Fitch Ratings has upgraded Ping An Bank Co., Ltd.'s (PAB) Viability Rating (VR) to 'b+' from 'b'.

At the same time, Fitch has affirmed PAB's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BB+', Government Support Rating (GSR) at 'bb+' and Short-Term IDR at 'B'. The Outlook is Stable. The assigned VR is in line with the implied VR but does not drive its IDRs.

The upgrade of PAB's VR is driven by our assessment that, like other similarly sized banks in China, its intrinsic credit profile has benefitted from regulatory developments in recent years, resulting in a reduction in its off-balance-sheet activity as well as a moderating risk appetite. These were factors we had identified as potential outcomes at the time we raised our operating environment (OE) assessment to 'bbb-' in 2021 from 'bb+'.

Key Rating Drivers

Government Support-Driven IDR: The bank's Long-Term IDR is driven by our assessment of a moderate probability of government support, as expressed by the assigned GSR at 'bb+'. This takes into consideration the bank's size and modest domestic systemic importance. The bank does not have direct state ownership or a history of direct government support. PAB's 'B' Short-Term IDR is mapped to its Long-Term IDR.

Differentiation in D-SIB Status: China's regulators designated PAB a domestic systemically important bank (D-SIB) in October 2021, but we believe D-SIB designation alone may not materially affect the government's propensity to support PAB to the same extent as peers with higher systemic importance or closer government linkages. This is because the government is likely to prioritise support for larger D-SIBs in the event China's banking system experiences systemic stress.

Stable OE: We expect China's economic growth to recover in 2023 as Covid-19 restrictions have been lifted, which will support consumption. Our 'bbb-'/stable OE score is above the 'bb' category implied score, as we believe China's robust external finances and a record of stable economic performance, which are incorporated in the Chinese sovereign rating, will provide greater financial and economic stability than the implied OE score indicates.

Improving Franchise: The upward revision of PAB's business profile score to 'bb+' from 'bb' reflects the improvement in its franchise for retail deposits, which rose to 31% of total deposits by end-2022 from 24% at end-2019. Still, the score is still lower than the 'a' implied category score. This reflects issues over management and governance that are not uncommon in China, given pressure from the authorities to support segments of borrowers during challenging times, similar to most Chinese banks rated by Fitch, as well as its large exposure to shadow-banking activity and unsecured consumer lending

Reduction in Shadow-Banking Activity: We revised both PAB's risk profile and asset-quality scores to 'b+' from 'b' to reflect the reduction in its shadow-banking activity, in line with the regulatory tightening enforced by China's authorities, and its non-performing loan (NPL) resolution in recent years. PAB's off-balance-sheet wealth-management products (WMPs) declined to around 26% of deposits by end-2022 from 29% at end-2021. Its entrusted investments, at around 6% of total assets, remained below the mid-tier average of 9% at end-2022.

That said, PAB's 'b+' asset-quality score is below the 'bbb' category implied score due to its higher loan growth appetite than peers and large exposure to unsecured consumer lending (36% of total loans), which could leave its asset quality more susceptible to deterioration in an economic downturn. Still, its reported impaired-loan ratio was largely stable at 1.6% in 2022 due to its active NPL resolution.

Consumer Focus Supports NIMs: PAB's earnings and profitability score of 'b+' is below the 'bb' category implied score to reflect understatement in its risk-weight calculations due to its high non-loan exposures. The bank's reported net interest margin (NIM) of 2.8% was higher than the mid-tier average of 2.0% in 2022 in light of its unsecured consumer lending focus, but this was partly offset by its high impairment charges. We expect the bank to report a stable operating profit/risk-weighted asset ratio (1.5% in 2022) over the next two years.

Growth Appetite Pressures Capitalisation: PAB's capitalisation and leverage score of 'b' is below the 'bb' category implied score to also reflect the understatement of the bank's risk-weight calculations from its high non-loan exposures. Its reported common equity Tier 1 (CET1) ratio was 8.9% at end-1Q23, below the mid-tier bank average. We expect the bank's growth appetite will continue to pressure its capitalisation.

Non-Deposit Funding: The upward revision of PAB's funding and liquidity score to 'bb-' from 'b+' considers its improving retail deposit contribution to total deposit funding, which takes advantage of its online capability and cooperation with its parent, Ping An Insurance Group. However, the score is still below the 'bbb' category implied score, given PAB's reliance on non-deposit funding, similar to most other Chinese banks.

