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. SMBC’s IA also considers the Group’s business diversification which provides resilient earnings, its stable funding and liquidity position, supported by a very large customer deposit base domestically and its sound asset quality and capital position. 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 the fact that the Group’s overseas business operations make strong usage of market funding, particularly short-term funding.

The Group has Russian exposure through its aircraft leasing operations and a local subsidiary in Russia, however, DBRS Morningstar expects the potential negative impact on the P&L to be manageable given the relatively limited size of these operations relative to the Group’s total assets as well as the Group’s strong earnings generation ability.

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 substantial deterioration of the Group’s risk profile or capital position.

RATING RATIONALE

Franchise Combined Building Block (BB) Assessment: Strong
With total assets of JPY 257.7 trillion at end-March 2022 (approximately USD 1,966.3 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. With a strategy to acquire a large amount of high quality aircraft, SMBC AC, the aircraft leasing arm of the Group announced in May 2022 that it had reached an agreement to acquire a 100% equity stake in Goshawk, one of the leading aircraft leasing companies globally for approximately USD 1.5 billion, which is expected to reinforce the Group’s franchise in this sector. The Group is also present in Asia, in particular Indonesia, India, Vietnam and the Philippines, with a multi franchise strategy. The Group is exposed to Russia through its subsidiary SMBC AC, which offers aircraft leasing and has a net book value of USD 0.8 billion (net of provisions) or JPY 82 billion. In addition, the Group also has banking business in Russia, including a local subsidiary, with the exposure totalling USD 2.9 billion, largely related to Russian borrowers and central bank exposure.

Earnings Combined Building Block (BB) Assessment: Good/ Moderate
In FY3/22, the Group reported profit attributable to owners of the parent of JPY 706.6 billion, up 37.8% from JPY 512.8 billion in FY3/21, and back to a pre-pandemic level when compared to FY3/20 (JPY 703.9 billion). The improved FY3/22 results largely reflected lower credit costs year-on-year (YoY) along with improved domestic business growth. Credit card and consumer finance usage are recovering thanks to higher consumption levels in Japan. As a result, the Group reported an improved return on equity (ROE) of 7.3% in FY3/22 up from 5.4% in FY3/21, and also similar to the 7.6% reported in FY3/20. DBRS Morningstar considers the Group’s ROE as sound given the ultra-low interest rate operating environment in Japan. Credit costs reduced in FY3/22 to around JPY 274.4 billion, compared to JPY 360.5 billion in FY3/21, however this remained somewhat elevated compared to FY3/20 when credit costs amounted to JPY 170.6 billion. The Group's efficiency ratio was 61.8% in FY3/22 (vs. 62.3% in FY3/21) supported by higher revenues and despite operating expenses going up 4.2% YoY, reflecting business recovery from COVID-19 as well as higher variable marketing costs .

Risk Combined Building Block (BB) Assessment: Strong/Good
SMBC Group's asset quality remains sound, even though there has been an increase in NPLs during FY3/22, which we understand was largely driven by asset quality deterioration in Japan. The Group's NPLs as per the Financial Reconstruction Act totaled JPY 1157.6 billion at end-FY3/22 up 20% from JPY 966.5 billion at end-FY3/21, with the NPL ratio increasing to 1.08% at end-FY3/22 from 0.98% the year before while the NPL coverage ratio was a strong 66.98% (compared to 66.26% the year before). The Group, similar to domestic megabank peers, has a relatively high concentration in Japanese equities and government bonds, which continue to present risk management challenges and expose the Group to valuation fluctuations through unrealized gains and losses in the CET1. At end-FY3/22, the Group's JGB holdings increased to JPY 15.8 trillion compared to JPY 14.3 trillion at end-March 2021, and compared to JPY 7.1 trillion at end-March 2020. As a result, these represented 141% of the Group’s Tier 1 Capital at end-March 2021, compared to 128% at end-March 2021 and 90% at end-March 2020. SMBC’s exposure to Japanese equity holdings accounted for a sizeable 10.7% of Tier 1 Capital, although the Gorup has been successfully reducing exposure compared to 11.3% at end-FY3/21, and 17% at end-FY3/17.

Funding and Liquidity Combined Building Block (BB) Assessment: Very Strong/Strong
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 56% at end-March 2022. The usage of non-JPY wholesale funding (including medium to long-term funding in the form of corporate bonds and currency swaps), remained largely unchanged, totaling 58% of total non-JPY funding at end-FY3/22 compared to 57% at end-FY3/20. DBRS Morningstar considers the usage of wholesale funding in the Group’s overseas operations as significant, particularly in short-term funding (interbank funding and including repos and CD/CP), which represented 34% of total non-JPY funding at end-March 2022. The Liquidity Coverage ratio (LCR) was a sound 141.7% for the period January-March 2022 .

Capitalisation Combined Building Block (BB) Assessment: Good
SMBC Group has a sound capital position. Including net unrealized gains/losses on available-for-sale-securities, the Group had a fully-loaded Basel III Common Equity Tier 1 (CET1) ratio of 14.5% at end-March 2022, while the Basel III leverage ratio was 5.17%. Excluding the impact of net unrealised gains/losses on available-for-sale securities, the Basel III fully-loaded CET1 ratio was 12.1% at end-March 2022, slightly down from 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. Nevertheless, this is still well above the minimum regulatory requirement of 8%, even when including the G-SIB surcharge of 1%. 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-March 2022.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/398638

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Social (S) Factors

The Social factor does not affect the ratings or trend assigned to SMBC, however, the ‘Product Governance’ subfactor is viewed as relevant due to alleged market manipulation at the Group’s brokerage arm SMBC Nikko Securities and the potential to negatively impact the Group’s reputation due to a criminal trial. We also note some clients temporarily suspended businesses with the brokerage house, and that a third party investigation is still ongoing.

This S factor is new and was not present in the prior credit rating disclosure.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

Notes:

All figures are in JPY unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (19 July 2021) - https://www.dbrsmorningstar.com/research/381742/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 (17 May 2022) https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings

The sources of information used for this rating include Morningstar Inc. and Company Documents, SMBC Consolidated financial results for the fiscal year ended March 31, 2022, SMBC Investors Meeting Presentation FY3/2022, SMBC Overview Presentation of FY3/2022, SMBC Data Book FY3/2022. 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.

The conditions that lead to the assignment of a Negative or Positive trend are generally 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: https://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/398637

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: Elisabeth Rudman, Managing Director, Head of European FIG - Global FIG
Initial Rating Date: 09/26/2001
Last Rating Date: 06/23/2021

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