DBRS Confirms Commonwealth Bank at AA; Trend Stable. Sub Debt Under Review, Negative Implications

DBRS Ratings Limited (DBRS) has today confirmed Commonwealth Bank of Australia (CBA or the Bank) including the AA Deposits and Senior Debt rating and the R-1 (high) Commercial Paper rating. The trend is Stable. CBA’s ratings reflect an intrinsic assessment (IA) of AA (low), combined with a support assessment of SA-2, which results in a one notch uplift to the final rating from the IA. The SA-2 reflects the systemic importance of CBA to the financial system in Australia, and the generally supportive regulatory framework. Concurrently the Bank’s AA (low) subordinated debt ratings have been placed Under Review with Negative Implications.

The confirmation reflects the Bank’s strong Australian and New Zealand franchises, predictable earnings streams, solid capital levels and adequate liquidity as well as the conservative risk profile. The Stable trend reflects DBRS’s expectation that the Bank will continue to enjoy the benefits of its sound risk management culture, its ample earnings generation ability and its solid capitalisation. The ratings are unlikely to see upward pressure in the medium term, given their already high level, and the reliance on wholesale funding. Therefore any upward pressure would require a substantial reduction in the level of wholesale funding, whilst maintaining low levels of credit losses, solid and predictable earnings and continued sound capital management. Downward pressure on the ratings would be likely if the proportion of wholesale funding, especially short-term wholesale funding, were to increase, or if the Bank’s asset quality were to deteriorate substantially.

CBA’s sizeable and well balanced franchise across Australia and New Zealand is a key strength underpinning the ratings which are at the top-end of DBRS’s global rating universe. Potential growth outside of Australia is likely to be in areas where the Bank believes it has a competitive advantage and as a result DBRS would not expect any major mergers or acquisitions.

The ability of CBA to consistently generate strong and resilient earnings is a key rating consideration and the earnings profile further supports the overall high rating. In 2014 CBA reported income before provisions and taxes (IBPT) of AUD 11.95 billion, up 11.4% on 2013, while loan impairment charges reduced by almost 12% to AUD 953 million. The Bank’s IBPT is driven primarily by the strong domestic franchise with Australia accounting for 85% of income, with the bulk of the remainder coming from the NZ operation. Given the reliance on the Bank’s home market DBRS views positively that CBA’s income sources are diversified across several business lines, all of which were profitable in 2014, however it does leave the Bank vulnerable to a downturn in the Australian economy.

CBA’s funding position has improved substantially in recent years as customer deposits have grown considerably faster than lending. As a result the Bank’s (DBRS calculated) gross loan to deposit ratio has improved from 164% in 2009 to 139% in 2014. However the still high loan to deposit ratio means that the Bank continues to have a high reliance on wholesale funding with AUD 249.7 billion of debt issued at end-June 2014. Although DBRS does view positively the diversified mix of funding sources, by type, maturity, currency and market the level of wholesale funding continues to expose the Bank to the potentially more volatile wholesale markets, especially as short-term funding accounts for 36% of total wholesale funding at end-June 2014. At end-June 2014, CBA had a liquidity portfolio of AUD 139 billion, which covered 99% of the Bank’s total short-term funding, including long term debt with a residual maturity of less than one year. As of January 1, 2015 CBA will be required to have a Basel 3 Liquidity Coverage Ratio (LCR) in excess of 100% as APRA (Australian Prudential Regulatory Authority) is not implementing this requirement with a phase-in period. As a result of the shortage of AUD denominated High Quality Liquid Assets (HQLA) the RBA (Reserve Bank of Australia) is providing a Committed Liquidity Facility (CLF) to the Australian banks, which DBRS views as a positive development for the banking system.

In DBRS’s opinion CBA has a conservative risk profile as evidenced by the good quality loan book, the diversification by industry and the low cost of risk. At end-June 2014 the Bank’s well performing Australian and New Zealand residential mortgage books accounted for 66% of the Bank’s loan book. The bulk of the remainder of the Bank’s loan book consists of business and corporate loans, and other consumer loans. Total impaired loans as a percentage of gross loans were 0.53% at end-September 2014 and the coverage of impaired loans was 122%. The Bank’s commercial lending is well spread by industry and performance and continues to show low levels of impaired loans.

DBRS views CBA as having a strong capital position, driven in part by the Bank’s strong profitability. At end-June 2014, the Bank reported an APRA Basel 3 Common Equity Tier 1 (CET1) ratio of 9.3%, up from 8.2% at end-June 2013. This is already in excess of APRA’s 8% minimum requirement by January 1, 2016, which comprises a minimum CET1 ratio of 4.5% (effective from 1 January 2013), and then an additional CET1 capital conservation buffer of 3.5%, inclusive of a Domestic Systemically Important Bank (DSIB) requirement of 1%. At end-September 2014 the APRA CET1 ratio was 8.6%, with the reduction being driven by the 2014 final dividend and growth in RWAs.

DBRS notes the publication of the Australian Financial System Inquiry’s (FSI) final report on December 7, 2014. The higher capital requirements and higher mortgage risk weights for banks using the internal ratings based (IRB) approach for calculating regulatory capital, which are recommended in the report, are viewed positively by DBRS as these should help to further improve the resilience of the banking system. DBRS also notes that the FSI has recommended that Australia implements a framework for minimum loss absorbing and recapitalisation capacity, in line with emerging international practice. DBRS will continue to monitor how this evolves in Australia and the potential impact on systemic support.

Concurrently DBRS has placed CBA’s AA (low) Subordinated Debt rating Under Review with Negative Implications. Since the financial crisis, in many jurisdictions, the approach of regulators and authorities in dealing with struggling banks has evolved to the extent that subordinated debt may now be required to be “bailed-in” outside of a bankruptcy or resolution. Whilst we acknowledge that the Australian authorities are yet to endorse bail-in and burden sharing policies for senior debt, the regulator already has some powers to transfer assets, which, in certain circumstances, could be used to achieve a similar economic effect to a bail-in. DBRS also notes that the FSI final report recommends the introduction of a bail-in framework. As a result of these developments DBRS views that the probability of subordinated debt being treated adversely in a stress scenario has increased. Consequently, DBRS will review whether to notch these instruments from the bank’s Intrinsic Assessment (IA), rather than from the senior debt rating, in line with the criteria “Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities” published in December 2013. As a result rating downgrades are expected to be limited to one notch.

Notes:
All figures are in AUD unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2014). Other methodologies used include the DBRS Criteria: Support Assessment for Banks and Banking Organisations (January 2014) and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (December 2013). These can be found can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance

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Lead Analyst: Ross Abercromby
Rating Committee Chair: Alan G. Reid
Initial Rating Date: January 24, 2005
Most Recent Rating Update: July 17, 2013

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