Fitch Ratings has upgraded Bank of Beijing Co., Ltd.'s (BOB) Viability Rating (VR) to 'bb-' from 'b+'.

At the same time, Fitch has affirmed BOB's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BB+', Government Support Rating (GSR) at 'bb+', and Short-Term IDR at 'B'. The Outlook is Stable. The assigned VR is in line with the implied VR but does not drive its IDRs.

The upgrade of BOB's VR is driven by our assessment that, like other similarly sized banks in China, its intrinsic credit profile has benefitted from regulatory developments in recent years. This has resulted in a reduction in its off-balance-sheet activities as well as a moderating risk appetite. These were factors Fitch had identified as potential outcomes when we upgraded the operating environment (OE) assessment to 'bbb-' from 'bb+' in 2021.

Key Rating Drivers

Government Support-Driven IDR: The Long-Term IDR is driven by our assessment of a moderate probability of government support, as indicated by the assigned GSR of 'bb+'. Our view considers the bank's limited size and modest domestic systemic importance. It also recognises BOB's entrenched franchise within Beijing, including its business relationships with state-owned enterprises. BOB's Short-Term IDR of 'B' is mapped to its Long-Term IDR.

Differentiation in D-SIB Status: China's regulators designated BOB as a domestic systemically important bank (D-SIB) in October 2021. Still, we believe the D-SIB designation alone may not materially affect the state's propensity to support BOB relative to peers with higher systemic importance or closer government linkages. This is because the government is likely to prioritise its support for larger D-SIBs if China's banking system experiences systemic stress.

Stable OE: We expect China's economic growth to recover in 2023 as Covid-19 restrictions are lifted, which will support consumption. The OE score of 'bbb-'/stable is above the 'bb' category implied score, as we believe China's robust external finances and a record of stable economic performance, which are incorporated in the Chinese sovereign rating (A+/Stable), will provide greater financial and economic stability than the implied OE score indicates.

High Concentration Supports Business Profile: BOB has close relationships with large state-owned enterprises in the capital city. Around half of its loans and two-thirds of its revenue come from the Beijing area, which has one of the most resilient local economies in China, and the contribution has remained stable over the years.

However, BOB's business profile score of 'bb' is lower than the 'bbb' implied category score due to issues over management and governance. Such issues are not uncommon in China due to pressure from the authorities to support certain borrower segments during challenging times. The score also reflects the bank's above-peer exposure to entrusted investment, which was reported at 12% at end-2022.

Reduction in Shadow Banking: We revised upwards both BOB's risk-profile and asset-quality scores to 'bb-', from 'b+', to reflect the reduction in its shadow-banking activity, in line with the regulatory tightening by China's authorities. BOB's off-balance-sheet wealth-management products (WMPs) declined to around 16% of deposits by end-2022, from 21% at end-2021.

We expect BOB to maintain a largely stable reported impaired-loan ratio (1.4% at end-2022) in light of its continued non-performing loan resolution. The 'bb-' asset-quality score is below the 'bbb' category implied score to reflect the bank's higher growth appetite and exposure to shadow-banking activity relative to higher rated peers.

Stable Profitability: BOB's earnings and profitability score of 'b+' is below the 'bb' category implied score, reflecting the understatement of risk-weight calculations from non-loan exposures. We expect its operating profit/risk-weighted assets ratio, reported at around 1.2% in 2022, to benefit from its focus in Beijing and remain largely stable, despite continued pressure on the net interest margin.

Entrusted Investments Weigh on Capitalisation: The capitalisation and leverage score of 'b+' is below the 'bb' category implied score, reflecting our belief of understatement of risk-weight calculations from non-loan exposures. We expect BOB's high entrusted investment exposure (12% of total assets at end-2022) to continue to weigh on its capitalisation. Its reported common equity Tier 1 (CET1) ratio declined to 9.5% by end-1Q23, from 9.9% at end-2021.

Reliance on Non-Deposit Funding: We expect the loan-to-deposit ratio (LDR) to remain stable in the next two years. The upward revision also reflects its improving retail deposit franchise that increased to 28% of total deposits by end-2022, from 23% at end-2019. That said, the score is still below the 'bbb' category implied score in light of the bank's reliance on non-deposit funding, similar to most other Chinese banks, which may result in an understatement of the LDR and strain BOB's on-balance-sheet funding.

