S&P: Bank outlook stable on “highly supportive” government

From S&P Global Ratings:

Major Australian Bank Outlooks Revised To Stable, Macquarie Bank To Positive, After Policy Clarity On Government Support

  • Based on APRA’s announcement today that it is proceeding with its plan to strengthen Australian banks’ loss absorbing capacity–as well as other relevant factors–we believe that the Australian government remains highly supportive of the country’s systemically important banks.
  • Increased loss absorbing capacity could lessen the need for the Australian government to provide financial assistance to banks in a stress scenario and thus lessen the financial burden on taxpayers. Nevertheless, we believe that this plan does not introduce any policy or process impediments to the government bailing out a systemically important bank.
  • Furthermore, we perceive materially reduced uncertainty over the Australian government’s future policy direction on supporting the banking sector. In particular, we now believe that government support is unlikely to diminish in the next two years.
  • Consequently, as we have previously foreshadowed, we have revised our outlooks on the four major Australian banks to stable from negative, and our outlook on Macquarie Bank to positive from developing.

MELBOURNE (S&P Global Ratings) July 9, 2019–S&P Global Ratings today said that it has revised to stable from negative its outlooks on the following four major banks in Australia: Australia and New Zealand Banking Group Ltd. (ANZ), Commonwealth Bank of Australia (CBA), National Australia Bank Ltd. (NAB), and Westpac Banking Corp. (Westpac). We affirmed the ‘AA-‘ long-term and ‘A-1+’ short-term issuer credit ratings on each of the banks. At the same time, we revised the outlook on Macquarie Bank Ltd. to positive from developing, and affirmed our ‘A’ long-term and ‘A-1′ short-term issuer credit ratings on the bank.

These actions follow the Australian Prudential Regulation Authority’s (APRA) announcement today that it is proceeding with the implementation of its plan to strengthen Australian banks’ loss absorbing capacity. We consider that the important principles underlying APRA’s plan remain unchanged compared with the proposal it announced in November 2018. The main difference is that APRA has set the target additional amount of loss absorbing capacity by Jan. 1, 2024, to a reduced 3% of regulatory risk weighted assets compared with 4%-5% in the previous proposal. We expect that the banks would predominantly use tier-2 capital instruments to strengthen their loss absorbing capacity.

Increased loss absorbing capacity could lessen the need for the Australian government to provide financial assistance to banks in a stress scenario and thus lessen the financial burden on taxpayers. Nevertheless, we believe that this plan does not introduce any policy or process impediments to the government bailing out a systemically important bank; in the unlikely event this was required. Nor does it suggest any diminution in the Australian authorities’ willingness to do so, in our view. Indeed, in some of the public statements this year, the Australian authorities have indicated that their rationale for strengthening the banks’ loss absorption capacity is somewhat different to that in certain other jurisdictions, where the key objective was to eliminate the need for taxpayers to fund a bank bailout. The Australian authorities have indicated that in Australia the objective is to protect the community from the potentially devastating broader impacts of financial crises by reducing the probability of failure; and by establishing sufficient recapitalization capacity such that, should a failure or near-failure occur, the overall cost to the economy is minimized.

In line with the views we have expressed in our previous publications, we see the implementation of this plan as an indication of the Australian government’s undiminished supportiveness toward the systemically important banks in the country (see “Credit FAQ: Australian Government Support For Banks: Will There Be More Twists In The Tale?” published on April 8, 2019, and “APRA Proposal To Enhance Loss Absorbing Capacity Could Lead To Stable Outlook For Australian Major Banks, Macquarie Bank,” published on Nov. 8, 2018). Furthermore, we now perceive materially reduced uncertainty over the Australian government’s future policy direction on supporting the banking sector. In particular, we now believe that government support toward the Australian banking sector is unlikely to diminish in the next two years.

Consequently, we now see a significantly reduced risk of a ratings downgrade in the next two years for the four major Australian banks and Macquarie Bank. Hence the revisions in our outlooks on these banks.

