Fitch Affirms Ratings of Four Australian Small Banks

(The following statement was released by the rating agency) Fitch Ratings-Sydney-October 22: Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) at 'BBB+' and Viability Ratings at 'bbb+' of the following four Australian-based small banks: Auswide Bank Ltd, Heritage Bank Limited (HBL), IMB Ltd and Police Bank Limited (PBL). The Outlook is Stable. A full list of rating action is at the end of this rating action commentary. Risk appetite remains the main driver of the banks' Viability Ratings due to elevated household-sector risk and the banks' moderate franchises. We consider the franchises to be a limiting factor for the rating. Household indebtedness increased to historical highs in 2018, with low wage growth and elevated underemployment, leaving households more vulnerable to a sharp rise in unemployment or interest rates. However, neither scenario is Fitch's base case for the sector. We do not believe the banks' underwriting standards or risk controls will weaken in the current environment of rising public and regulatory banking-sector scrutiny. We also expect tighter underwriting standards over the previous four years to support asset quality through the cycle. Fitch sees the four banks as price-takers due to their moderate national franchises, which tend to be stronger within their regional home markets. Some of the banks also benefit from community and member support. Geographic concentration is evident for most of the banks, however, they all operate stable business models with a focus on mortgage lending. Fitch expects modest earning volatility through the cycle in light of the banks' business mix and risk settings. The four banks have higher capital ratios than most of their larger domestic peers, but Fitch believes this is appropriate given their geographic concentration and small absolute capital bases, which make them more vulnerable in severe shocks. KEY RATING DRIVERS IDR, VIABILITY RATING AND SENIOR DEBT AUSWIDE Auswide's IDRs and Viability Rating are driven by its underwriting standards, which Fitch believes are consistent with medium-term performance expectations. The bank's rating also reflects its small franchise, stable asset quality and a funding profile that is more reliant on potentially more volatile wholesale markets compared with peers. The bank's mortgage and business-loan underwriting standards are largely in line with those of domestic peers. Asset quality has a high degree of stability, but the bank has strong geographic concentration in parts of Queensland. We believe its greater focus on asset growth and use of the broker channel is likely to increase the risk profile of its mortgage portfolio. Auswide's capitalisation is maintained with satisfactory buffers over regulatory minimums. The bank has reasonable capital flexibility; as a listed entity, it may be able to increase its internal capital generation through its dividend re-investment plan or raise capital directly through the capital markets, an option unavailable to its mutual peers. The bank sources about 70% of its funding from customer deposits, mainly stable retail deposits. However, Auswide remains reliant on wholesale funding markets and we do not foresee any significant change in the funding model in the next year or two. Available liquidity is greater than short-term wholesale funding, however, it may become more expensive or less stable during periods of stress. HBL HBL's IDRs, Viability Rating and senior debt rating reflect HBL's underwriting standards, which Fitch expects to remain conservative relative to larger peers and should support asset quality and capitalisation through the cycle. Underwriting standards have been tightened in response to regulatory change and the bank has improved risk controls, although they still lag those of larger peers. HBL's ratings also take into consideration the bank's modest franchise, moderate profitability and improved capitalisation. HBL benefits from a loyal member base, with support from its community ties. Fitch does not expect significant improvements in HBL's franchise in the short- to medium-term without acquisition activity, but this is not a focus for the bank. HBL's earnings and profitability metrics lag those of some peers due to the bank's mutual ownership structure, which results in a greater focus on customer service and a reliance on the broker channel to generate growth. Fitch expects HBL's profitability to remain broadly unchanged over the next year or two, but it could improve in the longer term as a result of technology and digital investment. Capitalisation, which improved significantly over the previous year on slowing loan and risk-weighted asset growth, is comparable with domestic peers. We expect weak credit growth to persist, meaning capitalisation is likely to remain at around current levels over the next year. The bank's risk-weighted ratios are towards the upper-end of Fitch-rated Australian banks, but this appears warranted, as HBL's small absolute size and mutuality limit financial flexibility and access to new common equity. IMB IMB's IDRs and Viability Rating are driven by its risk appetite, particularly its generally conservative mortgage underwriting standards and approach to growth. This is seen in its consistently strong asset-quality ratios, which remain strong relative to domestic and international peers. The bank's small franchise, steady earnings and capitalisation are also factored into its ratings. IMB has a strong presence around the Illawarra region in New South Wales, but its