DBRS Morningstar Confirms SMBC’s Long-Term Issuer Rating at A (high), Stable Trend

DBRS Ratings Limited (DBRS Morningstar) confirmed the ratings of Sumitomo Mitsui Banking Corporation (SMBC or the Bank), including its Long-Term Issuer Rating at A (high) and the Short-Term Issuer Rating at R-1 (middle). The trend on all ratings is Stable. The Intrinsic Assessment (IA) of the Bank, which is based on the financial strength of the consolidated Sumitomo Mitsui Financial Group (SMBC Group or the Group), is A (high). The Support Assessment is SA2, reflecting DBRS Morningstar’s expectation of timely systemic support in case of need, given the Bank’s systemic importance to the Japanese financial system. Given the sovereign rating of Japan is A (high) Stable trend, there is currently no uplift to SMBC’s Long-Term Issuer Rating. See the full list of ratings at the end of this press release.

KEY RATING CONSIDERATIONS
In maintaining SMBC’s IA of A (high), DBRS Morningstar recognises the Group’s strong domestic franchise in retail and wholesale banking, and the Group’s competitive position in certain specialised lending areas globally. This current level of the IA also takes into account the Group’s resilient profitability, despite some pressure in domestic revenues from the low interest rate environment, as well as the Group’s sound asset quality, with low levels of non-performing loans, and the solid capital levels. Conversely, the ratings also incorporate the Group’s concentration to holdings of Japanese Government Bonds and Japanese equities, which albeit reducing, could result in the Group facing volatility in its capital ratios due to market price fluctuations through these securities’ unrealised gains. The IA also considers the Group’s strong funding and liquidity profile, which benefits from a solid domestic deposit base and solid liquidity reserves, as well as the higher reliance of market funding in the Group’s overseas operations.

RATING DRIVERS
There could be upward pressure on the Bank’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, whilst maintaining a conservative risk-taking approach; 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.

A downgrade of the sovereign rating would likely lead to a downgrade of the ratings. Absent any change to the sovereign rating, negative pressure on the Issuer Rating would require a two-notch downgrade of the IA. DBRS Morningstar considers this is unlikely. However, this situation could arise from a substantial deterioration in the Group’s asset quality and from a significant weakening in the Group’s capital position.

RATING RATIONALE
SMBC Group is one of the large Japanese mega bank groups, with total assets of JPY 209.4 trillion at end-September 2019 (end-1HFY3/20 or the first six months of the fiscal year ending March 2020) (approximately USD 1,937.7 billion). In its domestic Japanese market, the Group has a strong franchise in retail and wholesale banking, in securities and in credit cards while globally the Group holds competitive positions in specialised lending areas such as aircraft leasing. As part of its current business plan, SMBC Group has been aiming to transform its business and asset portfolio, better manage costs, and strengthen capital. DBRS Morningstar considers that the Group has made good progress to date towards achieving the targets of this plan, assisted by the simplification of its organisational structure, the reorganisation of the branch network and the enhancement of its business processes through digitalisation and usage of robotics.

DBRS Morningstar considers that SMBC Group has demonstrated resilient profitability in recent years, as sound cost discipline and growth in the overseas businesses, combined with a solid non-interest income performance and low credit costs, have been able to offset the pressure from the negative interest rate environment and the low loan demand in Japan. In 1HFY3/20, the Group reported profit attributable to owners of the parent of JPY 432.0 billion (approximately USD 4.0 billion), down 8.6% year-on-year (yoy), largely driven by lower revenues due to the yen appreciation and a relatively weak performance in the wealth management business due to challenging market conditions . Operating expenses, albeit marginally up yoy, continue to be well managed, while credit costs remained low, albeit higher than a year ago, due to the absence of net reversals as recorded in 1HFY3/19.

In DBRS Morningstar’s view, SMBC Group has a moderate credit risk profile with strong asset quality and low levels of non-performing loans (NPLs). The credit portfolio continues to perform strongly with NPLs of JPY 695 billion, or 0.76% of total gross loans (based on the Financial Reconstruction Act), at end-September 2019 . However, the Group faces market risk in its banking activities as a result of its sizeable holdings of Japanese Government Bonds (JGBs), which totalled JPY 8.8 trillion, or 83% of the Group’s Tier 1 Capital at end-September 2019. Furthermore, and similar to its Japanese mega-bank peers, SMBC Group faces market risk from its sizeable exposure to Japanese equities, which could result in capital ratio volatility as a result of unrealised gains and losses. The ratio of the book value of the Group’s domestic equity holdings to its Common Equity Tier 1 (CET1) capital stood at 17% at end-September 2019 and SMBC Group aims to bring this ratio down to 14% by around 2020.

DRBS Morningstar considers that the Group has a strong funding and liquidity profile, supported by a strong domestic deposit base and good liquidity reserves. The Group’s net loan-to-deposit ratio (including negotiable certificates of deposit (NCDs)) stood at 58.7% at end-September 2019. Nonetheless, the Group’s overseas operations are increasingly using market funding as recent lending growth has outpaced the growth of overseas customer deposits. The Group’s net loan-to-deposit ratio in its overseas operations was 112% at end-September 2019 up from 104% at end-March 2017, while wholesale funding (including short-term and medium-to long-term funding) represented 53% of total overseas funding mostly in the form of corporate bonds, interbank lending and commercial paper.

SMBC Group has a solid capital position, supported by organic capital generation, a modest dividend payout ratio, and good access to capital markets. At end-September 2019, the Group had a fully-loaded Common Equity Tier 1 (CET1) ratio of 16.1%, when including the impact of net unrealised gains/losses on available-for-sale-securities. When excluding this impact, the Basel III fully-loaded CET1 ratio was 13.4% at end-September 2019 and this is still well above the minimum regulatory requirement of 8%. On a post-Basel III reforms basis, and excluding the impact of net unrealized gains/losses on available-for-sale securities, the Group’s CET1 ratio stood at 10.0% at end-September 2019.

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

Notes:
All figures are in JPY 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 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.

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: Maria Rivas, Senior Vice President - Global FIG
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer - Global FIG and Sovereign Ratings
Initial Rating Date: September 26, 2001
Last Rating Date: January 28, 2019

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