Rating Sensitivities

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

BOB's Long-Term IDR and GSR will come under pressure if Fitch perceives that the central government's propensity and/or ability to provide timely extraordinary support to the bank is diminished. A sovereign rating downgrade could indicate diminished ability to support, and the lower propensity may be reflected in an enhanced resolution framework and the authorities' strong intention to permit losses on senior debt obligations as a means of resolving banks. However, we do not expect either scenario to occur in the near term.

A reduction in the Beijing government's ownership or influence over BOB may also lower the state's propensity to support the bank if the reduction were to be significant, or if the bank's systemic importance were to reduce materially.

BOB's Short-Term IDR will be downgraded if its Long-Term IDR is downgraded to or below 'CCC+', which we consider highly unlikely in the short-to-medium term.

BOB's VR could be downgraded if the OE score is downgraded or if the bank returns to growing its entrusted investments or WMPs excessively, and significantly erodes asset quality and capital buffers. A sustained deterioration in the bank's financial metrics without having largely addressed perceived risks around transparency of exposures (such as off-balance sheet and non-loan), could lead to a VR downgrade. This includes a combination of the following reported core metrics:

The four-year average of impaired loans/gross loans increasing to and being sustained at around 6% (2019-2022 reported four-year average: 1.5%), although Fitch's assessment of asset quality will also consider other indicators, such as 'special-mention' loans, loan-loss provisioning, and whether and to what extent we believe reported metrics understate any deterioration in asset quality; and

CET1 ratio falling below 8.5% without a credible path to return to existing levels.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

An upgrade of China's sovereign ratings could lead to positive rating action on the bank's GSR and its support-driven IDRs if that were to indicate greater ability to support BOB, with no less propensity to support.

BOB's Short-Term IDR would be upgraded if its Long-Term IDR is upgraded.

An improvement in BOB's capitalisation such that its CET1 ratio will be sustained above 10%, in conjunction with a further reduction in risk appetite and greater transparency in its financial statements - particularly around risks relating to shadow-banking activity, affecting our assessment of asset-quality metrics - would be positive for its VR assessment.

OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS

BOB's IDRs (xgs) are driven by its VR. The Long-Term IDR (xgs) has been upgraded to 'BB-(xgs)' from 'B+(xgs)' following the upgrade of the VR, while the Short-Term IDR (xgs) has been affirmed at 'B(xgs)'.

OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES

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

The bank's Long-Term IDR (xgs) could be downgraded if the VR is downgraded. The Short-Term IDR (xgs) could be downgraded if the VR is downgraded below 'b-'.

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

The bank's Long-Term IDR (xgs) could be upgraded if the VR is upgraded. The Short-Term IDR (xgs) could be upgraded if the VR is upgraded above 'bb+'.

VR ADJUSTMENTS

The OE score of 'bbb-' has been assigned above the 'bb' category implied score due to the following adjustment reason: sovereign rating (positive).

The business profile score of 'bb' has been assigned below the 'bbb' category implied score due to the following adjustment reason: management and governance (negative) and business model (negative).

The asset-quality score of 'bb-' has been assigned below the 'bbb' category implied score due to the following adjustment reason: non-loan exposure (negative) and underwriting standards and growth (negative).

The earnings and profitability score of 'b+' has been assigned below the 'bb' category implied score due to the following adjustment reason: risk-weight calculations (negative).

The capitalisation and leverage score of 'b+' has been assigned below the 'bb' category implied score due to the following adjustment reason: leverage and risk-weight calculation (negative).

The funding and liquidity score of 'bb-' has been assigned below the 'bbb' category implied score due to the following adjustment reason: non-deposit funding (negative) and deposit structure (negative).

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

Sources of Information

The principal sources of information used in the analysis are described in the Applicable Criteria.

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

BOB's IDRs are directly linked to China's sovereign ratings.

ESG Considerations

BOB has an ESG Relevance Score of '4' for Financial Transparency as there are still structural issues around financial transparency and disclosure. These are not captured in headline performance metrics in China and affect our assessment of the OE and the financial profile. BOB, like other mid-tier banks, is more exposed to this risk relative to state banks, due to its larger exposure to WMPs and entrusted investments stemming from the use of off-balance-sheet transactions. This has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.

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.

(C) 2023 Electronic News Publishing, source ENP Newswire