A Boom Time for Western European Banks

S&P forecasts that last year's growth trends will continue for the sector. Here's how that will affect individual ratings

Western European banks enjoyed a vintage year in 2005, as strong income growth, well controlled costs, and falling bad debts combined to produce strong increases in pretax profits. Banks with relatively large exposures to capital markets, corporate credit, and with low initial profitability saw the greatest proportional benefits in 2005.

Early 2006 is likely to see a continuation of these factors, and while the headwind of an eventual "normalization" of credit quality and capital market conditions will inevitably crimp future profit growth, interest rate rises in the Eurozone may benefit margins. Given the resilience of retail franchises and the growing diversity of revenue streams, the capacity of the industry to absorb shocks appears good. Meanwhile, industry consolidation -- despite associated shorter term risks -- is leading to improved diversification and profitability.

Together, these strong fundamentals are key drivers of positive outlooks. As a result, ratings are expected to continue to move upward on a selective basis in 2006. Here are Standard & Poor's outlooks for selected major rated banks:

ABN AMRO Bank N.V. (AA-)


The stable outlook reflects S&P's expectation that ABN AMRO's earnings will continue to benefit from efficiency improvements generated by ABN's group shared services initiative. The success of the downsized and further integrated wholesale clients business will be key in determining future performance, as will the strengthening of non-mortgage-related revenues for the U.S. business. A measured process of acquisitions that maintains the bank's current financial profile -- such as the recent acquisition of Banca Antonveneta -- will not affect the ratings.

On the contrary, a more aggressive acquisition strategy, particularly in emerging markets, which would add execution and financial risks to the balance sheet and leverage its capital position, would probably have negative rating implications.

Banco Bilbao Vizcaya Argentaria, S.A. (AA-)


The stable outlook reflects S&P's expectation that BBVA will maintain its strong operating performance, particularly in Spain and Mexico. Moreover, we expect BBVA to maintain its core capital objective of 6%. The outlook takes into account BBVA's willingness to continue to conservatively manage its exposure to Latin America. We expect the bank to be able to withstand a meltdown in one of the small Latin American markets, should this occur.

A severe stress in Mexico, while unexpected, would, however, have negative rating implications. S&P's base case is one of stable ratings for BBVA. An upgrade would depend on BBVA showing a more balanced business profile, with lower reliance on emerging markets, while obtaining a solid financial performance in all its business lines.

Banco Santander Central Hispano, S.A. (A+)


The positive outlook reflects the potential positive impact of the Abbey unit's restructuring on Santander's consolidated results, improving performance in other business units, maintenance of good overall asset quality, and a strengthening balance sheet. Abbey's renewed management focus has the capacity to transform the bank, enhancing its commercial dynamism. While the bank's cost-cutting programs are successfully improving its cost structure, ongoing changes in its organization and culture could lead to growth in operating performance. Nonetheless, macroeconomic and competitive factors could still hinder Abbey's capacity to increase its revenues, and its retail network is still undergoing some upheaval.

The outlook would be revised to stable if Santander were unsuccessful in improving Abbey's earnings. Santander is rebuilding its weakened core capital ratios after Abbey's acquisition through internal capital generation, and a significant reduction in its equity stake portfolio. The bank's announcement that it has reached an agreement to purchase 19.8% of U.S. financial entity Sovereign Bancorp (BBB-) will not represent a material change in its risk profile, but it will limit the improvement in Santander's capital position.

Barclays Bank PLC (AA)


The stable outlook reflects the expectation that earnings will remain good overall. Arrears on U.K. personal sector lending are rising, but should remain manageable. Barclays has an interest in value-creating corporate activity, however, and in organic expansion. S&P will continue to monitor the effect of this strategy on earnings quality, capitalization, and the risk profile, as it could, in some circumstances, put pressure on the outlook.

A positive rating action would require continued improvements in the diversity and sustainability of Barclays' earnings, and clarity regarding the changing international profile. However, tight capital policy will be likely to restrain the ratings. A negative rating action could follow if risk charges jump dramatically, or if the balance sheet is leveraged excessively to finance an acquisition.

BNP Paribas (AA)


The stable outlook reflects our expectations that BNP Paribas will maintain its robust financial profile and preserve its credit-risk-averse culture. Loan-loss provisions reached a cyclical low in 2004-05. As this level appears unsustainable, the current ratings take into account that loan-loss provisions could moderately increase in the near future. The stable outlook also reflects our belief that the bank's expansion policy will not hurt its risk profile or further weaken its capital position.

