Fitch says big 4 NZ banks' strong operating profitability relative to international peers likely to continue, supported by strong franchises and pricing power

Fitch says big 4 NZ banks' strong operating profitability relative to international peers likely to continue, supported by strong franchises and pricing power

Credit rating agency Fitch Ratings issued the statement below on Wednesday evening.

Fitch Ratings has affirmed the Issue Default Ratings (IDR) of New Zealand's four major banks at 'AA-'. 

The four banks are: 
- ANZ Bank New Zealand Limited (ANZNZ), wholly owned by Australia and New Zealand Banking Group Limited (AA-/Stable); 
- ASB Bank Limited, wholly owned by Commonwealth Bank of Australia (AA-/Negative); 
- Bank of New Zealand (BNZ), wholly owned by National Australia Bank Limited (AA-/Negative); and
- Westpac New Zealand Limited (WNZL), wholly owned by Westpac Banking Corporation (AA-/Stable). 

The Outlooks on ASB and BNZ's Long-Term IDRs are Negative, while they are Stable for ANZNZ and WNZL. A full list of rating actions can be found at the end of this commentary. This review does not include ratings of covered bonds issued by the banks.

KEY RATING DRIVERS 
IDRS, SENIOR DEBT AND SUPPORT RATINGS
The affirmation of the four major banks' IDRs and Support Ratings reflect Fitch's opinion that there continues to be an extremely high likelihood of support from the banks' Australian parents, if required. 

Fitch sees the banks as key and integral parts of their banking groups, having strong integration across management, risk frameworks and treasury teams. The prospect of support is bolstered by strong linkages between the Australian and New Zealand banking regulators, which Fitch believes would work together to ensure the stability of both financial systems. 

The Outlooks on the four banks' IDRs reflect those of their respective parents.

VIABILITY RATINGS
Fitch believes the four major banks' large market shares and pricing power allows them to generate sustainable profits through the cycle without weakening risk appetite. This in turn supports asset quality and capitalisation. The banks share common rating drivers, reflecting their similar business models and strong domestic franchises. 

Fitch expects New Zealand's (AA/Stable) GDP growth to be flat over the next two years and for the banks' operating environment to remain broadly supportive because of a strong labour market and low interest rates. Nevertheless, macroeconomic risks remain elevated due to the high leverage in New Zealand households.

New Zealand household debt had stabilised at around 164% of disposable income at end-September 2018, but was higher than most global peers. High leverage means households are susceptible to an interest rate or labour market shock, weakening the ability of households to service their debts. Such a shock could also lead to weaker levels of consumer spending and economic growth, which would adversely affect the banks, although this scenario is not Fitch's base case.

Capitalisation is likely to increase, possibly significantly over the medium-term, if the Reserve Bank of New Zealand's (RBNZ) capital proposals are implemented unchanged. The proposals would see minimum Tier 1 capital ratios rise to 16% for the major banks, with risk-weights also increased. Risk-weighted capital ratios are difficult to compare with international peers due to the different treatment of capital and risk-weight calculations across global regulators. However, the major banks compare favourably on unrisk-weighted capital ratios. Fitch believes they also benefit from a strong level of ordinary capital support from their parents.

The major banks' risk appetites are modest in Fitch's view. Credit risk is the primary risk for the banks. This is reflected in their strong weighting towards lending activities and low reliance on more volatile business operations. The major banks' underwriting standards, particularly for residential mortgages, are similar. Fitch does not believe the RBNZ's easing of some macroprudential policies will result in a significant weakening in underwriting standards as the relaxation was minor. 

The major banks do not appear to be beset by the same conduct and political issues as their Australian parents. Nonetheless, Fitch expects the major banks to increase their investment in this area following a joint review by the RBNZ and Financial Market Authority that found there were sector deficiencies in the governance and management of conduct risk.

Fitch expects the major banks' asset quality to remain sound relative to international peers over the next year or two, reflecting the conservative risk appetite and stable operating environment. A mild increase in the very low prevailing level of impaired loans is possible, but this should be manageable by the banks. Multiple rounds of macroprudential tightening since 2013 have resulted in the banks being less susceptible to large losses in their mortgage books. 

The major banks have strong operating profitability relative to international peers due to their strong net interest margins and efficient management of costs. This is likely to continue, supported by the strong franchises and pricing power. Profit growth and efficiency improvements are likely to slow in the short-term due to slowing credit growth, increasing compliance costs and higher investment in digital banking and IT.

The major banks' funding profiles are a weakness relative to similarly rated international peers due to the reliance on offshore wholesale funding. This is unlikely to change significantly in the medium term. The funding risks are well-managed through a diversification of maturity, currencies and product. Liquidity management is sound and most of the banks' liquid asset holdings are high quality and sufficient to cover capital market debt maturing within 12 months.

