(The following statement was released by the rating agency) Fitch Ratings-Sydney-January 31: Fitch Ratings has affirmed Westpac Banking Corporation's (WBC) Long-Term Issuer Default Rating at 'AA-' as part of the annual review of Australia's four largest banking groups. The Outlook is Negative. All other WBC ratings have also been affirmed. The review does not encompass WBC's covered bond issuance or its overseas subsidiaries. Westpac Banking Corporation; Long Term Issuer Default Rating; Affirmed; AA-; RO:Neg ; Short Term Issuer Default Rating; Affirmed; F1+ ; Viability Rating; Affirmed; aa- ; Support Rating; Affirmed; 1 ; Support Rating Floor; Affirmed; A ----senior unsecured; Long Term Rating; Affirmed; AA- ----subordinated; Long Term Rating; Affirmed; A+ ----junior subordinated; Long Term Rating; Affirmed; BBB ----senior unsecured; Short Term Rating; Affirmed; F1+ Key Rating Drivers IDRS, VIABILITY RATING AND SENIOR DEBT WBC's IDRs, Viability Ratings and senior debt ratings are underpinned by the bank's strong company profile, which drives its healthy asset quality and also supports other financial metrics. Meanwhile, its Outlook remains Negative reflecting the ongoing remediation processes to rectify issues identified in its culture, governance and accountability self-assessment and by the regulator. There is the potential for missteps during this process and may also detract management focus from its core businesses, which could lead to weakening in its profitability relative to domestic peers and ultimately impair its franchise. Federal government agency AUSTRAC's proceedings have revealed more weaknesses in WBC's risk controls and there could be more issues identified from the bank's external accountability and financial crime programme review. This indicates weaker governance of operational risk management than we had previously factored into our assessment of risk appetite and the remediation process is likely to take time and could be complex. The risk of missteps in this process, which leave Westpac at a disadvantage relative to domestic peers, contributed to Fitch revising the outlook on the risk appetite mid-point to negative from stable. WBC's strong company profile remains one of its main strengths and will continue to provide the bank with a moderate degree of pricing power in its key segments, which in turn should support its asset quality, earnings and profitability and capitalisation and leverage through the cycle. It also underpins WBC's funding profile, particularly in relation to its deposit base. WBC's asset quality is expected to remain sound in 2020, although minor deterioration is possible reflecting the challenges in certain sectors, including retail and agriculture. It has shown a very high level of stability in recent years especially its housing loans, which accounted for approximately 69% of its total loans at September 2019. We believe significant credit loss is unlikely in the absence of an economic shock, which is not Fitch's base case. Fitch expects the bank's profitability to remain satisfactory in 2020, although there could be continued pressure on costs especially from large one-off items. Nevertheless, we believe the bank's underlying profit will be supported by its sound margin management, low impairment charges and stringent cost control. Investment in systems and regulatory compliance could also remain elevated, but may be partly offset by savings from its productivity initiatives. WBC's capital position has been strengthened during 2019, driven largely by the AUD2.8 billion capital raising in late 2019. Fitch expects WBC's capital position to remain stable through 2020, reflecting the bank's sound retained earnings generation and moderate growth in risk-weighted assets. Large one-off expenses could continue to affect its capital ratios in 2020, but we expect these impacts to be manageable for WBC. WBC's reliance on offshore wholesale funding is a weakness compared with similarly rated international peers. However, its strong deposit franchise continues to support its funding profile and provide a stable source of long-term funding. WBC's liquidity management remains sound and its ample liquidity holdings help to mitigate this risk. SUPPORT RATING AND SUPPORT RATING FLOOR WBC's Support Rating and Support Rating Floor reflect its systemic importance, as highlighted by its market share and potential for contagion risk in a stressed environment. As a result, there is an extremely high probability of support from Australian authorities, if needed. The Support Rating Floor also reflects a record of sovereign support in the past, including the government guarantee provided to senior bond holders during the financial crisis of 2008. This is further reinforced by the regulatory approach to loss-absorbing capacity, which does not allow for a senior bail-in instrument. The additional loss-absorbing capital requirement is to be met through existing capital instruments, such as Tier 2 subordinated notes. