Fitch Ratings has affirmed SpareBank 1 SMN's (SMN) Long-Term Issuer Default Rating (IDR) at 'A' with a Stable Outlook.

Fitch has also affirmed SMN's Viability Rating (VR) at 'a'. A full list of rating actions is below.

Key Rating Drivers

Low-Risk Regional Bank: SMN's ratings reflect its stable and low-risk business model, strong profitability, resilient asset quality, robust capital adequacy and well-managed wholesale funding reliance. The ratings also factor in SMN's regional and overall moderate franchise in Norway, which leads to a geographically-concentrated loan portfolio.

Strong Franchise in Central Norway: SMN is the market leader in central Norway, with a well-established regional franchise and a strong relationship with the local community. SMN's membership of the SpareBank 1 Alliance (the second-largest financial group in Norway) provides greater product breadth, economies of scale and access to cheap covered bond funding. The SpareBank 1 Alliance is the second-largest lender in Norway, with about a 20% market share in lending.

Conservative Risk Profile: SMN has a strong risk-management culture, with a conservative attitude to credit risk, underpinned by prudent domestic regulations. SMN's credit risk mainly resides in its loan book (about 70% of assets at end-September 2023). Lending is mainly secured, with prudent loan-to-value ratios. SMN's investment guidelines are conservative and its debt portfolio comprises highly-rated and liquid bonds. The bank's credit expansion has been restrained and balanced between the retail and corporate segments.

Resilient Asset Quality: SMN's low levels of impaired assets and limited credit losses over economic cycles, conservative underwriting and a loan book dominated by resilient residential mortgage loans offset the bank's regional concentration risk. SMN's asset-quality metrics compare well with Nordic and international peers, but they are weaker than highly-rated Swedish banks.

We expect asset quality to remain strong and to be only modestly affected by the economic downturn, rising interest rates and inflation. Fitch expects the bank's impaired loans (Stage 3) ratio to modestly increase to a low 1.5% at end-2024.

Strong Profitability: SMN's stable revenue benefits from its close relationships with the local community, healthy margins, low funding cost, and diversified fee and commission income, which to a large extent is sourced from non-banking activities. Cost efficiency is superior compared with international standards, despite the bank's small size, and is underpinned by strong automation and digitalisation.

SMN's profitability is also supported by low loan impairment charges (LICs). We expect the operating profit/risk-weighted assets (RWAs) to remain strong at 3.6% in 2024 due to higher net interest and fee income, offsetting higher operating expenses and higher LICs.

Robust Capital Adequacy: SMN's high risk-weighted capital and leverage ratios are underpinned by its low risk profile, stable asset quality and healthy internal capital generation. We also consider the bank's only moderate capital base compared with highly-rated Nordic peers. At end-September 2023, SMN's common equity Tier 1 ratio of 19.7% was above its recently revised minimum of 17%, which includes a temporary Pillar II add-on of 70bp and 125bp Pillar 2 guidance.

Low Refinancing Risk: SMN's solid funding profile benefits from a stable deposit base and prudently managed refinancing risk. Like most Nordic banks, SMN relies on wholesale funding, in particular covered bonds issued through SpareBank 1 Boligkreditt (S1B), a joint covered-bond funding vehicle for member banks of the SpareBank 1 Alliance. The bank maintains strong coverage of short-term liabilities with good quality, unencumbered liquid assets.

Rating Sensitivities

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

SMN's ratings have sufficient headroom to absorb significant deterioration in the bank's financial profile. We could downgrade SMN's ratings if severe economic stress durably reduced its operating profit/RWAs close to or below 1.5% and the impaired loans ratio rises above 3% on a sustained basis.

SMN's structural reliance on wholesale funding means an unmitigated weakening of access to capital markets would also be negative for its ratings.

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

An upgrade is unlikely in the medium term unless SMN has a significant nationwide strengthening of its franchise while maintaining a low-risk profile and strong financial metrics.

OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS

Short-Term IDR

SMN's Short-Term IDR of 'F1' is the lower of the two options that map to a Long-Term IDR of 'A', driven by SMN's funding and liquidity score of 'a-'.

Deposits and Senior Debt

SMN's long-term senior preferred debt and deposit ratings are one notch above the bank's Long-Term IDR. This reflects the protection that we expect will accrue to deposits and senior preferred debt from the bank's junior resolution debt and equity buffers. We expect SMN's resolution debt buffer to remain comfortably above 10% of resolution-relevant RWAs in the long term, adjusted for S1B and SpareBank 1 Naeringskreditt, which are excluded from SMN's resolution strategy. At end-September 2023, we estimate this buffer equalled 17% of SMN's resolution-relevant RWAs.

SMN's short-term senior preferred debt and deposit ratings are mapped to their respective long-term ratings and also reflect our assessment of the bank's funding and liquidity at 'a-'.

No Government Support: SMN's Government Support Rating (GSR) of 'No Support' reflects Fitch's view that senior creditors cannot rely on receiving full extraordinary support from the sovereign if the bank becomes non-viable, given Norway's adoption of the EU's Bank Recovery and Resolution Directive. This legislation provides a framework for resolving banks that requires senior creditors to participate in losses, if necessary, instead of or ahead of a bank receiving sovereign support.

Fitch believes that being a member of the Sparebank 1 Alliance may result in SMN being supported by other Alliance members, but this is not an obligation, and is therefore not factored into the ratings.

OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES

The Short-Term IDR is sensitive to changes in SMN's Long-Term IDR and the funding and liquidity score.

The senior preferred debt ratings and the deposit ratings are sensitive to changes in the bank's IDRs. They are also sensitive to SMN maintaining a buffer of senior non-preferred and more junior debt of at least 10% of resolution-relevant RWAs, or could be downgraded otherwise.

An upgrade of the GSR would be contingent on a positive change in Norway's propensity to support domestic banks. While not impossible, this is highly unlikely in Fitch's view.

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 & leverage score of 'a' is below the 'aa' category implied score due to the following adjustment reason: size of capital base (negative).

The funding & liquidity score of 'a-' is above the 'bbb' category implied score due to the following adjustment reasons: non-deposit funding (positive), liquidity coverage (positive).

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

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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