The proposed acquisition by BNP Paribas of Italian bank Banca Nazionale del Lavoro SpA (BNL) is a large cross-border deal, that represents a departure from BNP Paribas' recent history of midsize acquisitions. We acknowledge the sound strategic rationale of the transaction as well as its modest downside risk, given BNL's repositioning in recent years. Although cross-border acquisition entails some execution risks, we also expect that BNP Paribas would be able to manage the integration process well, in line with its successful track record so far.

The outlook could be revised to negative if these expectations aren't met. Conversely, a revision of the outlook to positive would hinge on BNP Paribas' ability to successfully further diversify its business and earnings profile, without significant deterioration in its risk profile and capital position. This would, however, be dependent on significant progress being achieved at BNL.

Commerzbank AG (A-)

Eurohypo AG (A-)


The stable outlook on Commerzbank is based on S&P's expectation of reduced earnings volatility for Commerzbank, and that Eurohypo's profitability will continue to benefit from asset shifts to higher-margin business and acceptable provisioning needs. The purchase price and funding of the acquisition of Eurohypo was in line with the group's plan. S&P expects that capital will be gradually replenished through earnings retention to improve the group's capital ratios over the next two years, although a rebound to pre-acquisition capital ratios is unlikely.

For S&P to consider an upgrade, the new group would have to demonstrate stronger core earnings momentum to catch up with higher rated international peers. This would be helped by an improvement in the domestic economic and competitive environment and still fragile real estate markets, which is as yet uncertain. Conversely, a deterioration of asset quality and earnings could have negative rating implications.

Credit Agricole (AA-)

Calyon (AA-)

Credit Lyonnais (AA-)


The positive outlook on Credit Agricole's core entities reflects S&P's expectation that the group will focus on leveraging its enhanced business position to improve operating performance. The earnings recovery of the wholesale banking unit in 2004 and 2005 is expected to continue -- even though the targeted rise in Calyon's revenues and profitability will be challenging to attain -- with recent performance benefiting from extremely reduced cost of risk and from cost synergies. We believe that the cost of risk in CIB, even after returning to more "normal" levels in the medium term, will remain favorable, especially when compared with the pre-merger track record.

We expect the group to maintain at least its current core solvency levels, although it will continue to carry a number of small to midsize acquisitions. If both Calyon and Credit Lyonnais achieve sustainable stronger earnings, while the group continues to maintain a low risk profile, the ratings could be raised. Conversely, unexpected significant risk management issues in CIB, or operational or financial risks related to a major acquisition, could translate into an outlook revision or put downward pressure on the ratings.

Credit Suisse Group (A)

Credit Suisse (A+)


The positive outlook on CSG reflects the major and sustained improvement in profitability, and consequent enhancement in capitalization. S&P expects that capital will improve further on the potential divestment of Winterthur, which will also reduce CSG's exposure to capital markets and improve group returns. The outlook also reflects some potential for franchise development through the integration program, which should lead to greater coordination and cross selling over the medium term.

An upgrade is subject to a successful sale of Winterthur and continued strong profitability, particularly in the private bank, although no major improvement is expected yet in the investment bank. Conversely, the ratings could be constrained by unexpectedly large market losses, litigation charges, failure to sell its Winterthur unit, or failure to deliver results from the integration of its banking businesses.

Danske Bank A/S (AA-)


The stable outlook is based on the expectation of sustained earnings and efficiency, despite the prolonged low interest rate environment and heightened competition. The loan portfolio should continue to exhibit strong asset quality. Capital was strained by the acquisition of two Irish banks, but high earnings stability, in combination with the decision to exit large parts of the wholesale banking operations, have allowed a swift restoration of capital ratios to acceptable levels for the risk profile, even though capital targets are now slightly lower.

Failure to successfully integrate and enhance the acquired Irish operations could have a negative impact on the outlook or the ratings. A positive ratings action would require additional uplifts to earnings quality to compare more strongly with AA-rated peers, strengthened capitalization, and strong evidence of success in Ireland, confirming the credibility of the international retail-banking strategy. A positive rating action is unlikely given the current business concentrations.

Deutsche Bank AG (AA-)


The stable outlook reflects S&P's expectation that Deutsche Bank should be able to maintain sound earnings in a less favorable capital-market environment given the diversification achieved within its corporate banking and securities (CB&S) unit, and the enhanced absolute bottom-line contribution from its other business lines. Management is expected to remain committed to further progress in businesses outside investment banking.

