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

DBRS Ratings Limited (Morningstar DBRS) confirmed the credit 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 credit 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 Morningstar DBRS’s expectation of timely systemic support in case of need, given the Bank’s systemic importance to the Japanese financial system. However, given that the sovereign credit rating of Japan is also A (high), Stable trend, there is currently no uplift to SMBC’s Long-Term Issuer credit rating. See the full list of credit ratings at the end of this press release.

KEY CREDIT 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 such as aircraft leasing. SMBC’s IA also takes into account the Group’s business diversification and strong asset quality, which are supportive of recurrent and strengthening earnings. SMBC’s profitability levels have benefited from a higher interest rate environment and strong loan demand. Whilst SMBC’s funding and liquidity position is strong, supported by a very large and sticky customer deposit base domestically, Morningstar DBRS also notes that the Group’s overseas business operations make significant usage of wholesale funding, particularly short-term wholesale funding. The IA also takes into account a satisfactory capital position considering the sizeable exposure to Japanese Government Bonds and Japanese equities, which have declined, but still add volatility to regulatory capital ratios through mark-to market valuations.

CREDIT RATING DRIVERS

An upgrade of the Bank’s Long-Term credit ratings would require that the sovereign credit rating be upgraded providing room for systemic support to be consequently incorporated into the Long-Term credit ratings, in line with the SA2 Support Assessment, assuming the IA of the Bank either remains at the current level or improves. Alternatively, an upgrade would also result if the Group’s interconnectedness with the Japanese sovereign declines whilst profitability and capital levels materially improve so that the IA may be positioned higher than the sovereign credit rating.

A downgrade of the sovereign credit rating would likely lead to a downgrade of the credit ratings. Absent any change to the sovereign credit rating or to the Support Assessment, a downgrade of the Bank’s Long-Term Issuer credit rating would require a two-notch downgrade of the IA. Downward pressure on the IA would arise from a substantial deterioration of the Group’s profitability or capital levels.

CREDIT RATING RATIONALE

Franchise Combined Building Block (BB) Assessment: Strong

SMBC is one of three large Japanese mega bank groups with total assets of JPY 285.8 trillion (approximately USD 2,026 billion) at end-December 2023 (9M 2023). The Group has a strong retail and wholesale banking franchise in Japan while it has a strong presence in specialised lending areas globally. This includes aircraft leasing through its subsidiary SMBC AC. The Group is also present in Asia, in particular Indonesia, India, Vietnam and the Philippines, with a multi-franchise strategy.

Earnings Combined Building Block (BB) Assessment: Good/Moderate

The Group reported profit attributable to owners of the parent of JPY 792.8 billion (approximately USD 5.6 billion) in 9M 2023, up 3.5% from JPY 766 billion in 9M 2022, mainly due to a higher interest rate environment, loan growth in Japan, the recovery of SMBC Nikko, and low credit costs. The Group's efficiency ratio improved to 59.7% in H1 2023, compared to 61.6% in FY22, reflecting higher revenues and ongoing cost discipline. Going forward, Morningstar DBRS notes that, if the Bank of Japan increases its base rate from -0.1% to 0%, it would represent a positive net impact on the Group’s net interest income of approximately JPY 42 billion in the first year based on the assumption that the balance-sheet is unchanged from end-H1 2023.

Credit costs increased to JPY 134.7 billion in 9M 2023 due to the domestic consumer finance business, from JPY 111 billion in 9M 2022, which included reversals of JPY 58 billion, but still below the JPY 158 billion level in 9M 2021 which was driven by some large corporate borrowers. Credit costs represented about 11% of the Group’s IBPT in 9M 2023. Morningstar DBRS notes the Group has operations in Russia, and that it received insurance settlements in respect to 19 aircraft previously leased to Russian airlines, representing a positive bottom line profit of USD 317 million as of end-Q3 2023. In addition, SMBC guided for a maximum potential impairment on the bottom line profit of USD -70 million, which is manageable for the Group.

Overall, the Group reported a strengthened return on equity (ROE) of 10.1% in 9M 2023, compared to 10.1% in 9M 2022 and 8.6% in 9M 2021.

Risk Combined Building Block (BB) Assessment: Strong/Good

SMBC Group's asset quality indicators are solid. The Group's NPLs, as per the Financial Reconstruction Act, increased to JPY 985.1 billion at end-December 2023, up 6.2% compared to JPY 927.8 billion at end-March 2023 due to some large exposures at SMBC, but below JPY 1,157.6 billion at end-March 2022. The NPL ratio remains low at 0.81% at end-2023, compared to 0.80% at end-March 2023, and below 1.08% at end-March 2022. Morningstar DBRS continues to monitor the Group’s Russian exposure through its aircraft leasing operations and its Russian banking subsidiary, however, the negative impact on the Group’s P&L has been manageable given the limited size of these operations relative to the Group’s total assets and SMBC’s earnings.