franchise in the national context remains small. The bank operates a stable business model and has a traditional product offering, which reduces complexity and risk within the organisation. IMB's capitalisation is maintained with satisfactory buffers over regulatory minimums and is likely to remain broadly unchanged given the bank's growth and share buyback plans. IMB's risk-weighted and un-risk weighted ratios are towards the upper end of the range for similarly rated domestic peers. The bank sources about 90% of its total funding from customer deposits, most of which are stable retail deposits. The bank also utilises some wholesale funding, but this is mainly as a diversification tool. IMB has a strong liquidity position, with a high level of on-balance-sheet liquidity relative to peers. PBL PBL's IDRs, Viability Rating and senior debt rating reflect its underwriting standards, strong asset quality, capitalisation levels with solid buffers over regulatory minimums and wholly deposit-funded loan book. PBL's moderate franchise is aimed at servicing core members. It operates a stable business model with a focus on retail lending and benefits from a loyal membership base. The management change that occurred in 2016 is unlikely to alter the bank's core strategy in the short term, although it may increase its focus on improving its digital offering as well as its competitiveness via cost efficiencies. The bank's asset quality is comparable with that of its domestic peer group and loan impairments remain at modest levels that compare favourably against international peers. Asset quality is supported by PBL's underwriting criteria, which is focused on amortising owner-occupier mortgages. PBL has a higher proportion of personal lending than peers, although this risk is partially mitigated by the profile of its core borrowers - mostly public-service employees that Fitch sees as having higher employment security compared with other industries. However, the focus on this niche market creates concentration risk in terms of geographic and sector exposure. PBL has the highest capitalisation ratios within its domestic peer group, but Fitch sees its absolute capital base as small. Access to new capital is also limited due to its mutual ownership structure. SUPPORT RATING AND SUPPORT RATING FLOOR The banks' Support Ratings and Support Rating Floors reflect Fitch's view that while support from the authorities is possible, it cannot be relied upon due to the banks' small market shares and low systemic importance. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES The rating of the subordinated debt issued by HBL is notched down one level from the anchor Viability Rating for loss severity due to the potential of partial write-down. No notching has been applied for non-performance risk. RATING SENSITIVITIES IDR, VIABILITY RATING AND SENIOR DEBT The banks' IDRs and senior debt ratings are sensitive to factors that would affect their respective Viability Ratings, which are sensitive to any weakening in their respective risk appetites. This is most likely to be evidenced through more aggressive underwriting standards or looser risk controls while seeking asset growth, possibly in an effort to improve the franchise. This may manifest in a larger-than-peer deterioration in asset quality, profitability and capitalisation should there be a significant downturn in the operating environment. Strong asset growth may also challenge funding profiles, which could pressure ratings if not offset through adequate capital and liquidity management. Positive rating action would require a substantial improvement in the banks' franchises and market shares, which does not appear probable in the short term. SUPPORT RATING AND SUPPORT RATING FLOOR The four banks' Support Ratings and Support Rating Floors are sensitive to changes in Fitch's assumptions about the propensity or ability of the Australian sovereign (AAA/Stable) to provide timely support. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES The subordinated debt rating of HBL is broadly sensitive to the same considerations that might affect its anchor rating, the Viability Rating. The rating actions are as follows: Auswide: Long-Term IDR affirmed at 'BBB+'; Outlook Stable Short-Term IDR affirmed at 'F2' Viability Rating affirmed at 'bbb+' Support Rating affirmed at '5' Support Rating Floor affirmed at 'No Floor' HBL: Long-Term IDR affirmed at 'BBB+'; Outlook Stable Short-Term IDR affirmed at 'F2' Viability Rating affirmed at 'bbb+' Support Rating affirmed at '5' Support Rating Floor affirmed at 'No Floor' Senior unsecured debt affirmed at 'BBB+'/'F2' Subordinated debt affirmed at 'BBB' IMB: Long-Term IDR affirmed at 'BBB+'; Outlook Stable Short-Term IDR affirmed at 'F2' Viability Rating affirmed at 'bbb+' Support Rating affirmed at '5' Support Rating Floor affirmed at 'No Floor' PBL: Long-Term IDR affirmed at 'BBB+'; Outlook Stable Short-Term IDR affirmed at 'F2' Viability Rating affirmed at 'bbb+' Support Rating affirmed at '5' Support Rating Floor affirmed at 'No Floor' Senior unsecured debt affirmed at 'BBB+'/'F2' Contact: Primary Analyst Jack Do (HBL, IMB) Director +61 2 8256 0355 Fitch Australia Pty Ltd Level 15, 77 King St Sydney Australia 2000 Bert Jansen (Auswide, PBL) Director +61 2 8256 0345 Secondary Analyst Christopher Hilyard (IMB, Auswide) Analyst +61 2 8256 0343 Jack Do (PBL) Director +61 2 8256 0355 Tim Roche (HBL) Senior Director +61 2 8256 0310 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@fitchratings.com. 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