Moreover, the bank's drive to manage capital more aggressively is expected to be curbed, and the agreed disposal of its stake in Eurohypo AG (A-) is likely to lead to a sustainable improvement in adjusted common equity (ACE) and adjusted total equity (ATE).

Significant and sustainable progress in delivering continued profitable growth across business lines -- but most importantly in the noninvestment banking divisions -- would have positive rating implications. A failure to demonstrate the sustainability of sound earnings, particularly in its investment-banking division, would be considered negative. A significant increase in leverage would also have negative rating implications, including if litigation risk were to affect the bank's capital position significantly.

Deutsche Bank is increasingly eager to increase retail operations in emerging markets. If the bank were to embark on a major acquisition, such a transaction would have to be assessed in light of the impact on its financial profile, the strategic fit, and Deutsche Bank's track record in the respective markets.


Bank of Scotland (AA)

Halifax PLC (AA)


The stable outlook reflects HBOS' improved earnings capacity and balance-sheet strength. Overall asset quality will remain robust, underpinned by the mortgage book, but impairments will continue to rise due to the seasoning of recent lending and the general increase in U.K. retail delinquencies since the mid-2004 cyclical low. Core capitalization should remain stable, as more active capital management, including share buybacks, offsets increased retentions and slower asset growth. HBOS' rationale for the phased elimination of its pension deficit accords with S&P's view of the issue.

Sustained earnings growth and the maintenance of balance-sheet resilience through a more testing credit environment could have positive rating implications. The outlook could change to negative should asset quality indicators deteriorate significantly beyond current expectations. S&P expects that HBOS will continue to adjust its lending appetite according to its view of risk-adjusted returns, but the pace of future asset growth should be more consistent than it has been since the merger.

HSBC Holdings PLC (A+)



S&P expects HSBC to underpin its solid profitability and mitigate the risk of economic stress through its very strong earnings diversification and continuing organic earnings growth, although some markets are relatively mature or face difficult points in their business cycles. S&P doesn't expect HSBC to compromise its strong liquidity, healthy capitalization, and sound risk-management principles in order to chase growth.

The ratings could be raised within the next 12 to 18 months if HSBC demonstrates greater certainty regarding the quality and sustainability of HSBC Finance's earnings, and at the same time displays continued progress with earnings and franchise enhancement globally. The outlook could revert to stable if HSBC Finance exhibits structural declines in earnings quality or grows rapidly through additional acquisitions in volatile business classes, if risk charges jump dramatically at the group level, or if the risk profiles of the emerging-market operations deteriorate significantly.

ING Bank N.V. (AA)


The stable outlook reflects S&P's expectation that ING Bank will build on the tangible progress achieved in recent years. Although the pace of recent earnings growth will be very difficult to maintain, ING Direct should drive further improvements in profitability. The expansion of retail banking, refocusing of wholesale activities, and implementation of more proactive risk management will continue to benefit the bank's overall risk profile.

The priority given to efficiency improvements should help to offset the return of the provision charge to a more normal level. Core capitalization should remain broadly stable, as dividends and balance-sheet growth absorb retained earnings. As a core member of the ING Group, future rating actions on ING Bank would most probably be driven by developments across the overall group rather than purely within the bank. Rating changes aren't considered likely, but could result from a material positive or negative shift in the group's profitability or capitalization/leverage.

Lloyds TSB Bank PLC (AA)


The stable outlook reflects S&P's expectation that Lloyds TSB will build on the tangible progress achieved in the recent past. In particular, the outlook assumes that risk-adjusted profitability will remain strong, retained earnings growth will improve further, and core capitalization, according to S&P's measures, will strengthen.

A negative outlook could result if the expected growth in retained earnings and core capitalization doesn't materialize, or if there's an unexpectedly sharp rise in loan impairments. A positive outlook would require an immense improvement in balance-sheet strength, which S&P doesn't foresee over the rating horizon.

Nordea Bank AB (AA-)

Nordea Bank Finland PLC (AA-)

Nordea Bank Norge ASA (AA-)

Nordea Bank Denmark A/S (AA-)


The stable outlook reflects our expectation that Nordea will maintain its satisfactory profitability ratios through the business cycle with a more normalized level of loan losses, while maintaining its current low-risk profile. We expect progress in operational integration to continue in all business areas and tight control of operational costs to be maintained.

