Morningstar DBRS Confirms Westpac's LT Issuer Rating at AA, Stable Trend

DBRS Ratings Limited (Morningstar DBRS) confirmed the credit ratings of Westpac Banking Corporation (Westpac or the Group), including the Long-Term Issuer Rating at AA and the Short-Term Issuer Rating at R-1 (high). The trend on the Group's credit 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 Westpac's importance to the financial system in Australia. This results in a one-notch uplift to the Long-Term Issuer Rating from the IA. See a full list of credit ratings at the end of this press release.

KEY CREDIT RATING CONSIDERATIONS

The confirmation of Westpac's credit ratings reflects its very strong banking franchise in Australia and New Zealand, the Group's solid capital position, resilient earnings generation and sound asset quality despite some increase in impaired loans driven by the high inflationary and interest rate environment. The credit ratings also take into account the Group's strong liquidity position and large customer deposit base and reliance on wholesale funding. Additionally incorporated is the Group's good progress in improving its operational risk management following the completion of the CORE Programme to address past operational risk deficiencies and subsequent reduction of the regulatory capital add on in July 2024. The credit ratings also consider that whilst the asset side continued to benefit in H1 2024 from the repricing at higher interest rates, revenues have also declined partly reflecting the gradual pass through of higher interest rates to the cost of funding and that as a result, profitability remains weaker than most domestic and international peers.

CREDIT RATING DRIVERS

An upgrade of the credit ratings could be driven, over the longer-term, by a sustained improvement in profitability whilst maintaining sound asset quality and capitalisation.

A downgrade of the credit ratings could be driven by a prolonged significant deterioration in profitability and asset quality. Furthermore, a downgrade of the long-term credit ratings would occur if, in Morningstar DBRS's opinion, the likelihood of timely systemic support were reduced.

CREDIT RATING RATIONALE

Franchise Combined Building Block (BB) Assessment: Very Strong/ Strong

Westpac is one of the largest banks in Australia with total assets of AUD 1,052.7 billion at end-March 2024 (end-H1 2024). Westpac has a strong retail franchise in Australia, with a 21% market share in household deposits, 21% in household mortgages and 15% in business credit. Similar to domestic peers, Westpac has a strong retail market position in New Zealand (18% market share in both deposit and consumer lending and 16% in business lending).. On 9th September 2024, Westpac announced the change of its Chief Executive Officer, Anthony Miller, effective on 16th December and who will replace Peter King, who is retiring.

Earnings Combined Building Block (BB) Assessment: Good

Westpac has a generally resilient revenue generation, sound cost discipline and conservative risk profile that translates in low levels of loan loss provisions. The Group reported statutory net profit attributable to owners of AUD 3.3 billion in H1 2024, down 16% from AUD 4.0 billion in H1 2023, largely reflecting growth of operating expenses, weaker wealth management and trading revenues and the absence of some capital gains recorded in H1 2023 from the sale of businesses, despite loan loss provisions were slightly lower Year on Year (YoY). Statutory return on average ordinary equity (ROE) was 9.3% in H1 2024, down from 11.3% in H1 2023 albeit similar than the 10.1% in FY23. In H1 2024, Net interest income (NII) remained stable YoY largely reflecting growth of cost of deposits driven by the gradual repricing at higher interest rates and higher wholesale fundings costs after the repayment of the Term Funding Facility. The Net Interest Margin (NIM), on a statutory basis, was 1.92% in Q3 2024, similar to 1.89% in H1 2024 although down from 1.95% in FY23. Operating expenses, on a statutory basis were significantly up, 8% YoY in H1 2024 largely reflecting wage inflation and higher IT costs. As a result, the Group's cost-income ratio slightly deteriorated to 51% in H1 2024, although this still compares well with domestic and most international peers. The reported cost of risk (as a proportion of annualised average gross loans) remained low at 9 bps in H1 2024, stable from FY23.

