. In addition, given that NHB is a key operating subsidiary of NHFG and ultimately NACF, the bank is inherently exposed to group risk.

We expect NHB to maintain its above average funding and adequate liquidity profiles. The bank's good local-currency funding reflects its strong retail deposit base, which stems from its large household customer base and geographically diverse branch network in Korea. The bank's loan-to-deposit ratio (LDR) stood at about 110% as of December 2017, lower than the domestic banking sector average of about 120%. NHB's lower dependency on foreign-currency funding than its domestic peers' also supports our assessment of its funding base.

We view NHB's liquidity as adequate, backed by a sizable amount of government bonds, cash, and central bank balances. We also expect NHB's strong market position to keep its liquidity profile better than that of smaller domestic peers' under stressed situations. We consider the bank's liquidity ratios to be adequate: the ratio of its broad liquid assets to short-term wholesale funding was about 1.5x as of the end of 2017.

The stable outlook on NHB reflects our assessment that the bank has a very high likelihood of receiving government support at least over the next one to two years. The outlook also reflects that on the sovereign ratings on Korea. We also expect NHB's strong business franchise to continue to underpin its revenue stream and funding stability. We also believe the bank will likely manage its capitalization and asset quality from significant deterioration for the coming few years.

We could raise the ratings on NHB if we were to raise the sovereign rating on Korea.

We could lower the ratings on NHB if we were to lower the sovereign rating on Korea. Although a rather unlikely scenario over the coming one to two years, the rating on NHB may come under downward pressure if the bank's link with the government or its policy role weakens. This worsening could happen if the bank becomes more commercial and profit-driven, shifting away from servicing its mandate.

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