Fitch Ratings has affirmed Bendigo and Adelaide Bank Limited’s (BEN) Long-Term Issuer Default Rating (IDR) at ‘A-‘ with a Stable Outlook and the Viability Rating (VR) at ‘a-‘.
Key Rating Drivers
Traditional Banking Focus: BEN’s IDRs and senior debt ratings are driven by its VR, which is in line with its implied VR and reflects the bank’s risk profile. The risk profile is skewed towards residential mortgages. The bank’s focus on traditional banking, combined with a transparent business model, supports the bank’s financial profile and partly offsets its small franchise.
The Short-Term IDR of ‘F2’ is the lower of the two options available at a Long-Term IDR of ‘A-‘, as the funding and liquidity score of ‘a-‘ is not high enough to support the higher option; the threshold is a score of at least ‘a’.
Economic Growth to Slow: We expect high inflation and the steep rise in interest rates in 2022 through to May 2023 to result in slower economic growth and an increase in unemployment this year. However, we expect the weakening to be manageable and not result in sharp deterioration in asset quality. We factor in high household leverage into our assessment to reflect households’ susceptibility to higher debt servicing due to the rate hikes, resulting in an asset quality score at the lower end of the ‘aa’ category.
Small Yet Stable Franchise: BEN’s business profile score of ‘bbb+’ reflects its simple business model which we expect will limit earnings volatility through the cycle. The bank’s market share is modest, which acts as a constraint on this factor score. BEN is a price taker in its main operating segments and holds around 2% market share of total system assets and loans.
Moderate Deterioration in Asset Quality: We expect asset quality to weaken over the next two years as higher interest rates and elevated inflation put pressure on some borrowers. Buffers built up by borrowers along with low unemployment mean a significant increase in stage 3 loans appears unlikely.
NIM Expansion Benefits Profitability: We expect the four-year average of BEN’s operating profit/risk-weight assets ratio to rise and remain above 1.5% over the next two years. The increase in the core metric is driven by a reduction in risk-weight density following Basel III implementation, higher rates aiding the net interest margin (NIM) and loan growth above the system. The ratio is likely to peak in the financial year ending June 2023 (FY23), before falling on intense competition in both lending and funding markets which is likely to erode the NIM.
Regulatory Changes Boost Capital Levels: We expect the common equity Tier 1 (CET1) ratio to improve significantly from the 10.1% reported at end-December, following the Australian Prudential Regulation Authority’s implementation of the Basel III requirements. This has not resulted in a change to the capitalisation and leverage factor score, as we take into consideration the conservative Australian framework when assessing BEN’s capital position.
Solid Deposit Funding Base: We expect BEN’s funding profile to remain stable over the next two years, maintaining most of the improvement in the loan/deposit ratio over the past two years. The bank’s four-year average of loans/customer deposits of 124% places it at the top end of its peer group. The bank has a moderate reliance on wholesale funding, which it manages well, and we believe refinancing of the term funding facility will be manageable. Liquidity metrics are likely to moderate from current levels, which have been well above regulatory and management targets since the Covid-19 pandemic.
Rating Sensitivities
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
The VR and Long-Term IDR may be downgraded if one or more of the following were to occur:
the four-year average of the stage 3 loans/gross loans ratio increases to above 2.5% for a sustained period (FYE22: 1.5%);
the four-year average of the operating profit/risk-weighted assets ratio declines below 1% on a sustained basis (FYE22: 1.4%); and
the CET1 ratio falls below 9% (10.1% at end-1HFY23) without a credible plan to raise it back above this level.
The VR, Long-Term IDR and senior unsecured debt ratings are also sensitive to an increase in BEN’s risk profile, such as a loosening of underwriting standards or risk controls in the pursuit of growth, although that appears unlikely in the current environment.
A downgrade of the Short-Term IDR appears unlikely in the near term, as it would require the Long-Term IDR to be downgraded by at least two notches to ‘BBB’ and the funding and liquidity score to be lowered by at least two notches to ‘bbb’.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
An upgrade of the Long-Term IDR, VR and senior debt ratings appears unlikely over the next two years, as it would require both a significant improvement in BEN’s market position so that the business profile is consistent with a factor score of ‘a-‘, as well as a significant and sustained improvement in its financial profile.
The Short-Term IDR may be upgraded without an upgrade of the Long-Term IDR if the funding and liquidity score was upgraded by one notch to ‘a’.
OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS
Senior Unsecured: The long-term senior unsecured debt ratings are aligned with the Long-Term IDR, consistent with Fitch’s Bank Rating Criteria.
Subordinated: BEN’s subordinated Tier 2 debt is rated two notches below its anchor rating, the VR, which is consistent with the base case in Fitch’s Bank Rating Criteria. The two notches below the anchor rating are for loss severity, with non-performance risk captured adequately by the VR. None of the reasons for alternative notching from the anchor rating, as described in the criteria, is present.
Government Support Rating: The Government Support Rating of ‘bb’ reflects a moderate potential of support coming from the authorities, if needed, in light of BEN’s modest market share and role in the banking system.
OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES
Senior Unsecured
The long-term senior unsecured debt ratings will move in line with BEN’s Long-Term IDR.
Subordinated
The subordinated debt ratings will move in line with BEN’s VR.
Government Support Rating
A downgrade of Australia’s sovereign rating of ‘AAA’/Stable or a weakening in propensity for the authorities to provide support may result in Fitch lowering BEN’s GSR. Conversely, an increase in the probability of support from the authorities as a result of, for example increased systemic importance, may lead to a higher GSR for BEN.
VR ADJUSTMENTS
The earnings and profitability score of ‘a-‘ has been assigned above the ‘bbb’ category implied score for the following adjustment reason: historical and future metrics (positive).
Best/Worst Case Rating Scenario
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of environmental, social and governance (ESG) credit relevance is a score of ‘3’. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch’s ESG Relevance Scores, visit www.fitchratings.com/esg.
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