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
The confirmation of SMBC’s IA at A (high) reflects the Group’s strong domestic franchise in retail and wholesale banking with strong competitive positions in certain specialised lending areas globally. In DBRS Morningstar’s view, the Group’s business diversification has provided resilient earnings that have helped the Group to navigate the challenging economic and operating environment driven by the COVID-19 pandemic. SMBC’s IA also considers the Group’s stable funding and liquidity position, supported by a solid customer deposit base domestically, its sound capital position, although DBRS Morningstar notes that the capital ratios incorporate significant unrealised capital gains from securities, as well as the Group’s strong asset quality, although non-performing loans (NPLs) have increased in the last financial year as a result of the pandemic. The IA also takes into account the sizeable exposure to Japanese Government Bonds and Japanese equities, which add volatility to regulatory capital ratios through market valuation movements, as well as that the Group’s overseas business operations make strong usage of market funding, particularly short-term funding, although this reduced in the year to end-March 2021, supported by strong growth in overseas deposits.

RATING DRIVERS
An upgrade of the Bank’s Long-Term ratings would require either that the sovereign rating is upgraded and uplift for systemic support is consequently incorporated into the ratings in line with the SA2 Support Assessment or that the Group’s credit profile improves, and the 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 ratings. Absent any change to the sovereign rating or to the Support Assessment, a downgrade of the Bank’s Long-Term Issuer Rating would require a two-notch downgrade of the IA. Downward pressure on the IA could arise from a material deterioration of the Group’s asset quality or capital position, potentially as a result of the challenging and uncertain environment.

RATING RATIONALE
With total assets of JPY 242.6 trillion at end-March 2021 (end-FY3/21, the fiscal year ending March 2021) (approximately USD 2,193.4 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.

The Group has demonstrated resilient earnings generation although this was negatively impacted by the COVID-19 pandemic in FY3/21, most notably in the form of higher credit costs and pressure on profits in the domestic business as credit card and consumer finance usage reduced due to lower consumption levels in Japan. However, the Group was able to offset this pressure with a strong performance in Sales & Trading and Wealth Management businesses and the resilient performance of its overseas businesses. In FY3/21, the Group reported profit attributable to owners of the parent of JPY 512.8 billion, compared to JPY 703.9 billion in the previous year. The Group's reported return on equity (ROE) was 5.4% in FY3/21, lower than the 7.6% reported in FY3/20, however, we still consider this as sound given the challenging operating environment and we view that it compares well with many of the Group's international peers. The Group's efficiency ratio was 62.3% in FY3/21 supported by sound cost discipline, with operating expenses flat YoY. The Group expects credit costs to reduce in FY3/22 to around JPY 300 billion, compared to JPY 360.5 billion in FY3/21.

SMBC Group's asset quality indicators remain sound, even though there has been an increase in NPLs during FY3/21 as a result of the challenging operating conditions due to the COVID-19 pandemic. The Group's NPLs, as per the Financial Reconstruction Act, increased by 49% YoY to JPY 966.5 billion at end-FY3/21, and the NPL ratio was 0.98%, up from 0.68% at end-FY3/20. The increase in NPLs was largely related to borrowers in some sectors that have been impacted by the pandemic, both in Japan and overseas. Whilst net exposure to natural resources is sizeable at JPY 7.4 trillion portfolio, the NPL ratio remained stable YoY at 1% at end-March 2021. The Group has a relatively high concentration to Japanese equities and government bonds, which continue to present risk management challenges and expose the Group to valuation fluctuations. SMBC almost doubled its exposure to Japanese Government Bonds (JGB holdings) at end-FY3/21 to JPY 14.3 trillion, or 128% of the Group’s Tier 1 Capital. However, the increase was mainly related to bonds with a maximum of one year maturity which were used to temporarily access the Bank of Japan repo funding facility to provide liquidity support to Japanese corporates during the pandemic. SMBC’s exposure to Japanese equity holdings accounted for a sizeable 11.3% of Tier 1 Capital, albeit this is down from 13% at end-FY3/20, and from 17% at end-FY3/17.

SMBC Group has a stable 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 55.1% at end-March 2021. Significant growth in overseas deposits in FY3/21 (up 12% YoY in USD) has led to a reduction in usage of non-JPY wholesale funding (including medium to long-term funding in the form of corporate bonds and currency swaps), to 54% of total Non-JPY funding at end-FY3/21 from 57% at end-FY3/20. Despite the reduction, DBRS Morningstar considers the usage of wholesale funding in the Group’s overseas operations is significant, particularly in short-term funding (interbank funding (including repos and CD/CP)) that represented a high 30% of total Non-JYP funding at end-March 2021, although the proportion reduced from 35% at end-March 2020. The Liquidity Coverage ratio (LCR) was 140.1% for the period January-March 2021, and the Group’s HQLA accounted for a high 30% of total assets at end-FY3/21.

SMBC Group has a sound capital position. Including the impact of net unrealised gains/losses on available-for-sale-securities, the Group had a fully-loaded Basel III Common Equity Tier 1 (CET1) ratio of 16.0% at end-March 2021, while the Basel III leverage ratio was 5.65%. Excluding the impact of net unrealised gains/losses on available-for-sale securities, the Basel III fully-loaded CET1 ratio was 12.8% at end-March 2021. The Group’s 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 at 9.8% at end-March 2021.

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/362170/global-methodology-for-rating-banks-and-banking-organisations . Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (3 February 2021) https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings

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 Investor meeting FY3/21 Presentation, SMBC Consolidated Financial report for the fiscal year ended March 31, 2021 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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/380501

This rating is endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Maria Rivas, Senior Vice President, Global FIG
Rating Committee Chair: Ross Abercromby, Managing Director, Global FIG
Initial Rating Date: September 26, 2001
Last Rating Date: June 24, 2020

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