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

Westpac has a generally conservative credit risk profile and sound asset quality with low levels of impaired loans. However, Stage 3 have grown steadily since end-FY22 largely reflecting the impact of higher interest rates and inflation on borrowers repayment capacity. Westpac's Stage 3 loans (non-performing loans) went up 17% in H1 2024 and 15% YoY at end-FY23, although from a very low base to AUD 9,787 million, largely driven by mortgage lending deterioration. The Stage 3 loan ratio increased to 1.24% at end-H1 2024 from 1.07% of total gross loans at end-FY23. Stage 2 loans, which are loans where there has been a significant increase in credit risk but are still performing accounted for 21% of total gross loans at end-H1 2024 following a 34% growth YOY at end-FY23 driven by model adjustments to account for increased economic downside scenarios particularly on business loans. Exposure to the commercial property sector (6.6% of total credit exposures at end-H1 2024) continues to perform well with an impaired loan ratio of 0.07%.

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

Westpac has a sound customer deposit base supported by its strong franchise in Australia. At end-H1 2024, Westpac's customer deposits (including certificates of deposits, CDs) totaled AUD 702.2 billion, and were up 2% from end-FY23 and 6.5% from end-FY22. The Group's net loan-to-deposit was 112% at end-H1 2024 and end-FY23 and improved from 127% at end-FY18. Westpac's wholesale funding (as calculated by DBRS Morningstar and excluding certificates of deposits) accounted for 23% of total non-equity funding, with short-term funding representing 3% of total non-equity funding. The Group's refinancing needs are manageable with AUD 7 billion to refinance in Q4 2024, AUD 33 billion in FY25 and AUD 34 billion in FY26. This compares with AUD 35 billion issued in FY23. Liquidity is sound with a reported Liquidity Coverage Ratio (LCR) of 130%, and a Net Stable Funding Ratio (NSFR) of 113% at end-Q3 2024].

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

Westpac's capital position is solid on the back of strong earnings generation and sound access to capital markets. At end-Q3 2024, Westpac reported an APRA Common Equity Tier 1 (CET1) ratio of 11.96% (11.91% (pro-forma of completion of share buyback and the 17 bps increase from the reduction of Capital add-on and the benefit of the approval of IRRBB model), largely impacted by credit lending growth and dividend distribution. This compares to APRA's 10.25% minimum regulatory requirement and a management target of 11%-11.5% range in normal operating conditions. Westpac's current Tier 2 and LAC ratio was 6.4% at end-H1 2024, very close to the 2026 regulatory target].

Further details on the Scorecard Indicators and Building Block Assessments can be found at: https://dbrs.morningstar.com/research/439485.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Governance (G) Factors

The subfactor `corporate governance' is relevant to the credit rating of Westpac but does not affect the overall credit rating or trend assigned to the bank. This is reflected in the Risk grid building block. Morningstar DBRS considers Westpac still needs to make further progress in relation to Anti-Money Laundering/Counter-Terrorism Financing Act. This is still reflected in the capital add-on of AUD 500 million capital that was added in December 2019, following an announcement by AUSTRAC that they had identified alleged breaches of the Morningstar DBRS expects this capital add-on to remain in place until the Group improves its AML management to AUSTRAC's satisfaction. However, Morningstar DBRS consider that the Group has continued to improve its operational risk, as reflected in the completion of its Customer Outcome Risk Excellence (CORE) program which addresses the issues raised by the enforceable undertaking with APRA in 2020 and strengthened risk governance, accountability and risk culture. Following the completion of the CORE program, APRA announced the reduction of the capital add-on to AUD 500 million in July 2024 from the original AUD 1 billion requirement, which Morningstar DBRS sees as reflecting the significant progress made by the Group in operational risk.

There were no Environmental or Social factors 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 Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781

Notes:
All figures are in Australian Dollar unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (04 June 2024) https://dbrs.morningstar.com/research/433881 In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

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 these credit ratings include Morningstar Inc. and company documents, Westpac Q3 2024 Trading Update, Westpac H1 2024 Report, Westpac H1 2024 Financial Results, Westpac H1 2024 Presentation and Investor Discussion Pack, Westpac 2023 Climate report. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were 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

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's 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/439484.

These credit ratings are endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Maria Rivas, Senior Vice President, Sector Lead - European Financial Institution Ratings
Rating Committee Chair: William Schwartz, Senior Vice President - Global Fundamental Ratings, Credit Practices
Initial Rating Date: February 01, 2005
Last Rating Date: November 17, 2023

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