DBRS Upgrades SMBC to A (high); Trend Negative in Line with Sovereign

DBRS Ratings Limited (DBRS) has today upgraded the Issuer and Long-Term Deposits and Senior Debt rating of Sumitomo Mitsui Banking Corporation (SMBC or the Bank) to A (high) from “A”. Concurrently, the Short-Term Instruments rating was upgraded to R-1 (middle), from R-1 (low) and the Intrinsic Assessment (IA) to A from A (low). The IA is based upon the financial strength of the consolidated Sumitomo Mitsui Financial Group (SMFG or the Group). See the full list of ratings at the end of the press release.

The rating upgrade reflects the Group’s resilient wholesale and retail domestic franchise, as well as the growing consumer finance and international lending businesses, which have helped offset the challenges faced by the Group in the low-growth, low-interest rate domestic market. In addition, the Group benefits from good asset quality, solid capital levels and a stable deposit base. Although DBRS expects the Group to face some earnings pressure from the current challenges in the domestic and global environment, DBRS views the Group as well positioned relative to global peers.

The Bank’s IA is combined with a support assessment of SA2, which results in a one notch uplift to the final Issuer Rating and Long-Term Deposits and Senior Debt ratings for systemic support. The SA2 reflects the systemic importance of SMFG to the financial system in Japan, and the generally supportive regulatory framework. DBRS’s A (high) sovereign debt rating has a Negative trend and, given the uplift incorporated in the Bank’s ratings for systemic support, this leads to a Negative trend on the Bank’s ratings.

Further positive rating pressure is unlikely in the medium term given the recent upgrade and the Negative trend on the sovereign rating. Negative rating pressure could result from a downgrade of the sovereign, or a significant increase in the Group’s risk profile related to its overseas activities.

The Bank’s ratings are underpinned by SMFG’s strong franchise in Japan, where the Group has an approximate 13% share of domestic deposits (based on statistics provided by the Bank of Japan as of end-March 2015). The Group has a strong presence domestically across its main business divisions: commercial banking, consumer finance, securities and leasing. DBRS also views positively the Group’s overseas diversification, most notably in Asia, with overseas lending accounting for 29% of lending at end-March 2015, compared to 17% at end-March 2012.

SMFG has reported solid earnings over recent years, as strong non-interest income and overseas earnings growth, along with low credit costs have more than offset the ongoing weak domestic loan demand and low interest rate environment in Japan. DBRS expects earnings to come under some pressure as the Group absorbs the impact of negative interest rates in Japan, lower growth rates in China, stress in the energy loan portfolio, and a return to a more normal level of loan impairments. However, DBRS expects the Group to remain well placed relative to global peers.

SMFG has a solid risk profile, with asset quality supported by cyclically low level of bankruptcies in Japan. Total impaired loans as a percentage of gross loans were 1.13% at end-December 2015. The coverage ratio remained strong at 81.5% at end-September 2015. Whilst the Group’s commercial lending is well diversified by industry and geography, DBRS notes that SMFG had JPY 1.05 trillion of loan exposure in China at end-1H15, along with USD 4.7 billion (equivalent to JPY 562 billion) to Russia and USD 53 billion (equivalent to JPY 6.3 trillion) of exposure to non-Japanese oil and gas related industries. Whilst the majority of SMFG’s loan exposure in China is mostly to Japanese corporations, and 90% of the Group’s non-Japanese oil and gas related exposure is classified as high quality based on SMBC’s ratings, DBRS will continue to monitor these exposures given the respective stresses evident within each market.

SMFG’s funding position is underpinned by a very strong retail deposit base in Japan, with a loan-to-deposit (LTD) ratio for the Group of 63.6% at end-March 2015. SMFG’s overseas operations have also benefited from strong deposit growth in recent years resulting in a LTD ratio of 91% at end-FY14. A consequence of the surplus of domestic deposits and lack of demand for credit in the domestic economy has been that Japanese banks have amassed large holdings of domestic government bonds (JGBs). Although SMFG has reduced its exposure to JGBs in recent years, the exposure remained elevated at 136% of Tier 1 capital at end-December 2015. The JGB holdings expose SMFG to potential earnings volatility in relation to interest rate risk, as well as concentration risk to the Japanese sovereign.

DBRS views SMFG as having built up a solid capital position. At end-September 2015, the Group reported a fully-loaded Basel 3 Common Equity Tier 1 (CET1) ratio of 12.1%. DBRS also expects the Group to be well positioned to meet future Total Loss Absorbing Capacity (TLAC) requirements, although the domestic regulations are still to be finalised. The Group, like its peers, has a meaningful exposure to Japanese equities, which can lead to volatility in the P&L and capital ratios as a result of unrealised gains and losses. Although the ratio of domestic listed equities to Tier 1 and CET1 has decreased in recent years, unrealised gains remain significant and represented 230 bps in the Group’s CET1 ratio at end-September 2015. DBRS does, however, note the implementation of the Japanese Corporate Governance Code in June 2015, which requires companies holding shares of other listed companies as cross-shareholdings to disclose the reason for these holdings. SMFG has announced its intention to reduce the ratio of domestic listed equities to CET1, which stood at 28% at end-1H15, by half within approximately five years.

Notes:
All figures are in JPY unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (December 2015). Other methodologies used include the DBRS Criteria: Support Assessment for Banks and Banking Organisations (December 2015), DBRS Criteria: Guarantees and Other Forms of Explicit Support (February 2016), and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2016). These 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.

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: Elisabeth Rudman
Rating Committee Chair: William Schwartz
Initial Rating Date: February 13, 1987
Most Recent Rating Update: February 20, 2015

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