Long awaited Standard and Poor's bank credit rating rejig nears and it hints downgrade fears may prove overdone

By Gareth Vaughan

The big banks long wait to see whether Standard & Poor's (S&P) will follow rival Moody's Investors Service and downgrade their credit ratings is almost over with S&P set to apply its new rating criteria this month and hinting that the news may not be as bad as feared.

S&P currently rates all of New Zealand's big four banks, ANZ, ASB, BNZ and Westpac, at 'AA'. In banking circles it has been anticipated that S&P's new rating methodology would probably see the big local banks ratings downgraded one notch to 'AA-', potentially increasing their funding costs.

However, yesterday S&P said: "We expect the impact of the new bank criteria on our bank ratings will be less material than we anticipated in January this year."

'Pincer movement' was predicted

That comes after Peter Sikora, S&P's analytical manager for financial institutions in the Pacific, told interest.co.nz in February the S&P review would probably see a "slight pincering of the bank rating universe." He noted that "probably" 'AA' and higher rated banks would potentially come under "significant" review.

Now S&P now says: "Based on preliminary results, we now estimate that more than 90% of all ratings will remain within one notch of our current ratings, compared with the 85% we communicated in January because of rating actions taken in 2011."

"Around 60% will remain unchanged, while we expect approximately 20% to be upgraded by one notch and 15% to be downgraded by one notch. Less than 5% will be downgraded by two or more notches. Our goal is to make our bank ratings more transparent, potential rating transitions more predictable to credit professionals in the market, and to embed into our criteria what we have learned from observing how banks respond to adverse industry and economic conditions, starting with the 2007-2009 financial crisis and now with the sovereign debt crisis in Europe."

S&P said next week it'll publish its final new criteria for rating banks. Then, probably in late November, it'll start applying the new criteria aiming to finish implementation by mid-December.

"From late November through mid-December, we intend to publish the ratings on all banks based on the new methodology. Our goal is to communicate all rating actions (affirmations, upgrades, downgrades, CreditWatch placements) by mid-December," S&P said.

The credit rating agency has segmented banks into groups and will publish ratings on banks in these groups at the same time through a group press release.

"We will communicate to the banks which group they are in, the other banks in that same release, and when we expect to publish. Following each group media release, we will publish individual research updates on each bank including a list of ratings on affiliated rated entities, as well as the ratings by debt type--senior, subordinated, junior subordinated, and preferred stock. These research updates will also include our assessment of the following rating components of the relevant bank group," S&P added.

Bank downgrades to follow sovereign rating downgrades?

Westpac NZ CEO George Frazis last month told interest.co.nz he was worried about credit rating downgrades of the major New Zealand banks following the recent New Zealand downgrades of New Zealand's sovereign credit rating to 'AA' from 'AA+'by both S&P and Fitch Ratings. However, Frazis said in his view such a downgrade wouldn't be justified.  Westpac is also rated 'AA' by Fitch, with ANZ 'AA-' and BNZ and ASB unrated.

Any downgrade of the banks by S&P would come after Moody's downgraded ANZ, ASB, BNZ, and Westpac by one notch to 'Aa3' in May from 'Aa2', citing New Zealand's subdued economy and the banks' exposure to overseas wholesale financial markets where they source about one-third of their funding.

Royal Bank of Scotland banking analysts have suggested both New Zealand and Australian banks could face one to two notch credit ratings downgrades as a result of S&P's review based on the credit rating agency's Banking Industry Country Risk Assessment (BICRA) methodology, which S&P uses to reflect its view of the relative riskiness of a country’s banking industry. The analysts suggested a one notch downgrade could add 15-30 basis points to term funding costs.

Meanwhile, S&P said the publishing of its proposals for a new ratings framework in January came after a a major review. S&P staff then talked to about 10,000 ratings users and met with around 2,500 interested contacts around the world. In April S&P published a report summarizing the discussions. It says its new methodology will give more weight to the risks associated with growing economic imbalances, the resilience of the country's economy a bank operates in, and the importance of system-wide funding and the role of governments and central banks in this funding.

"Specifically, we are proposing that this analysis will set the starting point, or the anchor, for all bank ratings in a country. The BICRA methodology allows us to create a consistent framework to evaluate the relative strengths of banking systems and recognize how these trends affect our bank ratings. The goal of this analysis is to build a global lens through which we can examine both the economic and industry risks that determine the relative creditworthiness of the banks in a country," said S&P.

Is government support for a bank in strife weakening?

S&P said the new criteria will allow it to separate a bank's stand alone credit profile and the impact of government support in its ratings. This means a change in the likelihood of future government support for banks will be clearly identified and articulated.

Here in New Zealand the Reserve Bank is getting the trading banks to pre-position for its Open Bank Resolution (OBR) policy (or living wills), which Moody's says means there is now less expectation the government would use taxpayers money to bail out one of the country's major banks if it got into strife and more pressure for the Australian parent bank to cough up to stabilise its New Zealand subsidiary.

However, S&P said: "We believe governments continue to have significant economic incentives to support banks, because the economic costs of banking failures could be more damaging for a country."

"Nevertheless, politicians are under pressure to reduce the potential future costs of rescuing banks and at the same time need to foster confidence in their financial systems by offering to underwrite risks in banks' balance sheets and backstop funding needs where investors have withdrawn. The recent bail-out of Dexia, alongside the extension of new liquidity measures and the expected €108 billion bank capital raising for eurozone banks, demonstrates the economic realities that governments face and the real support they need to provide, despite any longer term political will to reduce it."

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