March 7, 2017 / 4:29 AM / 7 months ago

Fitch Affirms Australia's Four Major Banks

(The following statement was released by the rating agency) SYDNEY, March 06 (Fitch) Fitch Ratings has affirmed the ratings of Australia's four major banking groups: Australia and New Zealand Banking Group Limited (ANZ); Commonwealth Bank of Australia (CBA); National Australia Bank Limited (NAB); and Westpac Banking Corporation (WBC). The Outlook on each bank's Long-Term Issuer Default Rating (IDR) is Stable. The rating review focuses on the Australian-domiciled entities within each group and therefore does not encompass their overseas subsidiaries. A full list of rating action can be found at the end of this commentary. KEY RATING DRIVERS VIABILITY RATINGS, IDRS AND SENIOR UNSECURED DEBT The Long- and Short-Term IDRs and Stable Outlook of all four banks are driven by their Viability Ratings and reflect their dominant franchises in Australia and New Zealand as well as increasing macroeconomic challenges. Stable, transparent and traditional business models have proven effective in generating strong and sustainable profitability, while the banks maintained a conservative risk appetite relative to international peers. Fitch believes the role of Australia's banking regulator is critical in the banks managing rising macroeconomic risks, such as historically high household debt, continued strong property price growth, low interest rates and subdued wage inflation. These risks could challenge banks' financial profiles in the medium-term if left unchecked. House price growth outstripped wage growth over the last three years, putting pressure on affordability. Low interest rates, tax policies and increasing foreign investor demand have contributed to strong house price growth and rising household debt. Measures taken by Australia's banking regulator have tightened the banks' risk appetite, as reflected in underwriting standards that ensure households can service their loans in a higher interest rate environment. New Zealand's banking regulator has also limited new business growth to certain loan/value ratio mortgages, which protects the banks' loss-absorption buffers. The four major Australian banks dominate their home markets. Their combined assets accounted for 80% of Australia's banking system assets at end-2016 and 87% of New Zealand's banking system assets at end-September 2016. This dominance provides scale benefits and allows the banks to generate solid returns with simple business models. Most of the banks' assets are loans to households and businesses and operations are domestically focused, with Australia and New Zealand accounting for 80%-96% of exposures at default at each bank's last financial reporting period end. Digital banking has become an increasingly important distribution and revenue generation channel and Fitch expects the banks to continue investing heavily in technology. Fitch expects the banks' risk appetite to remain tight. Underwriting standards are influenced by the regulator's intervention through the use of macro-prudential tools, while pricing is used to compete for business growth. Fitch sees investor mortgages, interest-only mortgages and broker-introduced mortgages as riskier due a higher probability of weaker performance through the credit cycle compared with owner-occupied mortgages originated through proprietary channels. Broker-introduced mortgages could also be more susceptible to application fraud due to the broker incentive structure. However, the banks retain all underwriting responsibility and regularly conduct hindsight and broker performance reviews, helping mitigate some of this risk. The banks' exposures to commercial real estate lending is manageable, accounting for between 6% to 9% of total exposure at default at the banks' respective last financial reporting period end. A small portion of these were classified development exposures. Exposure to inner-city apartment developments also appears manageable. Fitch considers this segment higher risk due to potential oversupply and large proportion of foreign buyers who are likely to find it more difficult to obtain credit following tighter mortgage underwriting by the Australian banks. Fitch expects the banks' asset quality to remain a strength relative to similarly rated international peers, although there may be some deterioration in 2017. Household exposures should continue to perform solidly absent any sharp increases in lending rates and weaker labour-market conditions. However, slow wage inflation could pose a risk, especially as most borrowers opt for variable rates and banks have passed on their funding cost increases. The banks' mining and agriculture portfolios have experienced some asset-quality pressure. However, combined exposures are small, accounting for between 3% and 5% of exposures at default. Improvements in commodity prices should support work-out positions. Fitch expects the banks' capitalisation to continue strengthening in light of the likelihood of higher prudential capital requirements. Internal capital generation is supported by strong profitability and can be boosted through dividend reinvestment plans - participation in these plans tends to increase significantly if a discount on the share price is applied. Fitch believes Australian banks are well-capitalised despite lower common equity Tier 1 ratios relative to international peers. This reflects the Australian regulator's tougher capital standards, which include higher minimum risk-weightings for residential mortgages through Pillar 1 and larger capital deductions. Funding remains a weakness relative to similarly rated international peers. Fitch expects the banks to continue relying on wholesale markets in the medium-term. This reflects a lack of deposits in Australia, partly due to the country's superannuation scheme. Wholesale funding made up 35%-42% of total funding, excluding derivatives and equity, at each banks respective 2016 financial year end. The banks are likely to improve funding by further reducing their reliance on short-term offshore wholesale markets and lengthening their maturity profiles. They are also likely to focus on attracting stable deposits, especially in preparation of the incoming net stable funding ratio regulation from January 2018. In addition, the banks' liquidity positions are solid, reflecting a significant increase in liquid assets to meet liquidity coverage ratio requirements. The banks' average quarterly liquidity coverage ratios