DBRS Confirms SMBC at ‘A’, Trend Changed to Positive following Sovereign Action on Japan

DBRS Ratings Limited (DBRS) confirmed the ratings of Sumitomo Mitsui Banking Corporation (SMBC or the Bank), including its Long-Term Issuer Rating of ‘A’ and the Short-Term Issuer Rating at R-1 (low). The trend on all ratings has been changed to positive from stable, following the change in the trend on the ‘A’ sovereign rating of Japan to positive from stable on January 26, 2018. Concurrently, DBRS maintained SMBC’s Intrinsic Assessment (IA), which is based upon the financial strength of the consolidated Sumitomo Mitsui Financial Group, Inc. (SMFG or the Group), at ‘A’ and the Support Designation at SA2. The Bank’s Support Designation of SA2 indicates an expectation of timely systemic support in case of need, and this would lead to the incorporation of a notch of systemic uplift to the Bank’s debt ratings, if the sovereign rating were to be upgraded. See the full list of ratings at the end of the press release.

In maintaining SMBC’s IA at ‘A’, DBRS recognises the strong domestic franchise along with the growing overseas operations, which have helped to counterbalance the profitability challenges faced by the Group domestically as a result of the ultra-low interest rate environment and strong competition. The current level of the IA also incorporates the good asset quality indicators, the strong funding and liquidity profiles and the sound capitalisation levels.

SMFG is one of the three Japanese mega-banks. The Group has a strong domestic franchise in retail and wholesale banking, as well as a sizeable global network and competitive positions in specialised lending, such as aircraft leasing and project finance. SMFG’s earnings have been resilient in recent years, as growth in the overseas businesses combined with strong non-interest income and low credit costs have helped to counterbalance the low interest rate environment and weak loan demand in Japan. Operating expenses have been increasing in recent years, primarily as a result of revenue-growth seeking investments and leading to a slow deterioration in the Group’s cost-income ratio, which was 61% in 6M17. DBRS considers that this ratio compares favourably to the Group’s domestic and international peers and notes that SMFG targets a cost-income ratio of approximately 60% in the medium-term. Other strategic initiatives in the Group’s Medium-Term Management Plan include improving capital efficiency, increasing digitalization, branch reorganisation, growing non-interest income and expanding the business base in Asia.

SMFG has a good risk profile and strong asset quality with non-performing loans accounting for 0.91% of total gross loans, at end-September 2017, while coverage stood at 76.1%. DBRS notes that SMFG’s exposure to sectors and geographies that could face increased volatility appears to be well managed. Overseas lending growth has continued with total loan balances of USD 227 billion at end-September 2017, up from USD 172 billion at end-FY13 and from USD 195 billion at end-FY15. Even though SMFG’s credit quality remains sound, DBRS will continue monitoring the pace of the Group’s credit expansion and any warning signs with regards to the underwriting standards.

SMFG faces certain risks through its holdings of Japanese Government Bonds (JGBs) and Japanese equities. SMFG’s JGB portfolio remains sizeable at JPY 8.8 trillion, or 85% of the Group’s Tier 1 Capital. The ratio of the book value of its domestic equity holdings to its Common Equity Tier 1 (CET1) capital stood at 22% at end-September 2017. The Group continues to make progress towards its goal of reducing this ratio to a more manageable 14% by around 2020.

SMFG’s funding profile benefits from a solid domestic deposit base. At end-September 2017, the Group’s overall net loan-to-deposit ratio, including negotiable certificates of deposits, stood at 61.1% due to continued growth in customer deposits and limited credit expansion. The Group’s overseas operations make greater use of market funding and SMFG reported an overseas loan-to deposit ratio of 122% at end-September, however, DBRS notes that overseas deposits have been steadily increasing in recent years and reached USD 186 billion at end-1H17, up 14% yoy. Short-term funding through CDs and CPs for the combined SMBC, SMBCE and SMBC (China) on a managerial basis amounted to nearly 16% of the total non-JPY funding base, but DBRS notes that the majority of the overseas CDs and CPs have a maturity of 3 months of more. The Group’s liquidity is solid with a reported Liquidity Coverage Ratio (LCR) of 127.4% in 2Q17, well above the regulatory minimum of 100% to be introduced as of January 2019.

The Group has a solid capital position with a fully-loaded Common Equity Tier 1 (CET1) ratio, including the impact of net unrealised gains/losses on available-for-sale-securities, of 13.1%, and a transitional Basel III leverage ratio of 4.77% at end-September 2017. The CET1 ratio drops to 10.6%, when removing the impact of net unrealised gains/losses on available-for-sale securities. DBRS notes that the Group targets a minimum CET1 ratio of a little less than 9% at end-March 2018 and a minimum CET1 ratio of 10% at end-FY19, on a post Basel III reforms basis. Over the July-October 2017 period, the Group issued TLAC-eligible bonds in three different currencies for a total of USD 8,250 million, EUR 1,750 million and AUD 750 million. DBRS does not anticipate the Group facing difficulties in meeting future minimum TLAC requirements.

RATING DRIVERS
There could be upward pressure on the Group’s issuer and senior debt ratings if 1) the sovereign rating is upgraded and uplift for systemic support is consequently incorporated into the ratings in line with the SA2 support designation; 2) the sovereign rating is upgraded and there is also a strengthening of the Group’s profitability and progress with the cost efficiencies being implemented by the Group; or 3) the Group’s overseas activities increase sufficiently that the proportion and quality of profits and exposures outside Japan lead to the IA being positioned higher than the sovereign rating.

Negative rating pressure could arise from a material deterioration in the Group’s asset quality indicators or funding profile, as a result of the overseas expansion, or from a downgrade of the sovereign.

The Grid Summary Grades for Sumitomo Mitsui Banking Corporation are as follows: Franchise Strength – Very Strong/Strong; Earnings Power – Strong/Good; Risk Profile – Strong/Good; Funding & Liquidity – Strong; Capitalisation – Strong/Good.

Notes:
All figures are in JPY unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (May 2017). This can be found can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include SNL Financial and company reports. DBRS considers the information available to it for the purposes of providing this rating to be 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 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 and US regulations only.

Lead Analyst: Elisabeth Rudman, Managing Director, Head of EU FIG, Global FIG
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global Financial Institutions Group and Sovereign Ratings
Initial Rating Date: September 26, 2001
Last Rating Date: July 14, 2017

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