Fitch Upgrades Co-op Bank; Affirms Four NZ Banks
- TSB Bank Limited (TSB) at 'A-'/'F2';
- Southland Building Society (SBS) at 'BBB'/'F2';
- Nelson Building Society (NBS) at 'BB+'/'B'; and
- Wairarapa Building Society (WBS) at 'BB+'/'B'.
At the same time, Fitch has upgraded the Viability Rating (VR) of Co-op and affirmed the VRs of TSB, SBS, NBS and WBS. The Outlook for Co-op is Stable and the Outlook for SBS was revised to Stable from Positive. The Outlooks were maintained as Stable for TSB, NBS and WBS. The agency has also assigned a short-term senior unsecured rating of 'F2' on TSB's newly established registered certificate of deposit (RCD) programme
The Support Ratings (SR) and Support Rating Floors (SRF) of all these entities have been affirmed at '5' and 'No Floor' respectively. A full list of the rating actions is at the end of this commentary.
The upgrade in Co-op's IDRs and VRs reflect Fitch's expectation that the bank will be able to execute its turnaround and growth strategy while maintaining its risk appetite and appropriate levels of capitalisation. Fitch expects the bank to improve its earnings and profitability over the next 12-18 months as a result of its growth.
The Outlook revision for SBS reflects our view that the increasing macroeconomic risks in New Zealand mean SBS's growth strategy may result in higher risks for the bank than the agency anticipated in 2015, and therefore an upgrade over the next 24 months is less likely. In addition, the strong growth has resulted in a decline in SBS's capitalisation relative to peers, while it is also placing some pressure on the bank's funding profile.
The affirmation of the IDRs, VRs and senior debt ratings for the other financial institutions reflects our view that the entities are likely to continue to perform solidly over the next 12 to 24 months.
New Zealand household debt levels continue to rise and are high relative to other developed economies - this, along with high property prices, remain the key risks to the financial system. The Reserve Bank of New Zealand has attempted to control this via the introduction and subsequent tightening of macro-prudential tools, with some degree of success.
The operating environment more broadly should remain stable, which is likely to continue to support the entities' asset quality, although rising household debt and house prices could pressure asset quality if unemployment or interest rates increase. Weak dairy prices will continue to have an adverse impact on GDP growth, although this could be offset by growth in the tourism sector and construction, particularly in Auckland.
All five entities operate simple and transparent business models, which mainly focus on residential mortgages in New Zealand. These lenders have small national franchises and market shares relative to the major banks and are price takers, although most of their competitive advantage comes from their regional focus, loyal customer base and community support. Most of these entities maintain fairly strong capital ratios relative to international peers. This offsets their limited access to common equity as a result of their mutual or community trust ownership models. However, continued strong growth is likely to result in modest deterioration in capital ratios ratios for some of the entities.
KEY RATING DRIVERS
IDRS, VRs and SENIOR DEBT
TSB Bank Limited
TSB's IDRs, VR and short-term unsecured rating reflect its conservative risk appetite, simple business model, consistently sound asset quality that is above the industry average, strong balance-sheet structure, and sustainable operating profitability. TSB's liquidity and funding positions as well as capital ratios are healthy for an institution of its size and strong relative to international and domestic peers. The ratings also take into account TSB's small domestic franchise, geographic concentration and limited access to new capital.
Fitch believes that TSB's tighter treasury credit policy - implemented following the default of government-owned Solid Energy - should protect the bank from larger losses, especially within its liquidity and investment portfolios. Concentration risk has reduced and risk control measures have improved since mid-2015. Underwriting standards within the bank's loan book have remained sound despite above-system mortgage growth. The faster lending growth is the result of TSB's five-year strategy to reduce less-liquid investment securities and increase customer loans. TSB's ample liquidity and funding policy ensures its loan book remains fully deposit-funded while maintaining strong liquidity relative to peers. Profitability could benefit from wider margins as loans increase as a proportion of the asset mix. However, operating costs are likely to increase.
Southland Building Society
SBS's IDRs and VR reflect the bank's conservative risk appetite, improving asset quality and earnings, and sound capital ratios, offset by a modest domestic franchise and limited pricing power. The bank's adjusted strategy gives it the opportunity to expand its membership base in a targeted manner, although the rising macroeconomic risks in New Zealand make this more difficult to do so without leading to an increased risk profile - this is a key reason for the revision in the Outlook on SBS's Long-Term IDRs to Stable from Positive.