Its high off-balance-sheet exposure may understate its reported loan/deposit ratio (LDR) and strain its on-balance-sheet funding, despite a relatively stable Fitch-calculated LDR of 100% at end-2022. We expect the ratio to increase modestly in the next few years.

Rating Sensitivities

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

The bank's Long-Term IDR and GSR will come under pressure if Fitch perceives that the central government's propensity and/or ability to provide timely extraordinary support to the bank has diminished. For example, a sovereign rating downgrade could reflect diminished ability to support. Lower propensity may also be reflected through an enhanced resolution framework and strong intention by the authorities to permit losses on senior debt obligations as a means of resolving banks, though we do not expect either scenario to occur in the near term.

PAB's Short-Term IDR will be downgraded if its Long-Term IDR is downgraded to or below 'CCC+', which we think is highly unlikely in the short-to-medium term.

PAB's VR could be downgraded if the OE score is downgraded or if the bank resumes aggressive growth in its off-balance-sheet WMPs or entrusted investments, or there is excessive growth in credit-card receivables, especially if accompanied by lower underwriting standards or significant deterioration in household affordability, which would lead to a sustained deterioration in the bank's financial metrics, including a combination of the following reported core metrics without having largely addressed perceived risks around transparency of exposures, including off-balance-sheet and non-loan transactions:

The four-year average of the impaired loan/gross loan ratio increasing to and sustained at around 8% (2019-2022 four-year average of 1.4% on a reported basis), although Fitch's assessment of asset quality will also consider other indicators, such as 'special-mention' loans, loan loss provisioning, and whether (and to what extent) we believe reported metrics understate any deterioration in asset quality; and

The CET1 ratio falling below 8% without a credible path to return to existing levels.

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

An upgrade of China's sovereign ratings could lead to positive rating action on the bank's GSR and its support-driven IDRs if that were to indicate greater ability to support PAB, with no less propensity to support.

PAB's Short-Term IDR would be upgraded if its Long-Term IDR is upgraded.

An improvement in PAB's capitalisation such that its CET1 ratio is maintained at around 10% or above in conjunction with a further reduction in risk appetite and greater transparency in asset-quality metrics would be positive for its VR assessment.

OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS

PAB's IDRs (xgs) are driven by its VR. The Long-Term IDR (xgs) has been upgraded to 'B+(xgs)' from 'B(xgs)' following the upgrade of the VR, while the Short-Term IDR (xgs) has been affirmed at 'B(xgs)'.

OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative rating action/downgrade:

The bank's Long-Term IDR (xgs) could be downgraded if the VR is downgraded. The Short-Term IDR (xgs) could be downgraded if the VR is downgraded below 'b-'.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

The bank's Long-Term IDR (xgs) could be upgraded if the VR is upgraded. The Short-Term IDR (xgs) could be upgraded if the VR is upgraded above 'bb+'.

VR ADJUSTMENTS

The OE score of 'bbb-' has been assigned above the 'bb' category implied score due to the following adjustment reason: sovereign rating (positive).

The business profile score of 'bb+' has been assigned below the 'a' category implied score due to the following adjustment reason: management and governance (negative) and business model (negative).

The asset quality score of 'b+' has been assigned below the 'bbb' category implied score due to the following adjustment reason: non-loan exposure (negative) and underwriting standards and growth (negative).

The earnings and profitability score of 'b+' has been assigned below the 'bb' category implied score due to the following adjustment reason: risk-weight calculations (negative).

The capitalisation and leverage score of 'b' has been assigned below the 'bb' category implied score due to the following adjustment reason: leverage and risk-weight calculation (negative).

The funding and liquidity score of 'bb-' has been assigned below the 'bbb' category implied score due to the following adjustment reason: non-deposit funding (negative) and deposit structure (negative).

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579

Sources of Information

The principal sources of information used in the analysis are described in the Applicable Criteria.

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.

Public Ratings with Credit Linkage to other ratings

PAB's IDRs are directly linked to China's sovereign ratings.

ESG Considerations

PAB has an ESG Relevance Score of '4' for Financial Transparency as there are still structural issues around financial transparency and disclosure. These are not captured in headline performance metrics in China and affect our assessment on the OE as well as the financial profile. PAB, like other mid-tier banks, is more exposed to this risk relative to state banks, due to its larger exposure to WMPs and entrusted investments stemming from the use of off-balance-sheet transactions. This has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This 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. For more information on Fitch's ESG Relevance Scores, visitwww.fitchratings.com/esg

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