Fitch Revises Outlook on Macquarie Group and Australian Subsidies to Negative on Coronavirus Risk

(The following statement was released by the rating agency) Fitch Ratings-Sydney-25 May 2020: Fitch Ratings has revised the Outlook to Negative, from Stable, on the Long-Term Issuer Default Ratings (IDR) of Macquarie Group Limited (MGL) and its Australian subsidiaries, Macquarie Bank Limited (MBL), Macquarie Financial Holdings Pty Limited (MFHL) and Macquarie International Finance Limited (MIFL). At the same time, Fitch has downgraded MBL's Tier 2 debt rating to 'BBB+', from 'A-', and has removed the rating from Under Criteria Observation. All other ratings of the entities have been affirmed. Key Rating Drivers ISSUER DEFAULT RATINGS, VIABILITY RATINGS AND SENIOR DEBT MBL is the group's main operating subsidiary; the bank's Issuer Default Ratings (IDR), Viability Rating (VR) and senior debt rating are underpinned by strong risk-management, sound liquidity and solid capitalisation. These factors offset the greater level of complexity and risk appetite relative to Australian retail banks and a higher reliance on wholesale funding compared with international peers. MGL is the group's non-operating holding company and its IDRs, VR and senior debt rating are driven by similar factors as apply to MBL, although the starting point for the ratings is the group's consolidated risk profile. Fitch aligns MGL's ratings with the consolidated group assessment to reflect moderate common equity double leverage (MGL limits this to 110%) and sound liquidity management. Fitch rates MBL one notch higher than MGL, as we believe the risk profile of the main operating bank is better than the group's overall consolidated risk profile. We believe the creditors of the main operating bank are ringfenced from developments in other parts of the group due to the strong preference of Australian authorities to prioritise bank depositors over investors in other parts of the group. This is evident from more onerous regulatory restrictions on dividends and liquidity transfers from MBL. Meanwhile, MGL has large non-banking operations, through MFHL, which are subject to lower regulatory scrutiny than MBL's operations. The Negative Outlook on MBL and MGL reflects the significant uncertainty posed by the coronavirus pandemic-led economic downturn. This has resulted in Fitch revising the outlook on the entities' operating environment factor scores (MGL: a+, MBL: aa-) to negative. We expect the uncertainty to pressure asset quality and earnings, which may result in one or both metrics no longer being consistent with current rating levels; outlooks on these factor scores have also been revised to negative. We believe capital buffers are sufficient to withstand a significant downturn at the current factor score of 'a' and have retained a stable factor outlook, although capitalisation is likely to come under pressure due to weaker asset quality and earnings. Our base and downside cases are outlined in, Fitch Ratings Coronavirus Scenarios: Baseline and Downside Cases, at www.fitchratings.com/site/re/10120570 and, Global Economic Outlook: Crisis Update Late April 2020 - Coronavirus Recession Unparalleled, at www.fitchratings.com/site/re/10119280 The group's appetite for risk is generally larger than at most retail-focused Australian banks, but this is managed well through a strong risk-management framework and risk controls, while geographic and business diversity also provides an offset. Underwriting standards and investment criteria are generally in line with that of domestic peers, although greater exposure to commercial lending and market businesses contribute to greater variability in asset quality through a cycle. Growth can also be volatile compared with domestic peers given the nature of the business model; asset growth was over 30% in the financial year ended March 2020 (FY20), driven by increased derivatives exposure and growth in Australian residential mortgages. The latter has a focus on loan/value ratios of below 70%, which should reduce overall risk within the loan book. The group's lending exposure to corporate and commercial entities, in addition to the significant shock to employment from economic shutdowns, is likely to increase impaired loans. These may take six to 12 months to emerge and are then likely to take time to resolve. The size of the increase will ultimately depend on the length and severity of the shutdowns, the efficacy of government support measures and the subsequent impact on economic growth. Non-loan assets are large - making up over 60% of assets at FYE20 - and could also face pressure. Allowances for losses were increased as part of the FY20 results, but there is risk of further charges. This risk, combined with low rates and slow system loan growth, is likely to pressure earnings over the next two years. The large non-loan exposure contributes to a significant portion of income from non-interest sources. Some of this, such as base fees from asset management, should be more resilient in the current environment, although deal-related fee and trading income may be more variable. These income sources contribute to the greater earning variability of MGL and MBL relative to other, more retail-oriented, Australian banks. Capital buffers improved in FY20, leaving a large cushion to absorb asset quality and earnings deterioration. MBL's common equity Tier 1 (CET1) ratio using the local regulatory framework increased to 12.2%, from 11.4%, and was 14.9% on a globally harmonised basis. MGL's capital surplus to regulatory requirements was AUD7 billion (equivalent to 40% of the regulatory requirement), while the common equity double leverage ratio was 110%. We do not expect the funding profile of MGL or MBL to be significantly affected by the economic downturn. The group's approach to liquidity management, including a focus on longer dated issuance, diversity by product, currency and investor, as well as substantial levels of liquid assets, offsets some of the risks associated with its reliance on wholesale funding. MGL and MBL operate on similar liquidity risk settings. MGL's is required to meet all its obligations over a 12 month period with no funding market access, while MBL's assumes constrained access rather than no access. Liquid asset holdings at both MBL and MFHL more than covered wholesale funding maturities for the following 12 months at FYE20. In addition, MBL maintains strong regulatory ratios; its daily average Basel III liquidity coverage ratio for 4QFY20 was 173% and its net stable funding ratio was 118%. SUPPORT RATING AND SUPPORT RATING FLOOR MGL's Support Rating and Support Rating Floor reflect Fitch's view that support from Australian authorities cannot be relied upon. The agency believes that if support were provided to the group it would most likely be through the regulated bank, MBL. MBL's Support Rating and Support Rating Floor reflect a moderate probability of support, given its position as Australia's fifth-largest bank by total assets, that it is the only non-major bank that is subject to the Australian government's bank levy, and that it is a key player in the domestic financial markets. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES MBL's subordinated Tier 2 debt is rated two notches below its anchor rating, the VR, which is consistent with the base case in Fitch's Bank Rating Criteria, published 28 February 2020. The ratings on these instruments have been downgraded by one notch to reflect the change in the base case to two notches below the anchor rating for loss severity in Fitch's updated criteria, from one notch in the previous version. None of the reasons for maintaining the notching at one below the anchor rating are present. The ratings of these instruments have been removed from Under Criteria Observation. SUBSIDIARY AND AFFILIATED COMPANY MFHL's IDRs are aligned with those of its parent, MGL, to reflect that it is a key and integral part of the group's business, undertaking core non-banking activities. In addition, if MFHL were to default, it would constitute a huge reputational risk to the parent and damage its franchise. MIFL's Long-Term IDR is notched down once from its parent, MBL. MIFL is a small component of MBL and provides finance to Macquarie entities that MBL may otherwise be restricted from financing due to regulatory limits. It has no external funding. MIFL's Short-Term IDR of 'F1' is aligned with that of MBL and reflects Fitch's view that MBL's propensity to provide support is more certain in the short term. RATING SENSITIVITIES ISSUER DEFAULT RATINGS, VIABILITY RATINGS AND SENIOR DEBT MBL Factors that could, individually or collectively, lead to negative rating action/downgrade: MBL's VR and Long-Term IDR could be downgraded if the economic environment deteriorates significantly beyond our base-case scenario. We would lower the operating environment score to 'a+' under our downside scenario, which may result in a lower assessment of some financial profile factors. The ratings may also be downgraded, even if the operating environment score is not lowered, if a combination of the following occurs: - stage 3 loans/gross loans increase to above 2.5% for a sustained period; - operating profit/risk-weighted assets decline below 1.5% for a sustained period; - the CET1 ratio falls below 10% without a credible plan to raise it back above this level. A deterioration in the robust risk-management framework and sound liquidity management would also pressure ratings. MBL's Short-Term IDR would only be downgraded if its Long-Term IDR were downgraded by at least one notch and the funding score was lowered to at least 'a-'. Senior debt ratings are sensitive to the same factors as MBL's IDRs. Factors that could, individually or collectively, lead to positive rating action/upgrade: The Outlook on MBL's Long-Term IDR may be revised to Stable if Fitch's base-case economic scenario emerges, as we expect the financial profile would be sufficiently robust to withstand this at the current rating level. An upgrade of the ratings is less probable, as it would require a shallower downturn and swifter recovery than expected in Fitch's base case, combined with an improved company profile score and maintenance of the more stable profitability the bank has shown relative to many peers over the last five years. MGL Factors that could, individually or collectively, lead to negative rating action/downgrade: MGL's VR and Long-Term IDR are broadly sensitive to the same factors as those of MBL. In addition, the ratings may be downgraded if common equity double leverage increases to above 120% for a sustained period, although Fitch does not expect this to occur MGL's Short-Term IDR would only be downgraded if its Long-Term IDR were downgraded to 'BBB' or below and the funding score