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S&P Downgrades Erste, RZB, UniCredit, Affirms HYPO NOE, KA Finanz, Upgrades HYPO OO

Published: August 13, 2014; 19:25 · (FriedlNews)

S&P is downgrading three banks, affirming the ratings on two banks, upgrading one bank, and lowering various issue ratings on the banks' hybrid capital and guaranteed grandfathered debt.

Standard & Poor's Takes Various Rating Actions On Six Austrian Banks / Picture: © Flickr / Ryan H

Standard & Poor's Ratings Services said today that it has taken various rating actions on six Austria-based banks.

Austria has recently enacted legislation to bail in holders of Hypo Group Alpe Adria's subordinated debt, despite the State of Carinthia's grandfathered guarantee of this debt. In S&P's view, the new law indicates reduced predictability of extraordinary government support for systemically important banks, and for banks' hybrid capital instruments and grandfathered debt, than S&P previously envisaged. S&P is therefore downgrading three banks, affirming their ratings on two banks, upgrading one bank, and lowering various issue ratings on the banks' hybrid capital and guaranteed grandfathered debt. We are removing all the ratings from CreditWatch negative. The negative outlooks on three banks reflect S&P's view that the likelihood of state support could diminish further, as well as bank- and industry-specific factors. The stable outlooks on the other three banks mainly reflect S&P's assessments of bank-specific factors and each bank's status as a government-related entity (GRE).

We have also removed all the ratings from CreditWatch, where we had placed them with negative implications on June 10, 2014.

We have downgraded three highly systemically important Austrian banks and certain core subsidiaries, lowering the long- and short-term counterparty credit ratings on:

> Erste Group Bank AG (Erste) to 'A-/A-2' from 'A/A-1'; and
> Raiffeisen Zentralbank Oesterreich AG (RZB) to 'A-/A-2' from 'A/A-1'; as well as
> Our long-term counterparty credit rating on UniCredit Bank Austria AG (Bank Austria) to 'BBB+' from 'A-', while affirming the 'A-2' short-term rating.

The outlooks on all three banks are negative.

We have affirmed our 'A/A-1' long- and short-term counterparty credit ratings on HYPO NOE Gruppe Bank AG and KA Finanz AG.

In addition, we raised our long-term counterparty credit rating on Oberoesterreichische Landesbank AG (HYPO OO) to 'A+' from 'A' and affirmed the 'A-1' short-term counterparty credit rating.

The outlooks on these three banks are stable.

At the same time, we have lowered our issue ratings on:

> Bank Austria's junior subordinated debt and preferred stock to 'BB-' from 'BB', its grandfathered senior unsecured debt to 'BBB+' from 'AA-', and its grandfathered subordinated debt to 'BBB-' from 'AA-';
> RZB's junior subordinated debt to 'BB+' from 'BBB-'; and
> HYPO NOE's grandfathered senior unsecured debt to 'A' from 'AA'; as well as
> HYPO OO's grandfathered senior unsecured debt to 'A+' from 'AA' and its grandfathered subordinated debt to 'BBB' from 'AA'.

The rating actions follow the Austrian government's enactment of special legislation to bail in HGAA's subordinated debtholders, despite a grandfathered guarantee from the State of Carinthia for the debt. The legislation, passed in July, forms part of the law to transform HGAA into a wind-down unit from a bank, and it has been ratified by Austria's federal president. The Austrian government's decision to impose losses on HGAA's subordinated debtholders, despite the grandfathered guarantee, and public statements from government officials, in our view, indicate that the authorities' stance toward supporting systemically important banks is wavering. We consider, therefore, that extraordinary government support for a systemically important bank, or from the federal states for a bank's grandfathered instruments, is now less predictable than before.

Generally, however, we consider that in the absence of a legal framework for bank resolution in Austria, extraordinary future government support could remain available. Consequently, we continue to classify the Austrian government as supportive of the banking sector.

We understand that, in the coming months, the Austrian constitutional court will examine whether the new legislation complies with national and European statutes. There will therefore be a period of uncertainty for market participants until the court makes its ruling.

To reflect the increased uncertainty about potential future extraordinary government support for highly systemically important banks in Austria, such as Erste, RZB, and Bank Austria, we have applied a one-notch negative adjustment to our ratings on these banks. This adjustment partly offsets the two notches of uplift for extraordinary government support in the ratings, leading to the downgrades of the three banks and three core subsidiaries.

