DBRS Morningstar Confirms Commonwealth Bank at AA / R-1 (high); Stable Trend

DBRS Ratings Limited (DBRS Morningstar) confirmed the ratings of Commonwealth Bank of Australia (CBA or the Bank), including the Long-Term Issuer Rating and the Long-Term Senior Debt rating at AA. The Short-Term Issuer Rating was confirmed at R-1 (high). The trend on all ratings is Stable. The Intrinsic Assessment (IA) of the Bank is AA (low) and the Support Assessment is SA2, which results in a one notch uplift to the final rating from the IA. The Support Assessment of SA2 reflects the generally supportive regulatory framework and DBRS Morningstar’s expectation of a timely systemic support, given CBA’s importance to the financial system in Australia. See a full list of ratings at the end of this press release.

KEY RATING CONSIDERATIONS

The confirmation of the ratings reflects CBA’s extremely strong domestic franchise, particularly in retail banking, as well as the Bank’s conservative risk profile, robust capital levels and very strong earning generation ability which should enable the Bank to meet increasing capital requirements. The ratings also incorporate a well-managed funding and liquidity profile, despite a higher reliance on wholesale funding than most similarly rated international peers, as well as the Bank’s progress in addressing risk management issues.

RATING DRIVERS

Upward rating pressure on the IA would require the Bank to (i) become less reliant on wholesale funding, (ii) successfully continue to address outstanding regulatory issues, while (iii) maintaining very strong earnings and sound capital management.

Negative pressure on the IA would arise (i) if the proportion of wholesale funding were to increase significantly, or (ii) if the Bank had significantly larger than already identified operational risk issues given DBRS Morningstar’s limited tolerance of control issues at high rating levels.

Furthermore, negative pressure on the long-term ratings would arise (i) if DBRS Morningstar were to change the Support Assessment to SA3, in case DBRS Morningstar’s expectation for timely systemic support were to reduce, or (ii) if the rating of Commonwealth of Australia was downgraded to the same level or lower than the Bank’s IA.

RATING RATIONALE

Commonwealth Bank of Australia is a leading Australian bank, with very strong positions in the Australian retail sector, including market shares of 24.4% in home lending and of 28.1% in household deposits. In recent years, the Bank has divested assets, including its life insurance business in New Zealand and its global investment management business, and DBRS Morningstar views positively the Bank’s intention to focus on its core banking businesses, where its strength lies.

CBA has demonstrated very strong earnings generation ability in recent years, albeit lower in FY19. In FY19, on a statutory basis, the Bank reported net profit of AUD 8,571 million, down 8.0% on FY18. This was mainly due to a decrease in operating income, primarily driven by a lower net interest margin as well as a reduction in fee income, which reflected the removal of customer fee for certain products and lower advice fees, while operating expenses continued to increase on the back of elevated remediation costs and impairments picked up. On a cash basis, which refers to the Bank’s underlying results and excludes non-cash items and unrealised gains and losses related to hedging and IFRS volatility, net profit after tax from continuous operations was AUD 8,492 million, down 4.7% on FY18], similarly impacted by lower operating income, higher expenses, and increased impairments. Nevertheless, the Bank’s ROE was above 12% both on a statutory and cash basis.

The costs associated to elevated regulatory scrutiny over conduct issues have weighed on the Bank’s financial performance, however, efficiency levels remain very good. The reported cost-to-income ratio increased to 46.2% in FY19, trending up from 44.1% in FY18 and 41.6% in FY17, mainly reflecting increased customer remediation, risk and compliance programs costs as well as business simplification. The Bank’s remediation costs in FY19 totalled AUD 918 million representing about 8% of total operating costs, compared to almost 11% in FY18, as the Bank continues to refund customers for past shortcomings on wealth management and banking businesses. Despite this pressure, DBRS Morningstar notes that CBA is committed to achieving a cost-to-income ratio of below 40% - a better level than that reported over the past five years, which will reflect a simplified business model.

Credit quality remains very strong, with a gross impaired loans ratio of 0.45% in FY19, flat year-on-year, on the back of a still good Australian macroeconomic environment with a low unemployment rate. At the same time, rectifying identified operational risk shortcomings is currently a priority for CBA, as the Bank has encountered elevated regulatory scrutiny over conduct issues over the past years. The Bank is reporting some progress. However, DBRS Morningstar is expecting full implementation of the recommendations laid out by the Royal Commission and APRA will take time, in part because some of the recommendations are requiring legislative changes.

CBA has a well-managed funding profile, supported by a good access to the markets, good diversification and no significant wholesale funding refinancing concentration. The Bank’s net loan-to-deposit ratio, as calculated by DBRS Morningstar, stood at 131% at end-FY19, flat on FY18 and end-FY17. Similar to its major Australian peers though, the Bank relies to a higher degree than most of its global peers on wholesale market funding, which accounted for 30% of total funding at end-FY19. DBRS Morningstar views, however, that the Bank has a relatively good diversification in its wholesale funding profile in terms of product and currency. In addition, the Bank has a solid liquidity position with a Liquidity Coverage Ratio of 132% at end-FY19 (131% at end-FY18. The Bank’s Net Stable Funding Ratio was 112% at end-FY19 (unchanged on end-FY18).

DBRS Morningstar views CBA as having a robust capital position and being well-placed to address the evolving capital framework in Australia, which is resulting in additional capital requirements. The Bank reported an APRA Common Equity Tier 1 (CET1) ratio of 10.7% at end-FY19, up from 10.1% at end-FY18, even though the dividend payout ratio increased to 88% in FY19 from 80% in FY18. On a pro-forma basis, i.e. including sales of assets already completed and divestments expected to be finalised within the calendar year FY20, CBA’s pro-forma CET1 ratio was 11.8% at end-FY19. This is above APRA’s requested benchmark of 10.5% from January 1, 2020, albeit DBRS Morningstar notes that this benchmark is currently being recalibrated. On an internationally comparable basis, CBA reported a CET1 ratio of 16.2% (up from 15.5% at end-FY18) and a leverage ratio of 6.5% (up from 6.3% at end-FY18) according to the Bank’s calculations.

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

Notes:
All figures are in AUD unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2019). This 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 and the Reserve Bank of New Zealand and S&P Global Market Intelligence. DBRS Morningstar 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 Morningstar had no access to relevant internal documents for the rated entity or a related third party.

DBRS Morningstar 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 Morningstar's outlooks and ratings are under regular surveillance

For further information on DBRS Morningstar 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: Vitaline Yeterian, Vice President – Global FIG
Rating Committee Chair: Elisabeth Rudman – Managing Director, Head of European FIG – Global FIG
Initial Rating Date: January 24, 2005
Last Rating Date: November 20, 2018

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