Fitch Ratings has affirmed Switzerland-based Basler Kantonalbank's (BKB) Long-Term Issuer Default Rating (IDR) at 'AAA' with a Stable Outlook, and Viability Rating (VR) at 'a'.

A full list of rating actions is below.

Key Rating Drivers

Support Drives Ratings: BKB's Long-Term IDR and Shareholder Support Rating (SSR) are based on support from its majority owner, the Canton of Basel-Stadt, and reflect Fitch's view of an extremely high probability of timely support, if needed. The canton owns 86% of BKB and holds 100% of its voting rights.

Cantonal Guarantee: The ratings are underpinned by Fitch's view of the canton's creditworthiness and by the cantonal guarantee on BKB's non-subordinated liabilities under a specific cantonal law (the BKB Law). The cantonal guarantee applies to BKB as a legal entity and excludes BKB's operating subsidiaries, notably Bank Cler. However, in practice, Fitch believes that the canton would provide some indirect support to Bank Cler, as Fitch expects the supervisory authorities to require BKB to support Bank Cler in case of failure.

Support Manageable for Canton: BKB's consolidated assets (CHF53 billion at end-2023) are large relative to the canton's GDP (CHF40 billion at end-2021) and budgetary resources, but Fitch believes the bank's stable and resilient business model and its capital buffers mean recapitalisation needs would be manageable for the canton in a realistic stress scenario. This view is underpinned by the canton's strong economic fundamentals, including strong financial flexibility and low debt burden.

Universal Cantonal Bank: BKB's VR is based on our assessment of its consolidated profile and reflects its stable and low-risk business model, albeit with concentration on residential real estate in the Basel region and, via Bank Cler, across Switzerland. Our assessment benefits from low levels of impaired loans and strong capitalisation. It also reflects BKB's small size, modest nationwide franchise, adequate but consistent profitability and funding.

Large Real Estate Exposure: We view BKB's asset quality as strong, benefiting from conservative underwriting standards in mostly low-risk mortgage lending, which should protect the bank from a meaningful real estate price correction. Its impaired loan ratio was a low 0.6% at end-2023 and we expect it to remain below 1% in 2024 and 2025. Residential mortgage loans accounted for 75% of the loan book. Non-residential mortgage loans (16%) related mainly to office and commercial spaces, where we see more risks, and industrial premises.

Stable Profitability: BKB's profitability has been stable but remains modest relative to peers, with an operating profit of 1.1% of risk-weighted assets. We forecast this ratio to decrease slightly to 0.9% in 2024. Net interest income is the main revenue pillar and we expect it to decrease as policy interest rates decline. We expect earnings contribution from fee income to remain broadly stable and loan impairment charges to normalise but to remain low, given the still robust economy. Operating costs are likely to increase on the back of higher staff costs and continued investments in IT infrastructure.

Strong Capitalisation: BKB's end-2023 common equity Tier 1 (CET1) ratio was 17.8%, comparable with that of domestic peers. The canton expects a dividend pay-out from BKB of a minimum of CHF55 million annually averaged over four years of the current strategy period, although the actual pay-out is higher (2023: CHF92.6 million). The canton has also agreed that the bank maintains a 3% to 7% buffer over total capital regulatory requirements on an unconsolidated basis.

Stable Funding: BKB's funding benefits from its stable and granular retail deposit base, with a loan/deposit ratio of 130% at end-2023, up from 112% a year ago on the back of lower customer deposits and higher loans. We view the bank's capital-market franchise as weaker than listed Swiss peers, and with some concentration of large institutional deposits at the parent bank and certain reliance on short-term funding. However, we also believe that funding and liquidity benefit from the bank's cantonal guarantee and we do not expect a further significant increase in the loan/deposit ratio.

Rating Sensitivities

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

BKB's IDRs and SSR are primarily sensitive to adverse changes in our assessment of the canton's ability or propensity to support the bank. A material increase in the canton's contingent liabilities, which are currently dominated by BKB, could put pressure on BKB's IDRs. Contingent liabilities could increase, for instance, because of sustained growth of the bank's balance sheet in excess of the canton's GDP growth or due to a material delay by the canton in promptly addressing a potential capital shortfall at BKB. A deterioration of the canton's creditworthiness would also result in a downgrade of BKB.

BKB's IDRs and SSR are also sensitive to unfavourable changes in its relationship with the canton, particularly if the BKB Law is amended in a way that would weaken the guarantee's effectiveness or cast doubt on the timeliness of support. This could also negatively affect the VR as our assessments of BKB's business profile (notably franchise), and funding and liquidity both include ordinary support. However, we currently view this scenario as unlikely.

The VR would likely be downgraded on a sharp drop in property prices in Switzerland, resulting in significant asset-quality deterioration, with an impaired loans ratio materially and durably above 2%, and a CET1 ratio below 16%. However, Fitch does not expect a significant house price correction in Switzerland in the medium term.

The rating would also come under pressure if profitability materially deteriorates or if BKB increases its risk appetite, which could be indicated by higher loan growth at the expense of underwriting standards.

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

The Long-Term IDR is at the highest level on Fitch's scale and cannot be upgraded. An upgrade of BKB's VR would require an improved business profile, in particular a more diverse business model, leading to more diversified revenue, together with a record of strengthened profitability and healthy financial metrics, notably capitalisation.

VR ADJUSTMENTS

The business profile score of 'a-' is above the 'bbb' category implied score due to the following adjustment reason: business model (positive).

The capitalisation and leverage score of 'a+' is below the 'aa' category implied score due to the following adjustment reason: capital flexibility & ordinary support (negative).

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

BKB's IDRs and SSR are linked to Fitch's assessment of the Canton of Basel-Stadt's creditworthiness.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' 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. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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