have remained above 120%. The 2017 outlook for the banks' operating profit growth remains soft, with revenue growth to remain under pressure. Cost management will remain a focus, but could be affected by continued technology investment. Fitch expects impairment charges to continue rising from their cyclical lows. The banks' strategies focus on Australia's and New Zealand's more profitable market segments, especially residential mortgages and business banking. Growth in operations outside of these markets was contained in 2016. NAB successfully withdrew from the United Kingdom retail banking market and sold 80% of its life insurance business. ANZ's updated Asian strategy focuses on the institutional segment where ANZ has a competitive advantage. ANZ's strategy change also includes the exit of most of its Asian retail business, announced in October 2016, as well as the sale of its 20% stake in Shanghai Rural Commercial Bank in January 2017. The banks' senior unsecured debt ratings are driven by the same rationale as their Viability Ratings. SUPPORT RATING AND SUPPORT RATING FLOOR The banks' Support Ratings and Support Rating Floors reflect their systemic importance and an extremely high probability of support from Australian authorities, if needed. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES The ratings of the four major Australian banks' Tier 2 subordinated debt, both legacy and Basel III compliant instruments, are notched one level down from the Viability Ratings for loss severity. No notching has been applied for non-performance risk. Tier 1 hybrid capital instruments are notched five levels from the respective banks' Viability Ratings - two notches to reflect loss severity and three notches to reflect non-performance risk. This notching applies to both legacy and Basel III compliant instruments. RATING SENSITIVITIES VIABILITY RATINGS, IDRs AND SENIOR UNSECURED DEBT Rating upside for Australia's four major banks is limited due to their already high ratings, increasing macroeconomic risks and weaker funding profile relative to similarly rated international peers. Downside risks for the banks' Viability Ratings, IDRs and senior unsecured debt ratings include increasing macroeconomic challenges, a sharp slowdown in Chinese economic growth and deteriorating funding profiles. The ongoing rise in household debt and house-prices heightens the banks' sensitivity to a sharp housing correction if labour-market conditions and interest rates were to materially change. Pockets of Australia's property market may face oversupply due to a large number of newly built apartments being finalised over the next 12 to 18 months. Tighter credit conditions may mean some buyers cannot secure finance and settle their purchases. This could pose a risk to banks' financial profiles if settlement failure becomes widespread and leads to a meaningful house-price correction, particularly if combined with rising mortgage rates and weaker labour-market conditions. In addition, a worse-than-Fitch-expects slowdown in China's growth would slow Australia's economy and lead to higher unemployment given the countries' strong economic ties. This could pressure bank asset quality, profitability and capitalisation. Deterioration in the banks' funding and liquidity profiles could leave them susceptible to prolonged funding market dislocation, which could also place pressure on their ratings. SUPPORT RATINGS AND SUPPORT RATING FLOORS Fitch does not expect any change to the propensity of authorities to provide support despite global regulatory moves to limit implicit government support to banks. However, we do expect Australia's resolution framework to be strengthened in the medium term, which would potentially change our assumption around sovereign support. A change in the ability of Australian authorities to provide support, which is likely to be reflected in a downgrade of the Australian sovereign (AAA/Stable), may also result in a downgrade of the banks' Support Ratings and Support Rating Floors. However, this would not directly affect the banks' IDRs, which are driven by their Viability Ratings. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES Subordinated debt and hybrid instrument ratings are broadly sensitive to the same considerations that might affect the banks' Viability Ratings. The rating actions are as follows: Australia and New Zealand Banking Group Limited: Long-Term IDR affirmed at 'AA-'; Outlook Stable Short-Term IDR affirmed at 'F1+' Viability Rating affirmed at 'aa-' Support Rating affirmed at '1' Support Rating Floor affirmed at 'A' Senior unsecured long-term debt affirmed at 'AA-' Senior unsecured short-term debt affirmed at 'F1+' Market-linked debt affirmed at 'AA-emr' Subordinated debt affirmed at 'A+' Junior subordinated debt affirmed at 'BBB' Commonwealth Bank of Australia: Long-Term IDR affirmed at 'AA-'; Outlook Stable Short-Term IDR affirmed at 'F1+' Viability Rating affirmed at 'aa-' Support Rating affirmed at '1' Support Rating Floor affirmed at 'A' Senior unsecured long-term debt affirmed at 'AA-' Senior unsecured short-term debt affirmed at 'F1+' Subordinated debt affirmed at 'A+' National Australia Bank Limited: Long-Term IDR affirmed at 'AA-'; Outlook Stable Short-Term IDR affirmed at 'F1+' Viability Rating affirmed at 'aa-' Support Rating affirmed at '1' Support Rating Floor affirmed at 'A' Senior unsecured long-term debt affirmed at 'AA-' Senior unsecured short-term debt affirmed at 'F1+' Subordinated debt affirmed at 'A+' National Capital Trust I: Preferred stock (ISIN: XS0177395901) affirmed at 'BBB' Westpac Banking Corporation: Long-Term IDR affirmed at 'AA-'; Outlook Stable Short-Term IDR affirmed at 'F1+' Viability Rating affirmed at 'aa-' Support Rating affirmed at '1' Support Rating Floor affirmed at 'A' Senior unsecured long-term debt affirmed at 'AA-' Senior unsecured short-term debt affirmed at 'F1+' Market-linked debt affirmed at 'AA-emr' Subordinated debt affirmed at 'A+' Contact: Primary Analyst Andrea Jaehne (ANZ, CBA and WBC) Director +61 2 8256 0343 Fitch Australia Pty Ltd, Level 15, 77 King Street, Sydney NSW 2000 Tim Roche (NAB) Senior Director +61 2 8256 0310 Secondary Analyst Andrea Jaehne (NAB) Director +61 2 8256 0343 Tim Roche (ANZ, CBA and WBC) Senior Director +61 2 8256 0310 Committee Chairperson Mark Young Managing Director +65 6796 7229 Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: leslie.tan@fitchratings.com. 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