DBRS Morningstar Confirms ANZ’s Issuer Ratings at AA / R-1 (high); Stable Trend

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

KEY RATING CONSIDERATIONS
The confirmation of the ratings reflects ANZ’s strong domestic franchise, both in retail and institutional banking, as well as the Group’s conservative risk profile, robust capital levels and consistent earnings generation. The ratings also incorporate a well-managed funding and liquidity profile, which has seen a reduction in the usage of wholesale funding in recent quarters due to the liquidity injected into the system through the Reserve Bank of Australia’s (RBA) funding programs, and the significant increase in deposits due to extraordinary government support packages and precautionary savings. The confirmation of the ratings also takes into consideration the Group’s continued progress in addressing risk management issues. DBRS Morningstar also considers that the impact of the coronavirus (COVID-19) pandemic has negatively affected the operating environment, which may result in weaker revenue generation for ANZ in 2021 given lower interest rates, as well as some deterioration in its asset quality profile.

RATING DRIVERS
An upgrade of the ratings is unlikely in the near term, given the uncertain economic outlook. An upgrade of the ratings would require the Group’s credit profile to remain resilient throughout the COVID-19 crisis, accompanied by sustained lower reliance on wholesale funding while maintaining very strong earnings and capital levels.

The ratings would be downgraded if ANZ experiences a substantial deterioration of its asset quality profile, combined with lower returns and capital levels. Furthermore, a downgrade of the Long-Term Issuer Rating could occur if, in DBRS Morningstar’s opinion, the likelihood of timely systemic support were reduced.

RATING RATIONALE
ANZ is a leading Australian bank with a strong franchise in its core markets of Australia and New Zealand, both in retail and institutional banking. In recent years, the Group has rebalanced its institutional portfolio and refocused its activities towards core businesses, while the Group’s international operations were simplified through the disposal of non-core assets and minority stakes.

Supported by its strong positions in its core markets of Australia and New Zealand, ANZ has consistently generated strong revenues, although at lower levels in both FY20 and FY19. The Group reported statutory net profit attributable to shareholders of AUD 3,577 million in FY20, down 40% on FY19, reflecting the economic consequences of the COVID-19 pandemic, with increased impairment charges on the credit portfolio, an AUD 815 million impairment charge on two Asian equity investments, and the impact from accelerated software amortisation. On a cash profit and continuing operations basis, net profit after tax was AUD 3,660 million, or similarly 41% lower compared to FY19. Positively, efficiency levels remain very good with a cost-to-income ratio in FY20 of 54% on a cash basis. ANZ’s return on average ordinary shareholders' equity was down to 5.9% in FY20 from 10.0% in FY19. However, this is not out of line with the performance of many global peers given the challenging operating environment.

In FY20, credit impairment charges increased by 3.4 times to AUD 2,738 million, of which around 59% (c. AUD 1.6 billion) related to the build-up of credit reserves and additional sector specific overlays in light of the deteriorating economic outlook driven by the COVID-19 pandemic. Overall, ANZ's cost of risk increased to 43 bps in FY20, from 13 bps in FY19, and represented 33% of income before provisions and taxes (IBPT) in FY20, which DBRS Morningstar views as manageable for ANZ.

Despite the increase in the cost of risk, ANZ’s credit quality remains very strong. ANZ’s gross impaired loans ratio was around 1.0% according to DBRS Morningstar and including 90 days past due loans & restructured at FY20 (around 0.9% in FY19). The loan book consists predominantly of mortgages where the level of impaired loans remains low, while the Group’s corporate portfolio appears well-diversified by sector and is weighted towards Australia and New Zealand. With regards to the Group's exposures to sectors mostly affected by COVID-19, DBRS Morningstar notes that out of the 23,000 accounts that have received payment deferrals at some point over the period March-September 2020, circa 6,500 accounts remained under payment deferrals at November 9, 2020, which in terms of exposure at default totalled AUD 4 billion, or 5.9% of the book.

