Fitch downgrades CBA, ASB, NAB, BNZ, Westpac Group and Westpac NZ's long-term credit ratings one notch to AA-

Fitch Ratings has downgraded, by one notch, its long-term credit ratings on Commonwealth Bank of Australia (CBA), National Australia Bank (NAB) and the Westpac Banking Corporation - along with those of their respective New Zealand subsidiaries ASB, BNZ and Westpac NZ to 'AA-' from 'AA' - saying their reliance on overseas wholesale funding leaves them "susceptible to dislocation" in international wholesale funding markets.

The downgrades bring the banks in line with Fitch's existing, unchanged "AA-" rating on both the ANZ Banking Group and ANZ New Zealand. It also brings Fitch's ratings on the big banks' in line with rival Standard & Poor's, which downgraded all four to 'AA-' from 'AA' last December.

Fitch says it estimates wholesale funding comprises about 40% of total funding (excluding derivatives), for the banks with the offshore component of wholesale funding about 60% of the total. This exposure is managed well by the banks, with wholesale funding diversified by geography, product, investor and maturity, and hedged back into local currency through fully collateralised swaps and the maintenance of significant portfolios of central bank repo-eligible assets, says Fitch. On top of this the introduction of covered bonds for Australian and New Zealand banks provides an additional avenue of funding diversity.

"Nevertheless, this funding profile leaves the banks susceptible to dislocation in international wholesale funding markets."

"Fitch expects the banks will continue to improve this mix, with a greater focus on deposit-gathering, a reduced reliance on short-term wholesale funding, particularly from offshore sources, and a continued increase in the duration of wholesale funding," the credit rating agency says.

"However, any significant improvements over the medium-term will likely be constrained by structural impediments such as high levels of fixed capital formation (investment), a large and persistent current account deficit and mandatory pension savings which tend to be weighted towards equities."

"A high reliance on wholesale funding makes maintaining investor confidence key. Factors such as Australia's high household debt levels, elevated house prices and increasing reliance on Asia for trade may all impact this confidence, particularly if economic conditions in the region were to deteriorate significantly. Fitch does not expect such deterioration and notes that all four banks closely manage confidence through regular contact with investors."

It notes that within the four banking groups, ANZ and NAB have the most material operations outside Australia and New Zealand with ANZ in Asia and NAB in Britain. To date, ANZ's Asian expansion has been "measured" with the overall risk profile of the group not materially increasing.

"Nevertheless, these markets can be more volatile than Australia and New Zealand and the group will need to continue to prudently manage expansion," Fitch says.

Meanwhile, NAB's British operations, through Clydesdale Bank, have historically offered diversity in a well-regulated market and exposure is modest, being about 10% of group assets.

"However, earnings are likely to be subdued given a weakening outlook for the UK economy. This weakening outlook prompted NAB to announce on February 7, 2012 that it was undertaking a detailed review of these operations."

Fitch says on most other measures, the four major Australian banking groups remain amongst the strongest banks in its global rated universe and have therefore retained ratings in the 'AA' range.

"This reflects strong domestic franchises, robust risk management frameworks, solid profitability, competent liquidity management and sound and improving capital positions. The banks also benefit from, and contribute to, a solid domestic operating environment, while the Australian prudential regulator has proven itself to be conservative and hands-on."

Fitch's downgrades complete such moves by the big three global credit rating agencies on the big local banks over the past year after Moody's Investors Service downgraded its ratings on the big four New Zealand banks by one notch to 'Aa3' from 'Aa2' in May last year citing the country's subdued economy and the banks' exposure to wholesale financial markets.

Read Fitch's statement below:

Fitch Ratings has downgraded Commonwealth Bank of Australia's (CBA), National Australia Bank Limited's (NAB) and Westpac Banking Corporation's (WBC) Long-Term Issuer Default Ratings (IDR) and Viability Ratings (VR) by a notch. At the same time, Fitch has affirmed the ratings of Australia & New Zealand Banking Group (ANZ).

The Rating Watch Negative (RWN) on the four banks has been removed and a Stable Outlook placed on the Long-Term IDRs. A full list of rating actions, including those on the subsidiaries of the four banks, can be found at the end of this commentary. The VRs of the subsidiary banks were not included as part of this review; they will be reviewed at a later date as part of Fitch's normal review cycle.

The rating actions have been taken in the context of a broader review of the larger and highly rated banks in Fitch's rating portfolio. In Fitch's view, wholesale funding, particularly when sourced cross borders, has become more vulnerable to swings of confidence and for the major Australian banks this risk is better reflected at a VR of 'aa-' and therefore a Long-Term IDR of 'AA-'. As ANZ's VR is already at 'aa-', its ratings have been affirmed.

This action concludes Fitch's review of the four major Australian banks that was announced on 30 January 2012 (see "Fitch Places Major Australian Banks on RWN, Affirms Canadian Banks", dated 30 January 2012).

The downgrade of the Long-Term IDRs and VRs of CBA, NAB and WBC reflect the weaker funding profile of the major Australian banks relative to similarly rated international peers. Despite some improvement since 2008, all four banks retain a reliance on wholesale funding, particularly from offshore markets.

