See the latest Australian dollar analysis here:
Looks like I mistook tone for substance in my recent assessment that S&P was getting more bullish on Australia. Following the recent release of the sovereign report, I contacted former Australian sovereign analyst Kyran Curry and he confirmed that S&P’s stern outlook for Australia had not changed.
That is obvious today with the release of two new reports into the banks. The first is a gloomy assessment of prospects for any ratings upgrades, as well as more likely downgrades. The second report is a warning about the increasing risk of a New Zealand property crash and, wait for it, who is on the hook for that?
The first report is a repeat of the now familiar story:
- Our ratings outlooks for the Australian financial institutions sector for 2013 generally are stable. By contrast with the U.S. and Europe over recent years, the significant majority of our ratings on Australian financial institutions have stable outlooks, and our most likely scenario is that this will not change in 2013.
- We believe that the prospect for rating upgrades in 2013 is low, and that there is a greater possibility of rating downgrades. That said, our current view is that negative ratings transitions are less than a one-in-three possibility for the Australian major banks and most other rated financial institutions during 2013.
- Our expectation for 2013 is that most economic and industry risks affecting the banking sector are manageable for most Australian financial institutions at current rating levels. These include our likely base case outlook for risks associated the Chinese economy, industry sectors negatively affected by the high Australian dollar, commodity prices, and property sector risks. Economic and industry risks that could be most likely to cause negative ratings momentum include those associated with Australia’s high external debt and relative dependence on external borrowings.
With the usual acknowledgement that it is actually you, the tax-payer – that is the reason the bank’s have ratings this high:
We note that even if the stand-alone credit profiles (SACPs) of the Australian major banks were to improve by one notch, to ‘a+’ from ‘a’, this would not cause us to raise the issuer credit ratings to ‘AA’ from ‘AA-‘. While the Commonwealth of Australia (AAA/Stable/A-1+) is considered highly supportive of the banking sector, and we believe that the four Australian major banks are highly systemically important and therefore would be the beneficiaries of direct government support (in the unlikely event it were required), our ratings criteria envisages that fluctuation of the major banks’ SACPs could occur anywhere in the ‘a-‘ to ‘a+’ range for them to be rated ‘AA-‘. We believe that the prospect for rating upgrades for most regional banks and smaller retail financial institutions is fairly remote.
And the outcome if the Federal budget were to deteriorate? You guessed it:
‘A+’ from ‘AA-‘, all other rating factors remaining equal and unchanged, would be if our local currency issuer credit ratings on The Commonwealth of Australia were lowered to ‘AA+’ from ‘AAA’. The concomitant rating action on the banks would reflect our view that the four Australian major banks would continue to benefit from government support but not to the same extent, in consideration of the government having less capacity to provide extraordinary support (in the unlikely event that it were required).
So nothing new here, except of course that nothing has changed.
More interesting is the second report, about New Zealand property, which reckons:
- In our base case scenario we expect that strong asset quality ratios are likely to be maintained at levels supportive of banks’ current ratings.
- Potential risks to the banking sector include a sharp correction in property prices and a disruption in funding access.
- Should economic risk buildup and the Economic Risk score be lowered to ‘4’ from ‘3’ the ratings on New Zealand banks could be lowered.
- The issuer credit ratings and outlooks on the major banks remain linked to those on their parents.
The last sentence is the kicker. Through a chain of guarantees – Australian government > major banks > NZ subsidiaries – it appears the Australian tax-payer is also on the hook for New Zealand’s even large property bubble. S&P goes on:
That said, given the uncertain short-to-medium term outlook for the global economy, we are of the opinion that there remains a significant risk of a sharp correction in property prices.
We believe that a scenario that may lead to such a weakening of New Zealand’s macro-economic factors is a deterioration in the terms of trade or a widening in the current account deficit from its current cyclical low, which could heighten the risk of a sharp depreciation in currency and a sharp fall in property prices. In our view, such a scenario, in conjunction with a rise in unemployment, could increase the risk of a significant rise in banks’ credit losses, on the back of a build-up in housing prices and domestic credit over the period that preceded the global financial crisis.
We are of the opinion that such a scenario would have a material impact on the financial strength of the balance sheets of New Zealand banks.
The report concludes:
The outlooks on the four major banks remain linked to those on their respective parents. Potential triggers for a downward rating action on the four major banks could be a significant weakening in the rating on their respective Australian parents, or our assessment that their support to the New Zealand banking subsidiaries has significantly weakened.
We consider that the SACPs on all the New Zealand banks remain exposed to the risk of a sharp correction in property prices as a result of a weakening of New Zealand’s macro-economic factors. In our view such a scenario could include a deterioration in the terms of trade or a widening in the current account deficit from its current cyclical low. Should such a scenario materialize it could lead us to assign a higher risk score for economic imbalances, which could put pressure on our economic risk score under our BICRA assessment.
We are also of the opinion that there remains a significant risk of disruption in the banking sector’s access to funding, given the sector’s material dependence on external borrowings. In particular, we consider the New Zealand banking system’s sensitivity to a disruption in external funding could be more pronounced during a period of rapidly depreciating currency, falling property prices, or increased credit losses. Nevertheless, we consider that the major banks are likely to benefit from their parents’ support in normal as well as most stress scenarios.
Exactly right. I find it hard to envisage any scenario in which the majors were not on the hook for their kiwi progeny. An interesting scenario might be that New Zealand’s property bubble pops and Australia’s does not, leading to a downgrade in the subsidiary rating that moves up the chain to the Australian majors. New Zealand is small but not that small.
Anyways, it is a oft-unexplored chain of connections that does see Australian tax-payers also carrying the risk for New Zealand’s property bubble. It’s conceivable that we’d end up paying for kiwi losses if both property markets went under simultaneously and whatever shape the bailout took in Australia would trickle down to New Zealand through subsidiary recapitalisations. It’s perhaps more important now that even now we’re paying, through the inhibitions placed upon the budget owing to liquidity guarantees for the banks and their kiwi offshoots.
Very generous is the Australian tax-payer.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.