Moreover, the outlook reflects our expectation that Nordea will keep capitalization levels comfortably above its stated targets. Any unexpected change in the bank's prudent expansion strategy in Eastern Europe, a failure to contain costs, or a sharp deterioration in asset quality could have negative implications for the ratings.

Rabobank Nederland (AAA)


The stable outlook reflects S&P's expectation that Rabobank will continue to demonstrate a stable earnings performance, with low risk charges. The quality of capital isn't expected to erode further. Rabobank Nederland recently merged its Interpolis insurance operations with Achmea in exchange for an increase to 37% in its stake in Eureko B.V., Achmea's owner. This reflects Rabobank Nederland's search for opportunities outside its traditional core businesses, due to increased competition and limited growth prospects in Dutch financial services.

S&P will continue to monitor Rabobank Nederland's changing business structure, as it seeks to bolster its domestic profile and also grow selectively internationally. The ratings could come under pressure if the growing insurance and international components weaken future earnings quality, capitalization, and risk profile. Rabobank is expected to approach this diversification in a risk-averse manner, however.

Royal Bank of Scotland Group PLC (AA-)

National Westminster Bank PLC (AA)

Royal Bank of Scotland PLC (AA)


S&P expects that efficiency and overall asset quality will remain good (despite an upturn in U.K. personal-sector arrears), and that retained earnings generation will remain strong. This should enable a sustainable rebuilding of the adjusted common equity-to-risk-weighted assets ratio. The outlook could be revised to negative if core capital isn't rebuilt in line with expectations due to weaker-than-expected earnings generation or additional acquisitions.

S&P will also continue to monitor the financing and structuring of ongoing expansion, and its impact on risk and earnings. A positive ratings action would require continued delivery of superior profitability, in absolute terms and mix. RBSG's high leverage is likely to restrain the rating.

Societe Generale (AA-)


The positive outlook reflects the potential for an upgrade if SocGen can sustain the stronger operating profitability posted in 2004-05, while maintaining its strong balance sheet and focused strategy. This would require the expansion of the bank's growth platforms to compensate for any pressures on domestic retail revenues.

We also expect for 2006 a moderate increase in cost of risk; continued small to midsize acquisitions in retail businesses outside France; and a Tier 1 ratio of 7% to 7.5%, depending on the risk profile of the acquisitions. The outlook could be revised back to stable, however, if these expectations aren't met.

Standard Chartered Bank (A)


The positive outlook on SCB reflects its solid and growing earnings stream. This provides a steady source of capital generation, and should help SCB's capital ratios recover from their somewhat weakened position following the acquisition of Korea First Bank (now known as SC First Bank). The increased diversification of earnings over recent years means that SCB is no longer as sensitive to country-specific shocks. The outlook also reflects SCB's stronger strategic position, and the emerging benefits of the efficiency and investment programs of recent years.

In addition, SCB has proved itself adept at coping with sudden changes in its operating environment, having generally fared well with a variety of stresses over the past few years. An upgrade would be subject to sustained organic growth, broad stability in asset quality, a smooth integration of SC First, and a recovery in capital ratios. Negative ratings implications could arise from a significant increase in leverage or a reversal in organic growth.

Svenska Handelsbanken (AA-)


The stable outlook reflects S&P's expectation of sustained earnings capacity and very high efficiency, as well as a continued low level of problem loans and tight management of large credit exposures. Maintenance of satisfactory core capitalization measures will also remain one of the key factors for the ratings, particularly after the necessary capital injection made on January 2, 2006, for the demutualization of insurance unit SPP.

The outlook also assumes that progress will be made in risk and asset management and allocation techniques in the insurance operations, and that costs at SPP will continue to be reduced to allow the company to achieve sustainable administrative profitability. Failure to improve the earnings quality and balance-sheet strength of SPP could put some pressure on the ratings.



The stable outlook reflects S&P's expectation that UBS's performance will remain strong, although the powerful revenue growth achieved in the supportive environment of 2005 will be hard to match. Even if markets should descend into longer term retrenchment, however, the strength and diversity of the main business lines are expected to sustain earnings. Close management of lending underpins UBS's credit-risk profile, and a probable increase in value-at-risk is expected to be closely controlled and relatively modest in the context of group financial resources.

Core capitalization is expected to remain robust, with no material deviation from current ratio levels. Further bolt-on acquisitions are likely, but S&P doesn't expect a transformational deal. A deterioration in the stability and sustainability of earnings, or a marked increase in UBS's risk appetite or leverage, could have negative rating implications. Positive rating action is considered unlikely, given the sensitivity of revenues to financial market conditions.