In news just after the market closed, ratings agency Fitch has downgraded Commonwealth Bank of Australia’s (CBA), National Australia Bank Limited’s (NAB) and Westpac Banking Corporation’s (WBC) Long-Term Issuer Default Ratings (IDR) and Viability Ratings (VR) by one notch.
The ANZ division of MegaBank was left untouched, with Fitch re-affirming its rating.
The rating actions have been taken in the context of a broader review of the larger and highly rated banks in Fitch’s rating portfolio. In Fitch’s view, wholesale funding, particularly when sourced cross borders, has become more vulnerable to swings of confidence and for the major Australian banks this risk is better reflected at a Viability Rating (VR) of ‘aa-‘ and therefore a Long-Term IDR of ‘AA-‘. As ANZ’s VR is already at ‘aa-‘, its ratings have been affirmed.
This action concludes Fitch’s review of the four major Australian banks that was announced on 30 January 2012.
The downgrade of the Long-Term IDRs and VRs of CBA, NAB and WBC reflect the weaker funding profile of the major Australian banks relative to similarly rated international peers. Despite some improvement since 2008, all four banks retain a reliance on wholesale funding, particularly from offshore markets.
Fitch estimates that wholesale funding made up about 40% of total funding (excluding derivatives), with the offshore component of wholesale funding about 60% of the total. Fitch notes that this exposure is managed well by the banks, with wholesale funding diversified by geography, product, investor and maturity, all offshore funding hedged back into the functional currency through fully collateralised swaps and the maintenance of significant portfolios of central bank repo-eligible assets. Also, the introduction of covered bonds for Australian banks provides an additional avenue of diversity. Nevertheless, this funding profile leaves the banks susceptible to dislocation in international wholesale funding markets.
Fitch expects the banks will continue to improve this mix, with a greater focus on deposit-gathering, a reduced reliance on short-term wholesale funding, particularly from offshore sources, and a continued increase in the duration of wholesale funding. However, any significant improvements over the medium term will likely be constrained by structural impediments such as high levels of fixed capital formation (investment), a large and persistent current account deficit and mandatory pension savings which tend to be weighted towards equities.
A high reliance on wholesale funding makes maintaining investor confidence key. Factors such as Australia’s high household debt levels, elevated house prices and increasing reliance on Asia for trade may all impact this confidence, particularly if economic conditions in the region were to deteriorate significantly. Fitch does not expect such deterioration and notes that all four banks closely manage confidence through regular contact with investors.
Within the group of four, ANZ and NAB have more material operations outside Australia and New Zealand – ANZ in Asia and NAB in the UK. To date, ANZ’s Asian expansion has been measured and the overall risk profile of the group has not increased materially; nevertheless, these markets can be more volatile than Australia and New Zealand and the group will need to continue to prudently manage expansion. NAB’s UK operations, through Clydesdale Bank PLC (CB), have historically offered diversity in a well-regulated market and exposure is modest (about 10% of group assets).
However, earnings are likely to be subdued given a weakening outlook for the UK economy. This weakening outlook prompted NAB to announce on 7 February 2012 that it was undertaking a detailed review of these operations; as a result, Fitch has maintained the RWN on CB’s Long-Term IDR and placed the Short-Term IDR and Support Rating on RWN. The agency expects to resolve the RWNs following the completion of this review.
On most other measures, the four major Australian banks remain amongst the strongest banks in Fitch’s global rated universe and have therefore retained ratings in the ‘AA’ range. This reflects strong domestic franchises, robust risk management frameworks, solid profitability, competent liquidity management and sound and improving capital positions. The banks also benefit from, and contribute to, a solid domestic operating environment, while the Australian prudential regulator has proven itself to be conservative and hands-on.
The multiple-notch downgrade of the preference shares issued by CBA, NAB and WBC reflect the application of Fitch’s new bank regulatory capital securities rating criteria. In Australia, payment of distributions on Tier 1 instruments is subject to an annual profits test. Fitch believes this is an easily activated non-performance trigger and therefore rates Australian banks preference shares five notches below an institution’s VR.
The four major Australian banks dominate the Australian and New Zealand banking systems. At 31 December 2011, the four banks combined held 79% of Australian banking system assets, while in New Zealand this was 87% at 30 June 2011.