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.

Key Rating Drivers

VR-Driven IDR: Shizuoka Bank's IDRs are driven by its VR, which is assessed at the consolidated group level. Shizuoka Bank is the wholly owned core bank of Shizuoka Financial Group, Inc. following a group restructuring in October 2022.

The VR, which reflects the group's intrinsic credit profile, is the same as the implied rating, which is underpinned by its adequate loss absorption buffers and funding and liquidity balanced against the limited headroom in profitability for the rating level. The Short-Term IDR of 'F1' is at the higher of the two options mapped to the Long-Term IDR of 'A-', supported by the funding and liquidity score of 'a'.

Stable Operating Environment Outlook: Fitch expects Japan's economic recovery in 2022 and 2023 to remain steady, although slower than expected in light of inflationary pressure and a very weak outlook for global growth. This underpins the stable outlook on our 'a-' operating environment factor score. The pressure on growth from structural challenges and global uncertainties is factored into this assessment.

Leading Franchise: The VR considers the bank's strong market position in the Shizuoka prefecture, with the largest market share in loans at 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 client relationships in the region. However, Shizuoka Bank has a narrower business focus on lending and less geographic diversification than the major domestic banks.

Sound Risk Management: We believe Shizuoka Bank maintains a modest risk appetite, with conservative underwriting standards in the loan portfolio and adequate risk controls commensurate with its business profile.

Asset Quality Remains Sound: We expect Shizuoka Bank to maintain sound asset quality with consolidated non-performing loans (NPLs)/total loans at 1.2% in the financial year ending March 2023 (FYE23; 1.1% at the end of the first three months of FYE23). We believe the bank's loan portfolio is more vulnerable than that of the major banks to the phasing out of the government's pandemic-related subsidies because of its higher loans to SMEs. However, we expect any asset-quality deterioration to be modest, with sufficient headroom for the 'a-' asset-quality factor score.

Profitability Challenges Continue: We expect Shizuoka Bank to continue facing challenges in raising profitability due to domestic structural issues. The bank's low profitability remains a key weakness of its intrinsic credit profile as reflected in the 'bbb-' factor score. Focus on cost reduction and expansion of fee-generating businesses should support profit improvement although it may take some time.

Strong Capitalisation: We expect the common equity Tier 1 (CET1) ratio of the group to remain sound and higher than that of most major Japanese banks. Before the restructuring, Shizuoka Bank reported a CET1 ratio of 15.5% at end-June 2022. We assess capitalisation on a consolidated group basis, as Japan employs a single point-of-entry resolution framework. Additional capital accumulation may be slow, as profitability is under pressure, but we expect the bank to maintain sufficient capital buffers without taking on excessive risks.

Sound Funding Position: We expect Shizuoka Bank to maintain its sound funding and liquidity position, which benefits from abundant and stable access to local deposits as reflected in the 'a' factor score.

High Probability of Support: Shizuoka Bank's 'bbb-' Government Support Rating (GSR) reflects Fitch's assessment that the bank has a high probability of receiving 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 VR

The VR could come under pressure from a combination of a sustained deterioration in the consolidated operating profit/risk-weighted asset ratio to below 0.75% (three months ending June 2022: 0.79% consolidated; FYE22: 0.67% non-consolidated) 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 CET1 ratio consistently below 15% on a consolidated group basis).

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.

In addition, Shizuoka Bank's VR and IDRs may be pressured if we move to a standalone assessment of the bank, which may occur if the non-bank operations of Shizuoka Financial Group grow substantially. However, we do not expect this to occur in the short-to-medium term.

GSR

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 VR

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

GSR

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 result from an increase in the bank's systemic importance, reflected in a meaningful national market share. However, we think the likelihood is low over the medium term due to the bank's regional focus.

VR ADJUSTMENTS

The business profile score of 'a-' has been assigned above the 'bbb' category implied score due to the following adjustment reason: market position (positive).

The category implied operating environment score is at the cusp of 'aa' and 'a' and we have applied economic performance (negative) as an adjustment to arrive at the assigned score of 'a-'.

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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