S&P says housing biggest risk for banks as Fitch downgrades NAB

Australian Financial Review Feb 15, 2019 4.45pm

James Eyers

The main risk facing banks is the housing downturn and not the banking royal commission, which will make lenders cautious but have no lasting impact on reputations or funding costs, credit experts say.

"We see a scenario where the rapid unwind [of housing] is the most plausible scenario for what can go wrong for banks in Australia," S&P's director of financial institutions ratings, Sharad Jain, said.

"We think house prices will continue to slide down, which is partly about momentum, and partly a realisation as it gets played out in media repeatedly that house prices are overvalued and in a correction phase.

"But at the same time, we think that the risk of a harsh correction ... remains relatively low even though it is elevated by historical standards."

S&P Global expected banks to lend more cautiously as a result of the Hayne royal commission due to fears they'll be fingered for doing the wrong thing.

NAB re-rating

Fitch Ratings downgraded its outlook on NAB's long-term default rating from "stable" to "negative" on Friday, amid concerns management attention will be diverted to repairing its battered reputation.

S&P said its ratings remain unchanged and it expected the royal commission to have no impact on major bank access to wholesale funding or the cost of funding, although they will be more conservative approving home loan applications.

"We consider in the next two years particularly, the banks will act in a very cautious and conservative way because the banks certainly are not keen to be in the news [for] doing the wrong thing, by customers, for responsible lending or adding to system-wide risk," Mr Jain said.

"So even if there is no change in regulation, we believe the banks will ... be cautious, and as a response there will be some depression on credit growth, which is already depressed compared to what we have seen in the past couple of years."

Yet Fitch affirmed NAB's rating, reflecting its expectation the bank will maintain a strong credit profile over the short term. S&P also said on Friday it retained confidence in NAB, despite the departure of chairman Ken Henry and chief executive Andrew Thorburn last week, noting NAB still had "depth and breadth to fill the gap".

More broadly, the royal commission had cast doubts on Australian bank governance and reputation, but over the long term "we don't see it posing any lasting damage to the franchise[s] or funding costs," Mr Jain said.

Rather, the main risks for banks is the housing market downturn, and their reliance on external investors to fund the gap between lending and domestic deposits.

The S&P briefing was listened to by bank investors in Hong Kong, Singapore and the region, and the royal commission dominated questions over a webcast. Local investment bankers say they have been spending a lot of time in recent months reassuring global investors that bank debt raisings remain quality investments.

NZ, APRA capital levels

There was also interest about the impact of higher capital levels for the banks in New Zealand, after Reserve Bank of New Zealand governor Adrian Orr's fierce defence this week of its demand for equity buffers to be cranked up. "At the moment, the return on equity for banking is incredibly strong and we would even hazard to say over and above the risks they are holding themselves as private banks, because there is an aspect in most OECD countries of the ability to free ride – where returns can be privatised and losses can be socialised," Governor Orr said.

S&P said the major banks' tier-one capital would need to increase 43 per cent or $NZ17 billion ($16.3 billion) as a result of the proposals, and while credit ratings remain unchanged, the moves created "complex cross border issues" and there was "a lot of water to flow under the bridge" between the NZ central bank and Australian Prudential Regulation Authority to determine how capital could be allocated across the subsidiaries.

Fitch Ratings said last week that while the banking system faced short-term challenges in addressing shortcomings in culture and governance that led the misconduct exposed by Hayne, the scrutiny "should result in a sounder financial system longer term, helping to support banks' credit profiles".

Moody's Investors Service vice-president Frank Mirenzi said last week that while promoting a stronger framework for conduct, culture and operational risks, the royal commission recommendations were "unlikely to alter the favourable structure of the banking industry, which supports its profitability".