(The following statement was released by the rating agency) Fitch Ratings-Sydney-March 03: Fitch Ratings has affirmed Bank of New Zealand's (BNZ) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'AA-' as part of the annual review of New Zealand's four largest banking groups. The Outlook is Negative. The review does not encompass BNZ's covered bond issuance. BNZ International Funding Limited ----senior unsecured; Long Term Rating; Affirmed; AA- Bank of New Zealand; Long Term Issuer Default Rating; Affirmed; AA-; RO:Neg ; Short Term Issuer Default Rating; Affirmed; F1+ ; Local Currency Long Term Issuer Default Rating; Affirmed; AA-; RO:Neg ; Local Currency Short Term Issuer Default Rating; Affirmed; F1+ ; Viability Rating; Affirmed; a ; Support Rating; Affirmed; 1 Key Rating Drivers IDRS, SENIOR DEBT AND SUPPORT RATING The affirmation of BNZ's IDRs and Support Rating reflects Fitch's assessment that there continues to be an extremely high likelihood of support from the Australian parent, National Australia Bank Limited (NAB, AA-/Negative), if required. Fitch sees the banks as key and integral parts of their banking groups, having strong integration across management, risk frameworks and treasury teams. The prospect of support is bolstered by strong linkages between the Australian and New Zealand banking regulators, which Fitch believes would work together to ensure the stability of both financial systems. The Outlook on BNZ's IDRs is aligned to the parent. VIABILITY RATING Fitch believes BNZ's strong franchise and market share allows it maintain sound profitability from its pricing power through the cycle without weakening risk appetite and relying on volatile businesses. This supports asset quality and capitalisation. Increasing competition, potentially from new entrants in the digital space, could challenge BNZ's franchise but this is unlikely to occur over the next two years. Macroeconomic risks remain high in New Zealand due to the high level of household leverage relative to global peers. High leverage means households are susceptible to an interest rate or labour market shock, weakening the ability of households to service their debts. Such a shock could also lead to weaker levels of consumer spending and economic growth, which would adversely affect the banking sector, although this scenario is not Fitch's base case. BNZ's risk appetite is modest, in Fitch's view. This is reflected in its strong weighting towards lending activities, particularly residential mortgages and low reliance on more volatile business operations. BNZ's underwriting standards are comparable to peers, driven in part by regulatory controls. The Reserve Bank of New Zealand's (RBNZ) easing of some macroprudential policies over the last year will not cause a significant weakening in underwriting standards as the changes were minor, Fitch believes. Fitch expects BNZ's capitalisation to increase in line with peers over the seven-year implementation period of the RBNZ's minimum capital requirements. Under the framework, BNZ is required to increase its Tier 1 capital ratio to a minimum of 16% by 2027. Fitch believes BNZ will be able to meet these requirements, namely through retained earnings. BNZ is well capitalised and benefits from a strong level of ordinary support from its parent. The incremental increase in capital over the next several years will add further buffers to the bank's ability to withstand severe shocks. BNZ's reliance on wholesale funding, particularly from offshore sources, remains a weakness relative to similarly rated international peers. Offsetting some of the risk is the bank's sound liquidity management - most of the bank's liquid assets are of high quality and sufficient to cover capital market debt maturing within 12 months. BNZ also manages its wholesale funding well, with appropriate diversification of maturity, product and investor. Fitch believes the modest weakening in BNZ's profitability in the financial year ended September 2019 (FY19) could be repeated in FY20 due to the persistence of a number of earnings and profitability headwinds in the sector, including low - and potentially even lower - interest rates, easing non-interest income and subdued growth. Fitch still expects BNZ's earnings and profitability to be well-placed relative to international peers, despite these challenges. The bank's net interest margin and cost efficiency are strong, and this strength is likely to continue. Investment in business simplification and digital channels should also benefit earnings and profitability longer term, although it could result in higher expenditure in the near term. BNZ's asset quality is likely to remain sound relative to international peers over the next year, supported by low interest rates and a strong labour market. The increase in loan impairments in FY19 was in line with Fitch's expectations and largely driven by a number of commercial exposures. A further uptick in impairments is possible but should remain manageable. Residential mortgage impairments remain steady and near historical lows. Collateral across all lending portfolios remains strong and provision coverage is appropriate. SUBSIDIARY AND AFFILIATED COMPANIES BNZ issues wholesale funding through its wholly owned subsidiary, BNZ International Funding Limited. This subsidiary is a funding vehicle and is only used for BNZ's funding requirements. Fitch does not rate the subsidiary, only the senior unsecured debt issued by the subsidiary. The debt ratings are aligned with those of BNZ, as it guarantees the debt instruments. RATING SENSITIVITIES IDRS, SENIOR DEBT AND SUPPORT RATING The IDRs and Outlooks are equalised with its parent. Changes in the parent's ratings are likely to be also reflected in BNZ's ratings. The Support Rating and IDRs could be downgraded should Fitch change its view of BNZ's importance to NAB, or if the authorities change their cross-border regulatory approach. VIABILITY RATING Fitch views BNZ's strong and stable franchise, together with headroom within key financial metrics (eg asset quality and profitability) relative to averages for the 'a' category, as significant mitigating factors to a downgrade of the Viability Rating in the next two years. Nevertheless, downward pressure is most likely to arise from an unexpected sharp and prolonged deterioration in the operating environment, possibly due to an economic shock in China or Australia, as this could erode aspects of BNZ's financial profile, which we view as supporting the current rating. For example, deterioration in the impaired loan ratio to around 2.0% over a prolonged period is also likely to lower earnings and profitability on a sustained basis relative to similarly rated peers, leading to a lowering of both factor mid-points. The strengthened capital framework, while a long-term positive for the bank and its peers, is unlikely to result in any near-term upgrade of the Viability Rating by itself. Instead, an upgrade is likely to require further improvements in the funding and liquidity metrics to levels similar to banks with higher mid-points and maintenance of strong asset quality in combination with the strengthened capitalisation. SUBSIDIARY AND AFFILIATED COMPANIES The ratings of the senior unsecured securities issued by BNZ International Funding Limited are sensitive to the same factors as BNZ. Public Ratings with Credit Linkage to other ratings New Zealand bank IDRs are equalised with the Australian parent IDRs given our view on the potential for support. The ratings of the senior debt issued by the funding subsidiaries are equalised with the New Zealand bank IDRs as the parents provide guarantees over these instruments. ESG Considerations ESG issues are credit neutral or have only a minimal credit impact on the entity(ies), either due to their nature or 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. Contacts: Primary Rating Analyst Jack Do, Director +61 2 8256 0355 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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