Back in October last year I noted that the Bank of Queensland (BoQ) had been placed on negative watch by Moody’s Investors Service. On Friday of last week Moody’s finalised that watch with a downgrade:
Moody’s Investors Service has downgraded the ratings of Bank of Queensland Limited (“BoQ”) by one notch, upon conclusion of its review for possible downgrade initiated on 20 October 2011. Ratings affected by this downgrade are its long-term senior unsecured debt rating to A3 from A2, subordinated debt rating to Baa1 from A3, preference stock rating to Ba1(hyb) from Baa3 (hyb), short-term rating to Prime-2 from Prime-1, and Bank Financial Strength Rating to C- from C (its stand-alone rating, which maps to a Baa1 from A3 on the long-term ratings scale).
Given the fact that the credit environment has weakened further since October this downgrade probably isn’t too much of a surprise. What is interesting, however, is that some of the information found in the downgrade rationale could have a flow-on effect to other non-major lenders:
BoQ’s loans quality deteriorated markedly over FY2011, mostly as a result of a number of large commercial property loans. Whilst the bank has completed a comprehensive review of its largest commercial exposures, identifying and providing for weaker loans, the weakening economic environment will render it difficult to resolve these loans, as well as raising the risk of further asset quality deterioration including more depressed collateral valuations.
Meanwhile, with 40% of its funding from wholesale markets at FY2011, BoQ faces considerable challenges amidst a very difficult funding market, which may limit the availability cost-effective wholesale funding options. This is particularly relevant, given that BoQ plans to grow its loans above the system average going forward, in part to meet shareholders’ profitability expectations.
Indeed, this points to the key challenge facing Australia’s smaller regional banks going forward; achieving shareholder expectations for profitability similar to that of Australia’s major banks — but without taking on too much risk and within the constraints of generally having to pay more for funding (particularly wholesale), having lesser economies of scale and ability to invest in technology, and being less able to develop sizeable fee income streams.
Given the uncertainties outlined above, the outlook for BoQ’s BFSR and long-term ratings remains negative, and reflects our view that the subdued economic environment may have an adverse impact on the bank’s asset quality position. Another driver for the negative outlook is the challenge of sourcing reliable and cost effective funding for its above system growth targets.
BOQ is believed to be around 40% dependent upon local wholesale funding. With the major banks struggling to find cost-effective funding sources offshore, muscling in on local wholesale market and driving up the price – such as CBA’s monster issue last week – smaller banks face higher costs still owing to their lower rating. That being the case, Moody’s appears to believe they will struggle to grow in the coming year. Obviously this action by the rating agency isn’t going to help.