SUBSIDIARY AND AFFILIATED COMPANIES
The major banks issue a portion of their wholesale funding through their funding subsidiaries, ANZ New Zealand (Int'l) Limited, ASB Finance Limited, BNZ International Funding Limited and Westpac Securities NZ Limited. These entities are wholly owned subsidiaries of their respective parents and are used for their parents' funding purposes only. Fitch does not rate the subsidiaries, only the senior unsecured debt issued by the subsidiaries. The debt ratings are aligned with those of their parents, as the parents guarantee the debt instruments. 

RATING SENSITIVITIES
IDRS, SENIOR DEBT AND SUPPORT RATINGS 
The IDRs and Outlooks are equalised with those of their respective parents. Changes in the parents' ratings are likely to be also reflected in their New Zealand subsidiaries' ratings. The Support Ratings and IDRs may be downgraded should Fitch change its view of the major banks' importance to their parents, the authorities change their cross-border regulatory approach, or if the RBNZ's final capital proposals are so onerous that there is a significantly increased chance of the parents divesting their New Zealand operations. 

VIABILITY RATINGS
Fitch sees the rating sensitivities as being similar for the major banks due to the comparable rating drivers. The banks' Viability Ratings are sensitive to a weakening in their franchises or further increases in macroeconomic imbalances. These factors, combined with deterioration in economic growth that is most likely to be triggered by external factors, such as a more rapid slowdown in Chinese growth than Fitch forecasts, could lead to significant deterioration in asset quality, profitability and capitalisation. 

Downward pressure on the banks' respective Viability Ratings could also occur if Fitch observed a weakening in the banks' funding and liquidity positions, which could be caused by a prolonged closure of international wholesale markets.

SUBSIDIARY AND AFFILIATED COMPANIES
The ratings of the senior unsecured securities issued by the major banks' funding subsidiaries are sensitive to the same factors as their respective parents' IDRs. 

The rating actions are as follows: 

ANZ Bank New Zealand Limited:
Long-Term Foreign-Currency IDR affirmed at 'AA-'; Outlook Stable
Short-Term Foreign-Currency IDR affirmed at 'F1+'
Long-Term Local-Currency IDR affirmed at 'AA-'; Outlook Stable
Short-Term Local-Currency IDR affirmed at 'F1+'
Viability Rating affirmed at 'a'
Support Rating affirmed at '1'
Rating on long-term notes affirmed at 'AA-'
Rating on short-term notes affirmed at 'F1+'
Rating on long-term notes issued by ANZ New Zealand (Int'l) Limited affirmed at 'AA-'
Rating on short-term notes issued by ANZ New Zealand (Int'l) Limited affirmed at 'F1+'

ASB Bank Limited:
Long-Term Foreign-Currency IDR affirmed at 'AA-'; Outlook Negative
Short-Term Foreign-Currency IDR affirmed at 'F1+'
Long-Term Local-Currency IDR affirmed at 'AA-'; Outlook Negative
Short-Term Local-Currency IDR affirmed at 'F1+'
Viability Rating affirmed at 'a'
Support Rating affirmed at '1'
Rating on long-term notes issued by ASB Finance Limited affirmed at 'AA-'
ASB Finance Limited's note programme affirmed at 'AA-/F1+'.

Bank of New Zealand:
Long-Term Foreign-Currency IDR affirmed at 'AA-'; Outlook Negative
Short-Term Foreign-Currency IDR affirmed at 'F1+'
Long-Term Local-Currency IDR affirmed at 'AA-'; Outlook Negative
Short-Term Local-Currency IDR affirmed at 'F1+'
Viability Rating affirmed at 'a'
Support Rating affirmed at '1'
Rating on long-term notes issued by BNZ International Funding Limited affirmed at 'AA-'.

Westpac New Zealand Limited:
Long-Term Foreign-Currency IDR affirmed at 'AA-'; Outlook Stable
Short-Term Foreign-Currency IDR affirmed at 'F1+'
Long-Term Local-Currency IDR affirmed at 'AA-'; Outlook Stable
Short-Term Local-Currency IDR affirmed at 'F1+'
Viability Rating affirmed at 'a'
Support Rating affirmed at '1'
Rating on long-term notes affirmed at 'AA-'
Rating on long-term notes issued by Westpac Securities NZ Limited affirmed at 'AA-'.

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Who am I to argue with Fitch? I have very little exposure to banks in my portfolio now,despite the highly attractive yields. My view is that if the RB's capital proposals are fully implemented,,something has to give and I think the dividends will have to be cut.
That should lead to a repricing of the shares and at some point,they might become attractive again.As always,I may be wrong.