DBRS Confirms Westpac at AA / R-1 (high) with a Stable Trend

DBRS Ratings Limited (DBRS) has confirmed the ratings of Westpac Banking Corporation (Westpac or the Group) including the AA Long-Term Issuer Rating and Long-Term Senior Debt rating. The trend on all ratings is Stable. Westpac’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 Westpac to the financial system in Australia, and the generally supportive regulatory framework.

KEY RATING CONSIDERATIONS
The confirmation of the ratings reflects the strength of the Group’s franchise in its core markets of Australia and New Zealand, along with the consistent revenue generation, the conservative risk profile, the robust capitalisation levels and the improved funding and liquidity profile, despite the relatively high reliance on wholesale funding partly mitigated by the Group’s solid liquidity position as well as no significant refinancing concentration.

RATING DRIVERS
Any upward pressure would require (i) a reduction in the extent of the reliance on wholesale funding and (ii) addressing regulatory issues, whilst (iii) maintaining solid recurring earnings and continued sound capital management.

Negative pressure on the ratings would be likely if (i) the proportion of wholesale funding were to increase materially, and (ii) if the Group had larger than expected shortcomings in risk management, conducts or fines. (iii) Additionally, negative pressure could also arise if the Group’s asset quality metrics were to significantly deteriorate potentially due to a significant stress in property market.

RATING RATIONALE
Westpac enjoys strong market shares in the retail and business banking markets in Australia, and this is complemented by a strong retail market position in New Zealand along with a select presence in America, Europe and the Asia Pacific region, where the Group supports Australian customers operating in the region or assists international customers doing business in Australia and New Zealand.

The Group has consistently generated strong profitability metrics and this earnings strength is a key rating factor. In FY18, Westpac reported net profit on an underlying cash earnings basis of AUD 8.1 billion, flat on FY17, as increased operating income and reduced impairment charges were offset by elevated operating expenses. DBRS notes operating expenses have been impacted by remediation costs and also additional regulation and compliance costs, which it expects to continue. At the same time, the Group’s 43.7% cost-income ratio (on a cash basis) still indicates a highly efficient cost structure. DBRS also notes that cost discipline remains a key target for Westpac, with the Group aiming to achieve a cost-income ratio below 40%, utilising technology as part of the Group’s digital transformation to materially support efficiency.

Westpac’s risk profile remains low. The quality of the overall loan portfolio remains good with gross impaired loans plus loans over 90+ days past due (DPD) accounted for 0.76% of the total loan portfolio at end-FY18 (0.73%). The slight deterioration in credit quality was primarily driven by 90+ DPD loans in the Australian book . The Group’s loan exposure towards retail lending accounts for 72% of the total gross loan portfolio, including AUD 444.7 billion of Australian housing loans. Home loans represent Westpac’s largest exposure accounting for about 63% of the total loan portfolio at end-FY18. At the same time, the Australian mortgage portfolio remains very strong, with minimal impairment charges, significant early repayments and an average dynamic LVR of 43% at end-FY18 (42% at end-FY17). To date, the performance of this book has historically been strong with an annualised loss rate of 2 bps in FY18.

Operational risk control and risk management have been apparent in recent months. Westpac, along with the other major Australian banks, is part of the Royal Commission in the banking, superannuation and financial services industry that was initiated in December 2017 and will produce its final report in February 2019. To date, the financial implications for Westpac have been small, and the potential consequences of reputational damage remains unclear. DBRS will continue to monitor this area closely.

DBRS considers Westpac’s funding profile as improved. Similar to its major Australian peers though, the Group relies to a higher degree than most of its global peers on the wholesale market, and usage of wholesale funding remains significant. However, as a result of growth in customer deposits, the Group’s loan-to-deposit ratio improved to 137% (141% at end-FY17) - albeit still at the higher end of its domestic peer group. Total wholesale funding remains sizeable and stood at about AUD 237.9 billion (AUD 238.6 billion at end-FY17), with total short-term funding accounting for 30% of this at end-FY18 (35% at end-FY17) excluding long-term funding with less than 12 months maturity. DBRS notes Westpac had AUD 153.7 billion in unencumbered liquid assets at end-FY18 (AUD 137.8 billion at end-FY17) approximately representing 1.5 times of total short-term wholesale funding. Westpac also reported relatively important buffer over minimum requirements with an LCR of 133% (124%) and NSFR of 114% at end-FY18 (mandatory since 1 January 2018).

DBRS considers that Westpac has a robust capital position, which benefits from very strong/substantial earnings generation ability. The Group reported an APRA Common Equity Tier 1 (CET1) ratio of 10.6% at end-FY18, flat compared to end-FY17, and above APRA’s 10.5% “unquestionably strong” benchmark measured under the existing capital framework. Westpac had a leverage ratio of 5.8% at end-FY18. On an internationally comparable basis, Westpac reported a CET1 ratio of 16.1% and a leverage ratio of 6.5% at end-FY18. DBRS notes that in November 2018, APRA released a consultation paper with regards to implementing a framework for increasing the loss-absorbing capacity of Authorised Deposit-taking Insitutions to support orderly resolution. Under this proposal, the major Australian banks would need to increase their total capital requirements by four to five percentage points of RWA, mainly through the issuance of additional Tier 2 capital. While this proposal is undergoing a consultation process and may change, DBRS notes that under the published framework, that for Westpac, this is equivalent to approximately AUD 17.0 – 21.3 billion based on the current capital framework in DBRS estimates.

The Grid Summary Grades for Westpac are as follows: Franchise Strength – Very Strong/Strong; Earnings Power – Very Strong; Risk Profile – Very Strong/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 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: February 1, 2005
Last Rating Date: November 30, 2017

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