Furthermore, the bail-in of HGAA's subordinated debt, despite a grandfathered guarantee, sets a precedent. Therefore, we see a higher likelihood that the Austrian government will impose losses on holders of domestic banks' hybrid capital and grandfathered instruments. As a result, we lowered our ratings on Bank Austria's junior subordinated debt and preferred stock, as well as our ratings on RZB's junior subordinated debt. We also downgraded the grandfathered debt issued by Bank Austria, HYPO OO, and HYPO NOE and guaranteed by the federal states. We rate these issues according to our criteria for GREs. In our view, the likelihood of timely and sufficient state support for HYPO NOE's and HYPO OO's grandfathered debt has reduced to high from extremely high. Moreover, we no longer consider Bank Austria's grandfathered obligations to be government-related debt. The ratings on the three banks' grandfathered obligations are now at the same level as those on the banks' other senior unsecured or subordinated obligations.

This notwithstanding, we raised our long-term credit rating on HYPO OO by one notch because of the bank's improving capitalization, which has strengthened its stand-alone credit profile (SACP). We now believe that HYPO OO will maintain a risk-adjusted capital (RAC) ratio sustainably above 7%.

We affirmed our ratings on HYPO NOE because of the strengthening of the bank's performance and risk metrics, which we consider to be more in line with that of peers. In our view, this compensates for the weakening credit quality of the bank's owner, Lower Austria.

The negative outlooks on Erste, RZB, and Bank Austria mainly reflect our view that potential extraordinary government support for systemically important European banks will likely decrease as resolution frameworks are put in place over the next two years. If, as a result of such frameworks, we remove or reduce the notches of uplift for government support by year-end 2015, we would also review the one-notch negative adjustment in the ratings on these banks.

The negative outlooks on the core subsidiaries reflect those on the parent banks.

Both the negative and stable outlooks also reflect bank-specific factors and/or our view of the banks' vulnerability to risks regarding the stability of Austria's banking industry. Overcapacity in Austria's banking sector, resulting in low earnings through aggressive pricing, increasingly poses a risk to the stability of the banking system. Moreover, if the government's comparably high levy on banks remains in place over the longer term, it will further diminish domestic banks' chances of improving their modest earnings.

The negative outlook on Erste also reflects the bank's exposure in Central and Eastern Europe (CEE). We expect that the improved economic environment in the eurozone (European Economic and Monetary Union) will contribute to the development of Erste's domestic earnings, and that Erste's capital base will continue to improve. However, we don't expect the RAC ratio to increase materially higher than 7% over the next two years, owing to subdued overall performance as a result of still-high cost of risk at the CEE operations.

The negative outlook on RZB also reflects our view that RZB remains potentially vulnerable to the impact of worsening economic conditions in its extended home market in CEE, especially in Russia and Ukraine, over the next 12-24 months. This could lead to higher credit losses and weaker earnings for RZB than we forecast in our base case. Besides preventing RZB from strengthening its capital such that our RAC ratio for the bank sustainably exceeds 7%, weaker results could hinder the bank's ability to stabilize its asset quality metrics. This could lead us to revise our assessment of the bank's SACP downward and lower the long-term rating.

The negative outlook on Bank Austria also reflects our view that the ratings are sensitive to the potential deterioration of creditworthiness of the bank's full owner, UniCredit SpA, mainly because of the entities' tight operational interaction. In our opinion, any further weakening of the UniCredit group's creditworthiness over the next two years could constrain our view of Bank Austria's business, capital, risk, funding, and liquidity positions. Furthermore, the negative outlook reflects risks associated with Bank Austria's continued expansion in higher-risk countries. We consider that a further material increase in the proportion of exposure in Russia and Turkey would lead to lower business stability and a higher risk profile because downturns in these markets could lead to disproportionate losses.

The stable outlooks on KA Finanz, HYPO OO, and HYPO NOE reflect our current view of a low probability that bank resolution regime frameworks will impede the states' willingness and ability to provide extraordinary support to these banks if needed. This is mainly because we consider all three banks to be GREs with important public policy roles.

Our outlooks on HYPO OO and HYPO NOE reflect our expectation that the improving economic environment will support the strengthening of the banks' earnings and capital over the next two years.