DBRS Confirms Westpac at AA; Trend Stable. Sub Debt Placed Under Review, Negative Implications

DBRS Ratings Limited (DBRS) has today confirmed Westpac Banking Corporation (Westpac or the Bank) including the AA Deposits and Senior Debt rating and the R-1 (high) Commercial Paper rating. The trend is Stable. Westpac’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 Westpac 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 ratings, which are at the top-end of DBRS’s global rating universe, are underpinned by the Bank’s strong franchise, including market-leading positions in Australian retail banking, predictable earnings generation, a low risk profile, solid capital levels and its adequate liquidity position. The Stable trend reflects DBRS’s expectation that the Bank will continue to benefit from its sound risk management culture, its ample earnings generation ability and its solid capitalisation. The ratings are unlikely to experience upward pressure in the medium term, given their already high level, and the Bank’s reliance on wholesale funding. As a result, any upward pressure would require a significant reduction in the level of wholesale funding, while maintaining (i) low levels of credit losses, (ii) solid and predictable underlying profitability, and (iii) continued sound capital management. Negative rating pressure would likely be driven by a weakening of the Bank’s funding and liquidity profile, with, for example, an increased dependence on short-term wholesale funding, or a substantial deterioration in asset quality measures.

In confirming the ratings, DBRS recognises Westpac’s strong domestic franchise across Australia and New Zealand. Westpac’s strong position in its core markets has been complemented in recent years by the Bank’s small but growing presence in Asia. Westpac’s strategy in Asia is focused on supporting Australian and New Zealand customers operating, trading and transacting in the region, along with Asian customers seeking financial solutions and services in Australia and New Zealand.

Westpac’s strong profitability metrics underpins its high ratings. The Bank has reported strong levels of profitability in recent years, benefitting both from the relatively stable operating conditions in its core markets, Australia and New Zealand, and from its risk discipline, which has led to strong credit performance, and low impairment charges. In 2014, Westpac reported income before provisions and taxes (IBPT) of AUD 11.4 billion, an increase of 7% YoY, and net profit of AUD 7.6 billion, a 12% YoY increase.

Westpac maintains a conservative risk culture that has historically led to low loan losses. As a result, the Bank’s overall asset quality remains extremely good with impaired loans and impairment charges remaining at very low levels. Westpac’s overall sound credit quality benefits from the excellent performance of its large residential mortgage portfolio The Bank’s corporate lending is also relatively conservative, with the top 10 exposures accounting for only 1.1% of total committed exposure (TCE) at end-September 2014, and an impaired assets ratio, including loans 90+ days past due but well secured, of 1.62%. The Bank has also made significant progress in managing down its commercial property portfolio in recent years, from 9.6% of total committed exposures (TCE) in 1H09 to 7.0% in 2H14.

DBRS considers Westpac’s funding position as adequate given the high rating level. Although the Bank benefits from a diversified funding mix, and has reduced its use of offshore wholesale funding in recent years, the dependence on wholesale funding remains significant, as evidenced by a DBRS calculated gross loan-to-deposit (LTD) ratio of 143% at end-September 2014. In addition, the Bank’s use of short-term funding remains high, at AUD 89.2 billion at end-September 2014. Although DBRS views negatively the level of wholesale funding, it is partially mitigated by the Bank’s unencumbered liquidity portfolio, which at end-September 2014 totalled AUD 134.4 billion. DBRS also notes that at end-September 2014, the Bank reported a pro-forma Liquidity Coverage Ratio (LCR) of 103%, in excess of APRA’s (Australian Prudential Regulatory Authority) minimum LCR requirement of 100%, which comes into effect from January 1, 2015. As a result of 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.

Westpac has a solid capital position, with an APRA Basel 3 Common Equity Tier 1 (CET1) ratio of 9% at end-September 2014. 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%.

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 Westpac’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.

Separately, DBRS has also withdrawn the AAA ratings on debt guaranteed by the Australian government as this debt has been repaid.

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

For further information on DBRS historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Ross Abercromby
Rating Committee Chair: Alan G. Reid
Initial Rating Date: February 1, 2005
Most Recent Rating Update: July 17, 2013

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