DBRS Confirms ANZ at AA / R-1 (high); Trend Stable

DBRS Ratings Limited (DBRS) has today confirmed the ratings of Australia and New Zealand Banking Group Limited (ANZ or the Group) including the AA Deposits and Senior Debt ratings. The trend on all ratings is Stable. ANZ’s ratings reflect an intrinsic assessment (IA) of AA (low), combined with a support assessment of SA2, which results in a one notch uplift to the final rating from the IA. The SA2 reflects the systemic importance of ANZ to the financial system in Australia, and the generally supportive regulatory framework.

The confirmation of the ratings reflects the Group’s strong Australian and New Zealand franchise, with its leading market positions in both countries. The ratings also incorporate the Group’s solid capital levels, consistent profitability, conservative risk profile and improving funding and liquidity profile, as well as its ongoing strategic review.

After a period of international expansion and a focus on revenue growth, specifically in Institutional Banking, ANZ commenced a strategic review of operations in FY16, with the aim of rebalancing the Group towards retail and commercial activities, whilst simplifying its international activities, reducing operating costs and removing product complexity. DBRS views these developments positively. A successful re-focusing of its strategy towards less volatile businesses, along with a reduction of costs and complexity, should lead to a stronger, more balanced bank, and allow management to concentrate resources on the Group’s core Australian and New Zealand businesses, which have consistently produced higher returns. ANZ’s decision to exit its Asian minority investments is also viewed positively by DBRS, especially from a reputational risk perspective, in light of the recent compliance and anti-money laundering issues associated with AmBank Group, in which ANZ has a 24% interest share.

ANZ has generated consistent earnings in recent years, underpinned by its strong position in its core markets of Australia and New Zealand. Although statutory profit before tax in FY16 was down 22% year-on-year (YoY), to AUD 8.2 billion, DBRS notes that this was driven predominantly by a net charge of AUD 1.1 billion related to the application of an amended software capitalisation policy and the Group’s accelerated restructuring of its Institutional and international banking operations. On an underlying cash earnings basis, however, which excludes these items, along with other non-cash items, and losses related to hedging and IFRS volatility, ANZ reported a profit before tax of AUD 9.6 billion, broadly unchanged YoY, as a result of strong performance across the Group’s Australian division.

DBRS views ANZ’s risk profile as conservative evidenced by its good quality loan book, solid diversification by industry and low cost of risk. Whilst credit quality has deteriorated YoY in FY16, driven in part by the continued stress evident in the resource sector, the performance of ANZ’s overall loan portfolio remains strong. At end-FY16, gross impaired loans and loans over 90+ days past due (DPD) accounted for only 1.01% of gross loans. The coverage ratio also remains strong at 132% of gross impaired loans, or 71% of gross impaired loans and loans over 90+ DPD.

The Group’s lending exposure to sectors and geographies that are currently more susceptible to increased volatility, such as resources, New Zealand dairy and China, also appears well managed. At end-FY16, 61% of the Group’s Chinese exposure at default (EAD), which totalled AUD 22 billion, was to China’s central bank and its top five largest banks, with 86% having a tenor of less than one year. Whilst non-performing exposures have increased marginally YoY, to AUD 461 million in the Group’s resource portfolio (i.e. mining, oil & gas extraction), ANZ has been able to proactively manage down its EAD to AUD 16 billion at end-FY16, equivalent to 1.8% of the Group’s EAD, a 40 basis points decrease YoY. In addition, although the Group’s New Zealand dairy exposure remains under pressure, with a 1.1 percentage point YoY increase in the weighted average probability of default, only 1.15% of the Group’s New Zealand agriculture EAD was classified as impaired at end-FY16.

ANZ’s funding position has improved significantly in recent years, as strong customer deposit growth has helped to reduce the Group’s (DBRS calculated) net loan to deposit ratio from 138% at end-FY10, to 128% at end-FY16. The Group, however, in line with other major Australian banks, continues to rely significantly on wholesale funding, which accounted for 33.2% of total funding at end-FY16. Although the proportion of wholesale funding is viewed negatively, it is mitigated to a certain degree by the Bank’s improving liquidity position, with average liquid assets of AUD 176.8 billion in FY16, including AUD 122 billion of high quality liquid assets (HQLA), a 22% increase from end-FY15. As a result, the Bank reported an average LCR ratio of 126% in FY16, up from 122% in FY15. DBRS also notes that this compares well to short-term funding, including term funding maturing in less than one year, of AUD 141 billion at end-FY16.

DBRS views ANZ’s capital position as strong, with the Group reporting an APRA Basel 3 Common Equity Tier 1 (CET1) ratio of 9.6% at end-FY16, unchanged YoY, as strong organic capital generation offset risk-weighted assets (RWA) inflation related to the implementation of APRA’s changes to the calculation of Australian residential mortgages RWAs. As a result, the Group continues to surpass APRA’s additional capital buffer requirements, which result in a minimum CET 1 ratio of 8%. The Group’s leverage ratio, calculated on an APRA basis as Tier 1 capital % of Total Exposure, was 5.3% at end-FY16. On an internationally comparable basis, ANZ reported a CET1 ratio of 14.5%, and a leverage ratio of 6.0% at end-FY16.

Concurrently, DBRS has today withdrawn its Commercial Paper rating on ANZ and assigned an R-1 (high) Short-Term Instruments rating to ANZ, which reflects DBRS’s view of the Group’s short-term debt and deposit liabilities (i.e. maturing within 1 year).

RATING DRIVERS
Upward pressure on the rating is unlikely in the medium term given the already high rating level. Any upward pressure would require a 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.

Notes:
All figures are in AUD unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (July 2016). Other applicable methodologies include the DBRS Criteria: Support Assessments for Banks and Banking Organisations (March 2016) and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2016). 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, the Reserve Bank of Australia, the Australian Prudential Regulation Authority, Reserve Bank of New Zealand and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

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

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

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 historical default rates published by the European Securities and Markets Authority (“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, Senior Vice President - Global FIG
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer - Global FIG and Sovereign Ratings
Initial Rating Date: January 25, 2005
Most Recent Rating Update: December 17, 2015

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