Fitch Affirms 3 Korean Policy Banks at ‘AA-’; Outlook Stable

Industrial Bank Of Korea

25/06/2018 11:23

(The following statement was released by the rating agency)


Fitch Ratings-Seoul-June 25: Fitch Ratings has affirmed the ‘AA-’ Long-Term 
Issuer Default Ratings (IDRs) on South Korea’s three key policy banks – Korea 
Development Bank (KDB), the Export-Import Bank of Korea (KEXIM) and Industrial 
Bank of Korea (IBK). The Outlooks on the Long-Term IDRs are Stable. At the same 
time, Fitch has affirmed IBK’s Viability Rating (VR) at ‘a-’. A full list of 
rating actions is at the end of this rating action commentary.

KEY RATING DRIVERS 

IDRS, SUPPORT RATING, SUPPORT RATING FLOOR, AND SENIOR DEBT

The IDRs and Support Rating Floors of the three key policy banks are equalised 
with the IDRs of the South Korean sovereign (AA-/Stable). The banks' ratings, 
along with their Support Ratings of ‘1’, reflect Fitch's expectation that there 
is an extremely high likelihood that the state will provide support to the 
banks, if needed. 

The expectation is based on the important policy roles the three banks carry out 
for the country’s economy, the government’s controlling ownership of the banks 
and the government’s de facto solvency guarantee stated in the respective 
legislation to establish the banks. Under the acts, the government is obliged to 
make up for any losses incurred by the banks that are not covered by their 
reserves.

KDB’s policy role is to provide credit to foster development of local 
industries, develop social infrastructure and resources, and support corporate 
restructuring. Its policy role has been highlighted in recent years as it led 
the restructuring of oversupplied industries, such as shipping and shipbuilding. 
KDB is 100% directly owned by the government.

KEXIM offers credit to exporters, importers and overseas investment projects. 
KEXIM specialises in providing loans and guarantees to overseas construction and 
vessel manufacturing projects with long-term maturity, which commercial banks 
shy away from. The bank is effectively under full government ownership (66% 
directly, 24% through KDB and 10% through the Bank of Korea at end-2017).

IBK’s policy mandate is to build up an efficient credit system for viable SMEs. 
IBK can be expected to meaningfully contribute to the system’s stability in 
times of economic stress by extending more credit to SMEs should commercial 
banks reduce their exposures. Fitch believes that the government is committed to 
keeping its controlling ownership of the bank (52% of the common equity 
directly, 2% through KDB and 2% through KEXIM at end-1Q18). 

The Stable Outlook on the three policy banks' Long-Term IDRs reflects that of 
South Korea’s sovereign rating. 

The ratings on their senior unsecured debt, including global medium-term notes 
(GMTNs), US commercial paper (CP) and certificate of deposit (CD) programmes, 
are the same as the respective banks' Long-Term and Short-Term IDRs as they 
constitute direct, unconditional, unsecured and unsubordinated obligations of 
the banks. 

IBK'SVR

IBK’s ‘a-’ VR is mainly driven by the bank’s strong company profile, which 
isbacked by its sound corporate culture that is mindful of risks and South 
Korea’s resilient economy. While the bank’s operation is largely commercialised, 
the VR also takes into account IBK’s likely role as a countercyclical policy 
lender, especially when the economy is under stress or the commercial banking 
system has become more risk-averse towards SMEs. The potential drag on asset 
quality and profitability from this policy role is in part offset by the 
ordinary capital and funding support from its controlling shareholder, the 
government, and that IBK will still be expected to employ sound risk management. 


IBK’s SME-focused business model with its relatively limited large corporate 
exposure has helped the bank to deliver a stable performance over the last 
decade. Relative to Korea’s other policy banks, IBK’s low single-borrower 
concentration in its loan portfolio and adequate risk-based pricing have limited 
the risk of significant unexpected losses. Fitch expects IBK’s profitability, 
measured by operating profits/risk-weighted assets, to be 1.3% in the near term, 
a similar level to 2017 (commercial bank average in 2017: 1.4%).

Fitch expects IBK to maintain a satisfactory amount of capital in excess of the 
regulatory capital buffer zone in the medium term through modest earnings 
retention, and ordinary capital support from the government, if necessary. The 
modest impaired loan ratio of 1.5% at end-1Q18 is likely to be sustained in the 
near term under the current benign credit-cost environment in Korea. 

In addition to its national retail deposit/debenture franchise (unlike other key 
policy banks), IBK has strong access to the wholesale capital market, benefiting 
from investors’ strong confidence in potential support from IBK’s controlling 
shareholder. The loans-to-customer-deposits ratio of 127% at end-2017 (adjusted 
for loans and deposits to/from financial institutions as well as debentures sold 
to retail customers) remains higher than the commercial bank average (112%).

IBK'S HYBRID SECURITIES

IBK’s Basel III compliant Additional Tier 1 hybrid securities (AT1) rating is 
anchored by the bank’s Long-Term IDR and capped at ‘BBB’ in line with Fitch’s 
Bank Rating Criteria. 

