Fitch Affirms Lombard Odier at 'AA-'; Outlook Stable
Lombard Odier is the unlimited liability holding company that owns the main operating entities of the Lombard Odier Group. The rating actions are part of Fitch's periodic review of Swiss private banks.
KEY RATING DRIVERS
IDRS AND VR
Fitch views Lombard Odier's strong franchise as one of Switzerland's largest independent private banks as one of two factors of higher importance in assessing the bank's IDR and VR. Its franchise is diversified geographically across Switzerland, European onshore markets and Asia. However, as the bank focuses on a limited number of key operating segments (predominantly wealth management) we view the upside for its VR as limited.
Lombard Odier focuses on offering long-term wealth planning solutions to its clients. The bulk of its resilient earnings are generated by its wealth management division, which we expect to have sufficient critical scale to withstand industry-wide cost and revenue pressures. At end-2015, the group's assets under management (AuM) stood at CHF132bn, excluding double counting. The group also benefits from its technology and banking services division, which provides selected banking peers with access to Lombard Odier's IT platform and capabilities. The group saw strong growth in administered assets last year, reaching CHF59bn at end-2015.
The investment management division is not a major contributor to the group's profitability, but it complements the private banking offering and we expect it to develop its franchise, which is historically rooted in selected strengths, including convertibles.
We also view the group's low risk appetite as being of higher importance, which we expect it to maintain over the medium term. As a private bank, on-balance sheet credit exposures are limited and relate to an investment portfolio of highly liquid securities, largely sovereign and supranational debt, and to Lombard lending. The latter relates to lending to private banking clients collateralised by securities portfolios, and while it has seen strong growth (24% yoy to CHF2.6bn at end-2015), it remains small overall. While further controlled growth in Lombard lending is likely, as the bank seeks to offset margin pressure amid low interest rates, we expect risk controls and underwriting standards to remain strong.
Given its private banking focus and as for most of its peers, we continue to view operational risk as a key risk for Lombard Odier, despite the settlement and non-prosecution agreement reached with the US Department of Justice as part of the Swiss bank programme. The investigation was settled in December 2015 and resulted in a USD99.8m fine for Lombard Odier.
While this fine had already been fully provisioned for, it removed a considerable source of uncertainty for the group. Nonetheless, we expect operational risk controls to be strengthened as part of ongoing investments in data reporting systems ahead of the implementation of automatic exchange of information.
Market risk is low and well-controlled. The group's equity securities in the trading portfolio relate to the certificates business, which provides private banking clients with equity-linked securities, whose market risk is fully borne by the client.
Management has been stable, with strong succession planning in place. The bank is owned and managed by six partners, who have been successful in implementing the group's long-term strategy. However, this structure has resulted in some weaknesses in transparency and corporate governance.
Performance remains strong and stable although it is burdened by a high cost base, reflecting high personnel expenses for the industry, and the bank, and also non-recurring legal costs in 2015. Delivering on cost savings will be an important driver of profitability, given the group's high cost/income ratio and pressure from a greater proportion of operating expenses relative to revenues denominated in a strong CHF. Resilient net commission income helped sustain a 4% yoy increase in group revenues to CHF1.1bn in 2015, as did disciplined management of net interest income in a negative rate environment.
We view Lombard Odier's capitalisation as sound, as regulatory capital consisted exclusively of Common Equity Tier 1 (CET1) capital and covered a fairly high 25.7% of risk-weighted assets at end-2015, providing the group with a solid buffer of around CHF535m over minimum regulatory requirements. This partly mitigates the group's small capital base in absolute terms, as CET1 capital stood at CHF1bn at end-2015. We expect the group to maintain strong capital ratios, but judge that its current capitalisation leaves some room for reinvestment or bolt-on acquisitions. The large proportion of liquid, mainly short-term assets supports the group's strong liquidity profile.
The ratings factor in the absence of holding company double leverage and the strong fungibility of capital and liquidity across the group's operating entities, subject to regulatory limits. Our assessment of double leverage also takes into account the absence of external debt and the resulting low likelihood of cash flow mismatches.
SUPPORT RATING AND SUPPORT RATING FLOOR
Lombard Odier's Support Rating and Support Rating Floor reflect our view that support from the Swiss authorities cannot be relied on, primarily because of the group's low systemic importance. The group caters to an affluent international client base and does not have a retail deposit franchise in Switzerland. Should Lombard Odier require extraordinary support, we expect it to be provided from the partners' private wealth, but such support is not factored into our ratings.
RATING SENSITIVITIES
IDRS AND VR
The Stable Outlook reflects our expectation that the group will implement its cost reduction programme successfully and that its conservative risk appetite and strong capitalisation will remain unchanged.
A failure to improve operating efficiency would put pressure on the group's ratings as would structural deterioration in the group's performance, which could arise from a loss of franchise.
A material increase in risk appetite, which could be indicated by significant investments in less creditworthy securities, or rapid loan growth, or significant changes in underwriting standards, would also put pressure on Lombard Odier's ratings.
Given the relevance of operational risks for private banks and despite the resolution of the largest legal case to date for the group, any outsized operational or litigation loss that durably dents capitalisation without credible plans to restore it swiftly would also result in a rating review. While we expect Lombard Odier to grow prudently and maintain sound capital ratios, a material acquisition that would introduce execution risks or weaken capitalisation could lead to a downgrade.
As the ratings are assigned to the holding company, they are also sensitive to the build-up of double leverage at the holding company or changes to the fungibility of capital within the group.
Given Lombard Odier's high ratings relative to peers and challenges facing the sector, upside remains limited.
SUPPORT RATING AND SUPPORT RATING FLOOR
An upgrade of Lombard Odier's Support Rating and an upward revision of the Support Rating Floor is unlikely, given the group's low systemic importance.
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