Similar to its domestic megabank peers, the Group has a relatively high concentration of Japanese equities and Japanese government bonds (JGBs), albeit declining. These holdings present risk management challenges and expose the Group to market risk fluctuations. The Group's JGBs holdings decreased to JPY 8.9 trillion at end-December 2023 compared to JPY 9.5 trillion at end-September 2023, and JPY 9.6 trillion at end-March 2023 and a much higher JPY 15.8 trillion at end-March 2022. These represented 71% of the Group’s Tier 1 Capital at end-December 2023, down from 83% at end-March 2023, and much improved from 141% at end-March 2022. The Group’s Japanese equity holdings as a proportion of Common Equity Tier 1 (CET1) capital decreased to 9.8% at end-September 2023 down from 10.2% at end-September 2022 and 10.6% at end-March 2023, and well below 18% at end-FY18, as estimated by Morningstar DBRS.

Funding and Liquidity Combined Building Block (BB) Assessment: Strong

The Group has a strong funding and liquidity profile, supported by a strong and sticky domestic deposit base as well as ample liquidity reserves. The Group’s net loan-to-deposit ratio (excluding negotiable certificates of deposit (NCDs)) stood at 63.4% at end-December 2023 (58.5% including NCDs). Total deposits increased to JPY 163 trillion at end-December 2023, up from JPY 156 trillion at end-December 2022, up 2.4% YoY, or up JPY 3.9 trillion in absolute terms, mainly driven by an increase in deposits in Japan. SMBC’s average Liquidity Coverage Ratio (LCR) was 134.4% for the period July-December 2023. SMBC Group’s total high-quality liquid assets totaled JPY 75.5 trillion (representing approximately 29% of total Group’s assets) at end-September 2023. The Group’s Net Stable Funding Ratio (NSFR) for the period July-September 2023 was 127.7%.

While the Group’s strategy is to fund interest earning assets (mainly loans) by deposits and mid-long term funding, Morningstar DBRS considers the usage of non-JPY wholesale funding as significant, representing about 56% of total non-JPY funding at end-December 2023 (vs. 58% at end-March 2022). Medium to long-term funding includes corporate bonds and currency swaps. Meanwhile, the usage of short-term wholesale funding (interbank funding including repos and CD/CP) represented about a third of total non-JPY funding (31.5% at end-December 2023, vs 31% at-end December 2022, 34% at end-March 2022), as calculated by Morningstar DBRS.

Capitalisation Combined Building Block (BB) Assessment: Good

SMBC has a sound capital position, supported by organic capital generation thanks to a reasonable dividend payout ratio policy, and good access to capital markets. Including the impact of net unrealised gains on available-for-sale-securities, the Group’s fully-loaded Common Equity Tier 1 (CET1) ratio was 14.9% at end-December 2023, up from 13.7% at end-September 2022. This is well above the minimum regulatory requirement of 8%, even when including the G-SIB surcharge of 1%. The Basel III leverage ratio was 5.04% at end-2023, up from 4.8% at end-December 2022 (vs. a regulatory minimum of 3.5%).

Similar to its Japanese peers, the exposure to JGBs and Japanese equities add volatility to regulatory capital ratios through mark-to market valuations. On a finalised Basel III basis and excluding the impact of net unrealised gains on available-for-sale securities, the Group’s CET1 ratio was 10.0% at end-2023, compared to 10.1% at end-March 2023, compared to the Group’s target on CET1 ratio of c. 10%.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://dbrs.morningstar.com/research/429046.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Social (S) Factors

The Social factor does not affect the credit ratings or trend assigned to SMBC. The Social factor has changed from the prior credit rating disclosure. The ‘Product Governance’ subfactor was viewed as relevant due to market manipulation issues at the Group’s brokerage arm SMBC Nikko Securities. SMBC Nikko Securities has now recovered, and Morningstar DBRS does not see the potential negative impact on the Group’s financial and franchise strength as relevant to the credit assessment anymore.

There were no Environmental/Governance factor(s) that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) https://dbrs.morningstar.com/research/427030/morningstar-dbrs-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 (June 22, 2023), https://dbrs.morningstar.com/research/415978/global-methodology-for-rating-banks-and-banking-organisations. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies

The sources of information used for this credit rating include Morningstar, Inc. and Company documents, Sumitomo Mitsui Financial Group Inc. Consolidated Financial Results for the six months ended September 30, 2023 and the nine months ended December 31, 2023, SMBC Overview of Q3 FY3/2024, SMBC Overview of H1 FY3/2024, SMBC Data Book H1 FY3/2024. Morningstar DBRS considers the information available to it for the purposes of providing this credit rating to be of satisfactory quality.

Morningstar DBRS does not audit the information it receives in connection with the credit 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. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://dbrs.morningstar.com/research/429045.

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

Lead Analyst: Vitaline Yeterian, Senior Vice President, Credit Ratings, Global Financial Institution Group
Rating Committee Chair: William Schwartz, Senior Vice President, Credit Practices Group
Initial Rating Date: 26 September 2001
Last Rating Date: 07 March 2023

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