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES The ratings on WBC's Tier 2 subordinated debt are notched down one level from the Viability Rating for loss severity. No notching has been applied for non-performance risk. Tier 1 hybrid capital instruments are notched down five levels from WBC's Viability Rating - two notches to reflect loss severity and three notches to reflect non-performance risk. RATING SENSITIVITIES IDRS, VIABILITY RATING AND SENIOR DEBT We could downgrade WBC's IDRs, Viability Rating and senior debt ratings if the ongoing remediation processes fail to rectify the deficiencies in its risk controls, especially in relation to financial crime and regulatory compliance. This could lead to significant, prolonged reputational damage and keep management's focus away from its core businesses, resulting in a weakening in earnings relative to peers in the short-term and impairment in the franchise in the longer term. The ratings could also be pressured by evidence of failure in credit or market risk management. A sharp rise in the unemployment rate or significant decline in economic growth in Australia is likely to affect WBC's financial profile and could lead to asset quality no longer commensurate with its current mid-point of 'aa-'. This would in turn pressure profitability (mid-point of 'aa-') and potentially affect the bank's capitalisation and leverage, which has a mid-point of 'a+'. A significant deterioration in the bank's asset quality could be triggered by an external economic shock, including a sharp slowdown in China or financial market downturn caused by geopolitical events, although this is not Fitch's base case. The bank's asset quality is also susceptible to a material weakening in the Australian housing market, although we do not expect this to occur. There could be downward pressure on WBC's ratings should the bank's earnings come under sustained structural pressure, possibly caused by changes in industry and competitive dynamics. This may lead to reduced earnings retention, negatively affecting our view on capitalization. Alternatively, risk appetite may increase in response to such pressure, which would also likely result in more volatile asset quality through a cycle. There is limited buffer for weakened funding and liquidity metrics as the factor mid-point at 'a' is already two notches below WBC's Viability Rating. A weakening in the bank's funding and liquidity profile could increase its susceptibility to a dislocation in funding markets and result in a downgrade. WBC's company profile could be pressured by increased competition, particularly from the digital space, if it is not appropriately managed. This could in turn weaken WBC's market share and earnings. However, we believe this risk is unlikely to emerge in the short to medium term. WBC's Outlook may be revised to Stable if the bank is able to strengthen its governance of operational and compliance risks without a substantial impact on the ongoing business and earnings. The required changes could take several years to implement, but Fitch may opt to revise the Outlook earlier if the AUD1 billion operational risk charge is reduced or removed by the regulator, as it would indicate significant progress on remediation. However, we believe it is unlikely to occur in the next 12 months in light of the recent AUSTRAC proceedings. SUPPORT RATING AND SUPPORT RATING FLOOR A weakening in the propensity for the authorities to provide support may result in Fitch lowering the Support Ratings and Support Rating Floors of the major banks. A change in the ability of authorities to provide support, which is likely to be reflected in a downgrade of Australia's sovereign rating (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 may affect the banks' Viability Ratings. The instrument ratings may also be impacted due to changes proposed in Fitch's recently published Exposure Draft: Bank Rating Criteria (November 2019). ESG Considerations Unless otherwise disclosed in this section, the highest level of environmental, social and governance (ESG) credit relevance is a score of 3 - 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. WBC has an ESG relevance score of 5 for governance structure risk due to shortcomings in the bank's oversight of operational and compliance risks which has contributed to a number of conduct and cultural issues in recent years. Remediation of these issues is a complex and timely process which could distract management from ongoing operations and ultimately result in a weakening of WBC's credit profile relative to peers. This is highly relevant to the Negative Outlook on the Issuer Default Rating, which was revised from Stable in July 2019. WBC also has an ESG relevance score of 4 for customer welfare risk, reflecting the conduct and cultural issues mentioned in the previous paragraph. This negatively affects the bank's credit profile and is relevant to the rating in conjunction with other factors. Contacts: Primary Rating Analyst George Hong, Director +61 2 8256 0345 Fitch Australia Pty Ltd Level 15 77 King Street Sydney NSW 2000 Secondary Rating Analyst Tim Roche, Senior Director +61 2 8256 0310 Committee Chairperson Heakyu Chang, Senior Director +822 3278 8363
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