Fitch Affirms Australia's Four Major Banks

(The following statement was released by the rating agency)SYDNEY, May 11 (Fitch) Fitch Ratings has today 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 actions can be found at the end of this commentary.KEY RATING DRIVERS VIABILITY RATINGS (VR), IDRS AND SENIOR UNSECURED DEBTThe Long-Term and Short-Term IDRs and Stable Outlook of all four banks are driven by their VRs and reflect their dominant franchises in Australia and New Zealand. Stable, transparent and traditional business models have proven effective in generating strong and sustainable profitability while the banks maintained a generally conservative risk appetite relative to international peers. The banks' solid liquidity and capitalisation positions have continued to improve although they remained reliant on wholesale funding, particularly from offshore markets. Rising household indebtedness, historically low interest rates and high property prices in Australia and New Zealand continue to pose risks, although these are mitigated by the conservative and hands-on approach of the Australian prudential regulator. The four major Australian banks dominate their home markets. Their combined assets accounted for 79% of Australia's banking system assets at 31 March 2016 and 86% of New Zealand's banking system assets at 31 December 2015. This dominance provides scale benefits across a number of areas and allows the banks to generate good returns with relatively simple banking models. The majority of their assets are loans to households and businesses. Their operations are domestically focused, with Australia and New Zealand accounting for 79%-96% of exposures at default at each bank's most recent reporting date. Growth in operations outside Australia and New Zealand has been fairly contained with the two largest players, ANZ and NAB, withdrawing from offshore markets and refocusing on their home markets since 2015. NAB successfully exited its U.S. and UK businesses over the last 12 months while ANZ announced a change of its "super-regional" strategy, which is likely to reduce its Asian exposures. ANZ seeks to do this by reducing capital-intensity and organisational complexity while ensuring stronger profitability. We expect CBA, NAB and WBC to limit their Asian strategies to defend their domestic customer positions. We also expect the banks to focus business strategies on their home markets where their dominant franchises should support stronger and more sustainable returns. All banks have focused on digital banking, which has become an important distribution and revenue generation channel, although this area carries additional operational risks, such as cyber risk and fraud. Fitch believes that macro-economic risks are increasing as house price growth has outstripped wage growth for a sustained period, which is putting pressure on affordability. Low interest rates and tax policies likely contributed to strong house price increases and rising household debt. Measures taken by the Australian banking regulator should ensure households can service their loans in a higher interest rate environment, whereas New Zealand's banking regulator limited new business growth to certain loan-to-value ratio mortgages, which protects the loss-absorption buffers of the banks. We believe that these macro-economic risks are manageable in the absence of a significant economic shock, which would likely be driven by a hard landing in China, although this is not Fitch's base case scenario. However, Fitch has concerns about pockets of the Australian property market where potential oversupply of new residential development could hurt house prices over the next 12-18 months.The banks are likely to continue to tighten their risk appetites to address regulatory pressure and a more challenging operating environment. Improved underwriting standards implemented from mid-2015 should limit asset quality deterioration for loans originated recently. Mortgages generated between 2014 and mid-2015 may be more at risk given the weaker credit criteria at the time, although this may be offset by the higher interest rates at origination and increased house prices. Fitch also views investor mortgages, interest-only mortgages and broker-introduced mortgages as riskier due to their likely weaker performance through the credit cycle, relative to owner-occupied mortgages originated through proprietary channels. Broker-introduced mortgages are more susceptible to fraud relative to the banks' direct channels. The banks' commercial exposures are likely to be the first source of asset-quality problems, especially in light of continuing weak commodity prices. Impaired exposures and impairment charges in the first half of the financial year 2016 (1H16) have risen due to deterioration in some parts of the banks' portfolios. However, the banks' commercial portfolios are well diversified by single names and industries. Commercial real estate remains the largest non-financial institution, non-household industry exposure, accounting for 5%-9% of the individual exposures at default at end-1H16. Property development within these portfolios remains manageable. The banks' industry concentrations are low compared with that of some international peers.The 2016 outlook for the banks' operating profit growth remains soft, with revenue growth to remain under pressure as a result of asset competition, low interest rates and moderate credit growth relative to historical levels. Fitch expects impairment charges to continue to rise from their cyclical lows, although low interest rates should limit asset-quality deterioration as long there is no significant external event. We expect capitalisation to continue to strengthen over the medium term, partly driven by the regulatory uncertainty of international capital requirements. Retained earnings are the most likely source of capital generation. Dividend policies appear generous, but the banks benefit from dividend re-investment plans (DRP). The participation in the DRP tends to increase significantly if a discount on the share price is applied. The banks also have good access to capital markets, which was evident from their substantial ordinary capital issuances that raised a total of nearly AUD20bn in 2015 to address the impending capital requirements for residential mortgages. As a result of the capital rising, the banks' common equity Tier 1 ratios increased to between 9.7% and 10.5% under the Australian