Fitch estimates that wholesale funding made up about 40% of total funding (excluding derivatives), with the offshore component of wholesale funding about 60% of the total. Fitch notes that this exposure is managed well by the banks, with wholesale funding diversified by geography, product, investor and maturity, all offshore funding hedged back into the functional currency through fully collateralised swaps and the maintenance of significant portfolios of central bank repo-eligible assets. Also, the introduction of covered bonds for Australian banks provides an additional avenue of diversity. Nevertheless, this funding profile leaves the banks susceptible to dislocation in international wholesale funding markets.

Fitch expects the banks will continue to improve this mix, with a greater focus on deposit-gathering, a reduced reliance on short-term wholesale funding, particularly from offshore sources, and a continued increase in the duration of wholesale funding. However, any significant improvements over the medium term will likely be constrained by structural impediments such as high levels of fixed capital formation (investment), a large and persistent current account deficit and mandatory pension savings which tend to be weighted towards equities.

A high reliance on wholesale funding makes maintaining investor confidence key. Factors such as Australia's high household debt levels, elevated house prices and increasing reliance on Asia for trade may all impact this confidence, particularly if economic conditions in the region were to deteriorate significantly. Fitch does not expect such deterioration and notes that all four banks closely manage confidence through regular contact with investors.

Within the group of four, ANZ and NAB have more material operations outside Australia and New Zealand - ANZ in Asia and NAB in the UK. To date, ANZ's Asian expansion has been measured and the overall risk profile of the group has not increased materially; nevertheless, these markets can be more volatile than Australia and New Zealand and the group will need to continue to prudently manage expansion. NAB's UK operations, through Clydesdale Bank PLC (CB), have historically offered diversity in a well-regulated market and exposure is modest (about 10% of group assets). However, earnings are likely to be subdued given a weakening outlook for the UK economy. This weakening outlook prompted NAB to announce on 7 February 2012 that it was undertaking a detailed review of these operations; as a result, Fitch has maintained the RWN on CB's Long-Term IDR and placed the Short-Term IDR and Support Rating on RWN. The agency expects to resolve the RWNs following the completion of this review.

On most other measures, the four major Australian banks remain amongst the strongest banks in Fitch's global rated universe and have therefore retained ratings in the 'AA' range. This reflects strong domestic franchises, robust risk management frameworks, solid profitability, competent liquidity management and sound and improving capital positions. The banks also benefit from, and contribute to, a solid domestic operating environment, while the Australian prudential regulator has proven itself to be conservative and hands-on.

The multiple-notch downgrade of the preference shares issued by CBA, NAB and WBC reflect the application of Fitch's new bank regulatory capital securities rating criteria (see 'Rating Bank Regulatory Capital and Similar Securities' dated 15 December 2011 at www.fitchratings.com). In Australia, payment of distributions on Tier 1 instruments is subject to an annual profits test. Fitch believes this is an easily activated non-performance trigger and therefore rates Australian banks preference shares five notches below an institution's VR.

The four major Australian banks dominate the Australian and New Zealand banking systems. At 31 December 2011, the four banks combined held 79% of Australian banking system assets, while in New Zealand this was 87% at 30 June 2011.

The rating actions are as follows:

Australia & New Zealand Banking Group (ANZ)

-- Long-Term Foreign Currency IDR: affirmed at 'AA-'; removed from RWN; Stable Outlook

-- Short-Term Foreign Currency IDR: affirmed at 'F1+'; removed from RWN

-- VR: affirmed at 'aa-'; removed from RWN

-- Support Rating: affirmed at '1'

-- Support Rating Floor: affirmed at 'A'

-- Government-guaranteed debt: affirmed at 'AAA'

-- Non-guaranteed senior unsecured debt: affirmed at 'AA-'; removed from RWN

-- Subordinated debt: affirmed at 'A+'; removed from RWN

ANZ National Bank Limited (ANZNB)

-- Long-Term Foreign Currency IDR: affirmed at 'AA-', removed from RWN; Stable Outlook

-- Short-Term Foreign Currency IDR affirmed at 'F1+'; removed from RWN

-- Long-Term Local Currency IDR: affirmed at 'AA-'; removed from RWN; Stable Outlook

-- Short-Term Local Currency IDR: affirmed at 'F1+'; removed from RWN

-- VR: 'a' unaffected

-- Support Rating: affirmed at '1'

-- Government-guaranteed debt: affirmed at 'AA'

-- Non-guaranteed senior unsecured debt: affirmed at 'AA-'; removed from RWN

-- Short-term debt: affirmed at 'F1+'; removed from RWN

Commonwealth Bank of Australia (CBA)

-- Long-Term Foreign Currency IDR: downgraded to 'AA-' from 'AA'; removed from RWN; Stable Outlook

-- Short-Term Foreign Currency IDR: affirmed at 'F1+'

-- VR: downgraded to 'aa-' from 'aa'; removed from RWN

-- Support Rating: affirmed at '1'

-- Support Rating Floor: affirmed at 'A'

-- Government guaranteed debt: affirmed at 'AAA'

-- Non-guaranteed senior unsecured debt: downgraded to 'AA-' from 'AA'; removed from RWN

