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. However, given the sovereign rating of Japan is also 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 at 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. DBRS consider that the growing scale of economic and market disruption caused by the Coronavirus Disease (COVID-19) globally will likely affect the Group’s earnings and asset quality in the coming quarters. However, DBRS Morningstar considers that the Group is relatively well positioned to face the challenges arising from this environment given its diversified revenue generation ability, the low levels of non-performing loans to date and its sound funding and liquidity position. As the economic impact of the COVID-19 outbreak will continue to emerge in the coming quarters, DBRS Morningstar will continue to monitor the Group’s profitability, asset quality and capital position levels.

Conversely, the ratings also incorporate the pressure on the Group’s revenues from the low interest rate environment in Japan, as well as the Group’s concentration in holdings of Japanese Government Bonds and Japanese equities, which have recently suffered from market price fluctuations reducing regulatory capital levels through lower unrealised gains. The IA also takes into account the increasing interbank funding usage for the Group’s overseas operations, albeit the Group’s strong funding and liquidity position remains strong, supported by its large domestic deposit base.

RATING DRIVERS

Given the scale of the economic disruption caused by the COVID-19 outbreak, an upgrade of the Long-Term Issuer rating is unlikely. An upgrade of the Bank’s Long-Term ratings would require that: 1) the sovereign rating is upgraded and uplift for systemic support is consequently incorporated into the ratings in line with the SA2 Support Assessment; or 2) the Group’s overseas activities increase sufficiently that the proportion and quality of profits and exposures outside of 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 Long-Term Issuer ratings. Absent any change to the sovereign rating, a downgrade of the Long-Term Issuer Rating would require a two notch downgrade of the IA. This could occur from a substantial deterioration in the Group’s asset quality and a significant weakening in its capital position, potentially as a result of a prolonged adverse economic impact from COVID-19.

RATING RATIONALE

With total assets of JPY 219.8 trillion at end-March 2020 (end-FY3/20, the fiscal year ending March 2020) (approximately USD 2,043 billion), SMBC Group is one of the three large Japanese mega bank groups. The Group has a strong domestic franchise in retail and wholesale banking while globally it has a strong presence in specialised lending areas such as aircraft leasing.

SMBC Group’s profitability has been resilient in recent years, however, we expect that the COVID-19 outbreak will negatively affect the Group’s bottom line results due to weaker gross business profits and higher loan loss provisions. In FY3/20, profit attributable to owners of the parent was JPY 703.9 billion, slightly down YoY, primarily reflecting ongoing pressure on operating revenues from the low interest rate environment in Japan. Moreover, the disruption caused by the COVID-19 outbreak was visible in higher loan loss provisions and impairments on listed stocks. Operating expenses, however, remained broadly stable YoY and the cost-to-income ratio was 63%, slightly higher to the 60% recorded the FY3/19. Credit costs totalled JPY 170.6 billion, compared to JPY 110.2 billion in FY3/19, due to the absence of reversals recorded the previous year and the build-up of provisions related to COVID-19 (JPY 40 bn). For FY3/21, the Group expects loan loss provisions to increase to JPY 450 billion and profit attributable to the owners of the company to reduce to JPY 400 billion.

SMBC Group has entered into the COVID-19 crisis with strong asset quality and low levels of non-performing loans (NPLs), which represented 0.68% of total gross loans (based on the Financial Reconstruction Act) at end-March 2020. However, we consider that the Group has exposure to sectors that could potentially be negatively affected if the COVID-19 crisis were to be prolonged. These include its aircraft business (USD 13 billion), and its natural resources exposure (JPY 8.6 trillion) as well as certain domestic sectors such as retail and wholesale SMEs business (JPY 4.4 trillion), and real estate (JPY 7.6 trillion). Moreover, the Group faces market risk as a result of its sizeable holdings of Japanese Government Bonds (JGBs), and its sizeable exposure to Japanese equities, which have suffered from market volatility in the last few months. The Group’s JGB holdings accounted for 69% of the Group’s Tier 1 Capital at end-FY3/20, and its exposure to Japanese equity holdings accounted for 16% of Tier 1 Capital.

SMBC Group has a strong funding and liquidity position, partly supported by a strong and growing customer deposit base in Japan which translates into a net loan-to-deposit ratio (including negotiable certificates of deposit (NCDs)) of 60.1% at end-March 2020. The Group’s overseas operations have traditionally been funded by a combination of overseas deposits and wholesale medium-term funding which grew by a combined 5% in FY3/20. However, in the past quarter, the Group has increased the usage of interbank funding including repos which totalled USD 121 billion at end-FY3/20 and represented 22% of total funding at that date. This compares to USD 76 billion, or 16% of total funding at end-September 2019. Whilst the increase in this funding source is partly driven by COVID-19, DBRS Morningstar will continue to monitor the usage of this funding source to fund its overseas operations. The Liquidity Coverage ratio (LCR) was 126% and the Group’s Highly Liquid assets (HQLA) accounted for a high 30% of total assets at end-FY3/20.

DBRS Morningstar views SMBC Group’s capital position as strong, even though the regulatory capital ratios incorporate unrealised capital gains from available for sale securities. At end-FY3/20, the Group had a fully-loaded Common Equity Tier 1 (CET1) ratio of 15.5%, when including the impact of net unrealised gains/losses on available-for-sale-securities, down from 16.3% at end-FY3/19, negatively impacted from significant market volatility in 4QFY19. When excluding unrealised gains from AFS securities, the fully-loaded CET1 ratio was 13.3%, fairly stable YoY and well above the minimum regulatory requirement of 8%. Moreover, capital ratios will be negatively affected once the finalised Basel III rules come into force due to risk weighted assets inflation. 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 was 9.8% at end-FY3/20. The Group expects this ratio to remain at 9.5% during FY3/21, reflecting the impact of COVID-19.

ESG CONSIDERATIONS

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792

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/Good.

Notes:
All figures are in JPY unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (8 June 2020). https://www.dbrsmorningstar.com/research/346375/global-methodology-for-rating-banks-and-banking-organisations

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883

The sources of information used for this rating include SMBC’s FY2019 Results Presentation 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 12-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

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/363011

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: Elisabeth Rudman, Managing Director, Head of European FIG - Global FIG
Initial Rating Date: September 26, 2001
Last Rating Date: January 28, 2020

DBRS Ratings Limited
20 Fenchurch Street, 31st Floor, London EC3M 3BY United Kingdom
Tel. +44 (0) 20 7855 6600
Registered and incorporated under the laws of England and Wales: Company No. 7139960

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.