A range of somewhat interdependent factors drive our view that the Australian government is highly likely to provide timely financial support to a systemically important bank in the country, if needed:

  • The Australian economy’s dependence on the major banks’ continued access to offshore funding.
  • Contagion risk across the four major banks due to interconnectedness, and their dominant share of the Australian banking market.
  • Pragmatic political stance and little social opposition for government support.
  • Framework does not hinder government support.
  • No clear framework for loss absorption by senior creditors.
  • Track record.

Our revised outlooks on each of the above mentioned banks are as follows:

Australia and New Zealand Banking Group Ltd.

S&P Global Ratings’ outlook on ANZ is stable, reflecting our expectation that the bank will maintain solid operating performance, low credit losses, and adequate capital levels in the next two years.

Despite an ongoing orderly unwinding of imbalances in the housing markets, we consider that ANZ, along with the other Australian banks, remains exposed to risk emanating from a rapid growth in house prices and private sector debt for several years, in combination with Australia’s external weaknesses–in particular its persistent current account deficits and high level of external debt. We consider that these imbalances expose the banks in Australia to a scenario of a sharp correction in property prices, and its severe consequences. Nevertheless, we consider that the probability of such a scenario remains relatively remote and loan losses in the next two years are likely to remain very low by historical and international standards. In our base case, we expect that an orderly correction in house prices will continue in some parts of the country in the next one year.

Downside scenario

We believe a low probability downside rating scenario in the next two years would emerge if, contrary to our expectations, there is a rapid fall in Australian house prices, in conjunction with a significant weakening in other important macroeconomic factors, including curtailed access to external funding. In such a scenario, we would expect to lower our ratings on a number of banks in the country, including ANZ.

Upside scenario

We see a very limited upside to our issuer credit ratings on ANZ in the next two years. We see signs of easing economic imbalances in Australia due to the ongoing orderly correction in house prices following the rapid rise in house prices and private sector debt witnessed over a number of years. If this trend of orderly unwinding of imbalances were to continue and we formed a view that consumer and business sentiment (including in relation to house prices) is stabilizing, ANZ’s risk-adjusted capital (RAC) ratio could improve such that its stand-alone credit profile (SACP) strengthens to ‘a’. An improvement in ANZ’s SACP would translate into higher ratings on hybrid and subordinated debt instruments issued by the group, other things remaining equal. However, our issuer credit rating on ANZ and our ratings on senior debt issued by ANZ will remain unchanged even in that scenario.

Commonwealth Bank of Australia

S&P Global Ratings’ outlook on CBA is stable, reflecting our expectation that the bank will maintain solid operating performance, low credit losses, and adequate capital levels in the next two years.

Despite an ongoing orderly unwinding of imbalances in the housing markets, we consider that CBA, along with the other Australian banks, remains exposed to risk emanating from a rapid growth in house prices and private sector debt for several years, in combination with Australia’s external weaknesses–in particular its persistent current account deficits and high level of external debt. We consider that these imbalances expose the banks in Australia to a scenario of a sharp correction in property prices, and its severe consequences. Nevertheless, we consider that the probability of such a scenario remains relatively remote and loan losses in the next two years are likely to remain very low by historical and international standards. In our base case, we expect that an orderly correction in house prices will continue in some parts of the country in the next one year.

Downside scenario

We believe a low probability downside rating scenario in the next two years would emerge if, contrary to our expectations, there is a rapid fall in Australian house prices, in conjunction with a significant weakening in other important macroeconomic factors, including curtailed access to external funding. In such a scenario, we would expect to lower our ratings on a number of banks in the country, including CBA.