SBS's capitalisation and funding profiles have also been pressured by the strength of the balance-sheet growth, although we expect them to remain broadly consistent with those of international peers. The strategy is likely to assist earnings and profitability in the medium term, which should help support SBS's capitalisation.
SBS's deposits from customers are rated one notch above the bank's IDRs at 'BBB+', to reflect the substantial subordination other instruments provide to the deposits. Deposits from customers rank equally with wholesale funding, and ahead of redeemable shares - SBS's main funding source. SBS's wholesale funding increased strongly in the year to 31 March 2016 due to the large rise in assets, although wholesale funding combined with deposits from customers accounted for only 18% of total liabilities and 17% of total assets at 31 March 2016.
The Co-operative Bank Limited
Co-op's IDRs and VR reflect the bank's modest risk appetite, sound asset quality and still sound capital ratios. These considerations are offset by the bank's weaker earnings and profitability relative to peers. The upgrade reflects our view that the bank has and will continue to execute its strategic objectives and we expect the bank to improve its earnings and profitability over the next 12-18 months.
The bank appears to have maintained its modest risk appetite and continued to improve its risk management and controls. Co-op continues to primarily target loans with lower loan-to-value ratios (LVR). Its exposure to interest-only and investor mortgages has increased, although overall levels remain low and consistent with those of peers. The bank's strong growth is likely to result in some deterioration to the Fitch Core Capital ratios in the short term, although we expect the bank to continue to maintain its total capital ratio at around current levels through raising Tier 2 capital.
Nelson Building Society
NBS's ratings are constrained by its modest franchise, small absolute size and capitalisation. These constraints are reflected in the society's low level of pricing power and higher levels of concentration risk relative to larger peers. NBS's conservative risk appetite, robust asset quality and stable funding position offset these considerations.
NBS continues to deliver strong asset growth in the double digits while maintaining high deposit growth, supported by community support in its home region. Falling interest rates and increasing competition may challenge future profitability, although strong loan volumes should provide a buffer. NBS has limited access to new common equity and its capitalisation ratios continue to be pressured by strong growth.
Wairarapa Building Society
WBS's IDRs and VR reflect its modest franchise, weaker earnings profile and higher concentration risks relative to peers. WBS's property investment portfolio has historically provided stable rental returns, but adds the potential for volatility through fair-value market adjustments. WBS's conservative risk appetite and capital position offset these considerations.
WBS's capital ratios are high relative to peers, but we consider this appropriate given the society's small absolute capital base and limited access to new common equity and concentration risks. WBS's conservative risk appetite is reflected in its low level of historical losses and low LVR mortgages across its loan book. The society has reduced its property investment holdings as planned, but has indicated it will continue to regularly reassess its position.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The Co-operative Bank Limited
Co-op's subordinated notes are rated one notch below Co-op's Viability Rating (VR) of 'bbb' to reflect their below-average recovery prospects compared to senior unsecured notes. The notes would be written down in part or in full should the Reserve Bank of New Zealand appoint a statutory manager or deem that without the write down, Co-op was non-viable. No additional notching from the VR for non-performance is applied, as the VR already captures the point of non-viability. Under Fitch's methodology, the notes do not qualify for equity credit.
SUPPORT RATINGS AND SUPPORT RATING FLOORS
The SR and SRF of the five institutions reflect our view that while support from the New Zealand sovereign is possible, it cannot be relied upon. We believe the existence of the Open Bank Resolution Scheme (OBR) reduces the propensity of the sovereign to support its banks. The OBR allows for the imposition of losses on depositors and senior debt holders to support a fail institution. NBS and WBS are not covered by the OBR due to their status as non-bank deposit-taking institutions.
RATING SENSITIVITIES
IDRS, VRs and SENIOR DEBT
TSB Bank Limited
TSB's IDRs, VR and short-term senior unsecured rating are sensitive to deterioration in its risk appetite and capital position. A heightened risk profile, reflected in softer underwriting standards or weaker risk controls, or unsustainable asset growth may lead to deterioration in asset quality, operating performance and capitalisation, possibly resulting in negative rating action. An upgrade is unlikely in the short to medium term. Positive rating momentum would hinge on significant improvements in TSB's franchise, while its current business model and risk appetite remain stable.
Southland Building Society
SBS's IDRs and VR may be upgraded if macroeconomic risks in New Zealand were to reduce and the bank was to maintain its risk appetite, capital and funding positions while executing its growth strategy. We expect this to be reflected in growth in the bank's balance sheet and membership, and improved earnings without a material deterioration in asset quality.
