Fitch Affirms Police Bank at 'BBB+'; Outlook Negative

(The following statement was released by the rating agency) Fitch Ratings-Sydney-28 January 2021: Fitch Ratings has affirmed Police Bank Limited's (PBL) Long-Term Issuer Default Rating (IDR) of 'BBB+' with the Outlook unchanged at Negative. PBL's other ratings were affirmed. Key Rating Drivers IDRS, VIABILITY RATING AND SENIOR DEBT PBL's IDRs and senior debt ratings are driven by its Viability Rating (VR), which is underpinned by the bank's sound risk appetite evident through its conservative loan mix, robust asset quality, and strong capital buffers. PBL's profitability metrics are likely to remain towards the bottom end of peers over the next two years, due to some uncertainty in the operating environment, along with earnings challenges and business transformation. The Negative Outlook on PBL's Long-Term IDR has been maintained, reflecting downside risks to Fitch's base-case scenario. Profitability headwinds remain prevalent as margin compression, stiff competition and high costs hamper PBL's earnings. High management turnover has also been detrimental to its historical financial performance. The earnings core metric - operating profit/risk-weighted assets - had been declining, but was accelerated by the Covid-19 pandemic. The negative outlook on the factor score has been maintained to reflect the low buffers at the current score for further deterioration. The bank says that it has completed an organisational restructuring and implemented a number of cost-reduction measures which should benefit performance in the financial year ending June 2021 (FY21). Fitch would need to see the core metric return consistently above 0.5% in order to revise the factor outlook back to stable. Asset quality been resilient through the downturn, with low peak and current deferral levels. This reflects the job security of PBL's customer base (mainly police force members) which is above average, and the loan mix which is high, concentrated on amortising owner-occupied mortgages. We believe PBL's stage 3 loans/gross loans ratio, the core metric for asset quality, is unlikely to fall into a range that would suggest a downgrade to the factor score even in a scenario more severe than our base case. The outlook has been revised to stable from negative as a result. PBL remains well capitalised, with the core metric - the Common Equity Tier 1 (CET1) ratio - at 17.3% at end-September 2020. The core metric is at the top end of peers, and this is likely to remain the case, which drives our stable outlook on the 'a-' score. The bank maintains high capital buffers above regulatory minimums, however Fitch considers this appropriate in light of its small absolute size and limited access to new common equity due to its mutual ownership structure. Customer deposits are likely to remain the core source of funding, and the bank's simple business model means that it has a low reliance on wholesale funding sources. The loans/customer deposits ratio was 95% at FYE20, and compared well with its peer group. PBL's 'bbb+' score for funding and liquidity takes into consideration the bank's deposit structure and franchise, which means it could be more affected in a flight-to-quality scenario. Liquidity remains sound, and has benefitted from system support from the authorities through 2020. PBL has a small franchise and niche customer market, which restricts its VR. The company profile factor score of 'bbb' reflects is the bank as generally a 'price-taker', and has limited competitive advantages in its main operating segments. Fitch believes this is partially offset by the loyal customer base and transparent business model which focuses on traditional banking operations. Growth higher than the system average is possible - given PBL's small absolute size - but is not likely to be sustained over long periods. We have maintained a negative factor outlook on the 'aa-' operating environment score for Australian banks, to reflect continued downside risks to our base-case forecasts. A downgrade in the operating environment score on its own would be unlikely to result in a downgrade of PBL's ratings. Australia has controlled the spread of the coronavirus well, resulting in the economic outlook strengthening, although downside risk remains due to additional outbreaks and associated lockdowns. Fitch's base case, as outlined in the Global Economic Outlook - December 2020, is for Australian GDP to contract by 2.8% in 2020, before recovering by 3.8% in 2021. Under this scenario, we are likely to revise the operating environment factor outlook to stable in 2021. The ratings assigned to senior unsecured debt instruments are aligned with PBL's IDRs as per Fitch's Bank Rating Criteria, as Australia does not have a sophisticated resolution framework or full depositor protection. PBL's