The use of the Long-Term IDR as the anchor reflects our belief that Korea’s 
government has a keen interest in preventing the AT1 notes’ loss-absorption 
features from kicking-in, given a significant potential of reputational risk to 
the government and repercussions (e.g. surge in funding costs) on the country’s 
banking system. As the majority shareholder of IBK, the government has high 
influence on the bank’s management and strategy, and thus the performance of 
IBK. 

The ‘BBB’ cap corresponds to the rating cap that Fitch applies to IDR-anchored 
hybrid notes when the anchor IDR is in the ‘AA’ category.

The notes’ rating would have been higher without the rating cap because Fitch 
believes the non-performance risk, including discretionary coupon skipping, 
would be largely neutralised by the government’s pre-emptive measures to provide 
support, which we expect to be timely if needed. The coupon payments are 
constrained by distributable retained earnings, over which the government does 
not have full control because the account is dependent on the bank’s earnings. 
However, Fitch estimates IBK’s distributable retained earnings totalledover KRW6 
trillion at end-2017, which would be about three times the amount of the IBK’s 
total AT1 notes outstanding. The notes’ full and permanent write-off feature 
upon hitting the point of non-viability suggests poor recovery prospects. 

SUBSIDIARY AND AFFILIATED COMPANY 

Korea Development Bank, NY Branch is a branch of KDB. The rating on the branch's 
US CP programme is aligned with KDB's short-term debt rating because the CP 
programme's rating is sensitive to the same factors that drive changes to KDB's 
short-term debt rating.

RATING SENSITIVITIES 

IDRS, SUPPORT RATING, SUPPORT RATING FLOOR AND SENIOR DEBT

The three key policy banks' IDRs, Support Ratings, Support Rating Floors and 
senior debt ratings are sensitive to a change in Fitch's assumptions about the 
banks' relationship with the South Korean government and the sovereign's rating. 
They would be directly affected by changes to South Korea's ratings or to the 
solvency guarantee under the policy banks' establishment acts. Fitch does not 
expect any significant changes to either in the near to medium term.

IBK'S VR

An upgrade may be prompted by sustainable improvement in the operating 
environment, which may further solidify its business model and financial 
profile. A significant improvement in its capitalisation may also cause an 
upgrade.

Conversely, downgrade pressure may arise from a significant deterioration in the 
operating environment and/or its risk appetite, which may pressure asset quality 
and capitalisation.

IBK'S HYBRID SECURITIES

The rating on IBK’s AT1 notes is sensitive to a downgrade in the bank’s 
Long-Term IDR. For instance, a downgrade of the IDR to the ‘A’ category would 
prompt a two-notch downgrade in the rating of AT1 notes to ‘BB+’, reflecting a 
change in the rating cap. On the other hand, an upgrade in the IDR would not 
affect the issue rating due to the existing rating cap.

The rating is also sensitive to a change in the anchor or notching, potentially 
stemming from a change in Fitch's assumptions around the state’s ability and 
propensity to prevent IBK from triggering the notes’ loss-absorption features. 
For example, the notes could be downgraded if it becomes clearer that avoidance 
of coupon skipping will become increasingly difficult.

SUBSIDIARY AND AFFILIATED COMPANIES

KDB NY Branch's US CP programme rating is sensitive to the factors driving KDB's 
short-term debt rating.

SUMMARY OF FINANCIAL STATEMENT ADJUSTMENTS 

- The analysts have made the following assumptions in analyzing the 
loan-to-customer-deposits ratio:

- Customer deposits: IBK has a practice of selling its own debentures directly 
to retail customers (in an amount which is publicly disclosed). We assume such 
funding is sticky enough to be considered as a type of customer deposit, and can 
be included in an adjusted loan-to-customer- deposit ratio.

DATE OF RELEVANT COMMITTEE 

22 June 2018

Contacts: 

Primary Rating Analyst

Matt Choi, 

Associate Director

+82 2 3278 8372

Fitch Ratings Korea

9F Kyobo Securities Building

Seoul 150-737

Secondary Rating Analyst

Heakyu Chang, 

Senior Director

+ 822 3278 8363

Fitch Ratings Korea

9F Kyobo Securities Building

Seoul 150-737

Committee Chairperson

Parson Singha, 

Senior Director

+66 2108 0151

Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: 
wailun.wan@fitchratings.com.

Additional information is available on www.fitchratings.com

Applicable Criteria 

Bank Rating Criteria (pub. 22 Jun 2018)

https://www.fitchratings.com/site/re/10034713

Additional Disclosures 

Dodd-Frank Rating Information Disclosure Form 

https://www.fitchratings.com/site/dodd-frank-disclosure/10034886

Solicitation Status 

https://www.fitchratings.com/site/pr/10034886#solicitation

Endorsement Policy 

https://www.fitchratings.com/regulatory

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