Switzerland-Based Luzerner Kantonalbank's Proposed Additional Tier-1 Capital Notes Rated 'BBB'

FRANKFURT (S&P Global Ratings) April 15, 2019--S&P Global Ratings said today that it has assigned its 'BBB' issue rating to the additional tier-1 (AT1) capital notes to be issued by Luzerner Kantonalbank (LUKB; AA/Stable/A-1+).
In accordance with our criteria for hybrid capital instruments ("Bank Hybrid Capital And Nondeferrable Subordinated Debt Methodology And Assumptions," published Jan. 29, 2015, on RatingsDirect), the 'BBB' issue rating reflects our analysis of the proposed instrument and our assessment of LUKB's 'a+' stand-alone credit profile (SACP). We use the SACP as starting point for assigning the issue rating because we consider that the bank's majority shareholder, the Canton of Lucerne, would not support payments on the proposed notes. The bank's subordinated debt is specifically excluded from the statutory guarantee granted by the Canton of Lucerne.
The issue rating stands four notches below the SACP, due to the following deductions:
  • One notch because of the notes' contractual subordination;
  • Two notches reflecting the notes' discretionary coupon payments and regulatory tier-1 capital status; and
  • One notch because the notes contain a contractual write-down clause, which would be triggered if the Swiss government, the Swiss central bank, or the Canton of Lucerne were to provide extraordinary support to LUKB to prevent it from becoming nonviable.
The proposed instrument contains a write-down trigger if LUKB's common equity tier-1 (CET1) ratio falls below 5.125%. We consider such a CET1 ratio as a gone-concern trigger, which does not increase default risk further. Therefore, we do not apply additional notching. The bank reported a 14.28% CET1 ratio under the Swiss regulatory requirements, calculated on a Basel III phased-in basis as of December 2018.
Once the securities have been issued and confirmed as part of the issuer's tier-1 capital base, we expect to assign them intermediate equity content. This reflects our understanding that the notes are perpetual, regulatory tier-1 capital instruments that have no step-up. The payment of coupons is fully discretionary and the notes can additionally absorb losses without causing a default of the bank through the write-down feature. It is noteworthy that the expected increase in LUKB's capitalization will not enhance our already very strong assessment of the bank's capital and earnings.
We note that the proposed AT1 issuance includes a so-called dividend stopper, whereby if there is a deferral of interest on the proposed issue, LUKB is prohibited from making dividend payments on or repurchasing common stock until the arrearage, if any, has been cured and payments resume. We generally view such a stipulation as a neutral factor from a rating perspective.
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