Upside scenario

We see a very limited upside to our issuer credit rating on CBA in the next two years. We see signs of easing economic imbalances in Australia due to the ongoing orderly correction in house prices following the rapid rise in house prices and private sector debt witnessed over a number of years. If this trend of orderly unwinding of imbalances were to continue and we formed a view that consumer and business sentiment (including in relation to house prices) is stabilizing, we expect CBA’s RAC ratio to improve such that its SACP strengthens to ‘a’. An improvement in CBA’s SACP would translate into higher ratings on hybrid and subordinated debt instruments issued by the group, other things remaining equal. However, our issuer credit rating on CBA and our ratings on senior debt issued by CBA will remain unchanged even in that scenario.

National Australia Bank Ltd.

S&P Global Ratings’ outlook on NAB is stable reflecting our expectation that the bank will maintain solid operating performance, low credit losses, and adequate capital levels in the next two years.

Despite an ongoing orderly unwinding of imbalances in the housing markets, we consider that NAB, along with the other Australian banks, remains exposed to risk emanating from a rapid growth in house prices and private sector debt for several years, in combination with Australia’s external weaknesses–in particular its persistent current account deficits and high level of external debt. We consider that these imbalances expose the banks in Australia to a scenario of a sharp correction in property prices, and its severe consequences. Nevertheless, we consider that the probability of such a scenario remains relatively remote and loan losses in the next two years are likely to remain very low by historical and international standards. In our base case, we expect that an orderly correction in house prices will continue in some parts of the country in the next one year.

Downside scenario

We believe a low probability downside rating scenario in the next two years would emerge if, contrary to our expectations, there is a rapid fall in Australian house prices, in conjunction with a significant weakening in other important macroeconomic factors, including curtailed access to external funding. In such a scenario, we would expect to lower our ratings on a number of banks in the country, including NAB.

Upside scenario

We see a very limited upside to our issuer credit rating on NAB in the next two years. We see signs of easing economic imbalances in Australia due to the ongoing orderly correction in house prices following the rapid rise in house prices and private sector debt witnessed over a number of years. If this trend of orderly unwinding of imbalances were to continue and we formed a view that consumer and business sentiment (including in relation to house prices) is stabilizing, we expect NAB’s RAC ratio to improve such that its SACP strengthens to ‘a’. An improvement in NAB’s SACP would translate into higher ratings on hybrid and subordinated debt instruments issued by the group, other things remaining equal. However, our issuer credit rating on NAB and our ratings on senior debt issued by NAB will remain unchanged even in that scenario.

Westpac Banking Corp.

S&P Global Ratings’ outlook on Westpac is stable reflecting our expectation that the bank will maintain solid operating performance, low credit losses, and adequate capital levels in the next two years.

Despite an ongoing orderly unwinding of imbalances in the housing markets, we consider that Westpac, along with the other Australian banks, remains exposed to risk emanating from a rapid growth in house prices and private sector debt for several years, in combination with Australia’s external weaknesses–in particular its persistent current account deficits and high level of external debt. We consider that these imbalances expose the banks in Australia to a scenario of a sharp correction in property prices, and its severe consequences. Nevertheless, we consider that the probability of such a scenario remains relatively remote and loan losses in the next two years are likely to remain very low by historical and international standards. In our base case, we expect that an orderly correction in house prices will continue in some parts of the country in the next one year.

Downside scenario

We believe a low probability downside rating scenario in the next two years would emerge if, contrary to our expectations, there is a rapid fall in Australian house prices, in conjunction with a significant weakening in other important macroeconomic factors, including curtailed access to external funding. In such a scenario, we would expect to lower our ratings on a number of banks in the country, including Westpac.

Upside scenario

We see a very limited upside to our issuer credit rating on Westpac in the next two years. We see signs of easing economic imbalances in Australia due to the ongoing orderly correction in house prices following the rapid rise in house prices and private sector debt witnessed over a number of years. If this trend of orderly unwinding of imbalances were to continue and we formed a view that consumer and business sentiment (including in relation to house prices) is stabilizing, we expect Westpac’s RAC ratio to improve such that its SACP strengthens to ‘a’. An improvement in Westpac’s SACP would translate into higher ratings on hybrid and subordinated debt instruments issued by the group, other things remaining equal. However, our issuer credit rating on Westpac and our ratings on senior debt issued by Westpac will remain unchanged even in that scenario.