were to be lowered by at least one notch. Senior debt ratings are sensitive to the same factors as MGL's IDRs. Factors that could, individually or collectively, lead to positive rating action/upgrade: The Outlook on MGL's Long-Term IDR may be revised to Stable if Fitch's base-case economic scenario emerges, as we expect the financial profile would be sufficiently robust to withstand this at the current rating level. An upgrade of the ratings would require similar circumstances as for MBL. SUPPORT RATING AND SUPPORT RATING FLOOR Factors that could, individually or collectively, lead to negative rating action/downgrade: MGL's Support Rating and Support Rating Floor are already at the lowest level assigned by Fitch. MBL's Support Rating and Support Rating Floor may be downgraded if there is a negative change in our assumptions around the propensity or ability of Australian authorities to provide timely support. Neither appears probable over the next two years. Negative rating action will not directly affect MBL's IDRs, which are driven by its VR. Factors that could, individually or collectively, lead to positive rating action/upgrade: MGL's Support Rating and Support Rating Floor would only be upgraded if the regulatory focus in Australia was to change from protection of depositors to a broader group focus - this appears improbable. An upgrade of MBL's Support Rating and Support Rating Floor would require an increase in its systemic importance, as reflected in the bank's domestic franchise. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES Factors that could, individually or collectively, lead to negative rating action/downgrade: The ratings of MBL's Tier 2 debt would be downgraded if MBL's VR were downgraded. Factors that could, individually or collectively, lead to positive rating action/upgrade: MBL's Tier 2 debt ratings would be upgraded if the bank's VR were upgraded or any of the factors in Fitch's Bank Rating Criteria for notching only once from the anchor rating were met. SUBSIDIARY AND AFFILIATED COMPANIES Factors that could, individually or collectively, lead to negative rating action/downgrade: The Long-Term IDRs of MFHL and MIFL would be downgraded following downgrades of their respective parents. Factors that could, individually or collectively, lead to positive rating action/upgrade: A revision in the Outlook to Stable or an upgrade of the Long-Term IDRs of MGL and MBL would be reflected in the Outlook and Long-Term IDRs of MFHL and MIFL, respectively. Best/Worst Case Rating Scenario International scale credit ratings of Financial Institutions 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. 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 MFHL's ratings are linked to MGL's IDRs. MIFL's ratings are linked to MBL's IDRs. ESG Considerations The highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg. Macquarie Group Limited; Long Term Issuer Default Rating; Affirmed; A-; RO:Neg ; Short Term Issuer Default Rating; Affirmed; F2 ; Viability Rating; Affirmed; a- ; Support Rating; Affirmed; 5 ; Support Rating Floor; Affirmed; NF ----senior unsecured; Long Term Rating; Affirmed; A- ----senior unsecured; Long Term Rating; Affirmed; A- ----senior unsecured; Short Term Rating; Affirmed; F2 ----senior unsecured; Short Term Rating; Affirmed; F2 Macquarie International Finance Limited; Long Term Issuer Default Rating; Affirmed; A-; RO:Neg ; Short Term Issuer Default Rating; Affirmed; F1 ; Support Rating; Affirmed; 1 Macquarie Financial Holdings Pty Limited; Long Term Issuer Default Rating; Affirmed; A-; RO:Neg ; Short Term Issuer Default Rating; Affirmed; F2 ; Support Rating; Affirmed; 1 Macquarie Bank Limited; Long Term Issuer Default Rating; Affirmed; A; RO:Neg ; Short Term Issuer Default Rating; Affirmed; F1 ; Viability Rating; Affirmed; a ; Support Rating; Affirmed; 3 ; Support Rating Floor; Affirmed; BB+ ----senior unsecured; Long Term Rating; Affirmed; A ----subordinated; Long Term Rating; Downgrade; BBB+ ----senior unsecured; Long Term Rating; Affirmed; A ----senior unsecured; Short Term Rating; Affirmed; F1 ----senior unsecured; Short Term Rating; Affirmed; F1 Contacts: Primary Rating Analyst Tim Roche, Senior Director +61 2 8256 0310 Fitch Australia Pty Ltd Level 15 77 King Street Sydney NSW 2000 Secondary Rating Analyst Jack Do, Director +61 2 8256 0355 Committee Chairperson Heakyu Chang, Senior Director +822 3278 8363 Media Relations: Peter Hoflich, Singapore, Tel: +65 6796 7229, Email: peter.hoflich@thefitchgroup.com Leslie Tan, Singapore, Tel: +65 6796 7234, Email: leslie.tan@thefitchgroup.com Additional information is available on www.fitchratings.com Applicable Criteria Bank Rating Criteria (pub. 28 Feb 2020) (including rating assumption sensitivity) (https://www.fitchratings.com/site/re/10110041) Non-Bank Financial Institutions Rating Criteria (pub. 28 Feb 2020) (including rating assumption sensitivity) (https://www.fitchratings.com/site/re/10110170) Additional Disclosures Dodd-Frank Rating Information Disclosure Form (https://www.fitchratings.com/site/dodd-frank-disclosure/10122956) Solicitation Status (https://www.fitchratings.com/site/pr/10122956#solicitation) Endorsement Status (https://www.fitchratings.com/site/pr/10122956#endorsement_status) Endorsement Policy (https://www.fitchratings.com/regulatory) ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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