(The following statement was released by the rating agency) Fitch Ratings-Sydney-April 30: Fitch Ratings has revised the Outlook on Australia-based Heritage Bank Limited's (HBL) Long-Term Issuer Default Rating (IDR) to Negative from Stable and affirmed the IDR at 'BBB+'. At the same time, Fitch downgraded HBL's Tier 2 debt to 'BBB-' from 'BBB' and removed the rating from Under Criteria Observation (UCO). HBL's other ratings have been affirmed. Key Rating Drivers IDRS, VR AND SENIOR DEBT HBL's IDRs are driven by its Viability Rating (VR), reflecting the bank's stable business model and risk appetite that features more conservative underwriting standards relative to broader peers. Fitch believes the rapidly deteriorating operating environment will have a significant impact on the Australian banking sector and poses large downside risks. In particular, we expect asset quality and profitability metrics to weaken materially over the next two years.
Fitch revised the operating environment factor outlook to negative as part of this rating action. This is based on our expectation that GDP growth will decline sharply in 1H20 followed by partial recovery in 3Q20. Under Fitch's base case, a proper recovery in economic growth is not anticipated to begin until the last quarter of 2020, but a weakened labour force will still be a constraint. Under this scenario, we would maintain our operating environment mid-point at 'aa-' and revise the factor outlook back to stable once the recovery was established. However, risks are clearly to the downside and a longer, more protracted downturn and then a shallower recovery will have a more lasting impact on the Australian economy, through lower GDP growth and higher unemployment. Such a scenario would result in a lowering of our operating environment factor mid-point to 'a+'. (For details of the baseline case, see "Fitch Ratings Coronavirus Scenarios: Baseline and Downside Cases" at www.fitchratings.com/site/re/10116778 and "Global Economic Outlook: Crisis Update Late April 2020 - Coronavirus Recession Unparalleled" at www.fitchratings.com/site/re/10119280.) Fitch believes measures aimed at slowing the spread of the coronavirus will result in a significant economic weakening over the next two years. Historically low interest rates, rising unemployment and impairment charges will directly impact asset quality and earnings. HBL's factor outlooks for asset quality (mid-point of 'a-') and earnings (mid-point of 'bbb') have been revised to negative from stable, to reflect our expectations of weakening metrics and significant downside risks. However, HBL has some buffers at the existing mid-points, which means it would take more than a moderate deterioration before the respective mid-points were lowered.
Asset quality will take some time to show material weakening as measures by authorities and banks, such a repayment holidays, are expected to cushion the immediate impact of the downturn. We expect the non-performing loan ratio will increase substantially once these measures subside as there will be a portion of the customer base still unable to service its loans. HBL's sound underwriting standards and loan book - heavily weighted towards residential mortgages - support overall asset quality but do not eliminate downside risk.
Earnings were already facing pressure before the pandemic from low rates and strong competition. We expect the economic downturn to accelerate this in 2020 and into 2021, with a rise in impairment charges, lower interest rates for longer and slower credit growth adding to the existing pressure. Access to low-cost funding from the Reserve Bank of Australia (RBA) through a term funding facility and easing of competitive pressures will provide some relief to margin pressure.
HBL's continues to maintain reasonable capitalisation buffers above regulatory requirements and at its current mid-point of 'bbb+'. Fitch believes HBL's capital would be able to withstand a scenario moderately more severe than our base case, however the mid-point or outlook could still be reviewed should signs of a significantly deeper downturn arise. HBL's small size and limited access to new common equity remain as key drawbacks to the bank's capitalisaiton.
Fitch believes HBL's funding and liquidity profile is unlikely to be significantly affected, at least in the short term, due to the dislocation in funding markets. Modest reliance on wholesale funding sources, support from the RBA's facilities and a solid liquidity position should provide support to the mid-point and is reflected in Fitch's stable outlook on the factor.
SUPPORT RATING AND SUPPORT RATING FLOOR HBL's Support Rating and Support Rating Floors reflect Fitch's assessment that while support from the authorities is possible, it cannot be relied upon due to the bank's small market share and low systemic importance.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES HBL's subordinated debt is rated two notches below its anchor rating, the VR, which is consistent with the base case in Fitch's updated Bank Rating Criteria, published 28 February 2020. The change in the base case under the updated criteria means the ratings on these instruments have been downgraded by a notch to two notches below the anchor rating for loss severity, from one notch under the previous criteria. None of the reasons for maintaining the notching at one below the anchor rating is present. The ratings of these instruments have been removed from UCO. RATING SENSITIVITIES IDRS, VR and SENIOR DEBT Factors That Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade: HBL's IDRs and VR would be downgraded if the operating environment deteriorates significantly beyond Fitch's base-case scenario. A large enough downturn could trigger a downgrade of the operating environment mid-point, which could result in a downward revision of some financial profile factor scores
HBL's ratings may also be downgraded, even if the operating environment mid-point is not lowered, if there was a sustained deterioration in the bank's financial metrics, including: - Stage 3 loans/gross loans increasing to above 4%; - Operating profit/risk-weighted assets declining below 1% on a sustained basis; and - Common equity Tier 1 capital ratio falling below 10% without a credible plan to raise it back above this level.
Factors That Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade:
HBL's Outlook may be revised to Stable if the economic downturn is broadly in line with our base-case expectations. Under such a scenario, we would expect limited weakening of the bank's financial profile and the core metrics should broadly align with the VR of 'bbb+'.
Positive rating action on HBL's VR and IDRs appears unlikely given the Negative Outlook. It also reflects the bank's moderate franchise and small market share.
SUPPORT RATING Factors That Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade: HBL's Support Rating and Support Rating Floor are sensitive to changes in Fitch's assumptions about the propensity or ability of the Australian sovereign (AAA/Stable) to provide timely support. Negative action on the Support Rating and Support Rating Floor will not directly affect HBL's IDRs, which are driven by its VR. Factors That Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade: Positive action on the Support Rating and Support Rating Floor appears unlikely to affect HBL's IDRs unless the action provided by the sovereign is significant. 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. 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. Heritage Bank Limited; Long Term Issuer Default Rating; Affirmed; BBB+; RO:Neg ; 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+ ----subordinated; Long Term Rating; Downgrade; BBB- ----senior unsecured; Short Term Rating; Affirmed; F2 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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