The IDRs and VR may face negative pressure if macroeconomic risks continue to rise and SBS increases its balance sheet size quickly at the expense of its conservative risk appetite, or its sound funding and capital positions.
The rating on SBS's deposits from customers is subject to the same factors that influence the IDRs. In addition, a substantial increase in the proportion of senior unsecured debt (deposits from customers and wholesale funding) would reduce the subordination provided by other instruments and could result in a downgrade, aligning the rating with SBS's IDRs.
The Co-operative Bank Limited
Co-op's IDRs and VR would be sensitive to deterioration in its risk appetite or a higher-than-expected deterioration in its capital position. A heightened risk profile, possibly through weaker underwriting criteria or unsustainable growth could result in weaker asset quality, operating performance, capitalisation and may lead to negative rating action.
An upgrade in Co-op's ratings is unlikely in the short to medium term. Positive rating momentum would require significant improvements in Co-op's franchise while maintaining or improving its financial profile and risk appetite.
Nelson Building Society
NBS's IDRs and VR would be sensitive to an increase in its risk appetite, possibly from weakening underwriting criteria or aggressive growth resulting in a deterioration of its asset quality, profitability or material erosion in its capitlisation. An upgrade to NBS's ratings would require sustained improvements to the society's company profile and capital position.
Wairarapa Building Society
WBS's IDRs and VR would be sensitive to an increase in its risk appetite, which could result in a deterioration of its asset quality or erosion of its capitalisation. An upgrade in WBS's ratings is unlikely due to its small absolute capital base, modest franchise and higher level of concentration risk relative to peers.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The Co-operative Bank Limited
Co-op's subordinated debt ratings are broadly sensitive to the same considerations that might affect its VR.
SUPPORT RATINGS AND SUPPORT RATING FLOORS
The Support Ratings and Support Rating Floors are sensitive to any change in assumptions around the propensity or ability of the New Zealand government to provide timely support to each institution.
The rating actions are as follows:
TSB Bank Limited
Long-Term IDR affirmed at 'A-'; Outlook Stable;
Short-Term IDR affirmed at 'F2;'
Viability Rating affirmed at 'a-';
Support Rating affirmed at '5';
Support Rating Floor affirmed at 'No Floor'; and
Registered certificates of deposit assigned at 'F2'.
Southland Building Society
Long-Term Foreign-Currency IDR affirmed at 'BBB'; Outlook revised to Stable from Positive;
Short-Term Foreign-Currency IDR affirmed at 'F2';
Long-Term Local-Currency IDR affirmed at 'BBB'; Outlook revised to Stable from Positive;
Short-Term Local-Currency IDR affirmed at 'F2';
Viability Rating affirmed at 'bbb';
Support Rating affirmed at '5';
Support Rating Floor affirmed at 'No Floor';
Commercial paper affirmed at 'F2'; and
Long-term senior unsecured debt (deposits from customers) affirmed at 'BBB+'.
The Co-operative Bank Limited
Long-Term IDR upgraded to 'BBB' from 'BBB-'; Outlook Stable;
Short-Term IDR upgraded to 'F2' from 'F3';
Viability Rating upgraded to 'bbb' from 'bbb-';
Support Rating affirmed at '5';
Support Rating Floor affirmed at 'No Floor'; and
Subordinated debt upgraded to 'BBB-' from 'BB+'.
Nelson Building Society:
Long-Term Foreign-Currency IDR affirmed at 'BB+'; Outlook Stable;
Short-Term Foreign-Currency IDR affirmed at 'B';
Long-Term Local-Currency IDR affirmed at 'BB+'; Outlook Stable;
Short-Term Local-Currency IDR affirmed at 'B';
Viability Rating affirmed at 'bb+';
Support Rating affirmed at '5'; and
Support Rating Floor affirmed at 'No Floor'.
Wairarapa Building Society:
Long-Term Foreign-Currency IDR affirmed at 'BB+'; Outlook Stable;
Short-Term Foreign-Currency IDR affirmed at 'B';
Long-Term Local-Currency IDR affirmed at 'BB+'; Outlook Stable;
Short-Term Local-Currency IDR affirmed at 'B';
Viability Rating affirmed at 'bb+';
Support Rating affirmed at '5'; and
Support Rating Floor affirmed at 'No Floor'.
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