DBRS Upgrades SMBC to A (high) / R-1 (middle), Stable Trend

DBRS Ratings Limited (DBRS) has upgraded the ratings of Sumitomo Mitsui Banking Corporation (SMBC or the Bank), including its Long-Term Issuer Rating to A (high) and the Short-Term Issuer Rating to R-1 (middle). The trend on all ratings is now Stable. The Intrinsic Assessment (IA) of the Bank is now A (high), and DBRS notes that it is based upon the financial strength of the consolidated Sumitomo Mitsui Banking Corporation Group (SMBCG or the Group). The Support Assessment remains at SA2. This reflects 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 rating of Japan is 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 ratings upgrade reflects the recent upgrade of DBRS’s rating on Japan to A (high) from ‘A’ and the improvement in the Bank’s IA to A (high) from ‘A’. The improvement in the IA reflects the very resilient earnings, supported by the Group’s strong domestic franchise in retail and wholesale banking, as well as the Group’s global presence and competitive position in certain specialised lending areas. The A (high) IA also reflects the Bank’s strong asset quality, as evidenced by its low levels of non-performing loans. Nonetheless, its holdings of Japanese Government Bonds and Japanese equities are being reduced, but still present certain risk management challenges. The Group’s funding and liquidity profile is strong, benefiting from a solid domestic deposit base and ample liquidity reserves, although the Group’s overseas operations utilise more market funding. Capital levels are solid, although DBRS notes that these continue to incorporate sizeable unrealised gains on available-for-sale securities.

RATING DRIVERS
There could be upward pressure on the Bank’s issuer and senior debt ratings if: 1) the sovereign rating is upgraded further and uplift for systemic support is consequently incorporated into the ratings in line with the SA2 support designation; 2) the sovereign rating is upgraded and there is also a strengthening of the Group’s profitability; or 3) the Group’s overseas activities increase sufficiently that the proportion and quality of profits and exposures outside 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 Issuer Rating. Absent any change to the sovereign rating, negative pressure on the Issuer Rating would require a two-notch downgrade of the IA. DBRS considers this is unlikely. However, this situation could arise from a substantial deterioration in the Group’s asset quality, or from a significant weakening in the Bank’s capital position.

RATING RATIONALE
SMBCG, previously known as Sumitomo Mitsui Financial Group, is one of the large Japanese mega-banking groups. The Group has a strong domestic franchise in retail and wholesale banking, as well as in securities and credit cards. Additionally, it has significant operations outside Japan, with the Group having competitive positions in certain specialised lending sectors and various operations across Asia.

SMBCG’s earnings have demonstrated resilience in recent years. Growth in its overseas loans and deposits business along with strong non-interest income performance and low credit costs have successfully mitigated the pressure from the low interest rate environment in Japan and the modest domestic loan demand. In 1H18 (April-September 2018), reported profit attributable to owners of the parent was up 11% year-on-year, as a result of the steady performance in all business units as well as reduced operating expenses and lower credit costs. The Group’s cost-income ratio stood at 58.4% in 1H18, comparing favourably to its domestic and international peers. However, cost control remains a key focus. Following an increase in investment spending, operating expenses appear to have stabilised over the last two years. As part of its current medium-term plan, the Group aims to reduce expenses further through utilisation of robotics and reorganisation of branches and group companies, which should enable SMBCG to continue to meet its 60% cost-income ratio target in the medium-term.

SMBCG’s risk profile remains solid. It has strong asset quality indicators, including a non-performing loans ratio of 0.71% of total claims (based on the Financial Reconstruction Act), and a strong coverage ratio of 75.0% at end-September 2018. DBRS notes positively that the Group’s JGB holdings now account for only 66% of the Group’s Tier 1 Capital at end-1H18. However, similar to its Japanese mega-bank peers, SMBC Group also faces market risk from its sizeable exposure to Japanese equities, which could result in capital ratio volatility as a result of unrealised gains and losses. For the Group, the ratio of the book value of its domestic equity holdings to its Common Equity Tier 1 (CET1) capital stood at 20% at end-September 2018. SMBC aims to bring this down to 14% by around 2020.

SMBC Group’s strong funding and liquidity profile benefits from a strong domestic deposit base and good liquidity reserves. The Group’s net loan-to-deposit ratio (including negotiable certificates of deposit) stood at 58.0% at end-FY17. DBRS notes that overseas deposits have been steadily increasing in recent years. Nonetheless, the Group’s overseas operations continue to require market funding, given their loan-to-deposit ratio of 117.6% at end-September 2018. The Group utilises medium-to long- term funding, such as corporate bonds and currency swaps, as well as interbank funding and CDs and CP. DBRS will continue to monitor the funding mix of the overseas operations.

SMBCG has a solid capital position. It has a fully-loaded Common Equity Tier 1 (CET1) ratio of 14.9%, which includes the impact of net unrealised gains/losses on available-for-sale-securities. It has a transitional Basel III leverage ratio of 4.94% at end-September 2018. Excluding the impact of net unrealised gains/losses on available-for-sale securities, the Basel III fully-loaded CET1 ratio declined to 12.2% at end-September 2018. However, this level is still well above the minimum regulatory requirement. 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 was 9.8% at end-September 2018. SMBCG is targeting a CET1 ratio of 10% at end-FY19.

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

Notes:
All figures are in JPY 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 and company reports. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

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: Ross Abercromby, Managing Director - Global FIG
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer - Global FIG and Sovereign Ratings
Initial Rating Date: September 26, 2001
Last Rating Date: January 30, 2018

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