-- Short-term debt: affirmed at 'F1+'

-- Subordinated debt: downgraded to 'A+' from 'AA-'; removed from RWN

-- Preferred stock: downgraded to 'BBB' from 'A'; removed from RWN

Bank of Western Australia (BankWest)

-- Long-Term Foreign Currency IDR: downgraded to 'AA-' from 'AA', removed from RWN; Stable Outlook

-- Short-term Foreign Currency IDR: affirmed at 'F1+'

-- Support Rating: affirmed at '1'

-- Non-guaranteed senior unsecured debt: downgraded to 'AA-' from 'AA'; removed from RWN

ASB Bank Limited (ASB)

-- Long-Term Foreign Currency IDR: downgraded to 'AA-' from 'AA'; removed from RWN; Stable Outlook

-- Short-Term Foreign Currency IDR: affirmed at 'F1+'

-- Long-Term Local Currency IDR: downgraded to 'AA-' from 'AA'; removed from RWN; Stable Outlook

-- Short-Term Local Currency IDR: affirmed at 'F1+'

-- VR: 'a' unaffected

-- Support Rating: affirmed at '1'

Colonial Finance Ltd. (CFL)

-- Long-Term Foreign Currency IDR: downgraded to 'A+' from 'AA-'; removed from RWN; Stable Outlook

-- Short-Term Foreign Currency IDR: downgraded to 'F1' from 'F1+'; removed from RWN

-- Non-guaranteed senior unsecured debt: downgraded to 'A+' from 'AA-'; removed from RWN

-- Short-Term debt: downgraded to 'F1' from 'F1+'; removed from RWN

National Australia Bank Limited (NAB)

-- Long-Term Foreign Currency IDR: downgraded to 'AA-' from 'AA'; removed from RWN; Stable Outlook

-- Short-Term Foreign Currency IDR: affirmed at 'F1+'

-- VR: downgraded to 'aa-' from 'aa'; removed from RWN

-- Support Rating: affirmed at '1'

-- Support Rating Floor: affirmed at 'A'

-- Government-guaranteed debt: affirmed at 'AAA'

-- Non-guaranteed senior unsecured debt: downgraded to 'AA-' from 'AA'; removed from RWN

-- Subordinated debt: downgraded to 'A+' from 'AA-'; removed from RWN

-- Preferred stock: downgraded to 'BBB' from 'A'; removed from RWN

Bank of New Zealand (BNZ)

-- Long-Term Foreign Currency IDR: downgraded to 'AA-' from 'AA'; removed from RWN; Stable Outlook

-- Short-Term Foreign Currency IDR: affirmed at 'F1+'

-- Long-Term Local Currency IDR: downgraded to 'AA-' from 'AA'; removed from RWN; Stable Outlook

-- Short-Term Local Currency IDR: affirmed at 'F1+'

-- VR: 'a' unaffected

-- Support Rating: affirmed at '1'

-- Non-guaranteed senior unsecured debt: downgraded to 'AA-' from 'AA'; removed from RWN

Clydesdale Bank PLC (CB)

-- Long-Term Foreign Currency IDR: downgraded to 'A' from 'A+'; RWN maintained

-- Short-Term Foreign Currency IDR: 'F1'; on RWN

-- VR: 'bbb' unaffected

-- Support Rating: '1'; on RWN

Westpac Banking Corporation (WBC)

-- Long-Term Foreign Currency IDR: downgraded to 'AA-' from 'AA'; removed from RWN; Stable Outlook

-- Short-Term Foreign Currency IDR: affirmed at 'F1+'

-- VR: downgraded to 'aa-' from 'aa'; removed from RWN

-- Support Rating: affirmed at '1'

-- Support Rating Floor: affirmed at 'A'

-- Government-guaranteed debt: affirmed at 'AAA'

-- Non-guaranteed senior unsecured debt: downgraded to 'AA-' from 'AA'; removed from RWN

-- Market-linked debt: downgraded to 'AA-emr' from 'AAemr'; removed from RWN

-- Short-Term debt: affirmed at 'F1+'

-- Subordinated debt: downgraded to 'A+' from 'AA-'; removed from RWN

-- Hybrid capital: downgraded to 'BBB' from 'A'; removed from RWN

Westpac New Zealand Limited (WNZL)

-- Long-Term Foreign Currency IDR: downgraded to 'AA-' from 'AA'; removed from RWN; Stable Outlook

-- Short-Term Foreign Currency IDR: affirmed at 'F1+'

-- Long-Term Local Currency IDR: downgraded to 'AA-' from 'AA'; removed from RWN; Stable Outlook

-- Short-Term Local Currency IDR: affirmed at 'F1+'

-- VR: 'a' unaffected

-- Support Rating: affirmed at '1'

-- Government-guaranteed debt: affirmed at 'AA'

-- Non-guaranteed senior unsecured debt: downgraded to 'AA-' from 'AA'; removed from RWN

Westpac Lenders Mortgage Insurance Limited (WLMI)

-- Insurer Financial Strength Rating: downgraded to 'AA-' from 'AA'; removed from RWN; Stable Outlook