banking regulator's calculation at end-1H16. Nevertheless, we expect regulatory capital ratios to decrease between 60bp and 116bp once the new mortgage minimum average risk-weights of 25% are applied in July 2016 - excluding any other capital management actions.Funding remains a weakness relative to similarly rated international peers, with a high reliance on offshore wholesale markets. Wholesale funding made up 34%-42% of total funding (excluding derivatives and equity) at end-1H16. We believe that further improvements in the loan-to-deposit ratios are possible but are likely to be modest. We expect the banks to focus on lengthening their wholesale funding maturity profiles and reducing their short-term offshore wholesale funding while aiming to gather more stable deposits in preparation of the implementation of the net stable funding ratio in 2018. In addition, the banks' liquidity positions are solid, reflecting a significant increase in liquid assets to meet liquidity coverage ratio (LCR) requirements. The banks' average quarterly LCR have remained above 120%. The risks associated with the funding profiles are generally well managed as wholesale funding is diversified by geography, product, investor and maturity. All foreign-currency borrowings are hedged with fully collateralised swaps. The banks all undertake substantial investor meeting programmes to maintain confidence in the system.The banks' senior unsecured debt ratings are driven by the same rationale as the banks' VRs.SUPPORT RATINGS AND SUPPORT RATING FLOORS The Support Ratings and Support Rating Floors of the major Australian banks reflect their systemic importance, and an extremely high probability of support from the Australian authorities, if needed. SUBORDINATED DEBT AND OTHER HYBRID SECURITIESThe ratings of the major Australian banks' subordinated debt are notched one level down from the VRs for loss severity, and no notching has been applied for non-performance risk. Fitch rates legacy and new Basel III-compliant Tier 2 instruments. Tier 1 hybrid capital instruments are notched five levels from the respective banks' VRs - two notches to reflect loss severity and three to reflect non-performance risk. Fitch has not rated any Basel III-compliant Additional Tier-1 instruments.RATING SENSITIVITIESVRs, IDRs AND SENIOR UNSECURED DEBT Rating upside for the major Australian banks is limited, given their high ratings, increasing macro-economic risks and weaker funding profile relative to those of similarly rated international peers. Downside risks for the VRs, IDRs and senior unsecured debt ratings of the major Australian banks include a significant slowdown in Chinese economic growth, which would negatively impact the operating environment and in turn the banks' financial profiles. The dynamics of the Australian property market also pose a risk to the banks' ratings if house prices continue to rise quickly and household leverage further increases. The growing portion of offshore buyers and a potential housing oversupply in pockets of the Australian property markets may threaten the financial stability. Conduct risk could affect the banks' strategies and financial profiles, although the financial impact has been small to date. A material 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 FLOORSNo change to the propensity of the authorities to provide support appears imminent despite global regulatory moves to reduce implicit government support to banks, although we expect Australia's resolution framework to be strengthened in the medium term. This would result in the removal of any assumption of sovereign support. A change in the ability of the 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 Support Ratings and Support Rating Floors. Negative action on the Support Ratings and Support Rating Floors of the major Australian banks will not have a direct impact on their IDRs, which are currently driven by their VRs.SUBORDINATED DEBT AND OTHER HYBRID SECURITIESSubordinated debt and hybrid instruments issued by the banks are rated according to Fitch's rating criteria. Their ratings are broadly sensitive to the same considerations that might affect the banks' VRs. The rating actions are as follows: Australia and New Zealand Banking Group Limited (ANZ):Long-Term IDR: affirmed at 'AA-'; Outlook StableShort-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+'Commonwealth Bank of Australia (CBA):Long-Term IDR: affirmed at 'AA-'; Outlook StableShort-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 (NAB):Long-Term IDR: affirmed at 'AA-'; Outlook StableShort-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+'Preferred stock (ISIN: XS0347918723): affirmed at 'BBB'National Capital Instruments Euro LLC 2:Preferred stock (ISIN: XS0269714464): affirmed at 'BBB'National Capital Trust I:Preferred stock (ISIN: XS0177395901): affirmed at 'BBB'National Capital Trust III:Preferred stock (ISIN: AU3FN0000121): affirmed at 'BBB'Westpac Banking Corporation (WBC):Long-Term IDR: affirmed at 'AA-'; Outlook StableShort-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+'Contacts:Primary AnalystsAndrea Jaehne (ANZ, CBA and WBC) Director+61 2 8256 0343Fitch Australia Pty Ltd., Level 15, 77 King Street, Sydney, NSW 2000Tim Roche (NAB)Senior Director+61 2 8256 0310Secondary AnalystsAndrea Jaehne (NAB)Director+61 2 8256 0343Tim Roche (ANZ, CBA and WBC)Senior Director+61 2 8256 0310Committee ChairpersonJonathan LeeSenior Director+886 2 8175 7601Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: leslie.tan@fitchratings.com.Additional information is available on www.fitchratings.comApplicable Criteria Global Bank Rating Criteria (pub. 20 Mar 2015)https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=863501Additional Disclosures Dodd-Frank Rating Information Disclosure Form https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr _id=1004282Solicitation Status https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1004282Endorsement Policy https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&det ail=31ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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Fitch Australia Pty Ltd holds an Australian financial services licence (AFS licence no. 337123) which authorises it to provide credit ratings to wholesale clients only. Credit ratings information published by Fitch is not intended to be used by persons who are retail clients within the meaning of the Corporations Act 2001.