Short-Term IDR of 'F2' is at the lower of the two options available at a Long-Term IDR of 'BBB+', as the funding and liquidity score is not high enough to support the higher option (the threshold is a score of at least 'a'). SUPPORT RATING AND SUPPORT RATING FLOOR PBL's Support Rating of '5' and Support Rating Floor of 'No Floor' reflect Fitch's view that while support from the authorities is possible, it cannot be relied upon due to the banks' small market share and low systemic importance. RATING SENSITIVITIES IDRS, VIABILITY RATING AND SENIOR DEBT Factors that could, individually or collectively, lead to positive rating action/upgrade: The Outlook on PBL may be revised to Stable if we expect operating profit/RWA to be sustained above 0.5%. An upgrade in PBL's VR, Long-Term IDR and senior debt ratings appears unlikely, as reflected in our Negative Outlook. In order to upgrade the bank's ratings, the economic outcome would need to be significantly better than Fitch's base case, combined with a substantial improvement in PBL's franchise and core financial metrics. Upside potential for the Short-Term IDR is limited. However, an upgrade of the Long-Term IDR to 'A' or higher, or upward revision of the funding and liquidity score to 'a' or higher, would result in the Short-Term IDR being upgraded to 'F1' Factors that could, individually or collectively, lead to negative rating action/downgrade: PBL's Long-Term IDR, VR and senior debt ratings could be downgraded if we assess that the operating profit/RWA metric would be consistently below 0.5% over the next two years. This could result in a lower score for PBL's earnings and profitability factor, which in turn could lower the VR and Long-Term IDR. Furthermore, PBL's Long-Term IDR, VR and senior debt ratings could face downward pressure if the economic environment deteriorates significantly beyond our base-case scenario. We would expect to lower the operating environment score to 'a+' under this downside scenario, which could result in a lowering of our assessment of the financial profile factors. A weakening of these financial profile factors could trigger a downgrade in the ratings and may include: - Impaired-loan ratio increasing to and being sustained above 3% and; - CET1 ratio falling below 14% and unlikely to return above this level within two years. A downgrade of the Shot-Term IDR to 'F3' is unlikely but could be driven by a downgrade of the Long-Term IDR to 'BBB-' or below, or a combination of the Long-Term IDR being downgraded to 'BBB' and the funding & liquidity score lowered to below 'bbb+'. SUPPORT RATING AND SUPPORT RATING FLOOR Factors That Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade: Positive action on the Support Rating and Support Rating Floor would require a significant change to our assessment on the propensity of the authorities to provide support to small banks. An upgrade of these ratings is unlikely to affect PBL's Long-Term IDR, which is currently driven by its standalone credit strength and is multiple categories above the Support Rating Floor. Factors That Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade: The Support Rating and Support Rating Floor are at the lowest end of the scales, and no negative action is possible. Best/Worst Case Rating Scenario International scale credit ratings of Financial Institutions and Covered Bond 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. ESG Considerations Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means 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. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg Police Bank Limited; Long Term Issuer Default Rating; Affirmed; BBB+; Rating Outlook Negative ; Short Term Issuer Default Rating; Affirmed; F2 ; Viability Rating; Affirmed; bbb+ ; Support Rating; Affirmed; 5 ; Support Rating Floor; Affirmed; NF ----senior unsecured; Long Term Rating; Affirmed; BBB+ ----senior unsecured; Short Term Rating; Affirmed; F2 Contacts: Primary Rating Analyst Jack Do, Director +61 2 8256 0355 Fitch Australia Pty Ltd Suite 15.01, Level 15 135 King Street Sydney 2000 Secondary Rating Analyst George Hong, Director +61 2 8256 0345 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 Additional Disclosures Dodd-Frank Rating Information Disclosure Form (https://www.fitchratings.com/site/dodd-frank-disclosure/10150605) Solicitation Status (https://www.fitchratings.com/site/pr/10150605#solicitation-status) Additional Disclosures For Unsolicited Credit Ratings (https://www.fitchratings.com/site/pr/10150605#unsolicited-credit-ratings-disclosures) Endorsement Status (https://www.fitchratings.com/site/pr/10150605#endorsement-status) Endorsement Policy (https://www.fitchratings.com/site/pr/10150605#endorsement-policy) ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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