DBRS Confirms Commonwealth Bank at AA / R-1 (high); Trend Remains Stable

DBRS Ratings Limited (DBRS) has confirmed the ratings of Commonwealth Bank of Australia (CBA or the Bank) including the AA Long-Term Issuer Rating and Long-Term Senior Debt rating. The trend on all ratings is Stable. CBA’s ratings reflect an intrinsic assessment (IA) of AA (low), combined with a support assessment of SA2, which results in a one notch uplift to the final rating from the IA. The SA2 reflects the systemic importance of CBA to the financial system in Australia, and the generally supportive regulatory framework.

KEY RATING CONSIDERATIONS
The confirmation of the ratings reflects the Bank’s extremely strong domestic franchise, as well as the Bank’s very strong profitability, conservative risk profile, robust capital levels, and a well-managed funding and liquidity profile, supported by the Bank’s solid liquidity position as well as a relatively good diversification in the Bank’s wholesale funding profile with no significant refinancing concentration.

RATING DRIVERS
CBA is well-placed at its current rating level. However, there could be positive pressure on the IA if the Bank were able to (i) continue progress in improving the funding profile, and (ii) successfully respond to current regulatory issues, while (iii) maintaining continued solid earnings and sound capital management.

Negative pressure on the ratings would be likely (i) if the proportion of wholesale funding were to increase, or (ii) if the Bank had larger than expected conducts issues and/or fines given DBRS limited tolerance of control issues at high rating levels. (iii) Additionally, negative pressure could also arise if the Bank’s asset quality metrics were to significantly deteriorate potentially due to a significant stress in property market.

RATING RATIONALE
CBA’s ability to consistently achieve very strong profitability is a key factor in the high IA. In FY18, the Bank reported statutory net profit attributable to equity holders of the Bank from continuous operations of AUD 9,375 million, down 4.0% on FY17, mainly reflecting an increase in operating expenses. On a cash basis, which refers to the Bank’s underlying results and excludes non-cash items and unrealized gains and losses related to hedging and IFRS volatility, net profit after tax from continuous operations was AUD 9,233 million, down 4.8% on FY17, similarly impacted by higher expenses. Efficiency levels remain very good in spite of several one-off items (including the Australian Transaction Reports and Analysis Centre’s civil penalty and increased regulatory costs associated with the Royal Commission). The reported cost-to-income ratio increased to 45.4% in FY18 (42.7% in FY17), albeit still comparing favorably to many of the Bank’s international peers.

Credit quality remains very strong, with a gross impaired loans ratio of 0.41% in FY18, flat year-on-year on the back of the solid Australian macroeconomic environment. However, operational risk can be an important challenge for banking groups with the size and scope of CBA. DBRS notes CBA has encountered regulatory scrutiny over conduct issues in the past two years that have tarnished its otherwise strong performance. In June 2018, CBA announced that it had entered into an agreement with AUSTRAC to resolve the civil proceedings by agreeing to pay an AUD 700 million civil penalty together with AUSTRAC’s legal costs. The Australian Prudential Regulation Authority (APRA) concluded a Prudential Inquiry, which revealed a number of shortcomings in CBA’s governance, culture and accountability frameworks, particularly with regards to non-financial risks. DBRS recognises CBA has taken actions to address these issues and, at this stage, expects the Bank to successfully respond to current regulatory issues. CBA has entered into an Enforceable Undertaking (EU) with APRA as of April 30, 2018. Separately, CBA was also investigated by the Australian Securities and Investments Commission (ASIC) for manipulation of the Bank Bill Swap Rate (BBSW). The dispute was settled in May 2018 with CBA acknowledging attempt to engage in unconscionable conduct of BBSW and agreeing to pay a total amount of AUD 25 million.

With regards to credit risk, the Bank’s largest exposure remains towards the Australian home loans portfolio, which accounted for AUD 451.4 billion at end-FY18, or 60% of the total gross loans and acceptances. DBRS notes the Australian housing market has slowed down in 2018, in particular in Sydney and Melbourne. However, DBRS views CBA as well positioned to absorb a deterioration given that the Bank’s dynamic loan-to-value ratio (LVR) stood at 50% with 77% of the customers being ahead of their repayment schedule at end-FY18 - providing a buffer in case of a significant correction in house prices. Overall, the quality of the home loans portfolio remains very strong with impaired loans of AUD 1.3 billion, or 0.28% of the Australian mortgage portfolio.

DBRS views that CBA’s funding profile has improved over the past few years, as growth in customer deposits has outpaced the growth in loan volumes. As a result, the Bank’s net loan-to-deposit ratio, as calculated by DBRS, stood at 131% at end-FY18, stable from end-FY17 and down compared to 138% at end-FY14 and 142% at end-FY12. Similar to its major Australian peers though, the Bank relies to a higher degree than most of its global peers to the wholesale market, as total wholesale funding accounted for 31% of total funding at FY18. DBRS views, however, that the Bank has a relatively good diversification in its wholesale funding profile in terms of product and currency, with issuances in AUD, USD and EUR accounting for over 80% of debt maturing or with a call date of greater than 12 months. In addition, the Bank has a solid liquidity profile. At FY18, the Bank reported a Liquidity Coverage Ratio of 131% (129% at end-FY17), and DBRS anticipates that the usage of short-term funding will remain contained. The Bank’s Net Stable Funding Ratio was 112% (107% at end-FY17).

DBRS views that CBA has a robust capital position, which benefits from substantial earnings generation ability. The Bank reported an APRA Common Equity Tier 1 (CET1) ratio of 10.1% at end-FY18, flat on end-FY17. APRA’s requirement that CBA holds an additional AUD 1 billion of Operational Risk regulatory capital (RWA of AUD 12.5 billion) representing 0.27% of CET1 at 31 March 2018. The additional requirement was announced following the conclusion of APRA’s Prudential Inquiry into CBA. At the same time, the Bank maintained a dividend payout ratio of 75%. On a pro-forma basis, i.e. including sales of assets already completed and divestments expected to be finalized within the calendar year FY19, CBA had a CET1 ratio of 10.7% at end-FY18. On an internationally comparable basis, CBA reported a CET1 ratio of 15.5% and a leverage ratio of 6.3% at end-FY18.

The Grid Summary Grades for CBA are as follows: Franchise Strength – Very Strong/Strong; Earnings Power – Very Strong; Risk Profile – Strong; Funding & Liquidity – Strong/Good; Capitalisation – Very Strong.

Notes:
All figures are in AUD unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (July 2018). This can be found can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include SNL Financial, company documents, the Reserve Bank of Australia, the Australian Prudential Regulation Authority and the Reserve Bank of New Zealand. DBRS 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.

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

DBRS 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 twelve month period. DBRS’s outlooks and ratings are under regular surveillance

For further information on DBRS 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.

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

Lead Analyst: Vitaline Yeterian, Vice President – Global FIG
Rating Committee Chair: Roger Lister - Managing Director, Chief Credit Officer - Global FIG and Sovereign Ratings
Initial Rating Date: January 24, 2005
Last Rating Date: November 24, 2017

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