DBRS Morningstar Confirms Westpac at AA / R-1 (high); Trend Revised to Negative

DBRS Ratings Limited (DBRS Morningstar) confirmed the ratings of Westpac Banking Corporation (Westpac or the Group), 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 the Group’s long-term ratings has been revised to Negative from 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 Westpac’s importance to the financial system in Australia. See a full list of ratings at the end of this press release.

KEY RATING CONSIDERATIONS

In revising the trend on the long-term ratings to Negative from Stable, DBRS Morningstar has taken into account the revelation of serious shortcomings in operational risk following AUSTRAC (the Australian Transaction Reports and Analysis Centre)’s decision to commence civil penalty proceedings against Westpac in light of systemic non-compliance with the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (AML/CFT Act). It is currently unclear to what extent the Group’s earnings and capital may be negatively impacted by potential penalties or if the Group’s franchise or funding ability may be affected given the likely serious deficiencies in governance.

The confirmation of the long-term ratings reflects the strength of Westpac’s franchise in its core markets of Australia and New Zealand, the solid capital levels, as well as the very strong and consistent earnings generation ability which should enable the Group to meet increasing capital requirements. It also incorporates Westpac’s low levels of credit impairments and the sound asset quality. Conversely, the ratings also take into consideration the well-managed funding and liquidity profile, despite a higher reliance on wholesale funding than most similarly rated domestic or international peers.

RATING DRIVERS

Any upside pressure is unlikely in the short term. However, the trend on the long-term ratings could return to Stable if the Group were able to demonstrate limited franchise and financial impact from the financial crime investigations.

Additional negative pressure on the IA would likely be driven by (i) a significant deterioration in the Group’s profitability or capital levels as a result of the operational risk shortcomings, or (ii) a weakening in investor confidence that would affect access to wholesale funding.

Furthermore, there would be negative pressure on the long-term ratings (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 Group’s IA.

RATING RATIONALE

Westpac enjoys strong market shares in the retail and business banking markets in Australia, and this is complemented by a strong retail market position in New Zealand along with a select presence in America, Europe and the Asia Pacific region, where the Group supports Australian customers operating in the region or assists international customers doing business in Australia and New Zealand. However, AUSTRAC announced on 20 November 2019 that it had applied to the Federal Court of Australia for civil penalty orders against Westpac for recent findings in relation to serious shortcomings in risk management. Furthermore, on 25 November 2019 the Group announced that the CEO and some members of the Board will be leaving the Group. While Westpac has taken steps to address some of the issues raised by AUSTRAC, DBRS Morningstar considers that the impact of the revelation of these shortcomings on the Group’s franchise is uncertain.

The Group has consistently generated strong profits, albeit lower in FY19. The Group’s statutory net profit attributable to owners of the parent decreased by 16% to AUD 6,784 million in FY19, as a result of lower operating income and increased operating expenses. In particular, total operating income in FY19 was 6% lower than in FY18, mainly driven by lower wealth management and insurance income, while operating expenses were up 6% reflecting additional provisions for estimated customer refunds, a rise in regulatory, compliance and investment related spend, and exit costs in wealth businesses. Including notable items relating to customer remediation and the reset of the Wealth business, the Group’s cost-to-income ratio increased to 48.9% in FY19, from 43.5% in FY18, compared to a target of below 40% in the medium term.

Westpac’s asset quality remains good, supported by the benign albeit slowing economic environment in Australia. The Group’s gross impaired loans plus loans over 90+ days past due (DPD) accounted for a low 0.95% of the total loan portfolio at end-FY19, although weakened from 0.76% at end-FY18 reflecting a slight deterioration in the Australian housing loan portfolio.

DBRS Morningstar considers addressing non-financial risks is an important challenge for Westpac and a key consideration for the Negative Trend. Westpac has been in the process of actioning recommendations by the industry-wide Royal Commission and by APRA, following the conclusion of Westpac’s Culture, Governance and Accountability (CGA)’s self-assessment examining the Group’s risk culture, governance and accountability frameworks and practices, and the impact they have on the management of non-financial risks. However, the Group also needs to continue to address serious shortcomings in its operational risk framework and to strengthen its compliance, financial crime and Anti-Money Laundering (AML) activities, as made clear by AUSTRAC’s decision to commence civil penalty proceedings against the Group over a number of operational failures. In particular, the Group failed to report to AUSTRAC in a timely manner over 19.5 million International Funds Transfer Instructions (IFTIs) over the period November 2013 to September 2018 of transfers both into and out of Australia, while also failing to keep records on the origin of some of the fund transfers, pass information on the source of funds to other banks in the transfer chain and carry out appropriate customer due diligence on transactions to countries that have known financial indicators relating to potential child exploitation risks.

DBRS Morningstar views Westpac’s funding profile to have improved in recent years as growth in customer deposits has outpaced the moderate loan growth. As such, the Group’s net loan-to deposit ratio improved to 136% at end-FY19, albeit this is towards the higher end of the Group’s domestic peer group. DBRS Morningstar views, however, that the Group has relatively good diversification in its wholesale funding profile in terms of product and currency as well as no significant refinancing concentration. DBRS Morningstar also notes new term issuance has improved in terms of diversification by reduced usage of USD over AUD. The Group has a solid liquidity position with a Liquidity Coverage Ratio of 127% at end-FY19 while the Group’s Net Stable Funding Ratio was 112% at end-FY19.

Westpac’s capitalisation levels have been supported to date by very good earnings generation ability, large cushions over regulatory minimum, and continued access to capital markets. Nonetheless, any civil penalties in connection with serious and systemic non-compliance with the AML/CTF Act or additional capital requirements have the potential to reduce the Group’s large capital cushions. DBRS Morningstar notes Westpac’s APRA CET 1 ratio at end-FY19 was 10.7%, implying a capital cushion of 270 bps over the regulatory minimum. However, this is just above APRA’s benchmark of 10.5% that is set for January 1, 2020, while the dividend payout ratio remained in the 80% range. On an internationally comparable basis, Westpac reported a CET1 ratio of 15.9% (down from 16.1% at end-FY18) and a leverage ratio of 6.4% (down from 6.5% at end-FY18) according to the Group’s calculations.

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

Notes:
All figures are in AUD unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2019). This 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, the Reserve Bank of New Zealand, AUSTRAC (the Australian Transaction Reports and Analysis Centre) 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: February 1, 2005
Last Rating Date: November 30, 2018

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