Macquarie Bank Ltd.

The positive outlook on MBL reflects the upside scenario that the bank’s risk profile could improve in the next year if it continues to deliver good risk management outcomes.

Upside scenario

We would review our rating on MBL for an upgrade if: 1) the group finalizes its internal restructure; 2) in our view, the bank demonstrates its ability to deal with global credit headwinds; and 3) we see no signs that the bank’s risk appetite is increasing. In this scenario, and all other things remaining equal, we would expect to raise our issuer credit ratings on MBL and its senior debt by one notch to ‘A+/A-1’ from ‘A/A-1’, as well as raise our ratings on hybrid and subordinated debt issued by MBL to reflect the improvement in our assessment of the bank’s stand-alone credit quality.

Downside scenario

We would revise our outlook on MBL to stable in the next two years if we believe that the bank has been impeded in its progress toward meeting the triggers identified in the above upside scenario such that an improvement in its risk profile has become improbable.

Comments

  1. Pretzel Logic
    Basically S&P have said that the revision follows APRA changes. The APRA changes outlined actually weaken the banks loss absorption capacity from the previous policy. Time frame is extended and % decreased. How on earth can that increase credit ratings? S&P square this circle by saying that they have a strong or stronger belief that the Australian government is sitting behind the banks. (That is us by the way)
    They don’t give any reason for this other than an increased belief.
    ‘Australian authorities have indicated that their rationale for strengthening the banks’ loss absorption capacity is somewhat different to that in certain other jurisdictions, where the key objective was to eliminate the need for taxpayers to fund a bank bailout. The Australian authorities have indicated that in Australia the objective is to protect the community from the potentially devastating broader impacts of financial crises by reducing the probability of failure; and by establishing sufficient recapitalization capacity such that, should a failure or near-failure occur, the overall cost to the economy is minimized.’
    Recommendation 3 of the 2014 Financial System Enquiry was pretty unequivocal.
    “Implement a framework for minimum loss absorbing and recapitalisation capacity in line with emerging international practice, sufficient to facilitate the orderly resolution of Australian authorised deposit-taking institutions and minimise taxpayer support.”
    http://fsi.gov.au/publications/final-report/chapter-1/loss-absorbing/
    The government response to the enquiry seemed to endorse that.
    “In simple terms, these measures aim to ensure our financial system remains robust in the face of severe external shocks. The system must be able to maintain its core economic functions in crisis circumstances, including the provision of credit to households and firms. By requiring banks to take greater responsibility for their own resilience, the need for taxpayer-funded bailouts is reduced. The measures reduce the advantages the larger banks have over their smaller counterparts, increasing competition and leading to better outcomes for consumers”
    But now it’s a different story. The ‘overall cost to the economy’ is mentioned for the first time.
    This renewed belief could only have happened if the Treasurer privately briefed them.
    It would not be a coincidence that earlier this week ‘S&P Global Ratings has urged the Morrison government to stick to its budget surplus plan to maintain Australia’s AAA credit rating, rejecting calls from some economists to relax budget repair and inject fiscal stimulus into the economy.’ Basically S&P saying, sure we will let you weaken APRA loss absorption requirements without any negative rating implication for the banks but only if the budget surplus plan is maintained and you change your tune on the Financial System Enquiry Recommendation #3.
    And thus we have another example of the contradictory policies under Frydenberg. Protect existing house values by weakening lending standards and in the process shift price risk to new home buyers. This action increases the loss likelihood and negatively impacts bank credit ratings. So counter that with a nod and wink that the Government will weaken their resolve and rationale on recommendation 3 of the 2014 financial system Enquiry Report and in exchange recommit to a tight fiscal policy which will lead into a weakened consumer etc.

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