DBRS Morningstar views ANZ’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 112% at end-FY20, as per DBRS Morningstar calculations, driven by an increase in customer deposits of AUD 41 billion or 7.9% YoY. The Group had been relying to a higher degree than most of its global peers on overseas wholesale market funding but this has improved thanks to the ample supply of liquidity in the system by the RBA on the back of the establishment of the Term Funding Facility (TFF) in March 2020, which ensures that Australian banks can extend credit and support customers affected by the COVID-19 pandemic. Wholesale funding accounted for 30.8% of total funding at end-FY20, with short-term funding (i.e. certificates of deposit and commercial paper) down to 15% of wholesale funding , from 18% at end-FY19 and 22% at end-FY18. DBRS Morningstar views the Group’s wholesale funding profile to be well diversified in terms of product and currency with no significant refinancing concentration. ANZ has a solid liquidity position with the Group's average Liquidity Coverage Ratio (LCR) ratio in FY20 of 139%, while its Net Stable Funding Ratio (NSFR) ratio was 123.8% at end-September 2020.

DBRS Morningstar views ANZ as having a robust capital position, given the Group’s solid track record in generating earnings, and its flexibility to access markets. The Group reported an Australian Prudential Regulation Authority (APRA) Common Equity Tier 1 (CET1) ratio of 11.34% at end-FY20, which was flat compared with the prior year, as organic capital generation was offset by the FY19 and interim FY20 dividends, as well as the impact of the credit impairment charges and RWA movements. On an internationally comparable basis, ANZ’s CET1 ratio was 16.7% and its leverage ratio was 6.0% at end-FY20.

ESG CONSIDERATIONS
DBRS Morningstar views the Business Ethics and Corporate Governance ESG subfactors as significant to the credit rating, and these are included in the Governance factor. In recent years operational risk and control deficiencies have been identified, however, ANZ appears to be working towards improving controls and resolving these issues by strengthening its compliance function, and simplifying its business model.

Addressing operational risk issues is an important challenge for ANZ. In recent years, ANZ has streamlined its offering both domestically and internationally. The Group has disposed of businesses, including Wealth Australia, and minority stakes in other banks in Asia, with the simplification process appearing now to be completed. This reflects the management's strategy to re-focus towards businesses where the Group already possesses expertise, and we consider that the streamlining of operations has not materially affected the Group's franchise strength.

ANZ, along with the other three major Australia banks, has been part of various reviews with regards to a number of conduct issues over the past few years. The Group continues to implement the recommendations of the Royal Commission, which investigated misconduct in the banking, superannuation and financial services industry, and whose recommendations were published in February 2019. In particular, ANZ has stated that they will be implementing 16 initiatives of the Royal Commission in order to improve the treatment of retail customers, small businesses and farmers in Australia.

Furthermore, DBRS Morningstar notes that following the Group’s self-assessment into governance, culture and accountability, APRA imposed a capital add on of AUD 500 million in July 2019 to ANZ, which relates to identified weaknesses in non-financial risk management. Even though headline noise over past conduct issues appears to have abated, DBRS Morningstar will continue monitoring developments regarding regulatory and other state authorities, given DBRS Morningstar's limited tolerance on recurring conduct issues at ANZ's rating level. DBRS Morningstar expects that full implementation of the recommendations laid out by the Royal Commission and APRA will take time, in part because some of the recommendations require legislative changes.

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 ANZ are as follows: Franchise Strength –Strong; Earnings Power – Very Strong/Strong; Risk Profile – Strong; Funding & Liquidity – Strong/Good; Capitalisation – Very Strong/Strong.

DBRS Morningstar notes that this Press Release was amended on 1 December 2020 to incorporate the disclosure regarding rating methodologies and Coronavirus Disease.

Notes:
All figures are in AUD unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (8 June, 2020) https://www.dbrsmorningstar.com/research/362170/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 ANZ FY20 Annual Report, ANZ FY20 Pillar 3 Disclosure, ANZ FY20 Results Highlights, ANZ FY20 Investor Presentation, ANZ FY20 Results Transcript, Reserve Bank of Australia’s Financial Review, Australian Prudential Regulation Authority, 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.

With Rated Entity or Related Third-Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

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/370550

Ratings assigned by DBRS Ratings Limited are subject to EU and U.S. regulations only.

Lead Analyst: Vitaline Yeterian, Senior Vice President, Global FIG
Rating Committee Chair: Ross Abercromby, Managing Director, Global FIG
Initial Rating Date: January 25, 2005
Last Rating Date: November 29, 2019

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