Credit ratings agency Moody's has downgraded the senior, long-term unsecured credit ratings for Commonwealth Bank of Australia (CBA), ANZ Group, Westpac Group and National Australia bank to Aa2 from Aa1 because of its concerns about their exposure to funding on international wholesale financial markets.
Moody's said it was still reviewing the ratings of these banks' New Zealand units (ASB, ANZ, Westpac NZ and BNZ respectively).
"The downgrade reflects our view of the Australian banking system's structural sensitivity to conditions in wholesale funding markets", said Patrick Winsbury, a Senior Vice President based in Moody's Sydney office.
"Australia's major banks have relatively high levels of wholesale funding -- at about 40% of liabilities on average -- and the global financial crisis has underlined the speed with which shifts in investor confidence can impact bank funding," said Winsbury.
"While the major banks have reduced their sensitivity to disruptions in the wholesale funding markets, the Australian financial sector's long-term, underlying reliance on offshore debt remains in place; and which Moody's believes is better reflected at the Aa2 rating level."
Moody's said Australia's major banks had worked to reduce their sensitivity to disruptions in wholesale funding markets by diversifying their investor bases, increasing the weighted-average maturity of their borrowings, and by increasing liquid assets.
"Near-term growth in wholesale funding is also likely to remain restrained on subdued credit demand, ample deposit growth, and ongoing caution from the banks with regards to the potential for further volatility in wholesale funding markets," it said.
Moody's therefore expected the banks to continue reducing their wholesale funding requirements, particularly for short-term wholesale funding, for the next 12-18 months.
"However, the fundamental funding structure of the major Australian banks remains in place. Australia's mandatory superannuation scheme will continue to capture retail savings, of which only a low proportion are available to fund the banks. This situation is due in turn to the low allocation -- by international comparison -- of superannuation savings to fixed-income investments and deposits."
Also, Moody's said much of the recent increase in domestic deposits had come from the corporate sector.
"When the cycle turns and credit demand eventually picks up, the ratio of corporate deposits to loans may be expected to deteriorate. Retail deposit growth will then likely be insufficient to fund the banks' needs, driving them to increase wholesale funding once more," it said.
Offshore funding dependence
Moody's also noted that Australia has heavy investment needs and was likely to continue to run a sustained balance of payments deficit, which was likely in turn to perpetuate the banking sector's requirement for offshore funding.
"Furthermore, with the domestic economy increasingly biased to the commodity sector, terms of trade that are exceptionally favorable by historical standards, and high asset prices, there is a potential for confidence shocks to impact the banks' access to funding. During the recent crisis, the banks demonstrated that natural economic stabilizers do permit them to adjust their funding mix. Nevertheless, the downgrade reflects Moody's concern that -- in a less liquid and more volatile post-crisis world-- the banks' sensitivity to market conditions is better reflected at the new rating level."
In other respects, the banks continued to have strong credit profiles, with strong franchises, capital, and risk-adjusted earnings.
"Asset quality remains within expectations for the bottom of the credit cycle, and while the decline in the stock of problem loans may be slowed by the impact of rising interest rates and the strong Australian dollar, new impairment charges are in line with the long-run average."
Strong Systemic Support
Moody's also noted that the Aa2 rating reflected the inclusion of two notches of uplift from systemic support.
Moody's said it viewed bank supervisors and the government in Australia to be supportive by global comparison and the banks to have high systemic importance, as implicitly recognized by the government's "Four Pillars" policy (which restricts M&A among the banks).
Moody's also notes that creditor-unfriendly initiatives -- such a bail-in legislation -- are not on the policy agenda in Australia.
Moody's is currently assessing the credit impact of governments in a number of crisis-hit markets enacting policies that shift away from full creditor protection in favor of market discipline to achieve the objective of financial stability.
These include some successful attempts to share the cost of bank bailouts with bank creditors. If, in Moody's view, it is likely that this trend could ultimately impact the level of support that regulators and governments might provide to capital-qualifying instruments, then it is likely that Moody's would reduce or remove support from its bank subordinated debt ratings.
"Moody's is conducting a country-by-country analysis and expects to conclude on this matter in the third quarter of 2011. If no support were to be included in the subordinated debt ratings of the four major banks and BWA, then the ratings would fall by 2 notches to A2 from Aa3."
New Zealand unit ratings
Moody's said the ratings of the banks' foreign subsidiaries remained on review for possible downgrade, as there were credit issues specific to those institutions being considered in their reviews, in addition to the parental support factored into their ratings.
"In New Zealand, the review will also consider the sensitivity of the bank subsidiaries to wholesale funding markets and the Reserve Bank of New Zealand's Open Bank Resolution proposals."
There is no impact from this action on the Aaa ratings of the debt securities issued by the major Australian banks between 2008 and 2010 under the Australian government's guarantee scheme.
(Updated with more details)