Tuesday 07 March 2017 by Opinion

S&P heightens pressure on Australian banks

New Research Director, John Manning makes a big call on the four major banks and Macquarie

Australian major banks

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S&P has published a note outlining their concerns regarding rising household leverage and house prices over the past four years and how it may result in a one notch downgrade across the Australian banking sector (potentially two notches for some smaller names).

While the agency ascribes a one in three probability of a downgrade within the next two years, in my opinion, S&P will downgrade the four major banks and Macquarie one notch within the next 12-18 months.

They enjoy generous credit ratings compared to their offshore peers and while being well capitalised and highly profitable, have effectively operated in a strong market domestic market since 1994. Importantly, this threat for ratings downgrades is separate from S&P’s existing concerns over the sovereign rating and flow on implications for the majors as well as Macquarie.

Does this mean the five banks are becoming weaker entities?

Not really. The issues behind downgrade threats are more a reflection of the underlying macro environment. As evidenced  through to the Stand Alone Credit Profile (SACP) under the Banking Industry Country Risk Assessment (BICRA) methodology and not necessarily:

  • Weak capital structures,
  • Poorly provisioned balance sheets, or
  • Weak profitability

Indeed the outlook for all the key risk profile drivers remains robust.

The Australian banking sector as a whole should continue to build its capital reserves and I would anticipate plenty more hybrids and subordinated debt to be issued over the next 12-24 months. The hybrid Additional Tier 1 securities get better capital recognition from the ratings agencies, so expect to see issuance in size. Of course weaker entities will push hard to get their paper away in the short term given the aggressive ‘risk on’ search for yield evidenced in the market. This will not be sufficient to stop a one notch downgrade, but for some names, such as ME Bank, access to new capital may be enough to avoid double downgrades.

Money market implications      

A one notch downgrade to the existing longer term credit ratings of the four majors, as well as Macquarie, will result in a one notch downgrade in the short term ratings.

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