Fitch Ratings has affirmed the ratings of Australia’s four major banking groups: Australia and New Zealand Banking Group Limited (ANZ), Commonwealth Bank of Australia (CBA), National Australia Bank Limited (NAB) and Westpac Banking Corporation (WBC). At the same time it has revised the outlook on NAB’s Long-Term Issuer Default Rating to Negative from Stable. The Outlook on CBA’s Long-Term Issuer Default Rating remains Negative, while it is Stable for ANZ and WBC.
The rating review focuses on the Australian-domiciled entities within each group and therefore does not encompass their overseas subsidiaries.
NAB
The revision of the rating Outlook to Negative reflects the risk that NAB’s focus on remediating issues and changing culture means its ongoing operations may not receive sufficient management time, resulting in a weakening of NAB’s earnings relative to peers. Management changes may make this task more difficult in the short-term. The affirmation of NAB’s ratings reflects Fitch’s expectation that the bank will maintain its strong company profile in the short-term, which in turn supports its sound financial profile.
The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry and NAB’s self-assessment on governance, accountability and culture identified shortcomings within its management of operational and compliance risks, culture and governance. These were not aligned to what Fitch had previously incorporated into its ratings and resulted in a revision to our score for management and strategy, which also remains on negative outlook. NAB continues to have robust risk and reporting controls around other risks, including credit, market and liquidity risk, as reflected by its conservative underwriting standards and very high degree of asset-quality stability.
Fitch expects NAB’s asset quality and loan losses to display a very high degree of stability through business cycles, but could be more volatile than that of some domestic peers due to NAB’s greater business and corporate exposure.
Capitalisation and leverage are maintained with solid buffers over regulatory minimums, but ratios are at the lower end of those of domestic peers. However, these are likely to trend towards domestic-peer levels as NAB progresses towards meeting the Australian Prudential Regulation Authority’s “unquestionably strong” capital requirements by the 1 January 2020 implementation date. Additional capital requirements should be met in an orderly fashion given the bank’s strong market position and capital flexibility, with its capital position likely to be bolstered by the announced partial conversion of its NAB convertible preference shares into ordinary equity and slower forecast loan growth. The bank’s earnings and profitability are moderately variable over economic cycles and it remains reliant on offshore wholesale funding. Sound liquidity management provides some offset to this risk.
ANZ
The affirmation of ANZ’s ratings reflects the bank’s strong company profile and simple business model in its home markets of Australia and New Zealand, which support its financial profile. The bank’s strong market share across most products provides a higher degree of pricing power relative to smaller peers and allows it to generate strong and consistent operating returns through the cycle.
Australian household debt is still high relative to international peers, meaning households are susceptible to a sharp increase in interest rates or rising unemployment. The risk of external shocks also remains prominent in light of the geopolitical environment and potential impact on global growth. However, none of these scenarios are in Fitch’s base case.
The ongoing execution of ANZ’s simplification strategy supports the rating, as it is likely to reduce complexity, provide greater focus on key markets and improve the bank’s overall risk appetite. The focus on remediating and rectifying issues identified in various inquiries, including the royal commission, means there is a risk that the bank’s ongoing operations do not receive sufficient management focus, resulting in a weakening of its credit profile.
ANZ’s asset quality is likely to deteriorate modestly in 2019. Earning pressure should continue due to more modest loan growth, continued pressure on net-interest margins, rising funding costs, a probable rise in impairment charges and further remediation and compliance costs. ANZ maintains solid buffers over regulatory capital minimums and its common equity Tier 1 (CET1) capital ratio was the highest of Australia’s major banks as of September 2018. These buffers are likely to trend toward domestic-peer levels as asset sales are completed and capital returned to shareholders. There is a reliance on offshore wholesale funding, similar to other Australian major banks, but liquidity is managed well.
CBA
The affirmation of CBA’s ratings reflects Fitch’s expectation that the bank will maintain its strong company profile in the short-term, which in turn supports its sound financial profile. The Negative Outlook reflects challenges in remediating shortcomings in operational and compliance risk management that contributed to a number of conduct and compliance issues over more than a decade. Management’s focus may be diverted from ongoing operations when rectifying these shortcomings and increased compliance costs might manifest in weaker earnings, particularly in relation to domestic peers.
CBA’s remediation of these shortcomings is on track, but the process is only at an early stage and is complex. There have been significant changes in the last two years to the bank’s management and board, who appear committed to rectifying the outstanding issues. The group is also in the process of exiting its life insurance and wealth management operations, which may also distract management from core operations. Successful completion of the remediation and asset divestments without a significant erosion of the bank’s franchise would support the current ratings. The remaining operations after the asset divestments will focus on traditional banking operations in Australia and New Zealand.
CBA retains a market-leading position in Australian retail banking despite these issues and has invested heavily in technology to combat the looming threat of digital disruptors. The group continues to maintain peer-leading profitability, while asset quality is sound and capital has continued to improve. There is a reliance on offshore wholesale funding, similar to the other Australian major banks, but liquidity is managed well.
WBC
WBC’s strong company profile supports its ratings. The bank’s market share provides it with some pricing power relative to smaller peers in Australia and New Zealand and allows it to generate strong and consistent operating returns through the cycle, although in the short-term, we expect these to be affected by a challenging operating environment. In addition, WBC has been less affected by conduct-related issues than its domestic major-bank peers, meaning earnings may come under less pressure than for peers despite weaker system growth prospects. Nevertheless, WBC may still be susceptible to legal action from regulators and customers.
Partly offsetting the risks from high household debt is WBC’s loan underwriting, which Fitch believes is conservative in the global context. WBC has progressively tightened its underwriting for mortgages and commercial exposures, particularly property development, over recent years. This was driven in part by the regulator, mainly in relation to mortgages. The bank’s loan book is highly collateralised and we expect its asset quality to remain a strength relative to that of international peers, although loan impairments could rise modestly in 2019 from the current low levels.
WBC is unlikely to have difficulties to achieving “unquestionably strong” capital targets set by the regulator before the 2020 deadline – its CET1 capital ratio was already above the minimum at end-September 2018. Offshore wholesale funding reliance remains a weakness relative to many similarly rated international peers, although satisfactory liquidity management and diversification of funding helps offset some of this risk.
